Central banks are no longer the only game in town. Fiscal policy is becoming an increasingly important driver of economic and financial market outcomes amid growing sovereign debt across the advanced and emerging world.

By Nikhil Sanghani 

Here are five fiscal themes to look out for throughout 2025.

Are the bond vigilantes returning?

Tax cuts are coming in the US. Yet, at this stage, the scale that will be passed by US president-elect Donald Trump’s administration is unknown. It’s likely to increase the federal budget deficit and push the federal public debt on an even higher trajectory – well into the triple digits as a share of gross domestic product over the coming years.

Investors are wary. Partly due to the US fiscal trajectory, the 10-year US Treasury bond yield has steadily risen to close to 4.70 percent. This is not a ‘Liz Truss’ moment of fiscal panic but there is a renewed risk that bond vigilantes will return in full force this year.

In the UK itself, the 10-year gilt yield has surpassed the level reached during former Prime Minister Liz Truss’s tenure in October 2022 to above 4.80 percent. This presents a headache for Chancellor Rachel Reeves who is trying to balance fiscal consolidation with a struggling economy. She may be forced to amend her half-baked fiscal plans to stick to the government’s fiscal rules or risk a further market backlash.

France faces a similar dilemma. The new, fractured government has struggled to pass a 2025 budget with the latest plans only outlining moderate fiscal consolation. In a recent speech, Banque de France Governor, François Villeroy de Galhau, outlined the need for ‘reducing budgetary and tax uncertainty, which is weighing on businesses and households’. However, it’s unclear whether there will be sustained political appetite for fiscal tightening, which could lead to further investor concerns.

Will Germany release the debt brake?

One country with fiscal room is Germany. The debt brake (‘Schuldenbremse’), which limits Germany’s structural deficits to 0.35 percent of GDP, has been a key fiscal anchor for the country. Its public debt-to-GDP ratio has dropped towards 60 percent, while other major European countries have seen it rise to over 100%. But amid stagnant growth and a broken economic model, there are growing calls for the government to loosen the purse strings.

There may be a tentative shift towards higher public spending this year. The conservative Christian Democratic Union’s Friedrich Merz is almost certain to win February’s election and has hinted that the debt brake may be loosened. But Merz is unlikely to open the floodgates for significant fiscal stimulus. In the meantime, Germany’s economy will remain in the doldrums – a topic OMFIF will explore with their finance ministry and central bank in February 2025.

Will China unleash a fiscal bazooka?

Another struggling economy with fiscal space is China. Its economic weakness prompted fresh policy stimulus in late 2024 – initially by monetary authorities and then via fiscal policy through a Rmb10tn ($1.4tn) package to allow local governments to restructure their debts. These efforts prompted a sharp turnaround in the Chinese equity market.

The authorities are gearing up for more fiscal stimulus in 2025 amid looming US tariffs and continuing structural headwinds. Vice Finance Minister Liao Min stated ‘the direction of fiscal policy in 2025 is clear, very proactive’ and that ‘we will provide strong support for economic and social development’. This may increasingly target households through subsidies for consumer goods. But China’s government remains cautious in unleashing a ‘bazooka’ such as direct handouts to consumers.

Can emerging markets escape debt troubles?

Most major EMs have weathered the various economic storms of the past five years and 2024 saw some positive news on the fiscal front. Argentina witnessed a sharp turnaround as President Javier Milei delivered a primary surplus in his first year. There was fresh optimism on South Africa as the new coalition government embarked on economic reforms, prompting S&P to improve its sovereign credit rating outlook. Elsewhere in Africa, Ghana and Zambia finalised their sovereign debt restructuring deals last year.

However, many economies are not yet out of the woods. As highlighted in OMFIF’s Absa Africa Financial Markets Index 2024, 18 of 29 countries covered are in, or at risk of, debt distress – as deemed by the International Monetary Fund. Rising global bond yields, a strong dollar and heightened geopolitical tensions are a toxic mix for many emerging and frontier economies. Meanwhile, major EMs such as Brazil, Mexico and Hungary face home-grown fiscal challenges.

Will governments embrace new solutions?

The proposed US Department of Government Efficiency may be one of Elon Musk’s new pet projects. However, it does shine a light on an important topic: how to improve the effectiveness of government spending. Solving this problem will ultimately allow governments to tackle their rising public debt while meeting the demands for greater public spending on areas such as defence, healthcare and pensions.

In a report jointly published with EY, ‘The future of public money’ highlighted the need for governments to embrace new frameworks, accounting standards and technology. Most policy-makers remain unaware or resistant to structural changes on these fronts. But as fiscal problems mount, policy-makers may be forced to embrace new innovations and solutions. The risk of inaction is rising.

Nikhil Sanghani (pictured) is the Managing Director, Economic and Monetary Policy Institute at OMFIF.