High rich-world debt is a worry we must all confront

The culprit in part has been quantitative easing, when central banks increased money supply after the GFC. But the rise in debt at the government and corporate levels seems unyielding more than a decade-and-a-half later. This opening salvo from the report’s summary sets things in context: “Sovereign bond issuance in OECD countries is projected to reach a record $17 trillion in 2025, up from $14 trillion in 2023. Emerging markets and developing economies borrowing from debt markets has also grown significantly, from around $1 trillion in 2007 to over $3 trillion in 2024.” 

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Add to it the fact that central banks are reducing their exposure to government debt even as corporate debt in the OECD is rising and you have the makings of a debt funding impasse that could easily spiral into a crisis. 

Also, pension funds in the West have less aggregate exposure to government bonds. As Philip Coggan observes in a recent article for the Financial Times, this is because employees in the West increasingly use defined contribution plans to fund pensions in which the responsibility to make investment decisions is on them. Unlike large pension funds, they tend not to invest in government bonds as much. This leaves developed-world countries increasingly dependent on foreign investors; the OECD report says that foreigners own more than a third of their government bonds. 

As many developing economies know from experience, foreign investors tend to take flight quicker when things turn tough.

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What makes things more volatile is that while the low-interest rate environment has led to excess issuances, in a couple of years, a lot of these bonds will mature and will need to be refinanced at higher interest rates. 

But the bigger problem is that sensible economic policies, including debt reduction, are much harder to pursue with many populist and nativist parties ever more prominent and able to increase their support bases via outlandish claims on social media. 

In early July, the UK served as an early chronicle of bond market turbulence. After a revolt against planned welfare reform from its own members, the Labour Party government backed down, forgoing what would have been £5 billion in savings by the end of the decade. Facing hostile questioning from the opposition, Prime Minister Keir Starmer appeared not to give his chancellor of the exchequer Rachel Reeves full backing. Reeves was distressed and seemed to tear up. 

The following day, UK bond yields bounced up as markets speculated that Reeves was on her way out. It took a renewed statement of support from the prime minister for calm to be restored.

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There are broader lessons. The Starmer government is hemmed in by local election results in May that showed rapidly increasing support for the Reform Party and its anti-immigrant rhetoric. Against such a backdrop, making necessary changes to the UK’s National Health Service (NHS), for example, or  welfare benefits becomes harder. Sensible centrist leaders could seem dull in comparison with firebrands on the right who are economical with the truth on immigration as well as the need to bring down public debt. 

Last week, the International Monetary Fund’s (IMF) annual report on the British economy said Reeves’ rules to bring down the fiscal deficit were credible, but warned that “in an uncertain global environment and with limited fiscal headroom, fiscal rules could easily be breached if growth disappoints or interest rate shocks materialise.” These conditions apply to a host of developed economies, not just the UK.

If this were not a daunting enough backdrop, low interest rates since the GFC till recently have encouraged strange behaviour by OECD companies. “Corporates used the low-rate era to prioritise financial operations, partly severing the link between corporate investment and borrowing,” the report notes. This anodyne statement understates the excessive financialization of developed-world economies where companies have been lured into corporate buyouts and shareholder payouts because the cost of money had been so low. “Corporates… partly severed the link between corporate investment and borrowing. This impacts the ability to meet upcoming refinancing needs,” the report said.

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Meanwhile, ageing populations across the developed world add to health and pension costs. Last week, the IMF called upon the UK government to curb pension benefits and make higher income earners pay for medical care when using the NHS. 

In Japan, where the Bank of Japan (BoJ) has been the last central bank to exit quantitative easing, demand for government bonds has weakened among domestic banks. The BoJ has had to step in to buy government bonds. Yields have gone up markedly, but Japanese banks are uncertain where interest rates are headed, while those overseas who hitherto borrowed cheaply in yen to invest elsewhere are now unsure about this ‘carry trade’. 

These are inherently volatile conditions for the world economy. Pity developing economies that need to finance high levels of debt amid such stormy weather.

The author is a Mint columnist and a former Financial Times foreign correspondent.