## _spn0913 - References

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### I. Introduction and overview
- Global financial crisis majorly affects public finances via declining fiscal revenues (automatic stabilizers, lower asset and commodity prices), direct fiscal support to the financial sector, and discretionary fiscal stimulus.
- Projected changes (G-20):
  - Fiscal balances of G-20 advanced countries projected to weaken by 8 percentage points of GDP on average in 2008–09, with most deterioration occurring in 2009.
  - Government debt projected to rise by 20 percentage points of GDP in 2008–09 for G-20 advanced countries.
  - Fiscal balances of G-20 emerging market economies will deteriorate by 5 percentage points of GDP.
  - In 2014 the G-20 advanced country average public debt-to-GDP ratio is projected to exceed the end-2007 average by 36 percentage points of GDP.
- Key downside fiscal risks: further financial-sector support, persistence of output downturn, realization/sale of assets acquired during support operations.
- Four components critical for exit strategy:
  - Fiscal stimulus packages should not have permanent effects on deficits.
  - Medium-term frameworks with clearly identified policies and institutional arrangements to commit to fiscal correction.
  - Structural reforms to enhance growth.
  - Clear strategies for health and pension reforms where demographic pressures exist.
- Note: forecasts reflect April 2009 World Economic Outlook and information on fiscal stimulus and financial/industrial support gathered through mid-May; earlier version discussed February 20, 2009.

### II. Fiscal implications of the crisis: direct costs
- Forms of government support and fiscal accounting implications (GFSM 2001 guidance):
  - Capital grants: increase the deficit by the amount of the grant.
  - Equity purchases: no impact on fiscal balance if at market value, but increase gross debt; raise the deficit by any excess paid over value.
  - Asset purchases/swaps: same treatment as equity purchases.
  - Loans: no immediate impact on fiscal balance if no inherent subsidy, but increase government debt; reduce the balance by amounts not expected to be repaid.
  - Guarantees: no immediate impact on fiscal balance or debt unless likely to be called; fiscal impact occurs when guarantees are called or reserves are created.
  - Associated fees, interest, dividends: affect deficit like other government income/expense.
  - Central bank operations: reflected in central bank accounts; losses affect the budget over time via profit transfers or recapitalization; disclosure recommended for transparency.
- Headline support to financial sectors (advanced G-20 averages and examples):
  - Capital injections: average outlay projected at 3.2 percent of GDP for advanced G-20 (example range: 4.6 percent in the United States to none for Australia and Spain); smaller advanced economies (Austria, Belgium, Ireland, Netherlands) announced programs from 3½ to 5½ percent of GDP.
  - Asset purchases/direct lending by treasury: advanced G-20 average 4.4 percent of GDP; United Kingdom, Japan, and Norway each over 10 percent of GDP.
  - Central bank support (with/without treasury funding): liquidity lines, asset-backed securities purchases, commercial paper, asset swaps; only Russia, the United Kingdom, and the United States undertook these with treasury support.
  - Guarantees for financial-sector liabilities: sizable in Ireland, the Netherlands, Sweden, the United Kingdom, and the United States relative to GDP.
- Immediate impact on financing needs: averages "5 3 e4 percent of GDP" for the advanced G-20 as reported in source (Table 2.1 last column); central bank liquidity provisions and guarantees increase headline figures but may not require upfront financing.
- Emerging markets: limited financial-sector support so far; average immediate impact on gross debt about "1 e3 percent of GDP" based on limited information.

### III. Net cost over the medium term: recoveries, guarantees, central bank support
- Recovery rates and net costs:
  - Past crises: average recovery rate 51 percent for advanced countries vs 13 percent for emerging markets.
  - Recovery rates higher when fiscal balance stronger at start of crisis.
  - Medium-term net cost for G-20 advanced economies projected to be 2½ percent of GDP versus upfront cost of "5 3 e4 percent of GDP" (Table 2.2 figures as in source).
  - Table 2.2 (excerpted point estimates and intervals, PPP-weighted):
    - Upfront Government Financing (Point estimate, percent of GDP): G-20 economies 3.7; Advanced economies 5.8; Emerging economies 0.3.
    - Recovery Rate (Point estimate, percent of upfront outlays): G-20 economies 48.0 [95% interval: 28.2, 67.7]; Advanced economies 50.6 [29.5, 71.4]; Emerging economies 35.3 [21.3, 49.2].
    - Medium-term Net Cost of Direct Support (Point estimate, percent of GDP): G-20 economies 1.7 [95% interval: 0.9, 2.3]; Advanced economies 2.5 [1.4, 3.5]; Emerging economies 0.2 [0.1, 0.2].
- Central bank liquidity support and guarantees:
  - Central-bank outlays assumed recovery rate 90 percent; net cost from central bank operations could average "1 3 e4 percent of GDP" for advanced countries (Table 2.3 as reproduced).
  - Expected cost of explicit guarantees (indicative EICDS approach, November 2008 market data):
    - Outlays from contingent liabilities could be of the order of 1–3 percent of GDP (cumulative) for 2009–13 for the advanced G-20.
    - Point estimate of 1½ percent of GDP.
    - 1–3 percent range corresponds to optimistic 80 percent recovery and conservative 40 percent recovery assumptions.
  - Table 2.3 reproduced entries (figures verbatim from source):
    - Point estimate Range (i)(ii)(iii)(i)+(ii)+(iii)
    - Average for 3/ G-20 economies1.714.41.0[0.6, 1.9]14.31.13.8
    - Advanced economies2.522.91.6[1.0, 3.1]21.71.75.8
    - Emerging economies0.20.10.0[0.0, 0.0]2.00.20.4
    - (Rows labeled: Net cost of direct support; Total net cost; GrossGrossNet 2/; Guarantees; Liquidity provision by Central Bank and others; Expected cost 1/.)
  - Footnotes summarized in source: cumulative cost over five years; guarantee fees not netted; range reflects recovery-rate assumptions; central bank recovery rate assumed 90 percent; weighted by PPP GDP of 2007.

### IV. Fiscal implications of the recession: channels and magnitudes
- Three fiscal-cost channels:
  - Automatic stabilizers.
  - Other nondiscretionary effects beyond normal cycle impacts (lower asset prices, financial-sector profits, commodity prices).
  - Discretionary fiscal stimulus.
- Automatic stabilizers (G-20 averages based on output gap changes):
  - 2008 impact = -0.2 percent of GDP for the G-20.
  - 2009 projected impact = -1.8 percent of GDP for the G-20.
  - By country examples for 2009: Germany -3.5 percent of GDP; France, Italy, Japan, Russia, Turkey, United Kingdom: -2½ percent of GDP; several emerging economies (China, India, Indonesia): -½ percent of GDP.
  - Table 3.1 reproduction:
    - 2008 2009
    - Automatic stabilizers -0.2 -1.8
    - Of which:
    - Advanced countries -0.4 -2.1
    - Emerging market countries 0.1 -1.1
- Other nondiscretionary effects (estimated contributions to revenue deterioration):
  - Equity prices: 10 percent decline → cyclically adjusted revenues fall by 0.07 and 0.08 percent of GDP in current and subsequent years; equity declines through end-2008 imply cumulative fall 2008–09 of 0.6 percent of GDP for the G-20 (0.5 percent of GDP in 2009).
  - Housing prices: 10 percent decline → 0.27 percent of GDP decline in cyclically adjusted revenues next year; house-price declines imply 0.2 percent of GDP revenue fall in 2009 for G-20 weighted average.
  - Financial-sector profits: assumed CIT averages 3 percent of GDP; financial sector pays 25 percent of CIT and profits decline 50% on top of average decline; effect (after adjustment) about 0.2 percent of GDP revenue decline (split evenly between 2008 and 2009).
  - Commodity prices: staff estimate each 10 percent fall reduces G-20 fiscal revenue by 0.15 percent of GDP; effect for G-20 group 0.7 percent of GDP in 2009 (largely Russia, Saudi Arabia, Brazil).
  - Interest rate and exchange rate effects: overall modest in 2008 and 2009 for G-20.
  - Overall other nondiscretionary effects could account for an estimated 1.3 percent of GDP deterioration in fiscal positions of G-20 countries in 2009.
- Discretionary fiscal stimulus (announced/planned through early May 2009, PPP-weighted averages):
  - 2008: ½ percent of GDP.
  - 2009: 2.0 percent of GDP.
  - 2010: 1.5 percent of GDP.
  - Table 3.4 (PPP-weighted average totals reproduced): Total 2008 0.6; 2009 2.0; 2010 1.5.
  - Composition: about two-thirds expenditure measures, emphasis on infrastructure; seventeen G-20 countries announced infrastructure spending increases; social protection expansions; support to SMEs and strategic sectors; some measures target long-term objectives (health, education, green technologies).
  - Revenue measures: fourteen G-20 countries announced sizable personal income tax cuts; six announced indirect tax cuts; corporate income tax cuts/incentives in some countries.

