IMF dials up calls for urgent fiscal consolidation

The International Monetary Fund has issued a strong warning, urging advanced economies and others to cut government spending, slash deficits and reduce debt levels, stating that delays in action will only complicate the task in future years. Rodrigo Valdes, the head of the IMF’s Fiscal Affairs department, highlighted that rising sovereign bond yields are exacerbating fiscal pressures at a time when average public debt is set to reach 100% of gross domestic product, the highest since World War Two, leaving countries with less room for delay.

Valdes emphasized that the urgency of the situation has increased due to inflationary pressures, high global debt levels, and rising sovereign bond yields. He noted that if countries wait to act, the adjustment process will become more costly and painful. The IMF's message has become more urgent, according to Valdes, as the conditions have changed.

Ahead of the IMF and World Bank's annual meetings in Bangkok, Valdes pointed out that the fiscal results this year are worse than anticipated six months ago and even worse than a year ago. Many countries are now considering increasing spending instead of cutting back, he said.

Valdes stressed that the challenge for advanced economies with high debt levels is to build political support for concrete plans to contain borrowing costs in the medium term and limit the spillover effects to the rest of the world. The longer countries delay, the more severe the adjustment will become, according to the IMF.

While financing conditions for many emerging market and developing economies remain favorable, they could change in the future, the IMF warned. Countries with lower incomes need to strengthen their tax systems and improve spending efficiency.

High oil prices, persistent inflation, stronger investment demand, and higher-than-expected artificial intelligence growth have driven significant increases in long-term sovereign yields in recent months. The IMF reported that the Group of Seven's average 10-year government bond yield rose by over 110 basis points between February and September, reaching its highest level in nearly two decades.

The IMF projected that the effective average cost of government financing would reach 3.7% by 2031 from 2.3% in 2021. Interest payments in the US were expected to hit 5.3% of GDP by 2031, up from 2.8% in 2021, nearly equal to projected expenditure on Social Security. In low-income countries, interest payments already consume over 15% of tax revenues, compared to an average of around 9% between 2011 and 2019.

Valdes noted that governments in advanced economies are refinancing more debt at shorter maturities, causing higher rates to affect government costs more rapidly. For the G7 and Spain, the share of debt maturing within one year is now close to 30%.

Inflation rates above target and higher energy prices mean central bankers will likely need to keep interest rates higher for a longer period, which will limit governments' ability to respond to downturns as demands for increased spending on defense, energy security, and aging populations rise. Valdes estimated that the combined fiscal cost of these measures amounts to about half a percentage point of global GDP.