IMF warns governments against reliance on short-term Debt

Governments in advanced economies such as the U.S. should be wary of relying too heavily on short-term debt, since it exposes them more immediately to higher borrowing costs when inflation surges, the International Monetary Fund said Wednesday.The IMF said higher interest costs are already making it more challenging for governments to contain their borrowing.Yields on longer-term borrowing have risen over recent years, partly a reflection of a steady increase in debt sales and partly the consequence of a decline in demand from buyers such as central banks that favor extended maturities.In an effort to lower borrowing costs, some governments have switched to selling more short-term debt, which typically pays lower interest rates.However, the Fund warned that at a time when inflation shocks have become frequent, that shift may have the opposite effect to the one intended.Because governments have to issue new bonds to replace maturing securities more often when terms are short, they can find themselves facing higher costs as central banks raise their key interest rates to tame price rises during a supply shock, such as that caused by the war between the U.S. and Iran.“Governments in several advanced economies are refinancing more debt at shorter maturities, causing higher policy rates to pass through to government borrowing costs more quickly,” the Fund said.Among the Group of Seven leading advanced economies, the U.S. has relied most heavily on short-term Treasury bills to fund its budget deficit.The French government is considering boosting issuance of shorter-term debt, as investors grow more hesitant to lend to the debt-laden country for longer periods.The Fund said that a heavy reliance on short-term bills makes it more expensive for the government if the central bank raises its key interest rate in response to an inflation surge, which have become more frequent as conflicts between nations have proliferated.“High debt and shorter maturities can therefore make restoring price stability more difficult and more costly for the public finances,” the IMF warned.In the case of France, the European Central Bank has already raised its key interest rate twice since the war started in late February, and investors expect to see another move higher before the end of this year, and further moves in 2027.Governments may hope to avoid locking in to higher long-term interest rates by selling short-term debt instruments in the expectation that inflation will have been tamed by the time they mature, and new bills can be sold at a lower interest rate.But with more frequent inflation shocks, they may instead end up paying even higher rates, or at the very least not secure the reduction that they were hoping for.“Central banks may need to keep rates higher for longer, worsening debt dynamics,” the Fund said.The Fund said higher interest costs are already making it more challenging for governments to contain their borrowing. It forecast that interest payments by the U.S. government will rise to 5.7% of gross domestic product in 2031—roughly equal to spending on Social Security—from just 2.8% of GDP prior to the Covid-19 pandemic.Higher interest payments mean that many governments need to have smaller budget deficits before debt costs are covered—known as the primary deficit—in order to stop their debts from increasing further.At a global level, the Fund estimated that a primary deficit of 2.6% of GDP would stabilize debt relative to economic output, down from 3.3% now.“The global primary deficit is expected to widen in 2026, moving in the opposite direction from what is needed to stabilize debt,” it said.Write to Paul Hannon at paul.hannon@wsj.com