### V. Losses of funded pension schemes and fiscal risks
- Funded pension-scheme exposures:
  - 16 of 46 countries with data have pension fund investments in equities/mutual funds >10 percent of GDP.
  - Countries with higher exposure: Australia, United States, Canada, Iceland, Netherlands, Switzerland, Denmark, United Kingdom; emerging: South Africa, Chile, Brazil.
  - Estimated 2008 losses: United States 22 percent of GDP; United Kingdom 31 percent of GDP.
  - Mutual funds heavily weighted toward equities; pension real-estate investment small (below 3 percent of total assets on average for OECD).
  - Structured products ~8 percent of pension assets worldwide; concentration in United States, Sweden, Japan.
- Fiscal-account risk channels:
  - Direct effects from government pension-fund investments in affected assets.
  - Explicit guarantees to funded schemes (examples: PBGC, PPF costs of 0.4 percent of GDP in United States and 0.1 percent of GDP in United Kingdom).
  - Pressures to compensate pensioners from private plans.
- Government exposure examples:
  - U.S. federal, state, local defined-benefit plans held over $4 trillion in assets end-2007; value fell by roughly $1 trillion by October 2008; aggregate funding ratio fell to 65 percent in October 2008 (mark-to-market).
  - Historical example: contributions rose 45 percent over two years after 2000–02 equity market decline.
- Distributional incidence and likelihood of support:
  - Older workers and higher-income pensioners hold larger shares of funded pensions; likelihood of public support may reflect distributional and political factors.
  - Chile: government guarantees minimum pension level for individual accounts.

### VI. Outlook for public finances: short-term, medium-term, and downside scenarios
- Short-term (G-20 averages, PPP-weighted):
  - Advanced G-20: fiscal balances projected to worsen by 8 percentage points of GDP in 2009 relative to 2007.
  - G-20 advanced fiscal balances reach "9 3 e4  percent of GDP in 2009" as reported in source.
  - Half of deterioration due to fiscal stimulus and financial-sector support.
- Table 5.1 (changes, percent of GDP, difference with respect to previous period):
  - Advanced G-20 countries: Fiscal Balance change 2008 = -2.5; 2009 = -5.5; 2008-09 (A+B) = -8.0.
  - Emerging market G-20 countries: Fiscal Balance change 2008 = -0.6; 2009 = -4.5; 2008-09 = -5.1.
  - G-20 overall: Fiscal Balance change 2008 = -1.8; 2009 = -5.1; 2008-09 = -6.9.
  - Advanced G-20 Public Debt change 2008 = 5.8; 2009 = 14.2; 2008-09 = 20.0.
  - Emerging market G-20 Public Debt change 2008 = -1.3; 2009 = 2.3; 2008-09 = 0.9.
  - G-20 Public Debt change 2008 = 3.1; 2009 = 9.8; 2008-09 = 12.9.
- Medium-term:
  - Activity expected to recover; fiscal balances projected to improve as temporary stimulus expires, but remain weaker than 2007 unless tightening measures introduced.
  - Advanced economies: debt-to-GDP ratio in 2014 projected 36 percentage points above 2007 level.
  - Emerging economies: medium-term debt path more benign; debt ratios in 2010 above 2007 levels, declining trend resuming in 2011.
  - Table 5.2 selected fiscal balances and government debt (percent of GDP) excerpts include:
    - United Kingdom fiscal balances: 2006 -2.6; 2007 -2.6; 2008 -5.4; 2009 -9.8; 2010 -10.9; 2014 -6.4.
    - United States fiscal balances: 2006 -2.2; 2007 -2.9; 2008 -6.1; 2009 -13.6; 2010 -9.7; 2014 -4.7.
    - G-20 fiscal balances: 2006 -1.2; 2007 -1.0; 2008 -2.8; 2009 -8.0; 2010 -6.9; 2014 -3.4.
    - Government debt examples: Japan 191.3, 187.7, 196.3, 217.2, 227.4, 234.2 (2006–2014 series); United States 61.9, 63.1, 70.5, 87.0, 97.5, 106.7; G-20 countries 63.1, 62.8, 65.9, 75.7, 81.6, 84.6.
- Downside scenarios:
  - Lower growth scenario (growth 1 percentage point below baseline during 2009–2011):
    - Fiscal deficits rise by 1 percent of GDP on average.
    - Debt-to-GDP ratio increases by an additional 6 percentage points by 2011.
  - Prolonged stagnation scenario (decline in growth of 2 percentage points during 2009–2013, Japan 1991–2007–inspired):
    - Advanced countries: fiscal balances deteriorate on average by 2 percentage points of GDP relative to baseline.
    - Debt ratios rise by 18 percentage points by 2013.
- Additional downside risk channels:
  - Contingent liabilities from guarantees and central bank support not fully captured in baseline.
  - Recovery rates could be substantially lower due to lack of buyers and risk aversion.
  - Pension support costs excluded from baseline could materialize.
  - Combined shocks (weaker growth, contingent liabilities, higher interest rates) could produce major deterioration beyond baseline.

### VII. The risk for fiscal solvency and policy response
- Market indicators and concerns:
  - Long-term nominal interest rates declined in main advanced economies early in crisis; in recent months trend reversed in several countries.
  - Real interest rates broadly same as early 2007 in liquid markets.
  - CDS spreads: United States 8 basis points in June 2008 → almost 100 basis points in late February 2009 → around 50 basis points by mid-April 2009.
  - CDS spreads for Austria, Greece, Iceland, Ireland, Italy, Portugal, Spain rose more than 150 basis points by end-February 2009 (vs June 2008).
  - EMBI Global composite spread: 170 basis points at beginning of 2007 → 750 basis points in December 2008.
  - Primary bond issuance for emerging markets in Aug–Dec 2008 was half of same period in 2007.
- Level of government debt and solvency arithmetic:
  - Fiscal solvency requirement: debt must not be on explosive path (no-Ponzi condition).
  - Example arithmetic: one-off 10 percentage point rise in debt-to-GDP requires improvement in primary balance of less than 0.1 percentage point of GDP to stabilize debt ratio assuming r-g = 1 percentage point.
  - Historical large debt accumulations (100–200 percent of GDP) occurred in wartime, prolonged recessions, or protracted fiscal problems.
  - Empirical evidence: in normal circumstances and advanced countries, a 10 percentage point increase in debt ratios raises interest rates only by a few basis points if debt ratios below 100 percent.
  - Illustration: for some advanced countries, primary balance would have to improve by several percentage points starting 2014 to bring debt back to 60 percent of GDP over 15 years under unchanged-policy projections.
  - Aging adds further downward pressure on primary balances.
- Strategy to ensure fiscal solvency — four pillars (policy recommendations):
  - Make fiscal stimulus as temporary as possible to avoid permanent deficit increase.
  - Cast policies within medium-term fiscal frameworks that provide a commitment to fiscal correction once conditions improve and put in place institutional arrangements to monitor progress.
  - Pursue growth-enhancing structural reforms (prioritize spending with high social rate of return; tax reform to broaden base, reduce distortions, emphasize consumption/property taxes; reduce bias favoring debt over equity).
  - Commit to clear strategies to contain trend increases in aging-related spending (pension and health reforms).
- Medium-term framework design and measures:
  - Set credible medium-term targets over four–five years with clear policy actions.
  - Assess debt solvency under different scenarios including contingent liabilities.
  - Maximize recoveries from assets acquired in support operations; central bank losses should be promptly covered through budget transfers.
  - Use fiscal rules and fiscal councils where appropriate, with design features allowing flexibility for exceptional circumstances.
- Containing age-related spending:
  - Crisis fiscal burden is about 11 percent of aging-related costs for advanced countries (net present value comparison).
  - Urgent entitlement reforms (pensions and health) recommended, with country-specific amount and speed of adjustment.
  - Pension reforms: increase effective retirement age; target assistance to lower-income households rather than broad bailouts for funded plans.
  - Health reforms: equitable designs to secure public support when limiting coverage or shifting costs.
  - Timing and political economy: reforms are difficult during severe downturns but possible; combining stimulus with credible long-term entitlement reforms could improve reform prospects.

