Why 2025’s High‑Rate World Exposes Two Very Different Vulnerability Maps

Global public debt has climbed back above 99 % of world GDP, nearly five percentage points higher than pre‑pandemic levels. As the “Great Disinflation” of 2022‑24 gives way to structurally higher real rates, servicing that debt is suddenly expensive again. Interest outlays already absorb 5 % of revenues in most advanced economies (AEs) and about 14 % in low‑income countries (LICs)—double the share 15 years ago.

Yet the map of distress is uneven. The United States flirts with technical default every time Congress approaches the debt ceiling, but investors still treat Treasuries as the world’s safest asset. Italy, with a debt ratio above 135 % of GDP, relies on the European Central Bank’s Transmission‑Protection Instrument (TPI) to keep spreads under control. Meanwhile, Sri Lanka and Argentina have experienced outright payment stops, and a second wave of emerging‑market restructurings (Ghana, Zambia, Pakistan) is working its way through the G‑20 Common Framework.

This article dissects those divergences in five sections: (1) the macro backdrop of a permanent rate shift; (2) deep‑dive case studies of the U.S. and Italy; (3) forensic autopsies of Sri Lanka, Argentina, Ghana and Pakistan; (4) contagion channels through markets, banks and capital flows; and (5) a theory toolbox drawing on Reinhart‑Rogoff “debt intolerance,” MMT, r‑minus‑g arithmetic, the bank‑sovereign nexus, and Minskyan fragility. The conclusion offers policy options for both groups. Throughout, we keep resolution high by drilling down to debt‑service ratios, maturity profiles, currency splits, and credit‑default‑swap pricing.

1. The Macro Backdrop: From “Low‑for‑Long” to “Higher‑for‑Even‑Longer”

1.1 Rates, Growth and the End of the r < g Era

In 2010‑20, most advanced states enjoyed negative or near‑zero real borrowing costs; global r‑minus‑g (the gap between the nominal interest rate and nominal GDP growth) averaged ‑2 pp. Today, that gap is +0.6 pp for AEs and +2.1 pp for emerging markets (EMs), driven by:

Sticky Inflation at 3‑4 % in the U.S. and 5‑7 % across EMs despite aggressive hiking.
A flatter long end: the U.S. 10‑year Treasury sits near 4.34 % (17 Apr 2025), up 280 bp from its 2021 trough.
De‑anchored term premium as central banks shrink balance sheets faster than anticipated.

The IMF’s April 2025 WEO warns that interest costs in AEs will rise 0.9 pp of GDP by 2027; in EMs the jump is 1.3 pp. Debt‑service pressure collides with slowing growth: global GDP is projected at 3.3 % in 2025, versus a 2000‑19 average of 3.7 %.

1.2 Interest‑to‑Revenue Ratios: The New Stress Thermometer

United States: Interest outlays will top US$1 trillion in FY 2025, nearly 19 % of projected federal revenue (US$5.2 trn).
Other AEs (ex‑US): Average ratio ≈ 5 %.
EMs: Median ≈ 10 %; frontier LICs near 14 %.

Those shares matter more for solvency than sheer debt‑to‑GDP, because they measure fiscal space directly. Minsky would call the U.S. “hedge‑finance” (can pay interest out of income), Italy “speculative” (depends on rolling over principal), and Sri Lanka “Ponzi” (needs new borrowing even to pay interest).

2. Advanced‑Economy Case Studies

2.1 United States: The Self‑Inflicted Risk‑Free Asset

Metric	2019	2024	2025f
Debt/GDP (public)	79 %	98 %	100 %
10‑yr yield	1.9 %	4.15 %	4.3‑4.5 %
Interest Outlays	$376 bn	$890 bn	$1 tn

Source: CBO, Treasury, Reuters.

Debt‑ceiling brinkmanship re‑emerges roughly every 18 months. Each episode elevates T‑bill yields, induces money‑market funds to reallocate to the Fed’s ON‑RRP, and triggers rating downgrades (S&P 2011, Fitch 2023). Yet the T‑bill–OIS spread normalises swiftly once Congress suspends the ceiling—evidence of “exorbitant privilege.”

Debt‑Sustainability Scenarios (CBO, Jan 2025): Debt held by the public reaches 118 % of GDP in 2035 if policy remains unchanged. CBO’s stochastic fan chart shows a two‑thirds probability of breaching 130 % by 2040.

