Economic shock from Iran war risks driving up global debt levels, says IMF

The Iran war risks triggering a rise in global debt levels, forcing governments to choose between cushioning a cost of living shock and maintaining sound public finances, the International Monetary Fund has warned.

Against a volatile backdrop of the Middle East conflict, the Washington-based fund said the war could add to the already strained position of government finances throughout the world.

In its half-yearly fiscal monitor, the IMF said global debt levels were on track to increase because the war was pushing up the price of energy and food, fuelling higher government borrowing costs, and hitting economic growth.

After a rise in gross government debt levels to almost 94% of GDP last year, it warned this figure was on track to reach 100% by 2029, a level previously reached only in the aftermath of the second world war.

“The outbreak of war in the Middle East has added a new source of fiscal pressure to an already strained global landscape,” it said in the report.

“The conflict has material global reach, disrupting energy supplies, tightening financial conditions, and forcing governments to choose between shielding their populations from price spikes and preserving fiscal space.”

Global energy prices have surged since the first US-Israeli airstrikes on Iran on 28 February, risking a renewed inflation shock that has fuelled a sell-off in global debt markets – driving up borrowing costs for governments worldwide.

The IMF said on Tuesday that a further escalation of the conflict could trigger a global recession that would affect the UK more than any other G7 nation.

As finance ministers from around the world gather in Washington for the fund’s spring meetings, including the UK chancellor, Rachel Reeves, the IMF said any energy support schemes to shield the impact for households and businesses should be targeted and temporary.

Highlighting the risk to public finances worldwide after a succession of economic shocks had driven global debt levels higher in the past two decades, it said: “Support should be targeted and temporary, focusing on those most exposed and least able to absorb price increases.”

It also warned countries with precarious public finances against using further borrowing to cushion the blow. “A better approach is to reallocate spending within the same limits and prioritise crisis-related spending (which could be more politically feasible).

“The alternative is to lock in higher debt and higher interest costs, which will eventually force tougher choices – or worse, destabilise government debt markets and worsen conditions today.”

Warning that governments adding to borrowing could risk losing confidence in financial markets, the fund highlighted the fallout in the UK from Liz Truss’s 2022 mini budget.

“Episodes of market repricing in Japan, the US, and parts of Europe reflect heightened sensitivity to fiscal slippages and weak medium-term frameworks,” the IMF said.

“Although none have matched the scale of the United Kingdom’s 2022 episode, the message is clear: higher debt, fiscal uncertainty, and delayed consolidation now translate more rapidly into higher borrowing costs.”