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Fiscal Monitor
As Downside Risks Rise, Fiscal Policy Has To Walk a Narrow Path
January 2012
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Deficits in many advanced economies fell significantly during 2011, and most plan substantial adjustment this year. Continued adjustment is necessary for medium-term debt sustainability, but should ideally occur at a pace that supports adequate growth in output and employment. Given the large adjustment already in train this year, governments should avoid responding to any unexpected downturn in growth by further tightening policies, and should instead allow the automatic stabilizers to operate, as long as financing is available and sustainability concerns permit. Countries with enough fiscal space, including some in the euro area, should reconsider the pace of near-term adjustment. At the same time, some countries—notably, the United States and Japan—need to clarify their medium-term debt-reduction strategies. Adjustment should be supported by the availability of adequate nonmarket financing when, as in the euro area, market confidence is slow to respond to reforms.
In advanced economies, fiscal deficits fell in 2011 by about 1 percent of GDP overall, and by only slightly less after taking into account the narrowing output gap. The headline deficit fell by 2 percent of GDP in the euro area, and by a still sizable 1¼ percent of GDP in cyclically adjusted terms (Table 1). However, a large share of the improvement within the euro area is accounted for by Germany, where the cyclically adjusted deficit fell by 2¼ percent of GDP, reflecting an unusually strong response of revenues and employment to output. The cyclically adjusted balance also strengthened substantially in Spain, while France and Italy posted more modest improvements, as measures announced or approved in these countries will not take full effect until next year (see below). Cyclically adjusted deficits also fell substantially in the United Kingdom and the United States, but rose marginally in Japan owing to reconstruction costs related to the natural disaster.
Among European program countries, headline deficits were larger than expected in Greece owing in part to a weaker economic outturn. Slippages in the implementation of revenue and spending measures and lower tax compliance suggest that the cyclically adjusted deficit exceeded expectations as well, notwithstanding an improvement of 3 percentage points of GDP relative to 2010. In Portugal, the fiscal target was met through a one-time partial transfer of banks’ pension fund assets, implying that the underlying adjustment in 2011 was smaller than expected there, although still very sizable (4 percentage points of GDP in cyclically adjusted terms). In Ireland, headline fiscal outturns were on track, and the cyclically adjusted balance improved by 2 percent of GDP.
