The world’s $2tn interest bill

Mount­ing bor­row­ing costs and record debt are squeez­ing pub­lic fin­ances, for­cing gov­ern­ments to choose between higher taxes, spend­ing cuts and vital pri­or­it­ies such as defence.

By Ian Smith, Sam Flem­ing and Emily Her­bert Data visu­al­isa­tion by Jonathan Vin­cent

The world’s gov­ern­ments have cre­ated a $2tn mon­ster — a debt-ser­vi­cing bur­den that gobbles up tax rev­en­ues and has the power to over­whelm elec­ted lead­ers.

More money is now spent on ser­vi­cing the national debt than on defence in the UK, France and the US; the same is true for more than a dozen states in the 38mem­ber OECD rich coun­tries’ club.

Their prob­lem is that bor­row­ing costs have climbed to the highest in almost two dec­ades just as gov­ern­ments are tak­ing on record debt.

The total owed by the US gov­ern­ment reached a record $40tn last month. This year, OECD nations are expec­ted to bor­row $18tn between them, another all-time high. In 2025, the group’s total debt-ser­vi­cing bill exceeded $2tn, or 3 per cent of GDP.

That num­ber is set to rise in the com­ing years because of the bond sell-off that has pushed up yields since the Covid-19 crisis, increas­ing the cost of debt for gov­ern­ments across the world.

“These massive sov­er­eign debts are hav­ing to get refin­anced at ever-increas­ing rates,” says Mike Rid­dell, a fund man­ager at Fidel­ity Inter­na­tional. “Global investors are already start­ing to get scared.”

The sum­mer rout in the global bond mar­ket has only aug­men­ted the post­Covid surge in yields triggered by infla­tion shocks, increased gov­ern­ment bor­row­ing and the end of cent­ral banks’ “quant­it­at­ive eas­ing” bond-buy­ing pro­grammes. The aver­age bench­mark 10year bond yield for G7 coun­tries has reached 4 per cent for the first time since 2008, amid con­cerns about the infla­tion­ary impact of the Iran war and the sheer amount of debt being sought by both the pub­lic and private sec­tors — par­tic­u­larly tech groups.

Some eco­nom­ists counter that US yields in par­tic­u­lar are being pushed up by improv­ing growth expect­a­tions, which imply that interest rates will not need to be as low in the future to sup­port the eco­nomy. If there were a step change in growth, it could be a get-out-of-jail­free card for many coun­tries, boost­ing tax receipts, mak­ing the stock of debt more man­age­able and redu­cing the trade-off between interest costs and other areas of spend­ing.

But at present the pan­or­ama looks very dif­fer­ent. For big indebted eco­nom­ies with low growth such as the UK and France, debt ser­vi­cing has already forced a reck­on­ing in the man­age­ment of the pub­lic fin­ances. For Bri­tain, a sharp rise in bond yields helped eject former prime min­is­ter Liz Truss from power in 2022 after an unfun­ded tax­cut­ting “mini” Budget. But yields are higher still now: the UK’s interest pay­ments are cur­rently £110bn a year. In turn, France has churned through three prime min­is­ters since par­lia­ment­ary elec­tions in 2024, partly because of fiscal pres­sures set off by the cost of debt.

In both coun­tries and in many oth­ers across the world, politi­cians face a fun­da­mental choice on whether to raise taxes or shrink the state to get them­selves out of the corner they find them­selves in. The sheer scale of debt-ser­vi­cing costs also makes it supremely dif­fi­cult for coun­tries to raise spend­ing for stra­tegic pri­or­it­ies such as national defence and energy secur­ity.

“If debt interest were a gov­ern­ment depart­ment, it would be the second biggest in White­hall after health, big­ger than defence, the Home Office and justice put together,” John Healey, Bri­tain’s new chan­cel­lor of the exchequer, said yes­ter­day. “There’s noth­ing pro­gress­ive about the gov­ern­ment spend­ing £1 in every 10 [pounds] on debt interest.”

