The Bank for International Settlements has warned that debtor countries are at risk of a sudden loss of confidence, even as bond markets barely acknowledge the risk.
In its annual economic report released on Sunday, the Basel-based BIS said countries whose bloated fiscal positions are being further strained by high interest rates should prioritize fiscal consolidation. Claudio Borio, head of the BIS’s finance and economics department, said countries must act “urgently.”
“Experience shows that things can appear sustainable and then suddenly become unsustainable,” he told reporters. “That’s how markets work.”
The need for fiscal consolidation is a recurring theme for the BIS, but the comments come as it steps up scrutiny of indebted countries. Concerns about France this month led investors to demand the highest premium for French government bonds since 2012.
The Basel authorities did not name specific countries but included a chart showing debt and market values ​​for some of the world’s largest borrowers, including Japan, Italy, the United States, France, Spain and the United Kingdom.
To stabilize their finances, advanced economies could keep their deficits to below 1% this year, down from 1.6% last year, the BIS said — a fraction of the current U.S. deficit that the International Monetary Fund called “too large” last week.
“While financial market pricing suggests that the likelihood of fiscal stress is small at present, confidence could erode quickly if economic momentum weakens and both structural and cyclical needs emerge for urgent fiscal spending,” the BIS said. “Treasury markets would be hit first, but stress could become more widespread.”
But BIS officials acknowledge that inflation is subsiding, and the world is now on track for a “smooth landing,” said Agustin Carstens, general manager at the bank.
The services sector still poses a risk to the outlook, with prices there off pre-pandemic trends, the report said, while rising commodity prices due to geopolitical tensions could reignite inflation.
Given these pressure points, officials stressed that the central bank should be cautious about cutting rates too soon, as the need to reverse such measures as inflation returns could hurt its reputation, the report said.
The BIS suggested policymakers have already played a significant role in contributing to the problem, repeating its charge that “in hindsight” pandemic-era stimulus measures have probably increased the risks of second-order effects.
While central banks should not be too quick to ease monetary policy, officials said the government should also play a role in easing fiscal policy by broadening the tax base and undertaking structural reforms to better prepare the country for future challenges such as demographic change and climate change.
“Our main message is that central banks alone cannot deliver lasting gains in economic growth and prosperity,” Borio said. “Laying the foundations for a brighter economic future also requires action from other policymakers, particularly governments.”
