IMF says higher bond yields underscore urgency of fiscal consolidation

The International Monetary Fund (IMF) has called for prompt fiscal consolidation measures from advanced economies and others, warning that delaying action would only exacerbate fiscal challenges in the years ahead. Rodrigo Valdes, leader of the IMF’s Fiscal Affairs department, highlighted that rising sovereign bond yields were exacerbating fiscal pressures, particularly as average public debt approaches 100% of gross domestic product (GDP), the highest level since World War Two.

Valdes informed Reuters that fiscal outcomes for the year were worse than anticipated six months prior and compared to the previous year. Many countries are now anticipating increasing spending rather than implementing spending cuts. Valdes emphasized that advanced economies with high debt levels must secure political backing for plans to control borrowing costs in the medium term and mitigate spillovers to the global economy.

The IMF stressed that the longer countries delay adjustments, the more severe and costly the necessary adjustments become. While financing conditions for emerging market and developing economies remain favorable, they too must reduce their fiscal vulnerabilities and enhance debt management. Low-income countries, already facing tighter external financing, need to bolster their tax systems and boost spending efficiency.

Factors such as high oil prices, persistent inflation, heightened investment demand, and unexpected artificial intelligence (AI) growth have led to significant increases in long-term sovereign yields over the past few months. The IMF projects that the average cost of government financing will rise to 3.7% by 2031, up from 2.3% in 2021.

In the United States, interest payments are expected to reach 5.3% of GDP by 2031, compared to 2.8% before the COVID-19 pandemic, nearly matching projected expenditures on Social Security. In low-income countries, interest payments now consume over 15% of tax revenues, up from the 9% average between 2011 and 2019. Valdes noted that governments in advanced economies are increasingly refinancing debt at shorter maturities, accelerating the impact of higher rates on government costs.

Approximately 30% of debt in advanced economies and Spain is now maturing within one year. The IMF also warned that inflation rates above target and higher energy prices would likely force central banks to maintain higher interest rates for longer, limiting governments' capacity to respond to economic downturns while demands for increased spending on defense, energy security, and an aging population grow.

Valdes underscored the urgency of fiscal consolidation, stating that it is now "the time" for most countries to initiate these measures to avoid becoming trapped in worsening fiscal dynamics.