### VIII. Key statistics and selected quantitative findings (verbatim where reported)
- Immediate and medium-term support and costs:
  - Capital injections: advanced G-20 average 3.2 percent of GDP.
  - Asset purchases/direct lending: advanced G-20 average 4.4 percent of GDP.
  - Upfront Government Financing (Table 2.2 point estimates): G-20 3.7; Advanced 5.8; Emerging 0.3 (percent of GDP).
  - Recovery Rate point estimates: G-20 48.0 [95% interval: 28.2, 67.7]; Advanced 50.6 [29.5, 71.4]; Emerging 35.3 [21.3, 49.2] (percent of upfront outlays).
  - Medium-term Net Cost of Direct Support (point estimates, percent of GDP): G-20 1.7 [0.9, 2.3]; Advanced 2.5 [1.4, 3.5]; Emerging 0.2 [0.1, 0.2].
- Guarantees and contingent liabilities:
  - Indicative contingent-liability outlays (EICDS, Nov 2008): 1–3 percent of GDP cumulative for 2009–13 for advanced G-20; point estimate 1½ percent of GDP.
  - Table 2.3 reproduced figures (verbatim entries in source):
    - Average for 3/ G-20 economies1.714.41.0[0.6, 1.9]14.31.13.8
    - Advanced economies2.522.91.6[1.0, 3.1]21.71.75.8
    - Emerging economies0.20.10.0[0.0, 0.0]2.00.20.4
- Automatic stabilizers and nondiscretionary effects:
  - Automatic stabilizers: 2008 -0.2; 2009 -1.8 (G-20 percent of GDP).
  - Other nondiscretionary effects estimated contribution in 2009: 1.3 percent of GDP deterioration for G-20.
- Discretionary fiscal stimulus (PPP-weighted averages):
  - 2008 0.6; 2009 2.0; 2010 1.5 (percent of GDP).
- Pension fund losses and exposures:
  - 2008 estimated losses: United States 22 percent of GDP; United Kingdom 31 percent of GDP.
  - U.S. federal, state, local defined-benefit pension assets end-2007 > $4 trillion; value fell by roughly $1 trillion by October 2008; aggregate funding ratio fell to 65 percent in October 2008.
- Fiscal outlook and debt projections:
  - Advanced G-20: fiscal balances projected to worsen by 8 percentage points of GDP in 2009 relative to 2007.
  - Advanced G-20 public debt change 2008 = 5.8; 2009 = 14.2; 2008-09 = 20.0 (percent of GDP).
  - G-20 overall public debt change 2008 = 3.1; 2009 = 9.8; 2008-09 = 12.9.
  - Debt-to-GDP ratio of advanced countries projected to rise by 20 percentage points over 2008–09 (most pronounced upturn in recent decades).
  - Debt-to-GDP of G-20 advanced countries projected to increase by an additional 59 percentage points by 2030.
- Market indicators:
  - U.S. CDS spreads: 8 basis points (June 2008) → almost 100 basis points (late Feb 2009) → ~50 basis points (mid-April 2009).
  - EMBI Global composite spread: 170 basis points (beginning 2007) → 750 basis points (Dec 2008).
- Illustrative arithmetic:
  - One-off 10 percentage point rise in debt-to-GDP requires improvement in primary balance of less than 0.1 percentage point of GDP to stabilize debt ratio assuming interest-rate/growth differential of 1 percentage point.
  - For a 10 percent increase in the debt ratio, primary balance would have to improve by more than 1 percentage point to bring back ratio to original level within 10 years (alternative illustrative arithmetic reported in source).
- Net present value (NPV) comparisons of crisis vs aging (selected entries from Table 6.4, percent of GDP):
  - Australia: Crisis 30; Aging 48; Crisis/Aging 26.1
  - Canada: Crisis 21; Aging 72; Crisis/Aging 29.0
  - France: Crisis 31; Aging 27; Crisis/Aging 11.2
  - Germany: Crisis 29; Aging 28; Crisis/Aging 10.3
  - Italy: Crisis 35; Aging 16; Crisis/Aging 20.7
  - Japan: Crisis 35; Aging 15; Crisis/Aging 22.3
  - Korea: Crisis 20; Aging 68; Crisis/Aging 2.9
  - Spain: Crisis 39; Aging 65; Crisis/Aging 25.9
  - United Kingdom: Crisis 48; Aging 33; Crisis/Aging 14.2
  - United States: Crisis 37; Aging 49; Crisis/Aging 7.5
  - Advanced G-20 average (PPP-weighted): Crisis 35; Aging 409; Crisis/Aging 10.8
- Assumptions noted for long-run projections: interest rate/growth differential converges to 1 percentage point after 2014; pension and health contributions constant as ratio to GDP after 2014; if debt-to-GDP falls below 20 percent fiscal balance loosens to keep debt above 20 percent (Korea exception).

*Source: IMF staff estimates and analysis as presented in the supplied content unit (_spn0913 - References).*

### References .............................................................................................................

### _spn0913 - References

### I. INTRODUCTION AND OVERVIEW
- The global financial crisis is having major implications for the public finances of most countries: fiscal revenues are declining through automatic stabilizers and lower asset and commodity prices; direct fiscal support to the financial sector and discretionary fiscal stimulus are being provided.
- The fiscal balances of G-20 advanced countries are projected to weaken by 8 percentage points of GDP on average, and government debt is projected to rise by 20 percentage points of GDP in 2008–09, with most of the deterioration occurring in 2009.
- The fiscal balances of G-20 emerging market economies will deteriorate by 5 percentage points of GDP.
- For advanced economies, the increase in debt mostly reflects support to the financial sector, fiscal stimulus, and revenue losses caused by the crisis. For emerging economies, a relatively large component of the fiscal weakening reflects declining commodity and asset prices.
- Collapsing asset prices have adversely affected funded components of pension systems, posing potentially significant risks for public accounts over the next few years.
- While fiscal balances are expected to improve over the medium term, they will remain weaker than before the crisis. Public debt-to-GDP ratios will continue to increase over the medium term: in 2014 the G-20 advanced country average is projected to exceed the end-2007 average by 36 percentage points of GDP.
- On current policies, debt ratios will continue to grow over the longer term, reflecting demographic forces.
- Key downside fiscal risks for advanced and emerging economies include: possible further support to the financial sector, the intensity and persistence of the output downturn, and the return from management and sale of assets acquired during financial support operations.
- Four components are particularly important in formulating an exit strategy to maintain solvency and market confidence:
  - Fiscal stimulus packages, where appropriate, should not have permanent effects on deficits.
  - Medium-term frameworks, buttressed by clearly identified policies and supportive institutional arrangements, should provide a commitment to fiscal correction, once economic conditions improve.
  - Structural reforms should be implemented to enhance growth.
  - Countries facing demographic pressures should firmly commit to clear strategies for health and pension reforms.
- This note reflects macroeconomic and fiscal forecasts presented with the April 2009 World Economic Outlook and information on fiscal stimulus and financial and industrial sector support gathered through mid-May.
- An earlier version of the paper was discussed by the IMF’s Executive Board at a seminar on February 20, 2009.

