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DEBT AND SPENDING

High Debt and Deficits Have Raised Risks, Says IMF

IMF Survey online

May 18, 2010

  • Some further weakening of countries' fiscal accounts
  • Markets increasingly alert to fiscal developments
  • More for countries to do in clarifying exit strategies

Fiscal risks have risen in many countries even as the global economy recovers, the IMF said in a new study.

Some further deterioration in underlying fiscal conditions, increased financial market concerns about fiscal pressures, and slow progress in defining fiscal exit strategies are the main reasons for the growing risks, according to the IMF.

The IMF Fiscal Monitor: Navigating the Fiscal Challenges Ahead, analyzes fiscal developments in advanced, emerging market, and low-income economies, presents new evidence on the links between debt levels and growth, and examines financing requirements and policy options for fiscal retrenchment across economies.

Recent events in Europe have underlined the increased attention being paid by financial markets to countries’ spending and debt levels.

“There are some countries where the fiscal accounts are weaker and potentially more exposed to a loss of confidence,” said Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, which produced the report. “Those countries cannot afford to wait until 2011, they have to tighten their fiscal policies earlier, and this is already happening.”

Countries need to tackle spending

Advanced economies will face the larger challenge in tackling their debt levels, which are expected to reach on average 110 percent of GDP by 2015, according to the IMF. Research presented in the Monitor suggests that if unchecked, this buildup in debt could slow potential growth by up to 0.6 percent annually.

Some advanced economies will need to increase their cyclically adjusted primary balances on average by 8 percent of GDP to lower government debt to a more prudent level by 2030, say 60 percent of GDP, the IMF said.

Many countries are also facing additional spending pressures from projected increases in spending on health care and pensions, on the order of 4-5 percent of GDP in many cases, over the next 20 years.

The outlook is more favorable for emerging economies, where fiscal balances are expected to improve this year relative to last year, although not as quickly as previously predicted. Emerging economies will still be open to interest rate and growth shocks, including as a result of spillovers from the advanced economies.

Time to get specific on exit plans

The IMF said countries will need to map out in detail their plans to restore debt and deficits to more prudent levels.

The timing for countries to shift gear in their support of the economy will vary across countries, and will depend on economic and fiscal conditions, the IMF said.

The IMF pointed out that all countries should be putting in place reforms to strengthen their longer-term spending and debt reductions plans.

Reforms to health care spending and pensions take longer to yield savings, but can provide confidence about medium-term fiscal trends.

Some countries may need to increase revenues as part of their strategy, and the IMF paper discusses a package of measures that include eliminating below-standard value-added tax rates, and increasing tobacco and alcohol taxes, carbon taxation and property taxes. These measures could raise up to 3 percent of GDP in advanced economies, the IMF said.


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