High levels of debt – a political problem
23 OCT, 2025
Karsten Junius, Chief Economist at J. Safra Sarasin Sustainable AM
Are government bonds still safe? Total global public debt has risen significantly since the pandemic. Its sustainability is in doubt as bond yields and interest payments increase. Real bond yields have exceeded potential growth in some countries, meaning primary surpluses are required to keep public debt ratios stable. It is easy to propose the necessary corrective fiscal measures, but politically they are very difficult to implement, which could lead to political clashes. Investors are therefore likely to demand higher risk premiums for government bonds than in the past.
Aggregate public and private debt has risen to 235% of global GDP in 2024, according to the latest IMF Debt Monitor, and is expected to increase further in 2025. Contrary to the period before the global financial crisis, it is the public sector that has significantly leveraged up, while private sector debt ratios have declined. In fact, public debt rose to 110% of GDP in 2024 from 105% in 2019, while private debt fell to 157% in 2024 from 166% in 2019. This is partly due to higher savings during the pandemic, but there is also likely some crowding out of private investment by public spending.
Public debt in the euro area rose to 90% of GDP in 2024 from 86% in 2019, reflecting a significant deterioration in France despite improvements in Greece, Spain, and Portugal. Public debt also increased in the U.S. to 121% of GDP in 2024 from 108% in 2019, while remaining stable in Japan.
The problem with high debt levels is that debt servicing becomes highly sensitive to market perceptions of interest rates. In the euro area, 10-year government bond yields are currently 2.6% in Germany and 3.4% in France. Both countries were able to refinance at negative rates in 2020. This means that even with unchanged debt levels, interest burdens will rise as low-coupon bonds mature and are replaced by higher-coupon ones.
In the U.S., 10-year Treasury yields have increased by 145 basis points to 4.1% since December 2021. This partly reflects higher neutral interest rates. The long-term neutral rates implied by the market for the U.S. have risen about 125 basis points, while the FOMC’s dot plot points to an 80-basis-point increase. In addition, term premiums have increased significantly since late 2019, though they remain below the average of 100–150 basis points between 2000 and 2013. Term premiums include a default risk premium, currently 44 basis points for the U.S., according to the 5-year CDS. Another key factor behind the rise in term premiums is the reduction of bond holdings by central banks (Quantitative Tightening).
Current bond yields exceed both pre-pandemic levels and the average interest rate on outstanding debt in many countries. This implies that the average interest cost — and therefore the share of the budget that countries must allocate to debt service — will rise. This will crowd out other expenditures, lead to higher taxes, or increase deficits and debt.
From a market perspective, there are two groups of countries at risk:
- Those with a large base of foreign investors that depend on market financing, such as the United Kingdom.
- Euro area countries whose fiscal deficits and debt levels are constrained by international treaties and budgetary rules.
Financial markets worry about debt sustainability, measured by the stability of the debt-to-GDP ratio. This ratio is stable if real bond yields (r) equal real GDP growth (g) and if the primary budget balance is zero. If bond yields exceed the GDP growth rate, primary surpluses are needed to stabilize the debt ratio. While this is not economically impossible, as Italy has shown, it can be politically very demanding. For example, France last recorded a primary surplus in 2001 and has not achieved a balanced budget in 35 years.
Column 10 of Chart 4 provides an estimate of the medium-term adjustments needed in the primary balance, assuming that the interest cost on outstanding debt corresponds to current refinancing rates. The required adjustment of 3.4% of GDP is high for France. Adjustment needs in the U.S. and the U.K. are also considerable, around 2.5% of GDP. On the other hand, Greece and Portugal, which had high-yield bonds during the euro area crisis, are well positioned today and would not need further fiscal tightening.
Credit spreads that euro area countries must pay on their debt (over German bonds) should rise with the size of the primary surpluses required for debt sustainability. Although French spreads have recently increased, given the greater need for fiscal adjustment, French bonds still appear expensive compared with Italian ones. Using the same metrics, Greek and Portuguese bonds look cheap.
Trying to stimulate the economy through inflation is also dangerous, as inflation expectations could become unanchored. In both cases, risk premiums could rise, pushing bond yields higher and making the required adjustments even more difficult.
France and the U.S. are the two countries whose fiscal sustainability is not aligned with the current policy trajectory and where adjustments are clearly needed. However, they face different challenges. The U.S. apparently wants foreigners to participate in the consolidation of its finances. Higher tariffs and visa fees, and possibly taxes on foreigners’ investment returns, could be one means of doing so, although it is doubtful this would be sufficient. Higher inflation could be another path, though it would also harm domestic bondholders. This would lead to higher risk premiums for U.S. assets and a depreciation of the dollar.
France cannot “devalue” its debt, as monetary policy is conducted by the ECB for the entire euro area. Nor can it simply rely on higher GDP growth, as that would require significant structural reforms that could only materialize over several years. Its debt level is also not high enough to justify a default. Nor are its yields high or fundamentally unjustified enough for the ECB to intervene using the Transmission Protection Instrument (TPI). This leaves the most obvious options as raising taxes or cutting spending. However, both are politically challenging, as we have seen in recent weeks.
If current governments cannot deliver the required economic outcomes, they will need to broaden their coalitions beyond traditional partners or lose power to the opposition. For France, this likely means that minority political parties will soon form part of the government. However, this would still not solve its fiscal problems.
