Heavily indebted countries may look fine until suddenly they no longer do, the BIS warns
The Bank for International Settlements warns that indebted countries are vulnerable to a loss of confidence even if that risk is barely acknowledged in bond markets.
The Basel-based organization said in Annual Economic Report announced on Sunday that countries whose bulging fiscal positions are further stretched by higher interest rates should prioritize fiscal repairs. Claudio Borio, head of the BIS’s currency and economics department, said they had to act “with urgency”.
“We know from experience that things look sustainable until suddenly they are no longer sustainable,” he told reporters. “That’s how markets work.”
While the need to fix public finances has been a frequent theme of the BIS, the comments coincided with tighter scrutiny of indebted economies. Worries about France this month prompted investors to demand the highest spreads on the country’s bonds since 2012.
Basel officials did not name any specific countries, but they did show a chart looking at the debt and market prices of some of the world’s biggest borrowers, including Japan, Italy, the United States, France , Spain and the UK.
To maintain financial stability, advanced economies could run deficits of no more than 1% of gross domestic product this year, down from 1.6% last year, the BIS said. That is a fraction of Current US deficitbut International Monetary Fund was described last week as “too big”.
“Although financial market pricing currently suggests only a very small likelihood of public financial stress, confidence could quickly collapse if economic momentum weakens and urgent public spending needs arise on both a structural and cyclical basis,” the BIS said. “Government bond markets would be the first to be affected, but stress could spread more broadly.”
But inflation is falling, BIS officials acknowledge. Managing Director Agustin Carstens said the world is now preparing for a “soft landing.”
Services still pose a risk to that outlook, with prices in that region out of line with pre-pandemic trends, the report said. Additionally, rising commodity prices due to geopolitical tensions could cause inflation.
With these pressure points in place, officials stressed that central banks should be wary of cutting rates too soon, which could damage their reputations if such policies need to be reversed amid a resurgence in inflation, the report said.
The BIS said that policymakers had contributed significantly to the problem, and reiterated the charge that “in retrospect”, pandemic-era stimulus measures may have increased the risk causes a second-round impact.
While central banks should not ease too soon, governments also have a role to play in implementing overly loose fiscal policy, officials said. Instead, they should broaden their tax bases and introduce structural reforms to meet future challenges including demographic shifts and climate change.
“Our key message is that central banks cannot deliver sustained increases in economic growth and prosperity on their own,” Borio said. “Laying the foundation for a brighter economic future also requires action from other policymakers, especially governments.”
