Rising government borrowing costs have overtaken defense budgets across most of the Group of Seven advanced economies, according to credit rating agency Scope Ratings, a shift that highlights the growing fiscal squeeze facing major Western governments even as they simultaneously push to increase military spending.
A Structural Shift in Government Budgets
The crossover reflects years of accumulating public debt combined with a higher interest rate environment that has made servicing that debt considerably more expensive than it was during the previous decade of near-zero borrowing costs. Scope Ratings has pointed to this dynamic as a defining feature of sovereign credit risk across advanced economies, noting that higher interest payments increasingly compete directly with other budget priorities, including the very defense spending increases many of these same governments have pledged to deliver.
The pattern is perhaps most starkly illustrated in the United States, where net interest costs are projected to exceed $1 trillion in fiscal year 2026, according to Congressional Budget Office estimates, compares with a military budget that could reach as much as $1.15 trillion for the same year. That razor-thin margin means the U.S. now sits right at the threshold where interest payments could easily overtake defense spending outright, a milestone that would have seemed almost unthinkable just a decade ago when interest costs represented a far smaller share of the federal budget.
Defense Spending Pressures Add to the Squeeze
The timing of this fiscal strain is particularly awkward given the parallel push across NATO member states to dramatically increase military spending. At the 2025 NATO summit, all member states except Spain, which received an exemption, agreed to raise annual defense-related spending to 5% of GDP by 2035, a target driven substantially by pressure from Washington. Scope Ratings has warned that higher defense expenditure will lead to higher borrowing and deteriorating debt-to-GDP trajectories across most European countries specifically, unless governments find ways to reduce spending elsewhere or raise additional revenue to offset the added military costs.
That tension is playing out unevenly across the G-7 and broader European economies. Scope’s analysis suggests governments in Central and Eastern Europe are moving to front-load their defense spending increases, while countries facing tighter fiscal constraints, including Belgium and France, along with Southern European nations like Portugal and Italy, appear likely to take a more gradual approach to meeting the new targets.
Why Interest Costs Keep Climbing
The underlying dynamics driving rising interest costs extend beyond any single country’s specific fiscal choices. Elevated global inflation, still running above central bank targets across many advanced economies at the start of 2026, has limited policymakers’ ability to ease monetary policy as quickly as previously anticipated. The Iran war has compounded that pressure, with the IMF noting that the conflict’s disruption to energy markets and global supply chains has added further inflationary pressure throughout the year, pushing some central banks toward higher policy rates rather than the cuts investors had originally expected. Those higher rates translate directly into steeper borrowing costs for governments refinancing existing debt or issuing new bonds to fund spending.
A Warning Sign for Sovereign Credit Profiles
From a credit rating perspective, Scope Ratings has emphasized that assessing a country’s fiscal health goes well beyond simple compliance with existing budget rules. The agency focuses on a government’s broader fiscal stance, including budget balances, the sustainability of interest payments relative to overall spending, and medium-term debt trajectories, all factors that become increasingly strained as interest costs consume a larger share of available fiscal space. Germany’s defense spending shortfall relative to its NATO commitments has been highlighted as particularly large in absolute terms, illustrating how unevenly the pressure to simultaneously fund higher interest payments and expanded military budgets is being felt across the alliance.
What Comes Next
With defense spending commitments continuing to climb under NATO’s 2035 target and interest costs showing few signs of abating given the current inflation and rate environment, most G-7 governments face a genuinely difficult balancing act in the years ahead. Whether governments respond by cutting spending elsewhere, raising taxes, or simply allowing debt levels to climb further will likely shape sovereign credit assessments across the group for years to come, with Scope’s analysis suggesting the fiscal tension between debt servicing costs and military ambitions is unlikely to ease meaningfully anytime soon.