### II. FISCAL IMPLICATIONS OF THE CRISIS: DIRECT COSTS
- Government support to the financial sector can take various forms, with different implications for gross and net debt:
  - Operations directly by government typically entail an upfront rise in gross government debt, though not necessarily a change in net worth and the deficit if assets are acquired.
  - The fiscal impact over time depends critically on realization value of acquired assets (recoveries from sale).
  - Central bank operations and guarantees have less immediate implications for fiscal accounts but may entail medium-term costs.
  - Transparent treatment in fiscal accounts is necessary.

Box: Fiscal Accounting Treatment of Support to the Financial Sector (Guidance based on Government Finance Statistics Manual (GFSM 2001))
- Capital grants: Increase the deficit by the amount of the grant.
- Equity purchases: Have no impact on the fiscal balance if purchase is at market value, but increase government gross debt unless funded by drawing down cash balances; raise the deficit by any marked/undisputable excess of what the government pays over the value of the equity.
- Asset purchases/swaps: Same as equity purchases.
- Loans: Have no immediate impact on the fiscal balance if there is no inherent subsidy, but increase government debt; reduce the balance by any amount that the government cannot expect to be repaid.
- Guarantees: Have no immediate impact on the fiscal balance or debt unless there is a significant probability the guarantee will be called (in practice, when a reserve has been created); fiscal balance would weaken and debt increase if and when the guarantee is called.
- Associated fees, interest, and dividends: Affect the deficit like other government income or expense.
- Central bank operations: Reflected in the central bank’s balance sheet and income statement rather than the government’s; losses will affect the budget over time through profit transfers or recapitalization. For transparency, these operations should be disclosed, possibly as complementary information in the budget.

### A. Headline Support to Financial Sectors
- Advanced countries have provided, or announced intent to provide, significant support to financial sectors with wide variation in extent and nature.
- Table 2.1 estimates are based on official announcements of amounts allocated for financial sector support (or maximum amount of banks’ liabilities to be guaranteed), although they may not be used in full.
- Main categories of support and average figures for advanced G-20:
  - Capital injections: average outlay projected at 3.2 percent of GDP for advanced G-20 (range example: 4.6 percent in the United States to none for Australia and Spain). Among smaller advanced economies, Austria, Belgium, Ireland, and the Netherlands announced programs ranging from 3½ to 5½ percent of GDP.
  - Asset purchases and direct lending by the treasury: advanced G-20 average is 4.4 percent of GDP; notable large amounts in the United Kingdom, Japan, and Norway (each over 10 percent of GDP).
  - Central bank support with or without treasury funding: provided through credit lines, purchase of asset-backed securities and commercial paper, and asset swaps; only three countries (Russia, the United Kingdom, and the United States) undertook these with treasury support. Liquidity provisions without upfront treasury financing could entail future fiscal costs.
  - Guarantees for financial sector liabilities: provided for bank deposits, interbank loans, and bonds; deposit insurance limits raised in almost all countries. Guarantees in Ireland, the Netherlands, Sweden, the United Kingdom, and the United States are particularly large relative to GDP.
- Immediate impact on financing needs has been more limited than headline support: the immediate impact averages 5 3 e4 percent of GDP for the advanced G-20 (Table 2.1, last column). (Table 2.1 shows much larger figures when including central bank liquidity provisions and guarantees, which do not require upfront financing.)
- Emerging markets:
  - Financial sector support has been limited so far. Main measures include bank recapitalization (Hungary, Poland, and Ukraine); liquidity provision (Hungary, India, Mexico, Russia, Turkey, and Ukraine); and guarantees (blanket coverage in Egypt and Saudi Arabia; more limited guarantees in Hungary, Indonesia, Mexico, Poland, and Russia).
  - Based on limited information, the average immediate impact on gross debt of these operations is about 1 e3 percent of GDP.

### B. Net Cost over the Medium Term
- Medium-term net budgetary cost of financial support depends on the value and sale of acquired assets and potential losses from guarantees.
- Recovery rates and net cost:
  - Recovery rates are positively correlated with per capita income: past banking crises show advanced countries had an average recovery rate of 51 percent compared with 13 percent for emerging markets.
  - Recovery rates are higher the stronger the fiscal balance at the start of the crisis.
  - Based on estimates, the medium-term impact on gross government debt could be substantially lower than the upfront impact, but still sizable.
  - The average net cost for the G-20 advanced economies is projected to be 2½ percent of GDP, compared to upfront cost of 5 3 e4 percent of GDP (Table 2.2).
  - Recovery rates estimated for emerging markets are markedly lower, so the difference between gross and net outlays would be smaller.
- Table 2.2 (high-level summary):
  - Upfront Government Financing (Point estimate): G-20 economies 3.7; Advanced economies 5.8; Emerging economies 0.3 (in percent of GDP).
  - Recovery Rate (Point estimate, in percent of upfront outlays): G-20 economies 48.0 [95% interval: 28.2, 67.7]; Advanced economies 50.6 [29.5, 71.4]; Emerging economies 35.3 [21.3, 49.2].
  - Medium-term Net Cost of Direct Support (Point estimate): G-20 economies 1.7 [95% interval: 0.9, 2.3]; Advanced economies 2.5 [1.4, 3.5]; Emerging economies 0.2 [0.1, 0.2].
  - Note: figures are weighted by PPP GDP of 2007.
- Timing of asset recoveries depends on speed of economic and financial recovery: example recoveries include Sweden (94 percent after five years following the 1991 crisis) and Japan (1 percent after five years following the 1997 crisis; by 2008 Japan reached a recovery rate of 54 percent).
- Net cost of central bank liquidity support and government guarantees:
  - Potential costs from central bank liquidity support are likely to be more contained than those associated with government intervention.
  - Central banks have generally focused on providing liquidity support (relatively short maturities and higher-quality collateral), whereas governments have generally provided solvency support (operations with highest risk of loss).
  - The calculations assume a 90 percent recovery rate for central bank outlays. The net cost from central bank operations could average 1 3 e4 percent of GDP for advanced countries (Table 2.3).

*Source: IMF staff estimates (content unit: _spn0913 - References).*

### 10.      The expected cost of the (explicit) guarantees provided so far is not trivial, but the

### _spn0913 - 10.      The expected cost of the (explicit) guarantees provided so far is not trivial, but the

### Expected cost of explicit guarantees and contingent liabilities
- Indicative estimates use standard financial derivative pricing models: EICDS (expected default frequency implied credit default swap) spreads applied to guaranteed amounts.
- EICDS regarded as indicative of the “insurance” premium for providing guarantees; approach accounts for market volatility and probability of default of individual institutions and provides an approximate measure of government cost of providing guarantees.
- Based on November 2008 market data:
  - Outlays from contingent liabilities could be of the order of 1–3 percent of GDP (cumulative) for 2009–13 for the advanced G-20 countries.
  - Point estimate of 1½ percent of GDP.
- The 1–3 percent range corresponds to assumed recovery rates under:
  - optimistic scenario: 80 percent recovery rate;
  - conservative scenario: 40 percent recovery rate.
- Note on bias: The point estimate reflects market EICDS spreads which capture residual risk for banks once guarantees are in place but may not capture the full risk to the government; to correct, a “conservative” CDS (assuming conservative recovery) was used to derive the upper bound.

- Table 2.3 (hypothetical net cost, illustrative scenarios) — figures reproduced as in source:
  - Point estimate Range (i)(ii)(iii)(i)+(ii)+(iii)
  - Average for 3/ G-20 economies1.714.41.0[0.6, 1.9]14.31.13.8
  - Advanced economies2.522.91.6[1.0, 3.1]21.71.75.8
  - Emerging economies0.20.10.0[0.0, 0.0]2.00.20.4
  - Net cost of direct support
  - Total net cost
  - GrossGrossNet 2/
  - Guarantees
  - Liquidity provision by Central Bank and others
  - Expected cost 1/
  - Source: IMF staff estimates.
  - Footnotes in source: 1/ Cumulative cost over five years. Guarantee fees have not been netted from the gross cost of guarantees given the variability in fees across countries and maturity structure of debt, and given the legislative differences in applying those fees. The range reflects assumptions of (1) an optimistic recovery rate of 80 percent; and (2) a conservative recovery rate of 40 percent. 2/ The recovery rate for outlays by central banks is assumed to be 90 percent. 3/ Weighted by PPP GDP of 2007.

