Why food and fuel subsidies will push up debt

“A surge in food and fuel prices is raising pressure on governments around the world to pick up the tab for consumers,” says The Wall Street Journal. “Spooked by protests that have broken out recently from Bangkok to Sicily, many governments have adopted subsidies or tax breaks to shield households and businesses.” 

Yet these handouts are causing government deficits and debt to balloon, just as borrowing costs are rising. In the eurozone, for example, governments are likely to run budget deficits of 4.5% of GDP on average this year.

Governments have become used to the idea that ever-higher spending is both “manageable and sensible”, says Mike Dolan on Reuters, thanks to years of low inflation and low interest rates. This assumption will now be tested by a sharp shift in the economic environment.

“In a one-two punch, pandemic lockdowns first floored borrowing rates and exploded government borrowing to prop up economies. But a rush to reboot created wild price distortions and supply bottlenecks that appear persistent and have now been exaggerated by an energy and commodity price squeeze since Russia invaded Ukraine.”

Interest rates are likely to rise in response, increasing the cost of carrying so much public debt, says asset manager Janus Henderson. Global government debt rose to $65.4trn in 2021, up 7.8%, with every country increasing its borrowing. 

Yet interest costs were just $1.01trn – equivalent to a record low interest rate of 1.6%. In 2022, debts will rise further – to a forecast $71.6trn, up 9.5% – while higher rates will raise interest costs by an estimated 14.5%. The UK will see an especially sharp rise, because inflation-linked bonds account for around 25% of outstanding government debt.

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