People walk in the financial district in London, on May 11.HENRY NICHOLLS/Reuters
Record debts, high interest rates, the costs of climate change, health and pension spending as populations age and fractious politics are stoking fears of a financial market crisis in big developed economies.
A surge in government borrowing costs has put high debt in the spotlight, with investors demanding increased compensation to hold long-term bonds and policy-makers urging caution on public finances.
Over 80 per cent of the $10-trillion rise in global debt in the first half to a record $307-trillion came from developed economies, the Institute of International Finance says.
The United States, where brinkmanship around a debt limit brought it close to a default, Italy and Britain are of most concern, more than 20 prominent economists, former policy-makers and big investors told Reuters.
They do not expect a developed economy to struggle paying debt, but say governments must deliver credible fiscal plans, raise taxes and boost growth to keep finances manageable. Heightened geopolitical tensions add to costs.
A fragile environment with higher rates and shrinking central bank support raises the risk of a policy misstep sparking a market rout, as shown by Britain’s 2022 “mini budget” crisis.
Peter Praet, former chief economist at the European Central Bank, said that while debt still appears sustainable, the outlook is worrying given longer-term spending needs.
“You can take many, many countries today, and you will see that we are not far away from a public finances crisis,” said Praet, who joined the ECB during 2011′s debt crisis.
“If you have an accident, or a combination of events, then you go into an adverse non-linear dynamic sort of process. That is something which is a real possibility.”
High funding needs and central banks removing support are increasing pricing uncertainty for investors, Sophia Drossos, hedge fund Point72 Asset Management’s chief economist, said.
“Deficit and debt levels make us uncomfortable,” said Daniel Ivascyn, chief investment officer at bond giant PIMCO, which is a little bit reluctant to own a longer-term bond.
Spending plans lacking credibility were seen as most likely to spark market turmoil.
Longer term, “government debt trajectories pose the biggest threat to macroeconomic and financial stability”, said Claudio Borio, head of the Bank for International Settlements monetary and economic department.
Budget wrangling has hurt U.S. credibility, costing it a top-notch AAA rating.
Olivier Blanchard, senior fellow at the Peterson Institute for International Economics, was most worried about the United States given a “broken political budget process” and large primary deficits.
“How does it end? I suspect not by default, but when markets start reflecting their worries in Treasury prices, by a political crisis and a potentially ugly adjustment,” the former IMF chief economist said.
Hedge fund Bridgewater Associates’ Ray Dalio expects a U.S. debt crisis.
A U.S. Treasury spokesperson highlighted Secretary Janet Yellen’s recent comments on the budget deficit and rising rates.
Yellen told the Wall Street Journal last week the government was committed to a “sustainable fiscal policy” and the budget could be adjusted to ensure that.
Italy’s 2.4 trillion-euro debt pile is the focus in Europe, where the IMF has said high debt leaves governments vulnerable to crisis.
Its debt risk premium jumped this month as it cut growth and hiked budget deficit forecasts. Scope Ratings warned Italy could be ineligible for a crucial ECB bond-buying scheme.
A tipping point is Italy’s potential to lose investment-grade ratings. Moody’s rates it one notch above junk with a negative outlook.
Rome’s debt ratio rising again would make a downgrade more likely. That risks “significant ramifications” for southern Europe, said M&G Investments’s Jim Leaviss.
Economy Minister Giancarlo Giorgetti said he did not fear a downgrade but could not rule it out. The ministry declined to comment for this story.
Moody’s reviews Italy in November.
Low growth has kept Italian debt high, a risk across Europe and Britain, where belt-tightening plans will depress public investments.
“If we don’t have a brighter growth outlook in Europe, then the math of debt sustainability looks quite poor,” said PGIM fixed income chief global economist Daleep Singh, former adviser to U.S. President Joe Biden.
Britain’s Treasury said it was on track to reduce debt and growing the economy with major reforms.
Debt is near or higher than 100 per cent of output in Britain, the United States and Italy. Aging populations, climate change and geopolitical risks such as wars in Ukraine and the Middle East mean significant spending pressures ahead.
Interest payments surging with high rates add to the pressure.
U.S. net interest payments will rise from 2.5 per cent to 3.6 per cent of GDP by 2033 and 6.7 per cent by 2053, the Congressional Budget Office estimates. But Yellen’s preferred measure, adjusting for inflation, suggests payments below 1 per cent of GDP for the rest of this decade.
Britain’s Office for Budget Responsibility expects interest costs to rise to 7.8 per cent of revenues by 2027-28, from 3.1 per cent in 2020-21, exacerbated by inflation-linked debt.
Even Germany’s interest spending is up 10-fold since 2021 to nearly €40-billion. A crisis is unlikely but budget planning would face “major challenges”, the Supreme Audit Institution said.
Efficient spending, reforms and growth plans are key.
“We need more investment, not less,” said King’s College London professor Jonathan Portes, Britain’s cabinet office chief economist during the financial crisis.
Borrowing is a harder sell at higher rates, so governments need credible plans. The EU is revising its fiscal rules, Britain’s opposition Labour Party promises to legally require OBR reviews of tax-and-spending plans.
While unpalatable, taxes need to rise, particularly in the United States and Britain, and some spending cuts are inevitable, economists stressed.
Not enough reforms are being implemented, OECD chief economist Clare Lombardelli warned.
Delays will hurt governments’ ability to address future shocks.
“If we just trundle along as we have right now, we will see a crisis in the next decade,” said LBBW chief economist Moritz Kraemer, who oversaw S&P’s European sovereign downgrades in 2011.