### Fiscal implications of the recession: overview
- Three fiscal-cost channels from the recession (and policy responses):
  - Automatic stabilizers.
  - Other nondiscretionary effects beyond normal cycle impacts (including lower asset prices, financial sector profits, commodity prices).
  - Discretionary fiscal stimulus.
- Timing: some effects short-lived (automatic stabilizers reverse with recovery; some discretionary measures include sunset provisions); others longer-lasting or permanent (tax breaks hard to reverse; above-normal pre-crisis asset/commodity price–related revenues do not resume).

### A. Automatic stabilizers
- Impact increasing rapidly as economic conditions weaken.
- Estimated impact (computed on changes in the output gap):
  - 2008: automatic stabilizers impact = -0.2 percent of GDP for the G-20.
  - 2009: projected impact = -1.8 percent of GDP for the G-20.
- 2009 country examples:
  - Germany: -3.5 percent of GDP.
  - France, Italy, Japan, Russia, Turkey, United Kingdom: -2½ percent of GDP.
  - Several emerging economies (including China, India, Indonesia): -½ percent of GDP.
- Sensitivity rule of thumb from source: a uniform 1 percentage point of GDP worsening in the G-20 output gap broadly translates into a ѿ percent of GDP increase in the fiscal deficit. (Intuition: government size ≈ one-third of GDP for G-20 weighted average.)
- Table 3.1 reproduction:
  - 2008 2009
  - Automatic stabilizers -0.2 -1.8
  - Of which:
  - Advanced countries -0.4 -2.1
  - Emerging market countries 0.1 -1.1
  - Sources: IMF, World Economic Outlook, April 2009; and IMF staff estimates. 1/ Averages, based on PPP GDP weights.

### B. Other nondiscretionary effects
- Broad finding: output gap changes alone insufficient to capture several fiscal impacts; five effects highlighted:

  - Equity prices
    - Regression estimates: a 10 percent decline in equity prices leads cyclically adjusted revenues to fall by 0.07 and 0.08 percent of GDP in the current and subsequent years.
    - Using these estimates, equity market declines through end-2008 imply cumulative fall in revenue for 2008–09 for the G-20 weighted average of 0.6 percent of GDP (of which 0.5 percent of GDP in 2009, assuming no further decline).

  - Housing prices
    - Regression estimates: a 10 percent decline in real housing prices leads to a 0.27 percent of GDP decline in cyclically adjusted revenues in the following year.
    - Because housing price declines have been smaller than for equity prices (less than 10 percent versus 50 percent for equities), fall in cyclically adjusted revenues from house price declines estimated at 0.2 percent of GDP for the G-20 weighted average in 2009.

  - Financial sector profits
    - Financial sector significant source of CIT: over one-quarter of CIT revenues for the United States and the United Kingdom during 2000–07 came from the financial sector.
    - Calculation assumptions: CIT revenues averaged 3 percent of GDP across G-20 during 2004–06 (weighted). Assumes financial sector pays 25 percent of CIT and experiences a decline in profits of 50 percent on top of average decline. To avoid double-counting with equity effect, this effect is reduced by a quarter.
    - Result: decline in financial sector profits could contribute about 0.2 percent of GDP additional revenue decline (evenly split between 2008 and 2009).

  - Commodity prices
    - Effect could be sizable in 2009 for some emerging markets; for G-20 group the figure is 0.7 percent of GDP in 2009 (largely reflecting Russia, Saudi Arabia, Brazil).
    - Staff estimate: each 10 percent fall in commodity prices will reduce G-20 fiscal revenue by 0.15 percent of GDP.
    - Note: Some countries may choose not to pass declines to users; such a decision treated as discretionary and not included here.

  - Interest rate and exchange rate effects
    - Lower interest rates reduce debt service in lower-risk countries; rising risk premia and depreciation could raise it in others.
    - Overall impact likely modest in 2008 and 2009 for G-20 countries.

- Overall magnitude:
  - These other nondiscretionary effects could account for an estimated 1.3 percent of GDP deterioration in fiscal positions of G-20 countries in 2009.
- Table 3.2 and Table 3.3 referenced in source for country and aggregate breakdowns.

### C. Discretionary responses to the crisis (fiscal stimulus)
- Average announced/planned fiscal stimulus across G-20 (budgetary cost, per source, based on packages announced through early May 2009):
  - 2008: ½ percent of GDP.
  - 2009: 2.0 percent of GDP.
  - 2010: 1.5 percent of GDP.
- Nature of measures (impact on deficit and debt):
  - Temporary: temporary effect on deficit, permanent effect on debt level (spending often designed to expire).
  - Permanent: permanent effect on deficit and cumulative effect on debt (most revenue measures).
  - Self-reversing: temporary effect on both deficit and debt; few measures truly self-reversing but some sets could have no long-term impact (example: UK VAT cut offset by revenue-increasing measures starting 2010).
- Table 3.4 (G-20 estimated cost of discretionary measures) — PPP-weighted average totals reproduced:
  - Total (PPP-weighted average) 2008 0.6 2009 2.0 2010 1.5
- Composition and priorities (high-level findings):
  - Almost two-thirds of fiscal stimulus represented by expenditure measures, with emphasis on infrastructure.
  - Seventeen G-20 countries announced plans to increase infrastructure spending (often transportation networks), via central government spending or capital transfers to local authorities.
  - Social protection: strengthening unemployment benefits (Canada, Russia, UK, US, Turkey), cash transfers to the poor (Korea), support to children (Australia, Germany), support to pensioners (Australia, Canada).
  - Support to SMEs and strategic/vulnerable sectors in several countries (e.g., Korea, Canada, Germany, Russia).
  - Some measures target longer-term policy objectives (health, education, environmentally friendly technologies).
- Revenue measures:
  - Fourteen G-20 countries announced sizable cuts in personal income taxes (including Brazil, Canada, Germany, Indonesia, Japan, Spain, UK, US).
  - Six countries announced indirect tax cuts.
  - Corporate income tax (CIT) cuts present but generally smaller: CIT rate reductions (Canada, Korea, Russia), investment incentives (France, Korea), more favorable depreciation (Germany, Russia, US).

- Composition visualization and country-level listings summarized in source (Figure 3.1, Table 3.5); note classification convention in source:
  - T = temporary measures (explicit sunset or time-bound);
  - S = self-reversing measures;
  - P = permanent measures.

*Italic: Source — IMF staff estimates and analysis as presented in the cited IMF chapter/section.*

### 19.      A key fiscal risk presented by

### _spn0913 - 19.      A key fiscal risk presented by

### A. Losses of Funded Pension Schemes
- Funded components of pension systems (public and private) are a key fiscal risk from the crisis, reflecting both earnings on existing retirement saving and net deposits.
- 16 of the 46 countries with data have pension fund investments in equities and mutual funds greater than 10 percent of GDP.
- Countries with higher exposure (large shares of equities and mutual funds and higher pension saving relative to GDP) include: Australia, the United States, Canada, Iceland, the Netherlands, Switzerland, Denmark, the United Kingdom; and among emerging economies: South Africa, Chile, and Brazil.
- Estimated losses during 2008:
  - United States: 22 percent of GDP.
  - United Kingdom: 31 percent of GDP.
- Mutual funds in these countries are heavily weighted toward equities. Investment by funded pension funds in real estate is small (below 3 percent of total assets, on average, for OECD member countries).
- OECD estimate of holdings of potentially “toxic” assets (mortgage-backed securities and credit default swaps): average holdings of 3 percent of such assets in pension fund portfolios of member countries.
- Structured products represent about 8 percent of pension fund assets worldwide; concentration of this risk is in the United States, Sweden, and Japan.

