War Shock Requires Disciplined Fiscal Reaction – Analysis

The war in the Middle East is putting pressure on people, firms, and countries at a moment when public finances are already strained by long-term issues. Higher energy and food prices, tighter financial conditions, and greater uncertainty are once again prompting calls for fiscal support.

In shaping their responses to this shock, countries will need to carefully consider the balance between protecting the most vulnerable and preserving market price signals. The latest Fiscal Monitor argues that, with debt already elevated in many countries, fiscal policy must respond cautiously—providing support where needed without pushing public finances closer to the brink.

Weak starting position

Before the war, public finances were already stretched. The pandemic, the 2022 energy and food price shock, and rising trade disruptions left governments with higher debt, weaker buffers, and delayed adjustment.

Even when economies recovered, fiscal positions did not. Global growth was robust in 2025, yet there was no meaningful progress in repairing budgets. In many countries, deficits stayed high, debt kept rising, and interest bills grew rapidly.

The numbers are stark. The global fiscal deficit remained at 5 percent of gross domestic product in 2025. Gross public debt rose to 94 percent of GDP and is projected to reach 100 percent by 2029—one year earlier than expected just a year ago. Public finances in many countries are weaker than before the pandemic. Interest spending has climbed rapidly, from 2 to nearly 3 percent of GDP in only four years. At the same time, the gap between countries’ medium-term fiscal plans and what would be needed to stabilize debt globally has widened.

Structural challenges

The nature of today’s fiscal challenges has shifted. Weaknesses are no longer mainly cyclical or the result of temporary emergencies, but are structural: security spending, climate and energy transition costs, and rising interest bills are placing persistent demands on budgets, while revenues have not kept pace.

In this environment, every choice on revenue and spending has more lasting consequences. Waiting for growth alone to do the work is a very risky proposition. When pressures are structural, delaying consolidation does not buy time. It instead narrows options and raises risks.

Risks abound

Our reference forecast assumes that the war’s disruptions would ease by mid-2026. But that assumption is uncertain.

To assess the implications, the Fiscal Monitor considers a severe scenario from the World Economic Outlook in which oil prices stay 100 percent higher than projected in 2027, inflation pressures reemerge, and financing conditions tighten. Under these conditions, global debt-at-risk—defined as the 95th percentile of the projected debt distribution three years ahead, capturing a plausible extreme outcome—would exceed 120 percent of GDP, up from 117 percent in the WEO reference scenario, with the increase concentrated in emerging market and developing economies.

Beyond this conflict, other risks loom large. Fragmentation in trade and finance can lower growth and raise financing costs. Political instability can weaken reform and revenue collection. And abrupt repricing in markets, including in now dominant AI stocks, could tighten financial conditions quickly. At the same time, as central banks are unwinding their balance sheets, governments must rely more heavily on private investors to absorb growing debt issuance, making borrowing costs more sensitive to shifts in market sentiment.

Disciplined policy response

Fiscal discipline means choosing policies that protect stability today without undermining it tomorrow.

If governments decide to help companies and families facing higher energy or food costs, this support should be targeted and temporary, focusing on those most exposed and least able to absorb price increases. Many countries built effective social safety nets during the pandemic; these mechanisms can—and should—be used again.

Countries with narrow fiscal space should avoid financing support measures with additional borrowing. A better approach is to reallocate spending within the same limits and prioritize crisis-related spending (which could be more politically feasible). The alternative is to lock in higher debt and higher interest costs, which will eventually force tougher choices—or worse, destabilize government debt markets and worsen conditions today.

Fiscal and monetary policies should be tightly coordinated. Emergency spending shouldn’t create new aggregate demand, so that support measures don’t undermine central banks’ efforts to contain inflation.

Also, broad measures such as fuel subsidies, while politically appealing, are costly, poorly targeted, difficult to reverse, and encourage higher consumption when supply is constrained—pushing global prices even higher.

Short-term shocks must not distract from the larger task at hand. Restoring fiscal resilience requires credible medium-term consolidation. This means concrete measures and realistic sequencing, not distant or shifting targets. Spending pressures need to be confronted directly, inefficiencies reduced, and competing demands reconciled. On the revenue side, broadening tax bases, streamlining exemptions, and strengthening tax administration can raise revenues even in constrained settings.

The challenges are serious, but the tools are available. Well-designed fiscal frameworks, greater transparency, and clear communication of trade-offs can help governments build the public support needed for durable reform. Acting early and decisively will be critical to preserving stability in a world of recurring shocks and elevated debt.

—This article is based on the April 2026 Fiscal Monitor, “Fiscal Policy under Pressure: High Debt, Rising Risks.” 

About the authors:

• Krzysztof Bańkowski is an Economist in the Fiscal Affairs Department of the IMF. Previously, he worked for more than a decade at the European Central Bank. His work encompasses a broad range of policy and analytical issues, with a focus on developing and applying DSGE and semi-structural models to evaluate key fiscal policy questions.
• Natasha Che is a senior Economist in the Fiscal Policy & Surveillance Division of the IMF’s Fiscal Affairs Department. Before joining FAD, she worked in the Regional Studies Division of the Asia & Pacific Department and was the main desk economist for Cambodia and Brunei. Her research interests include machine learning and AI applications in economics, macroeconomic forecasting, trade, economic growth and structural change. 
• Era Dabla-Norris is a Deputy Director in the IMF’s Fiscal Affairs Department, where she leads the work on the IMF flagship report, the Fiscal Monitor and the work on Fiscal Policy and AI. Previously she was in the Asia Pacific Department as mission chief for Vietnam, where she also led the work on fiscal and productivity issues in the region. 
• Rodrigo Valdés, a national of Chile, assumed the role of Director of the Fiscal Affairs Department (FAD) at the end of October 2025. Prior to this, he was a Director of Western Hemisphere Department

Source: This article was published at IMF Blog