Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: Governments Confront Policy Dilemma on Debt, Growth

September 20, 2011

  • Rising public debt strains advanced economies' balance sheets
  • Emerging economies should use gains to protect against global risks
  • Low-income countries need to raise revenues, target social spending

Governments around the world face a dilemma—how to reduce debts and deficits, and support growth and employment as anxious financial markets rattle the global economic recovery.

Governments Confront Policy Dilemma on Debt, Growth

Job applicants in California: governments need to reduce debt and create jobs (photo: Joshua Sudock/Orange County Register)

FISCAL MONITOR

The latest edition of the IMF’s Fiscal Monitor said all governments face difficult policy choices. Many need to further develop their plans to reduce debts and deficits over the medium term, and then communicate them to investors and financial markets.

“The appropriate pace of adjustment in the short run will depend, for each country, on the intensity of the market pressure it confronts, the magnitude of the risk to growth it faces, and the credibility of its medium-term program,” said Carlo Cottarelli, head of the IMF’s Fiscal Affairs department, which produced the report.

In a speech last week in Washington, D.C., IMF chief Christine Lagarde said consolidating too quickly can hurt the recovery and worsen job prospects. In the short run, policymakers must focus on measures with the biggest bang-for-the-buck that create jobs and kick-start growth.

The IMF Fiscal Monitor is published twice a year to track public spending and government debt and deficits around the world. Quarterly updates are issued in January and July.

The IMF also released its World Economic Outlook and the global recovery has weakened. Growth in the advanced economies is projected at 1.6 percent in 2011. For emerging and developing economies growth is projected at 6.4 percent in 2011.

Progress continues in 2011

Advanced and emerging economies are making steady progress this year to reduce fiscal deficits, and the rate of improvement is broadly in line with projections made in the April 2011 Fiscal Monitor.

The average deficit for advanced economies is projected to be 6.7 percent of GDP in 2011, which is 0.4 percent better than projected in the April 2011 report.

The United States’ deficit is expected to fall to 9.6 percent of GDP in 2011, the IMF said. The overall deficit is about 1 percent of GDP smaller than projected in the April Fiscal Monitor. This is due in large part to a combination of increased government revenues and a slower pace of expenditure.

The IMF forecasts a significant decline in the United States’ deficit in 2012, but this does not fully incorporate the impact of President Obama’s proposed jobs plan. The plan would provide welcome support to job creation and growth in the short run, according to the IMF, but needs to be embedded in a clear medium-term deficit and debt reduction plan.

Europe is dealing with a government debt crisis and its impact on banks as it plans to reduce debts and deficits while struggling to sustain economic growth. Deficits in the euro area are expected to fall by about 2 percent of GDP this year and 1 percent of GDP next year. Countries facing relatively favorable financing conditions could opt to slow the pace of short-term adjustment, with compensating measures later should the growth outlook worsen significantly. Countries facing high borrowing costs from financial markets have to implement their deficit reduction plans in full and without delay, according to the IMF.

Japan’s devastating earthquake and tsunami in March slowed economic growth, and had a substantial impact on government revenues and spending.

But Japan’s fiscal woes predate the recent natural disasters, and the government needs to outline a set of measures to bring down the highest debt ratios and deficits among the advanced economies in the coming years, after taking care of reconstruction and social spending to help the economy rebuild.

Triple digit debt in advanced economies

Although most countries have planned cuts to help rein in debts, public debt in advanced economies is projected to top 100 percent of GDP in 2011. The bulk of this increase since 2007 is from the drop in GDP and government revenues as a result of the global economic crisis.

A fiscal sustainability risk map shows that risks remain high overall for advanced economies, and the divergence across countries has increased since April 2011.

Emerging economies

Overall, deficits are expected to decline by 1 percent of GDP in emerging economies in 2011 and about ¼ percent in 2012, according to the IMF. While there are differences across emerging economies, with some countries experiencing high commodity prices and strong capital flows, the IMF cautioned that some countries also have fiscal pressures that will need to be brought under control in the next few years.

Food and fuel price pressures

Low-income countries survived the crisis relatively well, thanks in part to the buffers they had built up during good times. They were able to spend money in the downturn to help support their economies, and in 2010 began cutting back on spending as their economies improved.

The pace at which low-income countries reduce debts and deficits has slowed in 2011 amid risks from rising food and fuel prices. They will need to better target social spending, raise more revenues, and spend efficiently to help make the best use of their limited resources.

Both emerging and low-income countries have to manage a delicate balancing act of addressing the social costs of high food and fuel prices, while keeping debt levels and deficits on a sustainable path.

■ The IMF will issue its Global Financial Stability Report on September 21 in Washington, D.C.