### B. Risks for Fiscal Accounts
- Three main channels of fiscal risk from pension fund losses:
  - Direct effects arising from investments by government pension funds in assets affected by the crisis.
  - Explicit guarantees provided by governments to funded schemes.
  - Pressures to make up for losses suffered by pensioners covered by private pension plans.
- Government exposure examples and data:
  - As of end-2007, over $4 trillion of assets were held by federal, state, and local government defined-benefit pension plans in the United States (more than one-fifth of total U.S. pension assets).
  - The value of these assets had fallen by roughly $1 trillion by October 2008.
  - Estimated aggregate funding ratio fell to 65 percent in October 2008 (mark-to-market basis).
  - During 2000–02, contributions subsequently increased by 45 percent over a two-year period following a similar equity market decline.
- National social insurance pension plans:
  - Some national plans (e.g., the United States) hold specialized assets largely impervious to financial market movements.
  - Other national systems (e.g., Japan, Canada, the Netherlands, New Zealand) hold substantial marketable securities, including equities.
  - National pension systems are not typically fully funded; impacts may be postponed or mitigated by recovery.
- Explicit guarantees:
  - Insurance against loss of assets in private defined-benefit plans due to employer insolvency exists in Canada (province of Ontario), Germany, Japan, Sweden, Switzerland, the United Kingdom, and the United States. Maximum benefits differ across countries; the United States, the United Kingdom, Sweden, and Germany offer relatively high amounts.
  - Potential costs to governments from deficits of guarantee funds and contingent liabilities of probable employer bankruptcies: 0.4 percent of GDP in the United States and 0.1 percent of GDP in the United Kingdom (PBGC, 2008; and PPF, 2008). These costs may increase if economic conditions deteriorate.
  - Guarantees of minimum benefits or rates of return for defined-contribution pension plans exist in France, Spain, Switzerland, the United Kingdom, and many Eastern European countries.
- Risks of government stepping in to support participants in private plans:
  - “Unprotected” defined-contribution plans comprise roughly three-quarters of defined-contribution assets; older workers face more severe cuts in retirement income, especially when purchasing annuities amid low account values and low interest rates.
  - Defined-benefit plans run by private employers face funding-rule-dependent increases in contributions and limits on benefit reductions.
- Distributional incidence affecting fiscal support likelihood:
  - In the United States, among people over age 65, funded pensions and annuities account for 21 percent of income of the richest quintile and 3 percent for the poorest (Burtless, 2008).
  - In the United Kingdom, occupational pensions comprise over 30 percent of income for the richest quintile of pensioners and only 1 percent for the poorest.
  - Chile: all participants invest in individual accounts, and the government guarantees a minimum pension level.

### V. The Outlook for Public Finances in Light of the Crisis
- General note: considerable uncertainty surrounds the outlook; outcomes could be significantly worse than the baseline if further distress and weaker output growth occur.

#### A. Short-Term Outlook
- For G-20 advanced economies:
  - Fiscal balances are projected to worsen, on average, by 8 percentage points of GDP in 2009 relative to 2007.
  - Fiscal balances reach 9
3

e4  percent of GDP in 2009 (Figure 5.1) — (as reported in source).
  - Half of the deterioration is due to fiscal stimulus and financial sector support.
- For G-20 emerging economies:
  - Fiscal balances deteriorate less than advanced economies but still significantly, reversing the improvement since 2003; a relatively large component is due to declining commodity and asset prices.
- Table 5.1 (changes, percent of GDP, difference with respect to previous period):
  - Advanced G-20 countries: Fiscal Balance change 2008 = -2.5; 2009 = -5.5; 2008-09 (A+B) = -8.0.
  - Emerging market G-20 countries: Fiscal Balance change 2008 = -0.6; 2009 = -4.5; 2008-09 = -5.1.
  - G-20 countries overall: Fiscal Balance change 2008 = -1.8; 2009 = -5.1; 2008-09 = -6.9.
  - Advanced G-20 countries: Public Debt change 2008 = 5.8; 2009 = 14.2; 2008-09 = 20.0.
  - Emerging market G-20 countries: Public Debt change 2008 = -1.3; 2009 = 2.3; 2008-09 = 0.9.
  - G-20 countries overall: Public Debt change 2008 = 3.1; 2009 = 9.8; 2008-09 = 12.9.
- Debt-to-GDP ratio outlook:
  - Debt-to-GDP ratio of advanced countries expected to rise by 20 percentage points over 2008–09—the most pronounced upturn in the last few decades.
  - More than a quarter of this increase is due to financial sector support packages.
  - Emerging economies also show a sizable increase in 2009—the first since 2002.
- Figures present PPP GDP-weighted averages and contributions to fiscal balance and debt from: automatic stabilizers, fiscal stimulus, financial-sector support, asset/commodity prices/interest, and other factors.

#### B. The Medium-Term Outlook and Risk Assessment
- Beyond 2009:
  - Activity is expected to recover with supportive macroeconomic and financial sector policies.
  - Fiscal balances are projected to improve as temporary stimulus measures expire and automatic stabilizers are reversed, but will remain weaker than in 2007 unless tightening measures are introduced.
  - For advanced economies, debt-to-GDP ratio in 2014 is projected to be 36 percentage points above the 2007 level.
  - Emerging economies: projected medium-term debt path more benign due to higher growth; debt ratios in 2010 will be above 2007 levels, with declining trend resuming in 2011.
- Table 5.2 excerpts (Fiscal Balance, Government Debt; In percent of GDP):
  - Selected Fiscal Balances (2006, 2007, 2008, 2009, 2010, 2014): Argentina -1.1, -2.0, -0.5, -3.3, -2.8, -1.7; Australia 1.9, 1.5, -0.7, -4.3, -5.3, -2.0; United Kingdom -2.6, -2.6, -5.4, -9.8, -10.9, -6.4; United States -2.2, -2.9, -6.1, -13.6, -9.7, -4.7; G-20 -1.2, -1.0, -2.8, -8.0, -6.9, -3.4.
  - Selected Government Debt (2006, 2007, 2008, 2009, 2010, 2014): Argentina 76.5, 67.9, 57.7, 50.4, 50.6, 48.5; Australia 9.6, 8.9, 8.9, 11.3, 13.9, 16.6; Japan 191.3, 187.7, 196.3, 217.2, 227.4, 234.2; United States 61.9, 63.1, 70.5, 87.0, 97.5, 106.7; G-20 countries 63.1, 62.8, 65.9, 75.7, 81.6, 84.6.
  - Averages based on PPP GDP weights.
- Downside scenarios assessed:
  - Lower growth scenario (growth 1 percentage point below baseline during 2009–2011):
    - Fiscal deficits would rise, on average, by 1 percent of GDP.
    - Debt-to-GDP ratio would increase by an additional 6 percentage points by 2011.
    - Emerging economies are less adversely affected on average due to smaller automatic stabilizers but remain vulnerable to commodity price declines.
  - Prolonged stagnation scenario (decline in growth of 2 percentage points during 2009–2013, inspired by Japan 1991–2007 experience):
    - For advanced countries, fiscal balances would deteriorate on average by 2 percentage points of GDP relative to baseline.
    - Debt ratios would rise by 18 percentage points by 2013.
    - The deterioration is also notable for emerging economies.

*Italic: Source — IMF staff estimates and IMF, World Economic Outlook, April 2009, as presented in the supplied content.*

### 32.      There are other significant downside risks.

### 32.      There are other significant downside risks.

### Key downside risks and channels
- Baseline estimates do not take into account potentially large contingent liabilities of the government arising from explicit and implicit guarantees and central bank support operations; these additional costs could materialize in case of further financial instability and further raise government debt in advanced countries.
- Government intervention to support financial markets has so far been limited in emerging market countries; the ramifications of the crisis in these countries may not have yet been fully felt, and stronger government support may be needed.
- Recovery rates assumed in the baseline may not materialize; recovery rates in the aftermath of this global crisis could be particularly low because of the dearth of external buyers and high risk aversion.
- The baseline excludes possible costs arising from support the public sector may be called to provide to fully-funded pension schemes.
- These additional risks are not independent from earlier shocks: they are more likely to arise in the context of weaker output growth, and could be accompanied by heightened concerns about fiscal solvency, leading to higher interest rates. All these risks could materialize at the same time, producing a major deterioration of the fiscal outlook relative to an already weak baseline.

