Sovereign Debt and Monetary Normalization: The Wide Gap in Advanced Economies

Japan's net debt will reach 122.8% of GDP in 2031, Italy's will peak at 126.7%, and France's at 112.6%, according to institutional projections. Yet, the Bank of Japan raised its key interest rate to 1.25% without managing to support the yen, exposing a major contradiction: rates are no longer enough to discipline sovereign debts in a world where potential growth remains low.

Key Points

Yen drops despite rate hike: The Bank of Japan raised its key interest rate to 1.25%, a first in decades, but the Japanese currency did not maintain its valuation against the dollar. This weak reaction revives the debate on the strength of US rates and the persistence of yield differentials. The market is testing the credibility of Japanese monetary normalization.

Short-term Treasury bonds become investors' favorite bet: These instruments are perceived as a way to bet on the Federal Reserve's ability to control inflation. This positioning reflects an anticipation of price stabilization, but also a distrust of the long end of the curve, exposed to budget deficits.

France is permanently settling into debt peaks: With net debt projected at 112.6% of GDP in 2031, Paris joins the club of the most indebted advanced economies, alongside Japan and Italy. This trajectory contrasts with that of Germany, whose net debt is expected to be limited to 60.7% of GDP, and South Korea, at 12.9%.

Mexico wants to develop its capital market: To finance its long-term growth and innovation, the country seeks to move beyond traditional financing methods. This strategy requires collaboration between authorities and market players, in a context where Mexico's nominal GDP is expected to reach $2,548.6 billion in 2030.

Turkey shows low net debt but rapidly rising nominal GDP: With net debt of only 23.0% of GDP in 2031 and a nominal GDP projected at $1,933.8 billion in 2030, Turkey presents an atypical profile among major emerging economies. This combination could offer it fiscal leeway, provided it controls its inflation.

Context

The 2008 financial crisis had already caused public debts in advanced economies to explode. The 2020 pandemic amplified the movement, with massive stimulus plans financed by the issuance of sovereign bonds. Since 2022, the rise in central bank key interest rates has increased the cost of this debt stock, without reducing primary deficits. Japan, a precursor of unconventional monetary policies, is now attempting a timid exit from yield curve control, while the United States and Europe face record financing needs. In this context, bond markets are becoming the scene of a tug-of-war between states and investors.

Key Players

Central banks, first. The Federal Reserve, the European Central Bank, and the Bank of Japan are pursuing divergent monetary policies. The Fed, whose key rates remain high, attracts global capital, which penalizes low-yielding currencies like the yen. The ECB, for its part, must contend with debt differentials within the euro zone: Italy and France are a concern, Germany is reassuring.

Institutional investors, next. Large asset managers, including Pimco, Apollo, and Goldman Sachs, arbitrate between short and long duration, between emerging and sovereign debt. Their choices determine the financing conditions for states. Qatar, through its sovereign wealth fund, and players like Brookfield or Citi, play a growing role in financing infrastructure and capital markets.

Emerging states, finally. Mexico, Turkey, Indonesia, and Nigeria seek to attract capital to finance their development. Nigeria, with a nominal GDP projected at $464.8 billion in 2030, and Kenya, at $183.6 billion, must contend with fragile banking systems, as illustrated by the issue of deposit insurance.

Data and Figures

Net debt projections for 2031 reveal a clear divide among advanced economies. Japan (122.8% of GDP) and Italy (126.7%) top the list, followed by France (112.6%) and the United States (115.4%). Conversely, South Korea (12.9%), Saudi Arabia (34.6%), and Turkey (23.0%) show much lower net debt levels. Germany (60.7%) and the United Kingdom (94.5%) are in an intermediate zone.

These disparities reflect divergent fiscal trajectories. France, with net debt exceeding 110% of GDP, is approaching Japanese and Italian levels, while Germany maintains relative fiscal discipline. Mexico (55.6%), Indonesia (40.7%), and South Africa (81.5%) present more varied profiles, with vulnerabilities related to the composition of their debt.

Nominal GDP projections for 2030 confirm the weight of major economies. Japan is expected to reach $5,002.2 billion, Indonesia $2,081.9 billion, Mexico $2,548.6 billion, and Turkey $1,933.8 billion. Nigeria ($464.8 billion), Kenya ($183.6 billion), and Morocco ($263.2 billion) remain intermediate-sized economies, but their demographic dynamics and infrastructure needs make them strategic markets.

Recent alerts on renewable energy production in France, with production rates exceeding thresholds in several regions (Brittany, Burgundy, Hauts-de-France, Auvergne-Rhône-Alpes), suggest an energy transition that could reduce dependence on hydrocarbon imports, but also create new investment constraints.

Analysis of Challenges

In the short term (1-6 months), the central question is the credibility of central banks. If the Fed maintains high rates, the dollar will remain strong, penalizing emerging economies indebted in dollars. The yen could continue to weaken, forcing the Bank of Japan to intervene or accelerate rate hikes, at the risk of further weakening Japanese public debt. In Europe, interest rate spreads between Germany and Italy or France could widen if markets doubt the fiscal trajectory.

In the medium term (1-3 years), the sustainability of sovereign debts will depend on growth. However, nominal GDP projections for 2030 show differentiated paces: Indonesia and Mexico are expected to grow faster than Japan or Italy. Countries that succeed in reducing their debt ratio without excessive austerity will be those that stimulate innovation and productivity. Mexico, with its capital market development strategy, is trying to create a virtuous circle. Turkey, despite low net debt, must control chronic inflation to attract stable investments.

Losers are states whose debt is denominated in foreign currency and whose tax revenues are vulnerable to shocks. Winners are those with fiscal leeway, such as Saudi Arabia or South Korea, who can finance their energy and digital transition without excessive reliance on markets.

Forward-looking Assumptions

Scenario 1: Successful monetary normalization (probability 40%). The Fed controls inflation, long-term rates stabilize, the yen recovers moderately, and sovereign debts remain sustainable. Conditions: no major inflationary shock, global growth above 3%, international monetary cooperation. Indicators to watch: interest rate spreads, US core inflation, Bank of Japan interventions.

Scenario 2: Debt crisis in an advanced country (probability 25%). A country like Italy or France sees its spreads soar, forcing the ECB to intervene or create a new instrument. Conditions: sovereign rating downgrade, political deadlock on the budget, financial contagion. Indicators: yield spread between Germany and Italy, agency ratings, capital flows.

Scenario 3: Decoupling of emerging markets (probability 35%). Emerging countries that reform their capital markets, such as Mexico or Indonesia, attract record foreign direct investment, while advanced economies stagnate. Conditions: political stability, structural reforms, improved business climate. Indicators: net capital flows to emerging markets, local currency bond issues, private credit growth.

Why it matters

The trajectory of sovereign debt and monetary normalization determine the cost of credit for households, businesses, and states. A debt crisis in a major advanced economy would have immediate repercussions on mortgage rates, retirement portfolios, and public budgets. Conversely, successful normalization management could restore confidence and free up capital for the energy transition and innovation. The question is not whether debts are high, but whether political and monetary institutions can coordinate their actions to avoid a brutal adjustment. The coming months will be decisive: markets are already testing the credibility of central banks. And what if the yen is the canary in the coal mine?