US budget deficits should not continue to expand in the coming decade, as they are reaching an unsustainable level that could even lead to a collapse of the global economy, the International Monetary Fund says. In particular, the IMF warned the US that its huge budget deficits have fueled inflation and pose “significant risks” to the global economy.
As the IMF reported in the Fiscal Monitor report (https://www.imf.org/en/Publications/FM), the US will record a fiscal deficit of 7.1% in 2025 – three times the average of 2% experienced by other advanced economies. In this regard, it is worth noting that concerns have been expressed about China’s public debt, with the country of the Dragon recording a deficit of 7.6% in 2025 – more than double the average of 3.7% shown by other emerging markets – as Beijing is faced with a large decrease in demand and an unprecedented housing crisis.
According to the IMF, the US and China were among four countries that “need to take critical policy action to address fundamental imbalances between spending and revenue.” The other two countries were the United Kingdom and Italy.
If anything, uncontrolled spending by the US and China could “have profound effects on the global economy and cause major problems in other economies,” the IMF said. In other advanced economies, such as the Eurozone, budget deficits were narrowed in 2023.
However, the IMF said the US is experiencing a “remarkably large fiscal slippage”, with the fiscal deficit reaching 8.8% of GDP last year – more than double the 4.1% deficit recorded in 2022. The Fund said the fiscal The country’s deficit had contributed 0.5 percentage points to core inflation – a measure of underlying price pressures that excludes energy and food.
This means that US interest rates will remain higher for longer in order for inflation to return to the Fed’s 2% target. The IMF noted that “large and sudden increases” in US borrowing costs typically lead to a spike in government bond yields around the world and volatility in exchange rates in emerging markets and developing economies.
Analysis found that a 1 percentage point rise in US interest rates led to a 90 basis point rise in other advanced economies and a 1 percentage point rise in emerging markets. “Global interest rates will contribute to tighter financial conditions, raising risks elsewhere,” the IMF said.
IMF sees ‘bubbles’ ready to burst in markets, everything hanging in the balance.
Meanwhile, high corporate valuations could pose a significant risk to financial stability as market optimism becomes disconnected from fundamentals, the head of the IMF’s Monetary and Capital Markets Department said. Financial markets have been on a strong rally for much of this year, boosted by falling inflation and hopes of imminent interest rate cuts.
But this “optimism” has stretched valuations to the point where they could become vulnerable to an economic shock.
There’s always that question, if a downside shock were to hit to what extent we see a repricing. Credit markets are a particular area of concern. Credit markets, where spreads are very tight, even as borrower fundamentals deteriorate, at least in some segments. Even the riskiest borrowers are able to issue new debt, and at very favorable rates.
Real estate risks
Concerns about IMF financing also extend to the real estate market, and especially commercial real estate. Mid- and small-sized lenders in particular could be vulnerable to shocks in commercial real estate, as the industry has come under pressure from the shift to remote work and online shopping, he said. There is actually a link between the exposure of some banks, particularly mid-sized and smaller banks, to commercial real estate which also tend to have a fragile funding base. Somehow the combination of exposure to risk in commercial real estate and that fragile financing that could in some scenarios reignite some volatility.
The IMF released its World Economic Outlook on Tuesday (https://www.imf.org/en/Publications/WEO/Issues/2024/04/16/world-economic-outlook-april-2024), in which it slightly upgraded its forecast for global growth, saying the economy had proved “surprisingly resilient”. It now sees global growth at 3.2% in 2024, but noted downside risks remain, including inflation and an increasingly uncertain path for interest rates.
