Fiscal Risks Retreat as Deficits Continue to Fall
IMF Survey online
April 16, 2013
- Fiscal adjustment is proceeding in most advanced countries
- Strengthening fiscal institutions seen as helpful to fiscal consolidation efforts
- Persistently high levels of debt still pose risk to future economic prosperity
A gradually improving global economy and progress toward reducing deficits in advanced economies have lowered short-term fiscal risks, yet many countries still face a long road back to fiscal health.
In the latest edition of its Fiscal Monitor, the IMF sees an improved picture across most of the world in terms of countries getting a handle on their deficits. Many countries have also taken important first steps to bring overall debt down to levels needed to ensure strong and vibrant economies.
Deficits in advanced economies fell by ¾ percent of GDP last year. They dropped both in headline and in cyclically-adjusted terms, and are projected to fall at a faster pace in 2013. The report attributes much of the improved picture to concerted efforts by governments to bring spending under control following the peak of the crisis in 2009, as well as a gradually improving external environment. The global economic outlook continues to improve with economic growth worldwide expected to reach 3.3 percent in 2013.
Why look at deficits in cyclically-adjusted terms?
Looking at the cyclically-adjusted budget deficit—that is, net of the effects of short-term fluctuations in output and income, gives a more informative snapshot of the government’s finances because it sets aside temporary ups and downs in the economy.
For instance, in times of recession, government tax revenues are generally lower and spending can be higher because of the need to make payments under unemployment insurance schemes.
By looking at the cyclically-adjusted budget deficit, economists get a better idea of what a government’s deficit is in the midst of normal economic conditions.
The IMF Fiscal Monitor is published in April and October each year to track public spending and government debt and deficits around the world.
Bringing public debt back to prudent levels poses a long-term challenge, according to the IMF report, but it is a challenge that can be succesfully met. Debt ratios are declining or stabilizing in about two thirds of advanced economies, but further adjustment efforts will be needed in the remaining third—representing 40 percent of global GDP. In some countries, particularly several European countries under market pressure, debt ratios will not peak until after 2014, as seen in the projections for France, Italy, and Spain.
In both the United States and Japan, the continued absence of a clear and credible medium- and long-term consolidation plan remains a concern. Stimulus spending and increasing social security outlays in Japan are expected to keep the deficit there at a level more than twice the advanced economy average. In the United States, an agreement on entitlement reforms and other much-needed measures to control the debt has yet to be reached.
“A number of countries will need to achieve large primary surpluses and maintain them for an extended period, which will be difficult, but there are no alternative quick fixes. Still, it can be done,” said Carlo Cottarelli, head of the IMF’s Fiscal Affairs Department.
Institutional reforms, such as fiscal rules, independent monitoring agencies, and medium-term spending frameworks, can buoy the credibility of fiscal adjustment packages and their political acceptance. Countries such as Ireland and Portugal have begun making institutional reforms by introducing limits on government spending, and ongoing reforms across Europe are calling on fiscal councils to play a strong and independent role in fostering fiscal discipline.
Moving at their own pace
The overall debt situation in most emerging market economies and low-income countries remains more favorable than in advanced economies, owing in part to relatively low levels of debt and deficits combined with low interest rates and growing economies. Under these conditions, many emerging market economies have had the scope to pause their fiscal adjustment. Yet, as the IMF report notes, medium-term pressures like infrastructure and age-related spending mean that these countries need to adopt a cautious approach to budget decisions going forward.
Fiscal consolidation is also on hold in most low-income countries, and deficits in most countries are still larger than precrisis levels. Strong spending growth, due in many cases to large increases in public investment, is leading to higher debt-to-GDP ratios in countries like Ghana and Senegal.
Many emerging market and low-income countries are also seeking to strengthen their fiscal institutions. Chile, Indonesia, and Mexico now publish reports that discuss fiscal risks. Others such as Croatia, Kenya, South Africa, and Uganda are turning to the use of fiscal councils for independent oversight of their budgets.
Energy subsidies reform
The Fiscal Monitor also cites energy subsidy reform as another way for some countries to help get a better handle on their deficit and debt. Both rich and poor countries spend large amounts of public resources to subsidize energy, but in many emerging market economies and low-income countries reforms are needed urgently.
According to the IMF, in addition to aggravating fiscal imbalances, subsidies crowd out priority spending on education and health and reinforce inequality—as they are typically captured mostly by higher-income households and exacerbate global warming and worsen local pollution by promoting overconsumption of fuel products. A recent IMF study suggests that a combination of phased price increases, targeted measures to protect the poor, and institutional reforms that depoliticize energy pricing can lead to successful reforms.