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US debt poses ‘significant risks’ to global economy

The IMF has warned the US that its massive fiscal deficits have stoked inflation and pose “significant risks” for the global economy.

The fund said in its benchmark Fiscal Monitor that it expected the US to record a fiscal deficit of 7.1 per cent next year — more than three times the 2 per cent average for other advanced economies.

It also raised concerns over Chinese government debt, with the country set to record a deficit of 7.6 per cent in 2025 — more than double the 3.7 per cent average for other emerging markets — as Beijing copes with weak demand and a housing crisis.

The US and China were among four countries the fund named that “critically need to take policy action to address fundamental imbalances between spending and revenues”. The others were the UK and Italy.

Rampant spending by the US and China in particular could “have profound effects for the global economy and pose significant risks for baseline fiscal projections in other economies”, the IMF said.

The assessment comes amid mounting concerns among economists and investors that 2025 will prove a crunch year for US fiscal policy.

The presumptive Republican presidential nominee Donald Trump has pledged to make his 2017 tax cuts permanent, a move the Committee for a Responsible Federal Budget think-tank expects to cost $5tn over the next decade. Democrats have been accused by Republicans and economists of doing too little to cut “discretionary spending” on healthcare and social security.

On Tuesday, IMF chief economist Pierre-Olivier Gourinchas said… Read more the US’s fiscal position was “of particular concern”, suggesting it could complicate the Federal Reserve’s attempts to return inflation to its 2 per cent goal.

“It raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy,” he said. “Something will have to give.”

Governments’ debt burdens have surged following high spending during the early stages of the pandemic and big rises in global borrowing costs as central banks have sought to tame the worst bout of inflation in decades.

The Congressional Budget Office said the US’s federal debt pile amounted to $26.2tn, or 97 per cent of gross domestic product, at the end of last year. The independent fiscal watchdog expects it to match a previous post-second world war high of 116 per cent in 2029.

In other advanced economies, such as the eurozone, fiscal deficits were curbed during 2023.

But the IMF said the US had exhibited “remarkably large fiscal slippages”, with the fiscal deficit hitting 8.8 per cent of GDP last year — more than double the 4.1 per cent deficit figure recorded for 2022.

The IMF said the country’s fiscal deficit had contributed 0.5 percentage points to core inflation — a measure of underlying price pressures that excludes energy and food. That means US interest rates would need to remain higher for longer to bring inflation back to the Fed’s 2 per cent goal.

The CBO already thinks the bill for net interest payments to holders of US debt will top $1tn after 2026.

The IMF noted that “large and sudden increases” in US borrowing costs typically lead to surges in government bond yields across the world and exchange rate turbulence in emerging market and developing economies.

A fund analysis found a 1 percentage point spike in US rates led to a 90 basis point rise in other advanced economies and an increase in emerging markets of 1 percentage point.

“Global interest rate spillovers could contribute to tighter financial conditions, increasing risks elsewhere,” the IMF said.

It added that Chinese government debt, unlike US Treasuries, tends to be domestically held, so a sharp rise is unlikely to impact global markets in the same way. But the fund argued that the country’s debt dynamics could still weigh on its trade partners.

“A larger-than-expected slowdown of growth in China, potentially exacerbated by unintended fiscal tightening given significant fiscal imbalances in local governments, could generate negative spillovers to the rest of the world through lower levels of international trade, external financing, and investments,” it said.

The IMF’s top fiscal policy official, Vítor Gaspar, said the economic power of both the US and China meant they had time to bring their finances under control. Both governments had more fiscal space than their counterparts, giving them “more room for manoeuvre to correct and control”, he said.