Why yields are going up

Up until the 2008 global fin­an­cial crisis, interest rates were rel­at­ively high for major eco­nom­ies, but levels of debt were gen­er­ally much lower. After that, debt surged but interest rates were kept lower by emer­gency meas­ures taken by cent­ral banks as well as low eco­nomic growth. Now, by con­trast, poli­cy­makers face an unen­vi­able com­bin­a­tion: record debt and high bor­row­ing costs.

While gov­ern­ments are still find­ing enough buy­ers for their debt, investors are demand­ing a higher price for their money. New bond sales in recent months for the UK, the US and oth­ers have locked in the highest yields in almost two dec­ades for longer-dated debt. This shift has been accel­er­ated by changes to pen­sion schemes in some coun­tries that have meant tra­di­tional long-term buy­ers step­ping back, replaced by fast-money hedge funds that can be quick to demand higher yields.

“The era of free money is def­in­itely over,” says Kim Craw­ford, a global fixed income man­ager at JPMor­gan Asset Man­age­ment. “The bond mar­ket is [now] look­ing for dis­cip­line.”

The nature of gov­ern­ment debt mar­kets, in which gov­ern­ments fund them­selves with debt that is repaid at a wide range of dur­a­tions, some com­ing due dec­ades into the future, means that the trans­mis­sion of higher bor­row­ing costs into higher interest costs occurs gradu­ally over time.

But the dir­ec­tion of travel seems clear. The US’s Con­gres­sional Budget Office estim­ates that Amer­ica’s debt costs will double over the next dec­ade and, on the cur­rent tra­ject­ory, exceed Social Secur­ity spend­ing after 2047. The bur­den for other coun­tries — which typ­ic­ally find it harder than the US to con­vince investors to buy their bonds on favour­able terms — is likely to be higher still.

The causes of the prob­lems with pub­lic fin­ances are deep-rooted and lon­grun­ning. They include a surge in spend­ing to battle the Covid-induced slump and energy crises, as well as broader fiscal chal­lenges since the fin­an­cial crisis brought down rates of growth.

Global pub­lic debt hit 94 per cent of world GDP last year, up more than 10 per­cent­age points since the year before the pan­demic. The IMF now believes it will reach 100 per cent by the end of this dec­ade. This sum­mer’s bond sell-off has aggrav­ated the prob­lem. Infla­tion­ary pres­sures stoked by the Iran war, ini­tially in energy prices, have forced cent­ral banks to pivot towards rate increases. The European Cent­ral Bank raised rates in June for the first time since 2023, and is expec­ted to do so again this week, while Fed­eral Reserve chair Kevin Warsh has begun to tee up an increase as soon as this month.

Some investors argue the uncer­tainty over infla­tion is feed­ing into higher long-term rates, with the mar­ket demand­ing more to lend to a gov­ern­ment over the long term. Oth­ers think that the higher yields are more a reflec­tion of wor­ries over grow­ing debt sup­ply, both from gov­ern­ments but increas­ingly from the cor­por­ate sec­tor.

The stock of com­bined gov­ern­ment and cor­por­ate debt glob­ally is approach­ing $300tn, accord­ing to the Insti­tute of Inter­na­tional Fin­ance, a think-tank.

Con­cerns about the lim­its of mar­kets’ will­ing­ness to fin­ance such a spec­tac­u­lar amount of debt come on top of investors’ wor­ries about developed gov­ern­ments’ unwill­ing­ness to rein in bor­row­ing. The US fiscal defi­cit, for example, is pro­jec­ted to remain above 7 per cent of GDP into the 2030s, accord­ing to the IMF, des­pite the coun­try’s rel­at­ively steady growth and an unem­ploy­ment rate of just 4.1 per cent today.