Theoretical lenses:

MMT argues the U.S. can always create dollars to service debt; default is political, not financial.
Blanchard’s r < g logic no longer holds when real rates exceed growth—as is now the baseline.
Unpleasant Monetarist Arithmetic (Sargent‑Wallace) warns fiscal dominance could force the Fed to monetise deficits, rekindling inflation.

2.2 Italy: Structural Constraints Inside a Currency Union

Italy’s debt ratio edged up to 135.3 % of GDP in 2024, with Rome projecting 136.9 % for 2025. Growth stagnated at 0.7 % last year, making the denominator side of the ratio unhelpful.

Market rates: The 10‑year BTP yield fell from 3.83 % in February to 3.34 % (11 Apr 2025) after the ECB signalled a June rate cut. The risk premium over Bunds remains contained at 165 bp, thanks to:
- ECB’s TPI, which allows sterilised BTP purchases if spreads spike.
- A long weighted‑average maturity of 7.1 years.
- Home bias: 63 % of BTPs are held by Italian residents (banks, households).
Structural headwinds: productivity flat since 2000, ageing demographics (median age 48), and supersized tax credits (“Superbonus”) causing stock‑flow adjustments that add €20 bn to debt in 2025.

From a European Stability Mechanism perspective, Italy is solvent if r < g – p, where p is the primary surplus. With r ≈ 3.5 %, g ≈ 1 %, p needs to be ≥ 2.5 % of GDP forever—a heavy lift for any elected government.

2.3 Comparative Takeaways

Currency issuance: The U.S. issues the reserve currency; Italy does not control the euro.
Liquidity backstops: The Fed’s SOMA vs. the ECB’s TPI.
Market psychology: Treasuries enjoy negative convexity premium; BTPs not so much.

Yet both share a vulnerability: dependence on political cohesion. A debt‑ceiling misfire or an Italian coalition crisis could push yields up by 100–250 bp within days, as historical VARs show.

3. Emerging‑Market Stress Tests

3.1 Sri Lanka: Anatomy of Asia’s First Default in Two Decades

Trigger: Twin deficits (budget 9 % of GDP; current account 5 %) and collapsing tourism revenue (‑88 % in 2020‑21).
Default date: 12 April 2022, first missed coupon on a 2023 maturity.
Deal: Bondholders approved a 27‑28 % nominal haircut plus “macro‑linked” GDP bonds in Dec 2024 (97.9 % participation).
IMF EFF: US$2.9 bn; second review completed Jun 2024. Performance “strong.”

Innovations: “Governance‑linked” coupon step‑downs if tax‑to‑GDP rises above 15 %. Critics fear path‑dependency reminiscent of Argentina’s GDP‑warrants fiasco.

3.2 Argentina: Serial Defaults in a Dollarised Psychology

Latest distress event: March 2024 “distressed exchange” of US$55.3 bn in peso notes, deemed tantamount to default by S&P.
Inflation progress: Monthly CPI just 2.2 % (Jan 2025), annual down to 84.5 %.
IMF future: Milei seeks a bridging SBA to cover 2025 Fund obligations pending a larger EFF.

The peso is overvalued; net FX reserves negative; and the 2025 financing gap still US$25 bn. Debt composition remains 78 % in local currency but half indexed to inflation, creating quasi‑dollar liabilities.

3.3 Ghana: The Common Framework’s Mixed Grades

Ghana defaulted on US$30 bn of external debt in Dec 2022 and clinched an Official Creditor Committee MoU in Jun 2024; Eurobond holders (US$13 bn) accepted 30–42 % NPV haircuts in Oct 2024. IMF disbursed the second ECF tranche after Parliament passed a 2 pp VAT hike. But domestic debt costs jumped: T‑bill yields still 28 %.

3.4 Pakistan: The King of “Roll‑Over Risk”

Islamabad completed an IMF SBA in May 2024 but faces external funding needs > US$25 bn/year against reserves < US$9.5 bn. Interest + amortisation already swallow 60 % of federal revenue; any slip risks following Sri Lanka down the default path.

3.5 Quantifying EM Fragility

Indicator (2024)	High‑risk EM median	Pre‑crisis EM (2014)
FX‑denominated debt / GDP	43 %	28 %
Interest / revenue	10 %	6 %
Reserves / short‑term external debt	0.9×	1.4×
5‑yr CDS	730 bp	290 bp

4. Contagion Channels and Systemic Spillovers

4.1 Portfolio‑Flow Whiplash

The Institute of International Finance expects net capital inflows to EMs of US$903 bn in 2024, but only US$716 bn in 2025 as tariff wars resurface. November 2024 saw US$19.2 bn net inflows, masking a US$11 bn equity outflow chased by a US$30 bn bond surge—classic “dash for yield” behaviour.

