What Could Wake the Markets
Global economic forecasts show little concern for mounting geopolitical uncertainty, but the risks are real. A commentary by Lorenzo Bini Smaghi
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
Every six months, the International Monetary Fund updates its projections for the world economy. The latest, published this week, differ only marginally from those of last spring — and even less from those of a year ago.
Global growth is expected to reach just above 3.2 per cent this year, broadly in line with last autumn’s forecast and slightly better than the estimate from April.
Regionally, the United States is expected to grow somewhat more slowly than anticipated (2.0 per cent versus 2.7 per cent projected a year ago), Europe slightly faster (1.2 per cent versus 1 per cent), while Asia shows a more robust recovery (5.2 per cent versus 4.5 per cent), driven largely by China and India.
In short, the global economy does not yet appear to be feeling the full weight of the growing uncertainty and geopolitical tensions that have emerged in recent months.
There is, however, one figure that diverges sharply from previous forecasts: the trajectory of US public debt.
The debt-to-GDP ratio, which a year ago was expected to reach 130 per cent by the end of the decade, has now been revised up by ten percentage points, to 143 per cent.
This means that over the next five years, public debt will rise by a further 20 percentage points relative to GDP — an acceleration compared to the past quarter century, when the ratio climbed from 60 per cent to 120 per cent.
The increase is largely due to the fiscal stance of the current administration under the so-called Big Beautiful Bill, which worsens the deficit by roughly 1.5 to 2 percentage points of GDP each year relative to previous projections.
No decline in indebtedness is expected in the next five years: the overall deficit is set to remain between 7.5 and 8 per cent of GDP, while the primary deficit — i.e. excluding interest payments — is forecast to stay between 3.5 and 4 per cent through the end of the decade.
By comparison, Europe’s public debt is expected to rise by only six percentage points over the remainder of the decade, reaching 92 per cent of GDP, with a deficit roughly half that of the United States.
The US is therefore poised to become the country with the second-highest public debt ratio in the world, after Japan. Yet the two cases differ profoundly: in Japan, most government bonds are held domestically — by pension funds and the central bank — while the US must rely heavily on foreign investors to absorb its debt.
The expansionary fiscal policy pursued by the new administration has contrasting effects in the short and medium term.
In the near term, fiscal stimulus supports economic activity and offsets, at least in part, the restrictive impact of other measures such as tariff increases and cuts to social spending. This helps explain why, despite recent uncertainty, the US economy has so far held up relatively well.
In the medium term, however, a sustained fiscal expansion cannot permanently support growth — nor prevent a sharp deterioration in public finances.
Of course, long-term forecasts carry wide margins of uncertainty. Much depends on how US fiscal policy evolves. The IMF assumes a modest but continuous increase in public spending, from 37.8 per cent of GDP this year to 38.2 per cent by the decade’s end, while tax revenues are expected to decline, at least until 2029. Given the degree of political polarisation, a drastic policy reversal seems unlikely.
It is also hard to predict the impact of exogenous factors such as the spread of artificial intelligence on productivity and growth, which may be significantly underestimated.
What cannot be ignored, however, is that these projections rest on the assumption that financial markets will continue to treat US debt and the dollar with benign tolerance. That assumption may prove overly optimistic.
Markets tend to react non-linearly, often abruptly, to data that defy expectations.
A triggering effect could come from the release, in the coming months, of a higher-than-expected US inflation figure — one that could upend expectations of rate cuts by the Federal Reserve.
Such a surprise would immediately push up yields across maturities, further raising the cost of debt service and the fiscal deficit.
In these conditions, a renewed bout of inflation fears could send seismic tremors through global financial markets.
