IMF Warns War and Debt Straining Global Finances, Urges Fiscal Caution

"The world economy is being tested again with the consequences of the war in the Middle East," Rodrigo Valdes, Director of the IMF's Fiscal Affairs Department, said on Wednesday (local time), warning that "public finances are more stretched in many, many countries."

The IMF urged governments to avoid broad fiscal stimulus despite rising pressure from higher fuel and food prices. Instead, it called for targeted and temporary support to protect vulnerable households while preserving market price signals.

"Fiscal policy should steer clear of discretionary demand stimulus," Valdes said, adding that such moves would make "harder the central bank's job in terms of inflation control."

The Fund cautioned against broad-based energy subsidies, describing them as "fiscally costly, regressive, and hard to unwind," while also distorting price signals and creating global spillovers.

The IMF officials said attempts by multiple countries to suppress prices could worsen global inflation. "If everybody does that, we're in big trouble," Valdes noted, stressing the need to "reflect scarcities through prices."

The current shock differs from the Covid crisis, officials said, as it is primarily supply-driven. "If you try to undo a supply shock by trying to prop up demand, you will end up with more inflation," Valdes said.

Deputy Director Era Dabla-Norris highlighted that governments now face tighter fiscal constraints than during the pandemic. "Countries have much less fiscal space, room for manoeuvre. Debt levels are high in many parts of the world," she said.

While governments have deployed a mix of tax cuts, subsidies and pricing controls, the IMF noted that responses so far have been more restrained than during the 2022 energy shock. However, the Fund warned that poorly targeted measures could impose significant long-term fiscal costs.

Beyond the immediate crisis, the IMF flagged worsening medium-term debt dynamics. Global public debt is projected to rise to 99 per cent of GDP by 2028, with risks skewed to the upside. In a severe scenario, debt could reach 121 per cent within three years, reflecting risks from geopolitical fragmentation, market volatility and financial repricing.

Higher interest rates are compounding the challenge, with real borrowing costs about 0.6 percentage points above pre-pandemic levels. At the same time, shorter debt maturities and increased reliance on private investors are making markets more sensitive to shifts in sentiment.

The IMF called for rebuilding fiscal buffers once conditions stabilise. "Rebuild fiscal buffers once conditions stabilise and do so without delay," Valdes said, warning that postponing consolidation would make future adjustments more difficult.

For low-income countries, the Fund stressed the need to boost domestic revenue mobilisation as external aid declines and fiscal pressures mount.

The IMF also pointed to emerging structural challenges, including the fiscal implications of artificial intelligence. While AI could improve tax administration and public service delivery, it may also "reshape jobs" and "increase inequality," placing additional strain on social protection systems, Dabla-Norris said.

The IMF's assessment comes as governments grapple with persistent inflation, geopolitical uncertainty and rising borrowing costs. Policymakers globally face the dual challenge of managing immediate shocks while ensuring long-term fiscal sustainability.

- IANS