The Bank for International Settlements has warned that heavily indebted countries are at risk of a sudden loss of confidence, although this risk is hardly recognised in bond markets.
The Basel-based institution said in its report: Annual Economic Report On Sunday, the World Bank Group released a report stressing that countries facing increasing financial pressures due to rising interest rates should prioritize financial reform. Claudio Borio, head of the Monetary and Economics Department at the Bank for International Settlements, said these countries need to act “urgently.”
“We know from experience that things seem sustainable until they suddenly stop. That’s how markets work,” he told reporters.
Although the need for fiscal reform has been a recurring theme for the Bank for International Settlements, these statements coincide with increased scrutiny of indebted economies. Concerns about France this month prompted investors to demand the highest premium on its bonds since 2012.
Basel officials did not identify any country in particular, but showed a chart examining the debt and market pricing of some of the world’s largest borrowers, including Japan, Italy, the United States, France, Spain and the United Kingdom.
In order to achieve financial stability, advanced economies this year can afford deficits of no more than 1% of GDP, down from 1.6% last year, the Bank for International Settlements said. This is a small part of Current US budget deficitthat International Monetary Fund He described last week as “very big.”
“While financial markets are pricing in a low probability of fiscal pressures at present, confidence could quickly collapse if economic momentum weakens and there is an urgent need for public spending on both the structural and cyclical fronts,” the BIS said. “Government bond markets will be hit first, but the pressures could spread more widely.”
But BIS officials admit that inflation is starting to ease. The bank’s director general, Agustin Carstens, said that the world is currently preparing for a “soft landing.”
Services remain a risk to the outlook, the report said, as prices in the region are not in line with pre-pandemic trends. In addition, increases in the cost of basic goods due to geopolitical tensions could lead to renewed inflation.
Given these pressure points, officials stressed that central banks should be wary of cutting interest rates too early. It could be costly to their reputation if they have to reverse policy as inflation picks up again, the report said.
The Bank for International Settlements suggested that policymakers have already done their fair share to contribute to the problem, repeating its charge that “with the benefit of hindsight,” pandemic-era stimulus may have increased the risk of second-round effects.
Officials said that while central banks should not ease their policies too quickly, governments also have a role in ultra-loose fiscal policy. Instead, it must expand tax bases and implement structural reforms to meet future challenges including demographic shifts and climate change.
“Our main message is that central banks alone cannot achieve a sustainable increase in economic growth and prosperity. Laying the foundation for a brighter economic future also requires action by other policymakers, especially governments,” Borio said.