Sudden‑stop risk is therefore bifurcated: countries with deep local‑currency bond markets (Mexico, India) hang on; those still in “original sin” (Kenya, Pakistan) see spreads gap‑out on every Fed repricing.

4.2 The Bank‑Sovereign Nexus

IMF research shows the share of sovereign bonds on domestic bank balance‑sheets has risen 4 pp in EMs since 2019. A sovereign mark‑down instantly erodes bank capital, prompting credit squeezes that feed back into public deficits—a doom loop witnessed in Sri Lanka’s 2022 meltdown.

4.3 FX and Commodity Shocks

Most EMs import energy; Brent’s rally to US$103/bbl in April 2025 (Russia‑Ukraine ceasefire breakdown) widens current‑account deficits just as the dollar hits a three‑year high, intensifying real‑effective‑exchange‑rate swings.

5. A Theory Toolbox for 2025

Reinhart & Rogoff’s “Debt Intolerance”: Countries with weak institutions default at debt loads AEs manage comfortably; Sri Lanka defaulted at 119 % of GDP while Japan sits near 250 %.
Original Sin 2.0 (Eichengreen‑Hausmann‑Panizza): EMs still struggle to borrow long‑term in domestic currency; local debt maturities average 3.2 years vs. 6.9 years for AEs.
Minsky’s Financial‑Instability Hypothesis: Prolonged low rates create fragile balance sheets; the 2020‑21 QE binge bred today’s rollover spikes.
Blanchard’s r < g Condition: Once r flips above g, debt stabilisation requires sustained primary surpluses. For Italy, with r – g ≈ 2.5 pp, the primary surplus must equal that gap × debt/GDP → about 3.4 % of GDP—politically taxing.
Modern Monetary Theory: Works only for monetary sovereigns with free‑floating currencies (U.S., Japan, U.K.); euro members and dollarised EMs cannot rely on it.
Game‑Theoretic Debt‑Ceiling Chicken: The U.S. Congress plays a repeated game with global markets; Nash equilibrium so far is “brinkmanship without default.”

6. Policy Recommendations

6.1 For Advanced Economies

Codify automatic debt‑ceiling suspension to remove tail‑risk premia from T‑bills.
Lengthen duration while curves are still relatively flat; every extra year of weighted maturity cuts rollover risk by 0.4 pp of GDP (IMF estimate).
Productivity reforms (digital public goods, immigration) to lift g back above r.

6.2 For Emerging Markets

Local‑currency bond‑market deepening via tax incentives for pension funds, benchmark yield curves, and transparent auction calendars.
State‑contingent instruments: GDP‑ or commodity‑linked bonds can share risk if well‑designed; Sri Lanka’s model will be the test case.
Regional reserve pools (e.g., Chiang Mai Initiative, African Monetary Fund) to complement the IMF and reduce dollar reliance.
Debt‑transparency standards to cap hidden bilateral lending and reduce “unknown unknowns” that spook investors.

6.3 Multilateral Agenda

Revamp the G‑20 Common Framework—time to include private creditors from day one and impose automatic stay on litigation during negotiations.
Green and SDG‑linked swaps: Creditors grant face‑value relief in exchange for verifiable climate or social spending, lowering both debt ratios and carbon footprints.
Central‑bank swap lines expansion: A modest enlargement of the Fed’s FIMA repo facility reduced EM stress in 2020; making it permanent would dampen sudden stops.

Conclusion: Diverging Roads, Shared Storm Clouds

The sovereign‑debt landscape of 2025 is Janus‑faced. Advanced economies confront self‑imposed political hazards; emerging and frontier markets battle hard budget constraints amplified by FX risk and exogenous shocks. Yet both are caught in the same structural vise: ageing populations, lukewarm productivity, and the end of cheap money. Policy credibility—whether it is the U.S. Congress proving it can pay its bills or Sri Lanka meeting governance triggers—remains the ultimate firewall. In that sense, default is as much about politics as macroeconomics. The world may tolerate differing debt levels, but it is increasingly intolerant of fiscal opacity and institutional drift.

If 2024 was a year of “selective defaults,” 2025 could mark a fork in the road: either a return to cooperative workouts and credible fiscal anchors, or a slide into fragmented capital markets where risk premia soar on every tweet, tariff, or parliamentary vote. The choice will define the global cost of capital—and with it, the trajectory of sustainable growth—for the rest of the decade.

Sovereign Debt Risks in Advanced vs. Emerging Markets