BIS Warns Governments of Imminent Debt-Related Confidence Crisis

The BIS cautioned governments that indebted countries could face a sudden loss of investor confidence, despite the low risk perceived currently in bond markets. It urged countries with worsening fiscal positions due to higher interest rates to prioritize fiscal discipline. With inflation easing, the BIS warned against hasty rate cuts by central banks and emphasized the importance of fiscal prudence and structural reforms.

In the face of mounting concerns over rising debt levels and interest rates, the Bank for International Sustainability (BIS) has issued a timely warning to governments, urging them to prioritize fiscal discipline and structural reforms [1]. With inflation beginning to ease, the BIS has cautioned against hasty rate cuts by central banks and emphasized the importance of addressing the root causes of fiscal and financial instability.

The global economic landscape has undergone a significant transformation in recent years, with inflation-adjusted interest rates rising above post-global financial crisis lows while medium-term growth remains weak [1]. This confluence of factors poses a considerable risk to countries with worsening fiscal positions, particularly those burdened by higher interest rates.

Debt sustainability is a critical concern in this context. According to the International Monetary Fund (IMF), debt sustainability depends upon four key ingredients: primary balances, real growth, real interest rates, and debt levels [1]. Higher primary balances and growth help to achieve debt sustainability, whereas higher interest rates and debt levels make it more challenging.

As a result of the pandemic and the ensuing economic downturn, public debt levels have surged, reaching 120 percent and 80 percent of output respectively by 2028 in advanced and emerging and middle-income economies, respectively [1]. This increase in debt levels occurs at a time when the macroeconomic environment has become less favorable, with medium-term growth projected to decline and elevated real long-term interest rates posing significant challenges.

The BIS's warning comes amidst growing concerns over the potential for a sudden loss of investor confidence in bond markets, despite the low risk perceived currently [2]. This cautionary tale highlights the need for governments to prioritize fiscal discipline and structural reforms to address the root causes of fiscal and financial instability and mitigate the risks associated with indebtedness and elevated interest rates.

References:

[1] IMF. (2023, March 28). The fiscal and financial risks of a high-debt, slow-growth world. Retrieved from https://www.imf.org/en/Blogs/Articles/2023/03/28/the-fiscal-and-financial-risks-of-a-high-debt-slow-growth-world

[2] Reuters. (2023, April 4). BIS warns of sudden loss of investor confidence in bond markets. Retrieved from https://www.reuters.com/business/finance/bis-warns-of-sudden-loss-of-investor-confidence-in-bond-markets-2023-04-04/