The "Eye of the Storm" in the Global Economy: Debt Crisis in Developed Countries

Developed countries are shifting from being the stabilizing anchor of the global financial system to a new source of risk. Amid surging energy prices and persistently high interest rates, the debt sustainability issues of the US, Europe, and Japan are becoming increasingly prominent. The fiscal health of these economies—which were once seen as the safe bedrock of global financial markets—has now become a looming concern investors can no longer ignore.

International Monetary Fund (IMF) Managing Director Kristalina Georgieva recently issued a warning, stating that developed economies have become the worst offenders regarding debt issues. As governments’ debt servicing costs continue to rise, fiscal space is further squeezed, limiting these countries’ abilities to provide cost-of-living support to their populations.

"We should be prepared for people to become even more dissatisfied," she noted, "and perhaps take to the streets." These remarks come on the eve of the IMF and World Bank annual meetings, with the conference held in Thailand—the very place where the Asian financial crisis began nearly thirty years ago.

Bank of America Securities further points out that the US and France are facing multiple pressures from high debt, rising financing costs, and obstructed fiscal adjustment. Both countries accumulated high levels of debt during the period of low interest rates but have found it difficult to reduce spending now that the financing environment is tightening. The US is mainly challenged by declining tax revenues, while France faces deeper structural income declines; the UK and Japan are also not immune.

The impact of this fiscal pressure is not limited to governments alone. Should yields on core assets such as US Treasury bonds continue to rise, financing costs for businesses, consumers, and governments alike will be affected. If high oil prices further fuel inflation, forcing the Federal Reserve or Bank of Japan to maintain tightening policies, emerging markets may face even greater pressures—forced to choose between raising rates themselves or enduring capital outflows.

The “Vicious Cycle” of Debt and Interest Rates

The root of developed countries’ debt predicament lies in the structural mismatch between the massive debt stock accumulated during the era of low interest rates and the current high-rate environment.

According to data from the Institute of International Finance (IIF), even before the latest round of bond selloffs, annual interest payments by wealthy nations’ governments have exceeded $3.3 trillion, more than total global defense spending or investments in artificial intelligence. Last month, the average yield on G7 10-year government bonds reached 4.3%, the first time since 2008.

Frederic Neumann, HSBC’s Chief Asia Economist, describes this situation as a “dangerous cycle”—“As debt servicing costs rise, investors push interest rates even higher.” As Bloomberg reports, sovereign credit spreads between developed and emerging markets are narrowing, eroding the credit advantage of wealthy countries.

Bank of America Securities global economists Claudio Irigoyen and Antonio Gabriel have characterized this phenomenon as an issue of “time-inconsistent fiscal policy” in their latest Global Economic Weekly. The report notes that over the past twenty years, France’s and the US’s debt-to-GDP ratios have risen by around 50 and 60 percentage points, respectively, with most increases occurring during ultra-low interest rates. The core problem is not just excessive borrowing in the low-interest era, but also the failure of political systems to implement fiscal consolidation once easy financing conditions disappear.

US and France: Shared Troubles, Different Causes

The Bank of America Securities report takes a detailed look at the fiscal dynamics of the US and France, revealing similar predicaments but different driving factors.

The two countries’ debt-to-GDP ratios are both around 120%, with France slightly lower and the US slightly higher. Their primary deficits are both just over 2.5% of GDP, but the US faces a heavier interest burden, with an overall deficit around 6% of GDP versus France’s roughly 5%.

On the revenue side, both countries experienced a tax revenue boom between 2021 and 2022, followed by a marked decline after 2022. Bank of America Securities believes policymakers in both nations mistook this temporary surge for a permanent improvement and maintained structurally high spending levels. When revenues fell back, high spending could only be sustained through increased borrowing.

The differences lie in: for the US, the revenue decline is largely cyclical, reflecting the normalization of capital gains tax in 2022 and temporary effects in personal income tax; for France, the decline is more structural—partly due to previous tax reforms that reduced tax elasticity and ongoing slumps in corporate and labor tax revenues. Bank of America Securities emphasizes that for France, part of the revenue downturn may be permanent, and political fragmentation alongside the upcoming 2027 elections further complicates fiscal consolidation efforts.

