Global Navigator from KPMG Economics

January 23, 2025

This edition of Global Navigator explores the recent rapid rise of government debt and the dangers of high interest rates for debt repayment. The list of things that keep economists up at night is long and growing, but this is near the top of most lists. Since the beginning of the pandemic, more than $24 trillion has been added to global government debt balances. That means something very different today than it did during the 2000s when long-term bond yields – the cost of servicing government debt – were unusually low.

US Treasury bond yields have risen despite rate cuts by the Federal Reserve. That shift, coupled with a slower glide path on rate cuts abroad, is rippling through global financial markets. The value of the US dollar has strengthened, while the currencies across our trading partners have largely depreciated. (Japan is a recent outlier.) That has tipped off a global bond rout with bond yields rising just about everywhere. The resulting rise in interest expense on a larger stock of debt makes it harder to service existing debt obligations, which are still rising. 

Global government debt has skyrocketed over the last two decades to 97.5% of GDP (Chart 1). The Great Financial Crisis (GFC) and the pandemic triggered bursts in government spending around the world as countries scrambled to minimize the fallout from these events. More than three-quarters of the $95.4 trillion in government debt was originated since the end of the GFC.

Why do we care? Until recently, the risk of a debt crisis was low. Everything from the global savings glut at the start of the century to the near-zero rates and bond purchases by central banks made accumulating debt nearly costless. The rest of the world was willing to subsidize our addiction to debt with little to no consequences in higher rates.

That is no longer the case. Higher rates and the larger wedge between short- and long-term rates reflect investors’ newfound desire to be compensated for the risk they are taking by lending to us. The time value of money, or “term premium,” is pushing up rates. Those moves potentially crowd out private sector investment and raise the cost of servicing government debt.

Vicious cycles of needing to issue debt just to pay the interest expense increase the risk of a debt default. Think of the subprime housing crisis when many borrowers defaulted as rates rose; they were no longer able to service their mortgage debt via the equity in their homes and refinancing. Emerging markets have been more vulnerable than developed economies.

Several major developments have contributed to the surge in global government debt:

• The largest contributors to the surge in government debt were two massive crises: the global financial crisis (GFC) of 2008-09 and the COVID-19 pandemic. Governments collectively moved to limit the worst economic consequences and losses associated with those events, which accelerated the stock of debt on government balance sheets; it also shifted debt from the private sector onto government balance sheets via high profile bailouts of key industries.
• Next up are the structural shifts underway across both the developed and developing worlds. These include the promises made to support an aging population, the costs of mitigating the damages of a surge in natural disasters and climate change more broadly and escalating geopolitical tensions.
• The US was a leader in pushing for tax cuts over the last four decades, which widened the gap between revenues and spending. Indeed, the only years we saw federal surpluses were between fiscal years 1998 and 2001 when tax increases, more moderate spending and robust growth came together to push revenues above our spending obligations.
• Emerging market (EM) debt is persistent and more expensive due to the riskiness of the assets.
• China has filled some of the gap for developing economies with key commodities. There were 42 low- and middle-income countries that have debt exposure to China equivalent to more than 10% of their GDP in 2021. Chinese banks often charge higher rates than the IMF and World Bank.  
• China is in the midst of its own domestic debt bubble with an estimated $8 trillion in household and provincial government debt. The overhang of real estate debt dwarfs that of the US at the onset of the subprime housing crisis.
• Only two of the twenty most indebted countries have lower yields today than prior to the pandemic.

The situation is poised to get worse. We continue to age, while fertility rates are falling just about everywhere. That means that the dependency ratio, or those drawing upon their pension and health benefits versus those earning a paycheck and paying into the system, is rising. Immigration, which increases the ranks of those paying into the system but often restricts them from tapping benefits, alleviates some of the problem. However, the backlash to immigration is global in scope.

Forecasts of government debt do not include disaster aid or efforts to mitigate extreme changes in the weather or other shocks, such as hot wars or recessions. The magnitude of these events cannot be known and therefore goes unplanned. That means most, if not all, expectations of government debt issuance will be underestimated.

The higher stock of debt accumulated in the intervening years between the GFC and the pandemic, combined with higher interest rates and debt servicing burdens, makes sovereign defaults more likely in the coming years. EMs are more vulnerable but developed economies are not immune. The panic in the UK bond market in the Fall of 2022 and France’s recent woes are two examples. Those with currency advantages, like the US, or those that hold more of their debt internally, like Japan, will be less likely to default.

Countries that default on sovereign debt experience severe economic distress. Financial market volatility is contagious and triggers hesitancy from investors even after austerity measures are put in place. That constrains the ability to offset consequences from unemployment with fiscal stimulus and dampens the flow of foreign direct investment, which adds insult to injury to their growth trajectories. In response, civil unrest often intensifies along with trust in the nation’s leaders, which can sow the seeds of political instability.

Uncertainty surrounding trade wars, global migration and climate change in the coming years could portend more volatility in financial and currency markets. The recent appreciation of the dollar is a case in point: It has spurred unnerving currency depreciations among trading partners and a global bond rout. The currency chaos combined with larger debt burdens could prompt defaults or sovereign downgrades. Political brinksmanship and haphazard debt practices add to the uncertainty.