### Figure 5.6 scenario (government debt under alternative shocks)
- Scenario inputs reported: a 2 percentage point decline in growth, and a 200 basis point increase in real interest rates relative to the baseline starting in 2009; as well as a contingent liability shock corresponding to expected cost of guarantees.
- Averages are based on PPP GDP weights.
- Charts compare Base case vs Prolonged slowdown and Alternative scenario for Advanced G-20 Countries and Emerging Market G-20 Countries (visuals summarized in the source).

### VI. THE RISK FOR FISCAL SOLVENCY AND THE APPROPRIATE POLICY RESPONSE
- Economic agents’ confidence in governments’ solvency has so far helped avoid a meltdown of financial markets; doubts about fiscal solvency could lead to an increase in the cost of borrowing and, in turn, higher interest rates and exchange rate depreciations that add to government debt and could result in “snowballing” debt dynamics.
- Thus far, government debt market reaction to the weaker fiscal outlook has been relatively muted, but several troubling signs exist:
  - Long-term nominal interest rates have declined in the main advanced economies since the beginning of the crisis, although this trend has reversed in several countries in recent months.
  - Real interest rates are broadly the same as in early 2007 (where these can be reliably observed from long-term inflation-indexed bonds traded on liquid markets, for example, in the United States and the United Kingdom), although one might have expected a decline as a result of cyclical developments.
  - For some highly indebted advanced economies (e.g., Greece and Italy), spreads have risen significantly, although government bond yields in those countries remain broadly similar to their precrisis levels.
  - There has been an uptick in credit default swap (CDS) spreads for some major advanced countries, including the United States, though the implied perceived default risk remains relatively small.
    - CDS spreads for the United States rose from 8 basis points in June 2008 to almost 100 basis points in late February 2009 before moderating to around 50 basis points by mid-April 2009.
    - CDS spreads for Austria, Greece, Iceland, Ireland, Italy, Portugal, and Spain had all risen more than 150 basis points (by end-February 2009, compared with their June 2008 levels), though in some cases they declined somewhat by mid-April 2009.
  - Sovereign bond spreads for emerging economies have risen sharply: the EMBI Global composite spread rose to 750 basis points in December 2008 from 170 basis points in the beginning of 2007.
  - Primary bond issuance slowed sharply—issuance by all emerging markets in August–December 2008 was half of its level during the same period in 2007.

### A. The Level of Government Debt
- Fiscal solvency requirement: government debt must not be on an explosive path (no-Ponzi-game condition).
- Simple arithmetic example: a one-off rise in the government debt-to-GDP ratio by 10 percentage points requires an improvement in the primary balance of less than 0.1 percentage point of GDP to stabilize the debt ratio (assuming an interest rate/growth differential of 1 percentage point).
- Historical perspective: the rise in government debt observed so far in advanced countries is sizable but not exceptional; historically, large debt accumulations (bringing debt to 100–200 percent of GDP) have resulted from war-related spending, prolonged recessions, or protracted fiscal problems.
- Empirical evidence: in normal circumstances and in advanced countries, even a 10 percentage point of GDP increase in debt ratios would raise interest rates only by a few basis points (at least, if debt ratios are below 100 percent).
- Need to avoid perception that all one-off shifts in debt ratios will be accommodated; to allow government debt to act as a shock absorber, debt must improve in good years.
  - Example projection: in 2014, gross government debt ratios would stand above 100 percent of GDP in six advanced economies (Belgium, Greece, Ireland, Italy, Japan, and the United States) and between 60–100 percent of GDP in ten advanced economies (Table 6.1 referenced).
  - For a 10 percent increase in the debt ratio, the primary balance would have to improve by more than 1 percentage point to bring back the ratio to its original level within 10 years (illustrative arithmetic).
- Debt tolerance appears lower for emerging economies; government debt was below 60 percent of GDP in most default cases recorded in emerging economies in recent decades.
- Rollover risks are likely to increase; higher-debt advanced countries may be more exposed in coming years.
- Historical differences: wartime episodes were facilitated by comprehensive government control over the economy and capital controls; the current crisis involves large contingent liabilities associated with guarantees of financial sector obligations and future pension and health care spending pressures.

### Box 6.1 summary (Debt/GDP stabilizing primary balance)
- Debt ratio is constant when pb = (D/Y)(r-g)/(1+g), where D is debt stock, Y is GDP, r is nominal interest rate, g is nominal growth rate, and pb is primary fiscal balance as share of GDP.
- The text reiterates the arithmetic linking debt stabilization to primary balance given interest-rate/growth differentials.

### B. The Dynamics of Government Debt: Current and Future Deficits
- Debt solvency is forward-looking; public debt dynamics are driven by current and future deficits.
- Primary balances are now, in many countries, insufficient to ensure debt stabilization or to reduce debt to precrisis levels.
  - For some main advanced countries where the crisis has led to large increases in debt (including the United Kingdom and the United States), the primary fiscal balance would have to improve, starting in 2014, by several percentage points of GDP (compared with “unchanged policies” projections) to gradually bring debt back to, say, 60 percent of GDP over the following 15 years (Table 6.1 referenced).
  - Almost all advanced countries reported in Table 6.1 will still have primary balances in 2014 below what is required to stabilize their government debts (or bring them gradually down to 60 percent), assuming an interest rate/growth rate differential of 1 percent.
  - For a sample of selected emerging markets, the share of countries with 2014 primary balances below the level needed to stabilize the debt ratio or reduce it to a benchmark level of 40 percent of GDP is lower, but still more than one half.
  - Primary gaps would be larger if downside risks materialize.

### Aging and future deficits
- Primary balances are projected to weaken further owing to the demographic shock.
  - For EU-25 countries, Eurostat 2008 projections suggest on average a doubling of the old-age dependency ratio from 2005 to 2050; the European Commission (EC, 2006) projects for the EU-25 an average spending increase of 3.4 percent of GDP, with pension expenditures increasing by 2.3 percent of GDP and the rest accounted for by health and long-term care spending.
  - For the United States, the Congressional Budget Office (CBO) projects annual federal budget spending on pensions to increase from 4.3 percent to 6.1 percent of GDP from 2007 to 2050.
  - Emerging economies: the share of populations older than 65 is projected to increase in all emerging economies, with the old-age dependency ratio expected to triple, on average, by 2050 (United Nations, 2006). Korea faces the steepest increase; China and many other countries also face significant pressures.
  - An illustrative additional “cost pressure” scenario (2050 CPS column in Table 6.2) indicates budget strains could be substantially larger if the relative price of health and long-term care services increases more than assumed in the conservative baseline; for health spending, CPS assumes additional 1 percent annual growth in spending on top of demographic and income effects; for long-term health care, CPS assumes full “Baumol” effect.

### Selected numeric highlights and examples from the text
- Scenario shock inputs: 2 percentage point decline in growth; 200 basis point increase in real interest rates starting in 2009.
- CDS spreads for the United States: 8 basis points in June 2008 → almost 100 basis points in late February 2009 → around 50 basis points by mid-April 2009.
- EMBI Global composite spread: 170 basis points at the beginning of 2007 → 750 basis points in December 2008.
- Example stabilization arithmetic: a 10 percentage point rise in government debt-to-GDP requires an improvement in the primary balance of less than 0.1 percentage point of GDP assuming a 1 percentage point interest rate/growth differential.
- Historical high debt accumulations referenced: ranges of 100–200 percent of GDP in wartime or prolonged crises.
- Table 6.1 reports numerous country debt and primary balance figures (select examples shown in source): Japan gross debt 194.2, 189.6, primary balance -1.8, -0.2 ; Italy debt 104.1, 102.0; United States debt 63.4, 65.8, primary balance -0.8, -0.3; Ireland debt 23.6, 23.2, 63.6, 126.0 and primary balances as reported. (Full tabular entries appear in the source.)
- Figure 6.1 note: slope coefficient in bottom panel is 1.3 (i.e., a 10 percentage point increase in the debt-to-GDP ratio is associated with a 13 basis point increase in spreads).

