IMF Warns: ‘U.S. and Chinese Fiscal Deficits Are a Grave Risk to the Global Economy’

US fiscal deficit to hit 7.1% of GDP next year, triple the average for advanced economies
China’s fiscal deficit to reach 7.6%, double the average of emerging countries
US debt also affects inflation…high inflation-high interest rate vicious circle

The International Monetary Fund (IMF) warned on the 17th (local time) that the massive fiscal deficit in the United States is fueling inflation and poses a significant risk to the global economy.

The Financial Times (FT) cited an IMF report predicting that next year’s U.S. fiscal deficit will record 7.1%, more than triple the average of other advanced economies, which is 2% of the Gross Domestic Product (GDP). Due to sluggish demand and a real estate crisis, China is also expected to reach a government fiscal deficit of 7.6% of GDP next year, more than double the average emerging country’s 3.7%. The IMF pointed out in this report that the United States, China, the United Kingdom, and Italy need policy measures to resolve the fundamental imbalance between expenditures and income.

The IMF warned that the extensive government spending in the US and China “could have a significant impact on the global economy and pose a considerable risk to the baseline fiscal outlook of other economies.” Pierre-Olivier Gourinchas, the IMF’s chief economist, expressed concern about the U.S. fiscal situation, stating that it could complicate the Federal Reserve’s attempts to meet its 2% inflation target. He added that (the U.S. fiscal deficit) could pose not only short-term risks in reducing inflation but also raise long-term fiscal and financial stability risks for the global economy, suggesting that “Something will have to be sacrificed.”

Gourinchas’ remarks explain the situation where global borrowing costs have increased significantly as the U.S. has raised interest rates to curb inflation and the government’s debt burden has grown. The Congressional Budget Office (CBO) in the U.S. revealed at the end of last year that the U.S. federal debt reached $26.2 trillion, equivalent to 97% of GDP, and was expected to continue to increase, reaching a post-World War II high of 116% by 2029.

The CBO also explained that fiscal deficits and debt costs contribute 0.5 percentage points to the U.S. core inflation. This means that to bring inflation back to the Fed’s target of 2%, U.S. interest rates must remain high for now. The CBO already projects that the net interest payments to U.S. debt holders will exceed $1 trillion after 2026.

The sharp increase in U.S. borrowing costs leads to a surge in global bond yields and currency exchange rate instability in emerging and developing countries. According to one analysis, if U.S. interest rates rise by 1 percentage point, other advanced countries’ rates rise by 0.9 percentage points, and emerging countries’ rates rise by 1 percentage point. The IMF said, “Global interest rate hikes could tighten financial conditions further, increasing risks elsewhere.”

The IMF also warned about the Chinese government’s fiscal deficit. However, unlike the U.S., which spread its fiscal deficit to the global market by issuing treasury bonds, China tends to hold government debt internally, so the impact on the global market would be different. Yet, the dynamics of China’s debt could eventually burden its trade partners. The report stated, “Given the severe fiscal imbalances in China’s local governments, unintended fiscal tightening could lead to a larger-than-expected slowdown in China’s growth,” and “In that case, there could be negative ripple effects worldwide as international trade and external financial and investment levels decrease.”

The IMF emphasized the need for policy measures to resolve both countries’ fiscal imbalances. Vitor Gaspar, the Director of the IMF’s Fiscal Affairs Department, said, “Both the U.S. and China have economic power, so there is still time to control their finances.”