| Table 1. Fiscal Indicators, 2008–13 | |||||||||||
| (Percent of GDP, except where otherwise noted) | |||||||||||
| Est. | Projections | Difference from September 2011 Fiscal Monitor1 | |||||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2011 | 2012 | 2013 | |||
|
Overall Fiscal Balance |
|||||||||||
|
World |
-2.0 | -6.7 | -5.5 | -4.5 | -4.1 | -3.4 | 0.0 | -0.4 | -0.5 | ||
|
Advanced economies |
-3.8 | -9.0 | -7.6 | -6.6 | -5.7 | -4.6 | 0.0 | -0.4 | -0.5 | ||
|
United States |
-6.7 | -13.0 | -10.5 | -9.5 | -8.0 | -6.4 | 0.1 | -0.1 | -0.2 | ||
|
Euro Area |
-2.2 | -6.5 | -6.3 | -4.3 | -3.4 | -2.9 | -0.1 | -0.3 | -0.4 | ||
|
France |
-3.3 | -7.6 | -7.1 | -5.7 | -4.8 | -4.4 | 0.1 | -0.2 | -0.5 | ||
|
Germany |
-0.1 | -3.2 | -4.3 | -1.1 | -0.7 | -0.1 | 0.6 | 0.4 | 0.7 | ||
|
Italy |
-2.7 | -5.3 | -4.5 | -3.9 | -2.8 | -2.3 | 0.2 | -0.4 | -1.1 | ||
|
Spain |
-4.2 | -11.2 | -9.3 | -8.0 | -6.8 | -6.3 | -1.8 | -1.7 | -1.9 | ||
|
Japan |
-4.7 | -10.8 | -9.3 | -10.1 | -10.2 | -8.8 | 0.2 | -1.0 | -1.0 | ||
|
United Kingdom |
-4.9 | -10.4 | -9.9 | -8.6 | -7.8 | -6.5 | -0.1 | -0.8 | -1.4 | ||
|
Canada |
0.1 | -4.9 | -5.6 | -4.9 | -4.4 | -3.6 | -0.6 | -1.2 | -1.7 | ||
|
Emerging economies |
-0.4 | -4.8 | -3.6 | -2.6 | -2.7 | -2.5 | 0.1 | -0.4 | -0.5 | ||
|
China |
-0.4 | -3.1 | -2.3 | -2.0 | -2.0 | -1.4 | -0.4 | -1.2 | -1.3 | ||
|
India |
-7.2 | -9.7 | -8.9 | -8.5 | -7.9 | -7.6 | -0.4 | -0.4 | -0.2 | ||
|
Russia |
4.9 | -6.3 | -3.5 | 0.5 | -1.4 | -1.7 | 1.6 | 0.7 | 0.6 | ||
|
Brazil |
-1.4 | -3.1 | -2.8 | -2.6 | -2.4 | -2.3 | -0.2 | 0.4 | 0.3 | ||
|
Mexico |
-1.1 | -4.7 | -4.3 | -3.0 | -2.7 | -2.1 | 0.3 | 0.0 | 0.3 | ||
|
South Africa |
-0.5 | -5.3 | -5.1 | -4.9 | -4.8 | -4.2 | -0.6 | -0.9 | -0.9 | ||
|
Low-income economies |
-1.3 | -4.0 | -3.1 | -2.8 | -2.8 | -2.3 | 0.3 | 0.1 | 0.2 | ||
|
G-20 economies |
-2.7 | -7.6 | -6.2 | -5.1 | -4.7 | -3.9 | 0.1 | -0.4 | -0.5 | ||
|
G-20 advanced |
-4.4 | -9.6 | -8.2 | -7.2 | -6.3 | -5.1 | 0.1 | -0.3 | -0.5 | ||
|
G-20 emerging |
-0.2 | -4.8 | -3.5 | -2.5 | -2.7 | -2.5 | 0.0 | -0.5 | -0.6 | ||
|
General Government Cyclically Adjusted Balance (Percent of Potential GDP) |
|||||||||||
|
World |
-2.6 | -4.6 | -4.3 | -3.6 | -3.0 | -2.4 | 0.0 | -0.1 | -0.2 | ||
|
Advanced economies |