Polit­ical volat­il­ity has already led to higher debt interest costs than would have been paid oth­er­wise, some investors argue, in what is some­times dubbed the “moron premium”. In Europe, polit­ical fra­gil­ity since 2022 has added €100bn to interest expenses for the UK, Italy, France, Spain and Bel­gium, estim­ates insurer Alli­anz. Part of the rise in yields this year could be investors demand­ing com­pens­a­tion for polit­ical ruc­tions to come.

Another factor unset­tling the bond mar­ket this year has been events in Japan, for a long time the anchor that helped to hold down global bor­row­ing costs due to its neg­at­ive interest rate regime and vora­cious demand for for­eign assets. Now, the coun­try’s cent­ral bank is increas­ing interest rates just as Prime Min­is­ter Sanae Takai­chi embraces stim­u­lat­ory gov­ern­ment spend­ing. As Tokyo’s bor­row­ing costs climb to levels not seen since the 1990s, investors are fret­ting that the higher yields at home will attract money back from other mar­kets, push­ing up costs else­where.

Doomed to a doom loop?

One big worry for investors is that some coun­tries may be edging towards a vicious cycle in which rising debt costs make the fiscal out­look still worse.

In this “doom loop” scen­ario, the sheer scale of interest charges a gov­ern­ment has to pay under­mines the health of its fin­ances and pushes up its debt, caus­ing investors to push for higher yields that then drive up the cost of debt ser­vi­cing still fur­ther.

Unless lower interest rates or a surge of growth res­cue gov­ern­ment fin­ances, the only altern­at­ives are to increase tax rev­enue or cut spend­ing. But mar­kets are increas­ingly con­cerned that in many instances dif­fi­cult cuts are polit­ic­ally unachiev­able, whether it is a ques­tion of rein­ing in wel­fare expendit­ure in the UK or trim­ming over­all gov­ern­ment spend­ing in the US. Indeed, Pres­id­ent Don­ald Trump wants to increase the US defence budget to $1.5tn, the biggest rise since the second world war.

Politi­cians “don’t want to make these hard choices because they know if they do make these hard choices they are going to get kicked out at the next elec­tion”, says Neil Mehta, a port­fo­lio man­ager at RBC Blue­Bay Asset Man­age­ment. “I don’t know how this resolves itself.”

The anxi­ety sur­round­ing US indebted­ness is bleed­ing into global mar­kets and infect­ing any other sov­er­eign bor­row­ers seen as par­tic­u­larly fra­gile — among them other “serial offend­ers” such as Bri­tain, Italy and France, says David Rees, head of eco­nom­ics at asset man­ager Sch­roders. Some investors have this year dubbed the trio the “Bifs”, for their high debt loads and vul­ner­ab­il­ity to the energy shock.

While the dol­lar’s status as the world’s premier reserve asset means many investors have little option but to buy Treas­ur­ies, other coun­tries’ fin­ance min­is­ters may well have to do more than the US to get their fiscal houses in order.

“No one is expect­ing mir­acles” in terms of defi­cit reduc­tion, says Gilles Moëc, chief eco­nom­ist at insur­ance com­pany Axa. But coun­tries need to show they can get or keep the head­line defi­cit on a declin­ing path even if the US is unlikely to do so.

A key test in the UK will come next month with the first Budget since Andy Burnham became prime min­is­ter in July.

Higher debt costs, includ­ing from the UK’s large stock of infla­tion-linked bonds, are eat­ing up resources at a time when the gov­ern­ment faces pres­sure to improve pub­lic ser­vices and fund pledges to lift defence spend­ing.

That has triggered spec­u­la­tion that another round of tax increases will be required on top of big rev­enue-rais­ing Budgets in 2024 and 2025.

Bullish investors say Bri­tain, unlike some other coun­tries, has taken hard choices. Gross debt issu­ance is actu­ally down this fiscal year. But the UK’s bor­row­ing costs are the highest in the G7 and the coun­try’s spend­ing on debt interest is expec­ted to reach nearly 4 per cent of GDP by 2030-31, roughly double its share in the years run­ning up to the pan­demic.