*Source: IMF staff estimates; IMF, World Economic Outlook database; Bloomberg; and IMF staff calculations (content as provided in the supplied source).*

### 41.      Altogether the global fiscal outlook is somber. The debt ratio of G-20 advanced

### Altogether the global fiscal outlook is somber.

### Global outlook and debt projections
- The debt ratio of G-20 advanced countries is projected to increase by an additional 59 percentage points by 2030.
- Strains are also likely to appear in emerging economies, though long-term projections in those economies are subject to greater uncertainty owing to data limitations.
- Projection assumptions: interest rate growth differential as projected in the April 2009 World Economic Outlook until 2014 and converging thereafter to 1 percentage point; and pension and health contributions remaining constant as a ratio to GDP after 2014.

### Risks and trade-offs for fiscal policy
- Two critical questions:
  - Should the economic outlook deteriorate further, how much room does fiscal policy have to continue its supportive action?
  - What should be done to reassure markets that fiscal solvency is not at risk?
- Two opposite risks governments must balance:
  - The risk of prolonged depression and stagnation — the economic and fiscal costs of inaction could be even larger than the costs of action. The higher this risk, the more necessary it is for governments to take fiscal risks by providing further support (priority: financial sector; possibly also aggregate demand).
    - Note: To the extent that fiscal action is effective in supporting growth, its net fiscal cost is reduced by the automatic stabilizers. Example: the net cost of a 1 percentage point of GDP fiscal stimulus, assuming a unit multiplier, is about ¾ percentage point of GDP for the G-20.
  - The risk of a loss of confidence in government solvency — need to closely monitor developments in real interest rates, spreads, and debt maturity. The more these indicators weaken, the less room for further fiscal action.

### Strategy to ensure fiscal solvency — four pillars
- Fiscal stimulus packages should consist as much as possible of temporary measures.
- Policies should be cast within medium-term fiscal frameworks that envisage a gradual fiscal correction, once economic conditions improve, with proper arrangements to monitor progress.
- Governments should pursue growth-enhancing structural reforms.
- There should be a firm commitment and a clear strategy to contain the trend increase in aging-related spending in countries exposed to unsustainable demographic shocks.

### Composition of the stimulus package
- Fiscal stimulus should not raise deficits permanently; measures should be temporary or self-reversing where possible.
- The ideal is an intertemporal shift: raise deficits for the expected duration of the crisis and reduce them later so long-run debt levels are unchanged.
- Many announced stimulus packages do not fully conform to this prescription; governments should indicate early how temporary measures will be offset over the medium term.

### Medium-term fiscal frameworks (design and implementation)
- Medium-term fiscal and debt targets should be buttressed by a clear adjustment strategy and strong institutional setup (e.g., fiscal responsibility laws, fiscal rules, independent fiscal councils).
- Specific recommendations:
  - Set credible medium-term targets over the following four–five years and define clear policy actions to reach them.
  - Assess debt solvency under different scenarios to capture fiscal risks, especially increased contingent liabilities.
  - Maximize revenues from management and recovery of assets acquired during financial support operations; central bank losses from support to financial institutions should be promptly covered through government budget transfers.
  - Fiscal rules can help maintain or restore solvency if supported by political commitment, flexibility for exceptional circumstances, and thoughtful design to avoid excessive policy constraints.
  - Fiscal councils can provide independent monitoring and forecasts.

### Growth-enhancing structural reforms
- Rapid growth has been key in past episodes of sustained improvements in government debt ratios.
- Expenditure and tax policies should focus on fostering growth:
  - Expenditure policies: prioritize spending that boosts growth potential and high social rate-of-return items (basic transportation infrastructure, education, preventive health care); reduce unproductive spending; use targeted spending to pursue distributional objectives.
  - Tax reform: broaden the tax base, reduce rates to minimize distortions and promote equity, improve incentives to work and invest, simplify administration and compliance, and enhance tax code transparency.
    - Emphasize consumption taxes (especially a broad-based VAT) and property taxes, reduce remaining taxes on international trade.
    - Reduce bias in favor of debt vis-à-vis equity financing present in most tax systems.

### Containing age-related spending
- Two considerations:
  - Despite large fiscal costs of the crisis, the major threat to long-term fiscal solvency in advanced countries remains unfavorable demographic trends. Net present value calculations show the fiscal burden of the crisis is about 11 percent of the aging-related costs for advanced countries.
  - Many advanced countries had pursued prepositioning strategies (cutting debt, reducing other spending, keeping tax rates relatively high) to make room for future pension and health spending increases; the crisis has derailed or delayed that strategy.
- Urgency of entitlement reform:
  - With larger headline debt and lower primary balances, pressures from aging must be addressed by reforming pension and health entitlements.
  - Amount and speed of adjustment should be country-specific (demographics, growth prospects, borrowing costs, debt tolerance, public attitudes).
  - Postponing reforms will likely result in larger and more painful adjustments later; direct reforms of health and pension entitlements may involve smaller cuts in other priority spending than prepositioning strategies.
- Principles for effective entitlement reform:
  - Pensions: achieve savings while preserving intergenerational equity; main tool is increases in the effective retirement age; assist funded pension plans that incurred major losses only by targeted help to lower-income households.
  - Health care: reforms must be equitable to secure public support when limiting service coverage or shifting costs to the private sector.
- Political economy and timing:
  - Enacting major entitlement reforms during severe economic weakening is challenging but possible; successful fiscal stimulus could improve the climate for reform.
  - The crisis may offer opportunities for comprehensive “big bang” packages: immediate strong stimulus in exchange for long-lasting entitlement reforms.
  - Clear communication and identification of necessary actions and timing are critical.

### Key statistics and selected quantitative findings
- G-20 advanced countries: debt ratio projected to increase by an additional 59 percentage points by 2030.
- Net present value of impact on fiscal deficit of crisis and aging-related spending (in percent of GDP), selected entries from Table 6.4:
  - Australia: Crisis 30; Aging 48; Crisis/Aging 26.1
  - Canada: Crisis 21; Aging 72; Crisis/Aging 29.0
  - France: Crisis 31; Aging 27; Crisis/Aging 11.2
  - Germany: Crisis 29; Aging 28; Crisis/Aging 10.3
  - Italy: Crisis 35; Aging 16; Crisis/Aging 20.7
  - Japan: Crisis 35; Aging 15; Crisis/Aging 22.3
  - Korea: Crisis 20; Aging 68; Crisis/Aging 2.9
  - Mexico: Crisis 13; Aging 26; Crisis/Aging 14.8
  - Spain: Crisis 39; Aging 65; Crisis/Aging 25.9
  - Turkey: Crisis 22; Aging 20; Crisis/Aging 10.9
  - United Kingdom: Crisis 48; Aging 33; Crisis/Aging 14.2
  - United States: Crisis 37; Aging 49; Crisis/Aging 7.5
  - Advanced G-20 Countries (average, PPP-weighted): Crisis 35; Aging 409; Crisis/Aging 10.8
- Projection assumptions for the debt paths: after 2014 structural primary balance deteriorates due to demographic factors; if debt-to-GDP falls below 20 percent fiscal balance loosens to ensure debt remains above 20 percent (Korea permitted to fall below 20 percent); interest rate/growth differential converges to 1 percentage point.
- Example fiscal multiplier/accounting: net cost of 1 percentage point of GDP fiscal stimulus ~ ¾ percentage point of GDP for the G-20 assuming unit multiplier.

*Source: IMF excerpt from _spn0913 (PDF): "Altogether the global fiscal outlook is somber."*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0913.pdf_