Rich countries are now on the front lines as the global risk map evolves

(Bloomberg) — Typically called upon to act when poor countries become mired in debt, the International Monetary Fund will face growing signs of trouble among richer countries this week.

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Governments in the United States, Europe and Japan have seen borrowing costs rise to multi-decade highs as the U.S. war against Iran drives up inflation. This means they have to pay more to repay historically large debts, pushing them to borrow even more. This threatens to become a vicious cycle.

It all makes for an upsetting backdrop to the annual meetings of the IMF and World Bank in Bangkok, where finance ministers and central bank chiefs will gather starting Monday.

The host country was once ground zero for a major emerging market crisis. Host institutions were until recently preoccupied with the post-Covid struggles of weaker economies. Now the focus is on problems that originate in the developed world – the “worst offenders” on the debt front, according to IMF chief Kristalina Georgieva – but may not remain confined to those countries.

When borrowing costs rise at the heart of global finance, such as in the U.S. Treasury market, it typically impacts consumers, businesses and governments around the world. When the Federal Reserve or the Bank of Japan raise interest rates, as they did in the face of $100 a barrel of oil, there is pressure on their emerging market counterparts to follow suit or risk capital flight.

Georgieva says debt and energy – as well as the AI ​​boom that is boosting some economies but circumventing most – are at the top of this week’s agenda. Earlier in the Iran war, she emphasized the world’s resilience, but lately the combination of rising energy prices, inflation and interest rates has undermined her. “Normally this would not be a major problem,” she said last month. “But these are not normal times, as debt levels in advanced economies are at historic highs.”

“In the street”

What’s more, the IMF chief warned, governments that face higher interest bills will struggle to afford other things, like helping their citizens cope with the high cost of living. “We have to prepare for people to be even more unhappy,” she concluded. “Maybe in the street.”

Even before the latest wave of bond sales, rich-country governments were paying more than $3.3 trillion in annual interest – more than global spending on defense or AI, according to the Institute of International Finance. He noted a parallel with “debt-troubled” emerging markets of the past.

These bills are the legacy of trillions borrowed in the post-global financial crisis era of cheap money and the now higher cost of refinancing. Last month, the average yield on 10-year government debt in the Group of Seven countries reached 4.3% for the first time since 2008.

According to Frédéric Neumann, chief Asia economist at HSBC Holdings Plc, there is a “precarious loop”, in which “rising debt servicing costs lead investors to further increase interest rates”.

The IMF has been warning for years of growing debt risks and the need to reduce budget deficits. His word is like a law for emerging nations who must pay for their reform-related financing programs. But in countries that are not borrowers, “this leverage is limited,” explains Doug Rediker, former United States representative to the IMF.

A report by the IMF watchdog says only about 15% of fiscal recommendations to advanced economies such as the United States, Germany, France and the United Kingdom have been fully or largely implemented.

Some economists do not accept the idea that these countries are on the brink of a debt crisis, or that their budgets and obligations are the world’s most pressing problem.

“Debt servicing costs are rising, which means deficits are a bit bigger – so what? says Dario Perkins, Managing Director of TS Lombard. Soft budgets aren’t really what’s driving up yields, he says – “for me it’s just a matter of oil and monetary policy” – and inflation should come back down when energy prices stabilize.

“Impactful advice”

As for emerging markets, their greater resilience is partly due to bitter lessons learned from past crises – like the one that began in Bangkok almost 30 years ago.

After depleting its reserves to defend its currency peg, Thailand was forced to float the baht in 1997. The problems quickly spread to Malaysia, Indonesia and South Korea. The IMF rushed to offer giant loans, which at the time came with stricter austerity conditions than today. Since then, governments have tightened their budgets and banking rules, and built up financial reserves.

What Bloomberg Economics says

“Several emerging markets have done their homework in recent years and are arriving at this episode of market turmoil in better economic shape than previous ones. Smaller current account deficits and wider reserve coverage reduce the need to turn to the IMF for money.”

— Adriana Dupita, deputy chief economist for emerging markets. Click here for the full report

Some Asian leaders do not hesitate to point the finger at developed countries which have not shown the same caution.

It is now “the world’s systemically important economies that face the greatest fiscal challenges”, Singapore President Tharman Shanmugaratnam told Georgieva at a pre-summit event last week. “The IMF will not be able to save them,” he said, but its “pretty hard-hitting advice should be taken seriously.”

To be sure, rising yields elsewhere have had some impact on emerging markets – this has led investors to cut back on some riskier bets on emerging market bonds and countries like Thailand to consider short-term debt sales – but that impact has been limited. Cash-strapped countries borrowing from multilateral banks have so far been more willing to adjust loan agreements tied to existing projects than to seek new ones, World Bank President Ajay Banga told Bloomberg.

“Pressed on both fronts”

If fiscal and financial risks have shifted to richer countries, so could the political risks that Georgieva warned against.

Civil unrest has often been accompanied by economic pressures, as was the case in Asia during the crisis of the late 1990s. Jimena Blanco, of the intelligence firm Verisk Maplecroft, says that it is in developed countries that these types of risks are now increasing most rapidly.

In his office’s civil unrest index, Europe recorded the greatest deterioration over the past two years, followed closely by the United States and Canada. France has seen student protests intensify nationwide this month, with more than 265,000 demonstrators demanding funds to address teacher shortages and deteriorating facilities.

Meanwhile, “inflation and debt repayment demand more from the state,” Blanco says. “The populations are pressed on both fronts.”

–With help from Enda Curran.

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