France is facing sim­ilar pres­sure in fund­ing mar­kets, driv­ing the spread between its 10-year bor­row­ing costs and those of Ger­many’s ultra-safe debt — a key baro­meter of con­cern over Paris’s fin­ances — to about 0.9 per­cent­age points, close to its highest level since the after­math of the Euro­zone debt crisis.

Some Wall Street banks have down­graded their estim­ates for Paris’s pub­lic fin­ances. Mor­gan Stan­ley now thinks the coun­try’s fiscal defi­cit could hit 5.4 per cent of GDP this year, well above the gov­ern­ment’s 5 per cent tar­get.

Decis­ive action to rein in bor­row­ing remains dif­fi­cult at a time of ped­es­trian growth and the chal­lenge from the far-right Rassemble­ment National in the April 2027 pres­id­en­tial elec­tion.

Today’s politi­cians are being forced to make “dir­ect trade-offs between vitally import­ant areas of spend­ing and the debt interest bill”, says Car­mine Di Noia, dir­ector for fin­an­cial and enter­prise affairs at the OECD. “Your interest bill is dir­ectly con­strain­ing fiscal policy.”

Break­ing free

How do coun­tries escape from their debt cage? One option is so-called fin­an­cial repres­sion, meas­ures that com­pel domestic insti­tu­tions to buy more of their coun­try’s debt to sup­port demand and push down yields. A hap­pier out­come would be mean­ing­ful pro­ductiv­ity growth, driven by the AI revolu­tion, that would in turn make gov­ern­ments’ debt bur­dens much more man­age­able.

In the UK, the Office for Budget Respons­ib­il­ity, Bri­tain’s fiscal watch­dog, said recently that in a “high-pro­ductiv­ity scen­ario” for the coun­try’s eco­nomy, the debt bur­den as a pro­por­tion of GDP in 2075 would be just over half the baseline fore­cast, albeit still a daunt­ing 180 per cent.

Some are scep­tical the growth cav­alry will res­cue the rich world en masse from its budget dilem­mas. For what he calls “bas­ket cases” like the UK and France, RBC Blue­Bay’s Mehta says “the prob­lems with growth are more struc­tural . . . You do have to cut spend­ing.”

His­tory sug­gests gov­ern­ments will even­tu­ally do so. In a 2013 paper examin­ing the exper­i­ence of 55 coun­tries for up to two cen­tur­ies, IMF eco­nom­ists observed that “increases in the cost of sov­er­eign bor­row­ing prompt poli­cy­makers to tighten fiscal policy in response”. The UK has come back from big­ger bur­dens. Its debt pile reached a record high of about 250 per cent of GDP after the rav­ages of the second world war, but spend­ing restraint and eco­nomic growth helped by immig­ra­tion sent it tum­bling.

Another pos­sible course was taken by Canada in the 1990s, when the gov­ern­ment respon­ded to a gap­ing defi­cit with pain­ful spend­ing cuts. “If you pre­pare them well, people will under­stand,” Paul Mar­tin, the fin­ance min­is­ter at the time, later told the FT. “They will not stay with you unless they feel that the sac­ri­fice you’re ask­ing of them is going to suc­ceed.”

In the UK, some investors view tax rises as a bet­ter way to close the rev­enue gap, if the gov­ern­ment can avoid meas­ures that fuel infla­tion. But in many coun­tries, it will be polit­ic­ally costly in the extreme to cut spend­ing fur­ther, or pile more taxes on house­holds and busi­nesses strug­gling with the cost of liv­ing. “The prob­lem is that mar­kets don’t see a polit­ical will to make it work and to rein [debt] in,” says Tat­jana Greil-Castro, global head of invest­ments at Muzinich. “If you don’t rein it in, it will get worse and worse. [Then] it will have to end in a crisis.”