Why high government debt need not cause immediate concern

By Joe Aylott, Multi-Asset Strategist, Coutts

• High government debt reflects a structural shift in leverage from private sector balance sheets to the public sector.
• Stronger household and corporate balance sheets have helped the economy absorb shocks, with companies largely meeting loan repayments even during periods of stress.
• Rising government debt may place upward pressure on bond yields and lead to periodic volatility – a key reason why we diversify our investments through a range of strategies.

As populations age and societies become more complex, the cost of governing has risen sharply. The fiscal fallout from the Covid-19 pandemic and significant energy supply disruptions since have added further strain, propelling public debt levels to new heights.

Within the G7, government debt‑to‑gross domestic product (GDP) ranges from 64% in Germany to 237% in Japan, with six of the seven economies sitting above 100%, according to the International Monetary Fund (IMF).

These figures highlight that there is no easy political or economic solution to high government debt. Raising taxes risks slowing economic growth and alienating voters, while cutting spending is equally unpalatable. Financial ‘repression’ – where governments keep interest rates artificially low to reduce their debt burden – is also far from ideal as it undermines savers by eroding the real value of their money.

Yet despite these challenges, economies have shown resilience. The global economy entered an expansion phase this year, supported by stronger‑than‑expected corporate activity. Even with current geopolitical pressures, the IMF forecasts global real GDP growth of around 3.1% in 2026.

Private investigations reveal regime shift

A key reason for today’s economic resilience is that, while governments have accumulated large amounts of debt, the private sector is far less leveraged than in the past. In the US, for example, household debt has fallen from around 100% of income in 2009 to 71% today, according to the IMF. Total private sector debt has also declined, from 236% of GDP in 2008 to about 217%.

Over the past two decades, leverage has largely shifted from private sector balance sheets to those of governments, rather than reflecting an unchecked build‑up of debt across the economy.

This distinction matters. Healthier household and corporate balance sheets support consumer spending and business investment, providing a firmer foundation for corporate earnings. They have also fundamentally changed how shocks — such as geopolitical disruptions — are transmitted through the economy.

Historically, downturns were accompanied by sharp rises in the proportion of firms falling behind on bank loan repayments. In the US, this rose from around 2-3% in the early 2000s to more than 7% during the Global Financial Crisis, according to the US Federal Reserve. These surges in credit stress amplified recessions, forcing companies to de‑leverage aggressively and cut jobs, reinforcing weakness in demand.

By contrast, over the past decade these ‘delinquency rates’ have remained close to historical lows, with broadly around 1-1.5% of firms falling behind. This has persisted even through major shocks, including the Covid‑19 pandemic and the most aggressive interest‑rate hiking cycle in decades.

The result is a more resilient corporate sector in which the traditional feedback loop between credit stress and economic activity has weakened. Rising government debt reflects the increasing role of fiscal policy in absorbing shocks that would previously have led to private sector de‑leveraging. Economic cycles have not disappeared – they have evolved.

The implication is a fundamentally different macroeconomic regime: fewer acute, credit‑driven downturns but greater long‑term sensitivity to fiscal sustainability and policy constraints.

It remains unclear whether this shift is cyclical or structural. Early investment in artificial intelligence was largely funded from cash flow, but recent months suggest a growing reliance on debt financing. Corporate leverage remains modest for now but, if this trend continues, the traditional transmission mechanism from credit markets to the real economy may reassert itself.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

What does this mean for bonds?

The compensation investors demand for committing capital to longer‑dated government bonds – the ‘term premium’ – has risen in recent years. This reflects concerns around debt sustainability. As a result of this, and higher base interest rates, US and UK government bond yields have fluctuated between a narrow range of 4-5% for around three years now.

Given demographic pressures, government debt trajectories are unlikely to change meaningfully in the near term. This raises the possibility of further upward pressure on yields, which could introduce periodic volatility into government bond markets.

History shows markets occasionally challenge governments perceived as borrowing too freely or lacking credible fiscal plans. We saw episodes of this across several major bond markets during 2025, most notably in France (see chart below).

Higher yields would mechanically lower bond prices and weigh on returns. However, today’s relatively attractive yields mean bonds are currently generating a meaningful income stream. This could help cushion portfolios should prices come under more intense pressure in future.

Our investment view

We are underweight government bonds relative to equities, given our views on their presently reduced diversification qualities. They have proved less reliable in offsetting risks such as geopolitical shocks or sudden shifts in fiscal policy.

We therefore diversify beyond traditional assets. Alongside bonds, in some of our portfolios we hold  liquid alternatives that employ a range of return‑seeking strategies. We also maintain an allocation to gold, which underperformed in March but historically tends to do well during economic shocks.

That said, sovereign bonds remain a portfolio diversifier for us, particularly against recession risk. While today’s environment is expansionary, conditions can change, and high‑quality government debt could help cushion downturns.