Business feels the pressure as public debt piles up

The European Central Bank (ECB) cut interest rates for the seventh time in a year in April, while the Bank of England (BoE) announced a quarter-point reduction to its own rate in early May. The Federal Reserve (Fed) held policy rates steady again in May, though most economists believe it will resume easing at some point. 

In normal times, this would be excellent news for businesses. Reduced borrowing costs lighten their debt burden and increase cash flow. Easier access to credit spurs investment and drives expansion.

But these are not normal times. Escalating uncertainty and abrupt US policy shifts have shocked the global economy and reshaped the global fiscal outlook. Unusually, while policy rates have fallen, long-term US interest rates - yields on government bonds - have not. 

The focus is firmly on the US, because the US Treasury is the basis for the global financial system. In the US, the policy rate fell by 100 basis points between September 2024 and early May 2025, while the long-term interest rate rose by around 70 basis points in the same period. This divergence is unusual because short-term policy rates tend to move in tandem with long-term rates. Long-term rates generally consist of a series of expected short-term rates plus an inflation and risk premium.

The rise in long-term interest rates is bad news for both governments and businesses that need to borrow money. Bad debts and business insolvency are both likely to rise unless effective fiscal consolidation policies are quickly put in place.
 

Public debt causes private pain

A root cause of rising long-term interest rates is growing public debt. The International Monetary Fund (IMF) now projects global public debt to grow by 2.8 percentage points this year, driving debt to more than 95% of GDP. The organisation believes the upward trend will continue, pushing global public debt near to 100% of global GDP by the end of the decade.

Public finances were already stretched in many economies, and high public debt gives policymakers little room for manoeuvre at a challenging time. Trade wars are reducing growth prospects and ramping up uncertainty. A number of European countries have committed to increased defence spending. Populations are ageing and developing countries are seeing a reduction in foreign aid.

On top of it all, the early days of the Trump administration have brought global economic turmoil. Washington’s gung-ho attitude has focused attention on the quality of US institutions and the resilience of the country’s rule of law, undermining the country’s reputation as custodian of the global financial system. 

“Nothing feels certain in the US at the moment. To investors, US government bonds no longer feel like the safe haven they were just a few months ago, adding to upward pressure on long-term interest rates.”

Investors demand a risk premium

For investors in government bonds, slowing economic growth, rising public debt and an unpredictable US president add up to greater risk. Their response is to demand higher yields, pushing up long-term interest rates.

At time of writing, those rates stand at 4.5% in the US, up from 3.7% in September 2024. In other words, the US government is having to pay a higher interest rate to sell its bonds, increasing the cost of borrowing.

But this isn’t just a government problem, and nor is it just a US one. Rising yields on US government bonds can also impact company borrowing in the US and other countries. Corporate bonds are naturally more risky than government bonds because companies go bankrupt. When the yields on government bonds increase in response to risk, corporate ones usually rise as well, to maintain the gap.

In fact, a rise in long-term interest rates ripples through entire economies. “When governments pay more to borrow, corporate borrowing costs go up too,” says Bodnar. “Local banks also raise interest rates, making it more expensive for businesses to get loans or refinance existing debt. Higher global debt and fiscal instability do not just hurt governments - they affect corporate sector access to credit, investment decisions and business growth, especially in emerging and developing economies.”

Tighter credit conditions and higher borrowing costs put stretched businesses at risk. Small and medium sized companies in particular face an increased risk of insolvency. 

The impacts of higher US long-term interest rates are felt far beyond US shores. Governments in some countries are more exposed to rising US long-term interest rates than others. Countries like Mozambique, Sri Lanka, Tunisia and Argentina have debt in US dollars negotiated on commercial terms, alongside high external financing needs and low official reserves. This confluence of factors makes both public and private sectors more vulnerable to fiscal shocks.

Fiscal consolidation reduces risk

Against a background of rising government debt levels, the one weapon countries can deploy against volatility is fiscal consolidation. According to the IMF, “fiscal policy should prioritise reducing public debt and establishing and widening buffers to address spending pressures and economic shocks.” 

That’s easier said than done, of course. Every country faces its own peculiar set of risks, but tight public finances, slowing economic growth and rising spending commitments are challenges almost everywhere. Some tough decisions will have to be made if countries are to put their fiscal houses in order.

The upside is that gradual and credible consolidation plans will increase public confidence, and new spending that is carefully balanced by spending cuts or new revenue in other areas will reassure markets. Other measures to balance books might include targeted tax rises, astute debt restructuring and pensions reform. There are a number of other options, depending on local circumstances and political appetite.

“It won’t be straightforward, but if governments focus on effective fiscal consolidation it would help ease the burdens on business,” says Bodnar. “This would make it easier for companies to secure the credit they need to grow and operate, ultimately boosting their stability.”

No magic bullet for rising public debt

Rising public debt, and the increasing cost of it, pose a significant challenge to economies around the world. Volatile financial markets, higher long-term interest rates and slowing growth add to a perfect storm of challenges for governments and businesses as they seek stability.

Fiscal consolidation is by no means a magic bullet in these circumstances, but it may be the best weapon policymakers have to shore up vital business sectors. Effective fiscal consolidation can help restore trust in policymaking and institutions, critical for easing the upward pressure on borrowing costs in the current unpredictable economic environment.

“Long-term borrowing costs have been on the rise again as policy uncertainty has ramped back up in the US,” says Bodnar. "Next to ongoing trade uncertainty, investors are increasingly worried about the proposed budget bill’s expected impact on the government’s mounting debt burden."