IMF Fiscal Monitor — Fiscal Adjustment in an Uncertain World, April 2013


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Continued progress in reducing advanced economies’ deficits and gradually improving external environment have mitigated near-term fiscal risks, but the global outlook nonetheless remains bleak, and many advanced economies face a long, difficult and uncertain towards fiscal sustainability. Advanced economies’ deficits shrank by around ¾% of GDP in cyclically-adjusted terms last year and are expected to decline at a somewhat faster pace in 2013. Thanks to steady consolidation after the peak of the crisis in 2009, many advanced economies are now close to generating primary surpluses that will allow them to stabilize their debt ratios. Although this is an important step, it is only a first step. High debt, even if stable, retards potential growth, limits the scope for future discretionary policy, and exposes economies to further market shocks. Large increases in public debt have yet to cause interest rate spikes in many advanced economies, but lower rates are unlikely to persist indefinitely, especially since they partly reflect very slack monetary conditions that will eventually have to be reversed. Moreover, structural changes in sovereign debt markets could gradually erode some of the special statuses currently enjoyed by countries like Japan and the United States. In addition, with financial sector reform still progressing slowly, the risk of contingent liabilities materializing as a result of future financial sector disruptions remains significant. For all these reasons, simply stabilizing the debt of advanced economies at current levels would be detrimental to the medium and long-term economic outlook.

Sustained consolidation efforts to bring debt ratios down to more appropriate levels are therefore essential, although it is difficult in practice to determine what constitutes a prudent amount of public debt. Several advanced economies are now about 1 percentage point away from a primary surplus that, if sustained, would take their debt ratio to 60% of GDP by 2030. But even the continuation of these surpluses over time can be difficult. In total, about a third of advanced economies, representing some 40% of global GDP, still face major fiscal challenges. Most of these countries have never experienced debt levels similar to today’s, and certainly not for decades. They will have to undertake unprecedented budgetary efforts to bring their debt ratios back to traditional norms, even if this only has to be done over a relatively long horizon.

Although it is difficult to achieve sufficiently large primary surpluses and sustain them for an extended period, there is no other silver bullet. High inflation aimed at eroding the real value of debt or debt restructuring would entail substantial and long-lasting economic and social costs, so these are not options to be taken lightly. Privatizing public assets can help the adjustment process, but the stock of salable assets in most advanced economies is insufficient to significantly reduce debt. The amount of fiscal adjustment required by each advanced economy depends on its initial conditions, its ultimate objectives, and the macroeconomic conditions that will prevail in the interim. But to make rapid progress in reducing debt ratios, it will be essential to maintain the minimum possible differential between the interest rate on the public debt and the growth rate of the economy. In most cases, there is room for structural reforms to raise potential growth, which would help reduce the debt-to-GDP ratio more quickly, both by supporting the fiscal balance and through denominator effects. Of course, faster growth will also help reduce the social costs of fiscal consolidation and enhance its political sustainability. And to keep interest rates low, it will be essential that highly indebted advanced economies continue to pursue policies that will maintain market confidence.

The key elements of the package of measures required are well known: the most important of these is the development and implementation of a clear and credible plan to reduce debt ratios over the medium term. The continued absence of such plans in Japan and the United States remains a major concern, particularly given the introduction of new short-term stimulus measures in Japan (albeit temporary) and insufficient progress on measures to restore medium-term fiscal sustainability, including entitlement reform, in the United States. Such a plan could also allow the United States to avoid the excessive tightening of fiscal policies that would result if the sequestration of spending that began in March were to continue beyond the current fiscal year. In conducting their short-term policy, authorities in advanced economies should focus on structural balances and, funding permitting, allow automatic fiscal stabilizers to operate fully, to avoid pro-cyclical policies that would accelerate any slowdown in growth (while also ensuring that any upside growth surprises would be used to pay down debt faster). However, some advanced economies where private demand has been chronically underwhelming should consider smoothing the pace of consolidation if they have the fiscal space to do so.

Debt dynamics have remained relatively positive in most emerging market economies and low-income countries, driven by a negative interest rate-growth differential, and these countries have generally let automatic stabilizers operate fully over the year. latter while suspending the underlying fiscal adjustment process. Most of them plan to continue doing so this year. Those with low debt and public deficits can afford to maintain a neutral stance in response to a weaker global outlook. But countries with relatively high or rapidly rising debt levels face considerable risks, especially once effective interest rates rise as monetary policy normalizes in advanced economies and concessional financing advanced economies is declining. Many Arab countries in transition have exhausted their fiscal reserves and need to contain rising deficits and debt levels. The widespread use of energy subsidies makes commodity prices an additional source of vulnerability in many emerging and low-income countries. Subsidy reform, raising revenue from consumption taxes, and broadening tax bases would help support consolidation efforts. Commodity exporters also need to strengthen non-resource incomes and establish fiscal frameworks to limit short-term volatility and ensure long-term fiscal sustainability.

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