Rising public debt and what it could mean for investors

PUBLIC or sovereign debt, is an important way for governments to finance investments in growth and development. However, it is also critical that governments are able to continue servicing their debt and that their debt burden remains sustainable.

The International Monetary Fund (IMF) estimates the Group of 7’s (G7) gross government debt to reach around 126 per cent of gross domestic product this year, up from 85 per cent two decades ago.

The key factor driving the surge in public debt is the persistently high global fiscal deficit, which stands at approximately 5 per cent of GDP. This surge largely reflects extraordinary shocks, including the 2008 financial crisis and Covid-19 pandemic, such as subsidies and social spending, combined with rising net interest costs.

However, we anticipate the upward trend to continue. The IMF estimates that debt levels could climb to 137 per cent of GDP by 2030, driven by an ageing population which will lead to higher spending on healthcare and pensions, and a smaller tax base. Furthermore, increased defence spending will consume a greater proportion of already constrained fiscal budgets.

Tough choices

The risk is that debt could reach a point where persistent deficits and higher interest costs make it extremely difficult to reduce debt levels. In this environment, the question is not whether governments will act, but how –and what those choices mean for investors.

The conventional approach to deficit reduction involves implementing fiscal consolidation measures, such as tax increases or spending cuts, with the objective of reducing deficits. Partisan politics can hinder the formation of consensus.

France’s efforts to reduce the deficit in 2025 were unsuccessful due to the opposition of a divided parliament. In the US, the reduction of the deficit has not been a priority for either of the two main parties. Japan’s ruling Liberal Democratic Party has decided to pursue further fiscal stimulus as opposed to austerity measures. Meaningful fiscal consolidation in the G7 is likely to remain an exception.

Another tactic is to shift government borrowing toward shorter maturities. By issuing more short-term debt, governments can avoid locking in high borrowing costs for decades, hoping that rates will fall or fiscal conditions will improve. While this can be a strategic move to buy time, it also increases rollover risk and leaves governments more exposed to future inflation and yield spikes. This approach merely postpones the inevitable.

For example, the US Treasury has been focusing on short-term securities, especially T-bills, in its issuance strategy to avoid locking in current high long-term interest rates. As much as 33 per cent of US marketable debt maturing this year, or about US$2.3 trillion to US$2.4 trillion of the US$7 trillion in refinancing, is in short-term notes, which mature within 12 months. This puts significant upward pressure on rates.

Realistically, rather than rely solely on politically difficult spending cuts or tax hikes, a more subtle and likely pervasive approach is “financial repression”, which refers to policies that keep interest rates artificially low, making borrowing costs more manageable.

Financial repression

The concept of financial repression involves the strategic management of demand for government debt through various mechanisms, including bank, pension, and insurance rules, as well as central bank purchases. This approach has the indirect effect of reducing real returns for governments, which in turn can have a positive effect on their cash savings.

As a result of these policies, central bank balance sheets have already grown substantially over the past 20 years. We expect this growth to continue.

For investors, an immediate risk is that concerns over debt sustainability and credit rating cuts could trigger periodic volatility in bond yields. However, we believe that interventions will become more frequent to help stabilise or lower yields.

Over the medium term, more frequent interventions are likely to anchor interest rates and bond yields at lower levels than debt fundamentals might suggest. Aggressive yield suppression may increase FX volatility, as currencies absorb more of the adjustment.

Historically, exchange rates were fixed and bond yields floated. Today, both are market-determined, but we may be moving toward a regime of more fixed borrowing costs, with currencies absorbing more of the adjustment.

If governments and central banks increasingly intervene to manage yields, asset prices could rise initially as equities, government bonds, and commodities could perform strongly (in local currency terms) in the immediate aftermath, as real yields fall.

A more sustainable long-term debt reduction programme would be helpful. Governments can prioritise gradual fiscal adjustments within a credible medium-term plan to reduce public debt while helping to avoid crowding out private borrowing and investment. At the same time, fostering an environment that boosts economic growth and reduces uncertainty will help ease public debt and encourage private sector investment.

The writer is CIO South Asia-Pacific, UBS Global Wealth Management. He is also adjunct associate professor, Nanyang Business School, Nanyang Technological University