Rising Government Debt Threatens Financial Stability, Inflation, BIS Says

Governments should cut back on borrowing to ease one of the biggest threats to the stability of the global financial system and support efforts to tame inflation, the Bank for International Settlements said Sunday.

In its annual report on the global economy, the central bank for central banks warned that rising debt levels exposed governments to the risk of a crisis similar to that which roiled the U.K. in 2022, when investors suddenly shied away from government bonds, driving borrowing costs up sharply, weakening the currency and sending equity markets into a tailspin.

“Markets could at some point question fiscal sustainability,” Claudio Borrio, head of the BIS economic department, said in a press conference ahead of the release of the report. “We know from experience that things look sustainable until, suddenly, they no longer do.”

The warning comes as a surprise legislative election in France is underway Sunday. According to opinion polls, the eurosceptic and far-right National Rally party is set to win the most parliamentary seats and has promised large increases in spending to tackle immigration and lower energy costs. However, France’s budget deficit rose to 5.5% of gross domestic product in 2023, well above the 3% upper limit set by the European Union’s budget rules.

U.S. government debt has been rising even more sharply over the past decade, and the International Monetary Fund warned Thursday that it is set to reach a record high of 140% of GDP by 2032 if taxation and spending don’t change.

“Such high deficits and debt create a growing risk to the U.S. and global economy,” the IMF said in its annual assessment of the U.S. economy.

The BIS said that before the Covid-19 pandemic, the threat posed by high and growing debts was hidden by a long period of near-zero interest rates, which pushed debt servicing costs to historic lows. Since then, financing the energy-transition, geopolitical concerns and the looming burden of aging populations have increased demands on government spending as debt servicing costs have rebounded.

Bringing high levels of borrowing under control carries risks of its own. Kenya’s government said on Wednesday that it would reverse course on planned tax rises after nationwide protests against the measures turned deadly.

The BIS said those events underlined the importance of acting before the situation becomes dire.

“What you want to avoid is precisely a situation where the political environment is very charged,” said Agustin Carstens, general manager of the BIS.

In its annual report on the global economy, the BIS said that high levels of government borrowing stimulate the economy, adding to the difficulty of taming inflation.

“There is a risk that too much fiscal stimulus could add fuel to inflation,” said Borrio.

The Basel-based institution said inflation rates are likely to continue to fall around the world, without higher interest rates causing big rises in unemployment or falls in economic output. However, it warned central banks against lowering their key interest rates prematurely.

“The global economy seems to be poised for a smooth landing,” Carstens told reporters. “However, it is too soon to declare victory.”

The BIS said wages and services prices may rise rapidly for longer than anticipated, while a fresh jump in commodity prices could also slow the decline in inflation. If inflation began to pick up again, which Carstens said was an extreme scenario, the BIS said central banks should be prepared to raise their key interest rates.

Write to Enes Morina and Paul Hannon at [email protected] and [email protected]