The coming battle between world leaders and bond vigilantes

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The writer is chair of Rockefeller International

An epic clash is brewing in 2024. In a boom year for elections, with national contests from the US to India, incumbents seeking another term will be tempted as always to ramp up public spending before the vote. That puts them on course to collide with the global bond vigilantes who, reawakened from a long slumber by the new era of high interest rates, will be quick to punish profligate politicians.

As I noted early this year, ballots in more than 30 nations will offer a say to two out of every three adults in the democratic world — a record year of voting since data collection began in the early 1960s. This historic pageant of democracy will be an occasion for parties to indulge in their usual tactic of pre-election spending splurges. But if the money flows too freely, the newly alert vigilantes will show up to spoil the fun, selling off the nation’s bonds and currency. Many governments, having run up massive debts during the pandemic, are particularly vulnerable to these attacks now.

Battles are most likely in nations where leaders are under the heaviest pressure to increase spending, because their own popularity is so low. The rub: that is most countries. I track polls in 10 developed and 10 developing countries; approval ratings have fallen over the past year in three out of four, and the median rating is now just 45 per cent in developing countries, and a near-record low 36 per cent for the 10 developed countries.

Bond vigilantes, usually triggered by inflation, will also be quick to act in countries where a free-spending leader is making a bad fiscal situation worse. Six leaders face a 2024 election in countries where the deficit has been rising steadily and is now in what many bond investors would consider a danger zone — above 5 per cent of gross domestic product. They range from India and Bangladesh to South Africa and the US, where the deficit has nearly doubled from its pre-pandemic trend to around 6 per cent of GDP, the largest deficit among major developed countries.

South Africa is also at high risk. It has an unpopular candidate for re-election managing a widening deficit, and a large share of government bonds — 25 per cent — owned by foreigners. Facing power outages and rising inflation, president Cyril Ramaphosa’s approval rating slumped nearly 10 points in the last year to just over 40 per cent, and the country’s deficit has tripled since the 2000s to more than 5 per cent. Recent steps to restrain spending have also shifted it to targets likely to please voters, such as higher public wages, and public debt is still growing.

India’s risks are partially offset by the fact that it has a higher economic growth rate and showed fiscal restraint through the pandemic. But many state leaders have of late been engaging in a game of competitive populism. If prime minister Narendra Modi’s party suffers setbacks in this month’s state polls, then he too may feel compelled to step up spending on popular schemes.

Meanwhile, Mexico’s deficit is rising rapidly towards 5 per cent of GDP, the highest since the 1990s, and the popular president, Andrés Manuel López Obrador, is passing on the problem to an untested successor. While several frontier economies from Ghana to Sri Lanka have been forced over the past couple of years to cut spending as they faced bankruptcy, their leaders will find it increasingly hard to stay the course in an election year.

No country is immune. Going back to at least 1960, research shows, leaders have often raised spending or cut taxes to improve their re-election prospects. In recent decades, they tended to get away with it. Borrowing costs were so cheap through the 2010s that bond investors looked the other way, except in extreme cases like Argentina.

That changed in 2022 with the return of inflation and higher rates. Since then, the vigilantes have targeted nations all over the world. They helped force UK prime minister Liz Truss out of office, by selling off the UK’s bonds and currency in response to a budget-busting tax scheme. They compelled two old populist warhorses, Recep Tayyip Erdoğan of Turkey and Luiz Inácio Lula da Silva of Brazil, to embrace fiscal restraint. Erdoğan shelved bizarrely unorthodox policies and appointed financial market veterans to restore investor confidence. 

Notice the pattern. Financial markets are now so large, dwarfing any national economy, that the vigilantes usually prevail. Leaders take them on at their own risk. In the US, where complacency is high and many seem to think the global investors will never tire of buying American debt, it’s worth pondering the fate of the losers. Brazil, Turkey and the UK changed their wayward ways under vigilante pressure and are so far better for it. Taking on the bond vigilantes is mostly a losing battle but that won’t stop many politicians from trying.