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IMFSurvey Magazine: Policy

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Governments Need to Tackle Fiscal Risks, Says IMF

Government deficits will fall at a slower pace in 2011 as some advanced economies delay planned cutbacks (photo: IMF)

GOVERNMENT DEBT & DEFICITS

Governments Need to Tackle Fiscal Risks, Says IMF

IMF Survey online

April 12, 2011

  • Advanced economies need to reduce public debt
  • Emerging economies vulnerable to reversal of fortunes
  • Rising food and fuel prices strain some low-income country coffers

The outlook for government debts and deficits in 2011 is a mixed bag, with most advanced economies reining in fiscal deficits, but not fast enough to keep their debt from rising.

Fiscal balances are improving in most emerging economies, and some could do more as they experience a windfall from high commodity prices and strong capital flows.

Due to high debt and deficits, government financing needs continue to be large in advanced economies, and risks remain, according to the IMF’s latest analysis.

The IMF projects the pace at which advanced economies reduce their deficits and accumulated debt will be slower on average in 2011 than projected earlier, as the United States and Japan delay their plans.

The latest edition of the IMF’s Fiscal Monitor said many countries’ deficits will fall in 2011, reflecting fiscal tightening, particularly in Europe, and improved economic conditions. The average deficit for advanced economies is expected to fall by percent of GDP to 7 percent, which represents a slower pace than projected in the November 2010 report.

In 2011, emerging economies’ deficits are expected to fall 1 percent of GDP, but with big differences across regions. While emerging economies in Latin America and Europe are reducing deficits and debt levels, Asia with some exceptions, is not cutting back.

Japan’s devastating earthquake in March will require additional government spending for immediate humanitarian needs as well as reconstruction. Although it is too soon to estimate the fiscal costs, the country has ample funds to finance its rebuilding, the IMF said.

The United States will require significant deficit cuts in 2012 and 2013 to meet their commitments over the next few years. A downpayment in the form of deficit reduction this year would ease the burden in future years.

The IMF Fiscal Monitor is published twice a year to track public spending and government debt and deficits around the world.

Share the burden

The IMF said all countries that need to reduce their deficits must also take action to ensure that the burden of the fiscal adjustment, and the benefits of the economic recovery, are distributed fairly.

While most countries have plans in place to reduce their deficits and debt levels in the coming years, advanced and emerging market economies will need to

Control health care and pension spending, which is projected to rise significantly in advanced economies in the coming years

Strengthen the institutions charged with government budgets, revenues, and spending, and, where appropriate, introduce or strengthen fiscal rules and independent fiscal agencies to guide policy

• Ensure fiscal transparency and avoid accounting strategies that make fiscal accounts look better in the short run but lead to higher deficits later

• Improve targeting of social safety net spending on the most vulnerable groups in society.

Deficits dropping, debt still rising

While nearly all advanced economies will reduce their deficits in 2011, two-thirds will see their debt levels increase with the average topping 100 percent of GDP for the first time since World War II.

Countries from the United States to Europe will tighten their belts in 2012. Without new policies, deficit reduction is expected to slow in 2013 and 2014, leaving deficits substantially above levels last seen before the global crisis.

Earlier in the week, the IMF said the global economic recovery is gaining strength, with world growth projected at about 4 percent in both 2011 and 2012, but unemployment remains high, and risks of overheating are building in emerging market economies.

A fiscal sustainability risk map developed for this issue of the Monitor shows that risks remain high overall for advanced economies, and the divergence across countries has increased since November 2010.

Too much of a good thing

Emerging economies, including Brazil, India, and South Africa, have been buoyed by higher revenues thanks in part to capital flows, and in some cases higher commodity prices.

The IMF said booming emerging market economies should resist spending pressures and save any excess revenue from temporary factors, such as above trend growth, commodity price booms, and asset price booms. This will help them build up their fiscal buffers, avoid procyclical policies, and reduce pressures from overheating.

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 will slow in 2011 amid risks from rising food and fuel prices.

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.