UK: Prudent Budgeting Conceals Long-Term Challenges

The UK too faces a dual squeeze of fiscal pressure and political constraints. Bank of America Securities expects the UK government to release a relatively cautious Autumn Budget on October 28, prioritizing fiscal stability over large-scale expansionary measures.

Estimates from Bank of America Securities show the UK’s fiscal headroom under its stabilization rules has narrowed from £23.6 billion in March to about £10 billion—an approximately £14 billion reduction—primarily due to higher gilt yields, rising inflation, and slowing economic growth. To partly restore the fiscal space to around £17 billion, the government is expected to announce about £8 billion in tax increases.

On the spending side, the government is expected to introduce around £5.5 billion in energy support measures, including fuel duty freezes and VAT relief on electricity bills, to ease inflationary pressure. Bank of America Securities forecasts that these measures can reduce the 2027 inflation rate by about 20 basis points, but not enough to alter their view that the Bank of England will hike rates again in November and February next year.

Bank of America Securities stresses that the UK’s larger fiscal challenges will remain for the future—including whether to reverse non-protected departmental spending cuts, raise defense spending, and address social care funding gaps. These tough decisions have all been postponed until the next parliamentary term.

Japan: Trading Time for Space, Risks Remain

Japan presents a different path: thanks to ultra-loose monetary policy, long average debt maturities, and a domestic financing structure, Japan has postponed—but not eliminated—the fiscal consequences of high debt.

Bank of America Securities notes that Japan’s decades-long debt accumulation has occurred under highly accommodative monetary conditions. Favorable nominal growth, long debt maturities, and domestic financing can delay, but cannot eliminate, the fiscal impact of rising interest rates.

As the Bank of Japan continues raising rates amidst oil price pressures—with Bank of America Securities forecasting the policy rate to rise from the current 1.25% to 2.00% by the end of 2027—Japanese government bond yields have already surpassed 3%, and the pressure of rising debt servicing costs will gradually become apparent.

Emerging Markets: Lessons Learned, Relative Resilience

In contrast to the plight of developed countries, emerging markets have displayed relatively strong resilience overall.

Bloomberg Economics Deputy Chief Emerging Markets Economist Adriana Dupita notes, "Several emerging markets have done their homework in recent years and enter this round of market turmoil in better economic shape than before. Smaller current account deficits and ample FX reserves have reduced the need for IMF bailouts."

This resilience partially stems from painful lessons learned during the Asian financial crisis nearly thirty years ago. In 1997, Thailand was forced to abandon its currency peg, with the crisis quickly spreading to Malaysia, Indonesia, and South Korea. Since then, governments have tightened fiscal and banking regulatory rules and accumulated ample financial buffers.

Singapore President Tharman Shanmugaratnam bluntly noted at a pre-summit event that those now facing the greatest fiscal challenges are "systemically important economies of the world". "The IMF cannot save them," he said, "but its rather strong advice must be taken seriously."

However, spillover effects from developed countries' debt problems are already emerging: rising long-term yields have prompted some investors to cut their exposure to emerging market bonds, and countries like Thailand are considering switching to short-term debt issuance. World Bank President Ajay Banga told Bloomberg that cash-strapped countries now tend to adjust existing project loan arrangements rather than seek new financing.

Political Risks: Shifting from Emerging Markets to Developed Countries

As fiscal and financial risks shift towards wealthy nations, so too do political risks.

Jimena Blanco of risk intelligence company Verisk Maplecroft points out that, according to their social unrest index, Europe has seen the biggest deterioration in the past two years, with the US and Canada not far behind. This month, France has already witnessed massive student protests, with over 265,000 demonstrators taking to the streets to demand government action on teacher shortages and aging educational facilities.

"Inflation and debt repayment are placing more demands on countries," Blanco said, "and citizens are feeling the pressure from both sides."

An IMF surveillance report shows that the full or substantial implementation rate of IMF fiscal recommendations among developed economies such as the US, Germany, France, and the UK is only about 15%. Former US IMF representative Doug Rediker admits that for non-borrowing countries, the IMF's influence is "very limited." This means that amid political resistance and debt pressure, the path to fiscal consolidation in developed nations will be much harder than in emerging markets.