Governments Advised to Cut Back on Borrowing

In its annual report released Sunday, the Bank for International Settlements (BIS) urged governments worldwide to reduce borrowing to mitigate one of the most significant threats to global financial stability and support efforts to control inflation. This advice comes in light of recent economic disturbances and rising debt levels that threaten to precipitate crises similar to the one experienced by the U.K. in 2022.

  • The BIS, often referred to as the central bank for central banks, emphasized the dangers posed by increasing debt levels.
  • Claudio Borrio, head of the BIS economic department, warned that market confidence in fiscal sustainability could falter unexpectedly, leading to severe financial disruptions.

The 2022 U.K. crisis serves as a cautionary tale, where a sudden lack of investor confidence in government bonds led to a sharp rise in borrowing costs, a weakened currency, and plummeting equity markets. The BIS cautioned that similar scenarios could unfold elsewhere if governments do not manage their debt levels prudently.

Legislative Elections and Fiscal Policies in France

The report's release coincided with a surprise legislative election in France, where the eurosceptic and far-right National Rally party is poised to gain significant parliamentary representation. The party has pledged substantial increases in spending to address immigration and lower energy costs, despite France's budget deficit reaching 5.5% of GDP in 2023, far exceeding the EU's 3% upper limit.

  • In the United States, government debt has been rising sharply over the past decade. The International Monetary Fund (IMF) recently warned that U.S. debt is projected to reach a record high of 140% of GDP by 2032 unless significant changes are made to taxation and spending policies.
  • The IMF highlighted the growing risk such high deficits and debt pose to both the U.S. and global economies.

It was also noted that before the Covid-19 pandemic, the risks associated with high debt levels were masked by a prolonged period of near-zero interest rates, which kept debt servicing costs historically low. However, new demands such as financing the energy transition, addressing geopolitical concerns, and managing aging populations have increased government spending pressures as debt servicing costs rise.

Risks of Reducing Borrowing

While bringing borrowing under control is essential, it carries its own set of risks. For instance, Kenya recently decided to reverse planned tax increases following deadly nationwide protests against the measures. The BIS underscored the importance of taking preemptive action to avoid politically charged environments that make fiscal adjustments more challenging.

  • Moreover high levels of government borrowing stimulate economic activity, complicating efforts to tame inflation. Borrio cautioned that excessive fiscal stimulus could exacerbate inflationary pressures.
  • Despite this, the BIS expressed optimism about the global economic outlook, suggesting that inflation rates are likely to continue falling without causing significant rises in unemployment or economic downturns.
  • However, the institution warned central banks against prematurely lowering key interest rates, as unexpected rises in wages, services prices, or commodity prices could slow inflation's decline.

Agustin Carstens, general manager of the BIS, stated that while the global economy appears to be heading for a smooth landing, it is too early to declare victory over inflation. The BIS advised central banks to be prepared to raise interest rates again if inflation shows signs of picking up, even though this is considered an extreme scenario.

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