Advanced economies must ‘act now’ to lower debt as bond yields spike

Advanced economies should "act now" to tackle soaring debt levels as bond yields hit multi-decade highs, according to the International Monetary Fund (IMF). The global public debt has reached its highest point since World War II and is projected to exceed 100% of global GDP. IMF fiscal affairs deputy director Era Dabla-Norris emphasized that countries with high debt levels must create more room for higher spending pressures to address the situation promptly.

Debt levels have increased significantly in advanced economies since the 2008 global financial crisis, the COVID-19 pandemic, and the ongoing conflicts in Ukraine and Iran. Since late February, bond yields have risen by an average of 110 basis points, particularly on longer maturities. The surge in yields has been attributed to heightened inflation expectations due to soaring energy prices caused by the Iran war, prompting many central banks to raise borrowing costs to maintain price stability.

Higher debt and shorter maturities have made the relationship between fiscal and monetary policy more complex. Changes in short-term interest rates can quickly affect government borrowing costs. High debt levels act as an amplification mechanism for the effect on yields. The IMF projects that worldwide, governments' average interest payments will increase from 2.3% in 2021 to 3.7% in 2031, with the US interest payments expected to climb from 2.8% of GDP before the pandemic to 5.7% in 2031, which is almost equal to Social Security expenditure. For low-income countries, interest payments already average 15% of tax revenues.

To stabilize debt ratios, governments need to undertake fiscal consolidation more aggressively than previously required. Higher benchmark yields in advanced economies could also impact emerging markets by tightening global financial conditions. Dabla-Norris stressed the importance of clear communication about the necessity of consolidation, including the trade-offs involved, as governments face limited room for maneuver within their budgets. Delaying fiscal consolidation will only prolong the problem.