On countries becoming more debt-ridden, and why that has far-reaching consequences

The IMF finds that at the current rate, global public debt would reach its highest level since 1948. This year is significant because it marks a time when countries across the world, especially in Europe, were borrowing heavily to rebuild their economies after the massive destruction in the wake of the Second World War.

Higher public debt has many adverse consequences. For one, it increases the interest payments that governments (read taxpayers) have to make. That, in turn, forces governments to curtail their spending while raising taxes. Overall, a higher debt-to-GDP ratio shows that governments are inadequately prepared to deal with the next economic shock, which may require them to spend more or tax less.

The overall landscape, however, is quite varied as shown by the heat map in CHART 1. The so-called Advanced Economies are the most stretched in terms of public debt. For instance, Japan’s public debt is 230% of its GDP. What’s worse, across the board, these numbers are likely to get worse by 2030.

CHART 1.

The situation is slightly better when one looks at the data from the so-called Emerging Economies as well as Low-income Developing Countries. However, in most cases, the debt levels are pegged to rise in the coming year.

The size of the debt is going up for a variety of reasons, ranging from increasing demands for government expenditure on defence, climate change-related activities, dealing with disruptive technologies like AI and their impact on jobs, and the need for governments to bolster social safety nets, not to mention calls for higher wages and higher pensions.

The size of the debt is just one aspect of the problem. The cost of raising debt is another.

More often than not, governments simply roll over their debt. In other words, they pay back their old debt by raising new debt. But there was a crucial shift in the interest rate regime over the past five years. While interest rates were very close to zero in the developed countries between the Global Financial Crisis of 2008-09 and the Covid-19 pandemic, they have gone up sharply since then. That’s because central banks across the board have raised interest rates to contain inflation. The net result is that governments have had to borrow at higher interest rates, thus putting a greater burden on their finances.

“The conclusion is inescapable: starting from too high deficits and debts, the persistence of spending above tax revenues will push debt to ever higher heights, threatening sustainability and financial stability,” warned the IMF.