Defence-spending boom: IMF warns govts against economic imbalance

Suggests governments should be prepared to mitigate economic losses during war

The International Monetary Fund’s (IMF) World Economic Outlook in April spotlights the rise in global defence spending amid ongoing conflicts — including the United States (US)-Israel war against Iran, which is currently in a two-week ceasefire. However, the situation remains tense with initial peace talks failing. 

 

According to the ‘World Economic Outlook in the Shadow of War’, defence spending could go up further owing to geopolitical uncertainties, after already having risen to record levels since the Cold war (that ended in 1991). The IMF cautions governments against economic imbalance in the event of a defence-spending boom. 

 

This is relevant to India, the most populous developing country and among the world’s top five defence spenders and importers. India currently spends below 2 per cent of its gross domestic product (GDP) — over $4 trillion — on defence. It is the world’s fourth-largest economy but ranks among the lowest in personal income. India’s social realities are different from advanced economies and it faces significant strategic challenges in its immediate neighbourhood. 

 

After decades of declining global defence spending, rising geopolitical risks and more frequent military conflicts are pushing countries towards an inflection point, with several ramping up defence spending, the report says. As the reversal is happening at a time of already elevated spending pressures, policymakers face tradeoffs when spending more on defence. It warns defence-spending booms often weaken fiscal and external balances.

 

“Booms occurring in wartime are followed by sharp increases in public debt and large reductions in social spending, the standard ‘guns-versus-butter’ tradeoff. In contrast, peacetime booms tend to raise output without worsening debt or crowding out social spending. On the external side, stronger imports, the result of increased demand and in part of the purchase of foreign military equipment, worsen the current account,” the report said. 

 

The macroeconomic impact of the present defence buildup might differ from the past, as defence outlays are increasingly capital- and research-intensive and occur in economies that are more integrated but also more indebted. 

 

The report’s analysis of a sample of 164 countries since the end of World War II (1945) shows that governments have frequently engaged in sizeable spending booms, mostly financed through borrowing. Operating as a sector-specific demand shock, defence buildups during peacetime raise output and prices in the short term, especially when the increase in defence spending is permanent, and they can also raise medium-term growth through higher capital stock and possibly productivity gains. 

 

The report asks policymakers to consider some measures: Integrating defence buildup within credible medium-term fiscal frameworks; “carefully managing” macroeconomic conditions to prevent overheating and friction costs; and smoothing the pace of buildup to help mitigate bottlenecks, especially for large reallocations across sectors.

 

Current spending produces “larger short-term multipliers”, whereas capital spending, if it is directed at research-and-development outlays that does not crowd out nondefence productive investment, can support productivity over the longer term, it says. The mix is dictated mostly by security needs, countries should internalise macroeconomic constraints and recognise that scaling up defence investment typically requires a large upfront commitment and sustained spending, making it fiscally more demanding than increases in current outlays, according to the report. 

 

India spends between 5 per cent and 6 per cent of its defence budget (~7.85 trillion in FY27) on research and development. Experts have said that is not commensurate with the country’s military profile.

 

Colonel Rajneesh Singh (retired), research fellow, Manohar Parrikar Institute for Defence Studies and Analyses, a New Delhi-based think tank, said that India has traditionally had a prudent policy on defence spending but governments have displayed their intentions to increase the budget when necessary. 

 

India’s defence budget was 1.6 per cent of the GDP in 2019 but began to rise after the Galwan River valley clash with China in 2020. 

 

“Today, we are focussed on exporting defence goods made in the country to keep the revenues flowing while simultaneously we are trying to reduce or limit our imports of defence items through a policy of self-reliance in defence manufacturing.”

 

This is important, especially when aiming to balance defence with other essential spending, Singh said. But India must invest in strengthening its defence-industrial base sooner than later, he added. 

Preparing for the worst

 

• From 2020 to 2024, half of the countries increased their defence budgets 
• By 2024, 40 per cent of the countries allocated more than 2 per cent of their GDP to defence — in 2018, only 27 per cent did 
• Arms sales by the world’s 100 largest arms firms have doubled over the past 20 yrs 
• In 2025, Nato member countries committed to raise their annual defence spending to 5 per cent of GDP by 2035, from a previous 2 per cent 

 

Sources: IMF and Sipri