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

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

IMF Survey : Governments Must Press Ahead With Spending Reform

April 9, 2014

  • Fiscal risks abating but remain elevated
  • Emerging markets and low-income countries see rising fiscal vulnerabilities, although from still low levels
  • Difficult choices needed on spending reforms

In many countries, public finances remain on edge as economies struggle to return to pre-crisis levels of economic growth, highlighting the need for growth-supporting fiscal reforms.

Laborers construct a footpath in Quetta, Pakistan. Public finances in emerging markets are likely to see little change in 2014, with further improvements expected in 2015 (photo: Pakistan Press International Photo/Newscom)

Laborers construct a footpath in Quetta, Pakistan. Public finances in emerging markets are likely to see little change in 2014, with further improvements expected in 2015 (photo: Pakistan Press International Photo/Newscom)

Fiscal Monitor

In the latest edition of its Fiscal Monitor report, the IMF finds that recent policy moves have helped to broadly stabilize public debt ratios in most advanced economies, but debt in these countries remains at historic highs. The surge in public debt will take some time to unwind, and credible medium-term plans must be designed to both bring down debt ratios and at the same time enhance long-term growth prospects.

Across advanced economies, the pace of fiscal consolidation is set to slow in 2014 as focus shifts to how to best design fiscal policies supportive of both further consolidation and a still uneven recovery.

“In most countries, persistently high debt ratios continue to cast shadows over the medium term,” said Sanjeev Gupta, Acting Director of the IMF’s Fiscal Affairs Department. “Against this background, the top priority remains the design and implementation of credible medium-term consolidation plans to lower debt ratios to safer levels, while carefully balancing equity and efficiency goals.”

The IMF Fiscal Monitor is published twice a year to track public finance developments around the world.

Debt stabilizes in advanced economies

In 2013, a faster-than-expected pace of fiscal consolidation in several advanced economies helped stabilize the public debt ratio and reduce the average overall fiscal deficit among these economies to 5 percent of GDP—almost half its peak in 2009.

Higher revenues, in part buoyed by growth, and lower spending helped both the United States and United Kingdom significantly narrow their 2013 budget deficits. In Japan, however, the deficit held steady at just under 8 percent of GDP, and the country is now stepping up its consolidation efforts. To dispel policy uncertainty and support a rebound in economic growth, formulating a longer-term, growth-friendly fiscal strategy remains a priority in Japan, as well as in the United States.

Although budget plans for 2015 have not yet been adopted, fiscal consolidation looks set to continue next year. As a result, debt-to-GDP ratios will start declining in about half of the highly indebted advanced economies by 2015—by end-2013 only a few had reached that point.

Vulnerabilities rising in emerging markets and low-income countries

In emerging market economies, deficits remain significantly above pre-crisis levels, as most countries opted to postpone fiscal adjustment in 2014. In those emerging market economies closely integrated with international capital markets, the effects of normalizing global liquidity conditions is leading to increased borrowing costs and some financial volatility.

Even though the recent bouts of turbulence were not triggered by fiscal imbalances, less investor appetite for risk and tighter financing conditions may worsen the public debt situation in most of these countries. According to the Fiscal Monitor, well designed fiscal reform can boost investor confidence while at the same time strengthening safety nets and propping up domestic saving where it had been earlier eroded.

Fiscal deficits continued to widen in 2013 in many low-income countries as government spending persistently outpaced economic growth and revenue. Overall, debt ratios are projected to increase during the coming two years—although in most countries, at a moderate pace. Emerging evidence raises concerns on the efficiency of debt-financed spending; for example, it often does not seem to have been used to raise much needed public investment. According to the report, where fiscal adjustment is warranted in these countries, it should safeguard social safety nets and raise spending efficiency to address large remaining infrastructure gaps.

Spending reforms

Ensuring the sustainability of public finances requires difficult choices on both the taxation and spending sides of the budget. While tax reform can help boost potential growth through the removal of distortions, spending reforms help strengthen public service delivery. Coupled with the projected increase in age-related expenditures resulting from an aging population, pressures on government spending in the future will only increase.

The Fiscal Monitor sets out the main elements needed for meaningful spending reform:

Ensuring the sustainability of social spending and public sector wages. Health care systems in many countries have room to improve efficiency without drastically cutting services. For public pension systems, raising the retirement age and adjusting contributions and benefits are the key options. Containing the growth of the public sector wage bill in a lasting way would require replacing the across-the-board wage and hiring freezes with deeper, efficiency-enhancing structural reforms supported by social dialogue.

Achieving efficiency gains while aiming to reduce inequality. Large gains can be made in some countries by improving the efficiency of spending on education. In other countries, particularly emerging markets and low-income countries, improving the efficiency of public investment processes could make it easier to meet infrastructure needs.

Establishing institutions that promote spending control. Fiscal rules, such as those that define and limit spending, can impose binding commitments on the path of public spending. Decentralizing spending such that sub-national levels of government become more involved in delivery of services can help contain public sector growth and improve spending efficiency, provided it is well planned and implemented.