-3.7 | -5.9 | -5.9 | -5.1 | -4.2 | -3.2 | -0.3 | -0.4 | -0.4 | ||
|
United States2 |
-5.0 | -7.5 | -7.8 | -7.0 | -5.6 | -4.3 | -0.6 | -0.7 | -0.6 | ||
|
Euro Area |
-3.2 | -4.8 | -4.8 | -3.5 | -2.1 | -1.6 | -0.4 | 0.1 | 0.2 | ||
|
France |
-3.0 | -5.3 | -5.2 | -4.4 | -3.3 | -3.1 | -0.1 | 0.0 | -0.1 | ||
|
Germany |
-1.3 | -1.3 | -3.5 | -1.2 | -0.4 | 0.1 | 0.3 | 0.5 | 0.8 | ||
|
Italy |
-3.6 | -3.5 | -3.4 | -2.9 | -0.8 | 0.0 | -0.4 | 0.3 | 0.0 | ||
|
Spain |
-5.4 | -9.8 | -7.8 | -6.6 | -4.7 | -4.1 | -2.0 | -0.5 | -0.2 | ||
|
Japan |
-4.1 | -7.7 | -7.8 | -8.0 | -8.6 | -7.8 | 0.1 | -1.0 | -0.9 | ||
|
United Kingdom |
-6.5 | -9.0 | -7.8 | -6.3 | -5.1 | -3.7 | 0.0 | -0.4 | -0.8 | ||
|
Canada |
-0.5 | -2.5 | -4.0 | -3.8 | -3.2 | -2.5 | -0.8 | -1.3 | -1.5 | ||
|
Emerging economies |
-1.9 | -4.1 | -3.4 | -2.6 | -2.4 | -2.1 | 0.5 | 0.2 | 0.1 | ||
|
China |
0.0 | -2.4 | -1.5 | -0.7 | -0.6 | -0.2 | 1.1 | 0.3 | -0.1 | ||
|
India |
-9.3 | -10.7 | -9.5 | -8.9 | -8.3 | -8.0 | -0.6 | -0.3 | -0.1 | ||
|
Russia |
3.8 | -3.3 | -1.9 | 1.0 | -1.3 | -1.7 | 1.3 | 0.5 | 0.5 | ||
|
Brazil |
-2.2 | -2.2 | -3.3 | -2.8 | -2.2 | -2.2 | -0.2 | 0.6 | 0.4 | ||
|
Mexico |
-1.3 | -3.8 | -3.8 | -2.8 | -2.7 | -2.1 | 0.7 | 0.4 | 0.8 | ||
|
South Africa |
-2.0 | -4.9 | -4.6 | -4.4 | -4.0 | -3.6 | -0.7 | -0.6 | -0.5 | ||
|
G-20 economies |
-3.0 | -5.2 | -5.0 | -4.2 | -3.6 | -2.9 | 0.1 | -0.2 | -0.2 | ||
|
G-20 advanced |
-3.8 | -6.0 | -6.3 | -5.4 | -4.5 | -3.5 | -0.3 | -0.5 | -0.5 | ||
|
G-20 emerging |
-1.7 | -4.1 | -3.4 | -2.6 | -2.5 | -2.2 | 0.5 | 0.2 | 0.0 | ||
|
General Government Gross Debt |
|||||||||||
|
World |
59.5 | 65.9 | 70.0 | 70.1 | 70.9 | 70.9 | 0.6 | 1.5 | 2.2 | ||
|
Advanced economies |
82.0 | 93.7 | 99.7 | 103.5 | 107.6 | 110.2 | 1.0 | 2.1 | 3.0 | ||
|
United States |
76.1 | 89.9 | 98.5 | 102.0 | 107.6 | 112.0 | 2.0 | 2.6 | 3.1 | ||
|
Euro Area |
69.8 | 79.4 | 85.3 | 88.4 | 91.1 | 92.5 | 0.0 | 1.2 | 2.4 | ||
|
France |
68.3 | 79.0 | 82.4 | 87.0 | 90.7 | 93.1 | 0.1 | 1.2 | 2.3 | ||
|
Germany |
66.7 | 74.4 | 83.2 | 81.5 | 81.6 | 79.8 | -1.1 | -0.3 | -1.2 | ||
|
Italy |
105.8 | 115.5 | 118.4 | 121.4 | 125.3 | 126.6 | 0.4 | 3.9 | 6.5 | ||
|
Spain |
39.9 | 53.6 | 60.8 | 70.1 | 78.1 | 84.0 | 2.6 | 7.9 | 11.2 | ||
|
Japan |
196.2 | 216.3 | 219.0 | 233.4 | 241.0 | 246.8 | 0.3 | 2.5 | 3.8 | ||
|
United Kingdom |
52.5 | 68.4 | 75.1 | 80.8 | 86.6 | 90.3 | 0.1 | 1.8 | 4.4 | ||
|
Canada |
71.1 | 83.6 | 85.1 | 85.5 | 86.7 | 84.7 | 1.4 | 2.6 | 2.4 | ||
|
Emerging economies |
34.7 | 36.7 | 40.8 | 37.8 | 36.4 | 35.0 | 0.0 | 0.7 | 1.2 | ||
|
China |
17.0 | 17.7 | 33.5 | 26.6 | 23.3 | 20.9 | -0.3 | 1.1 | 2.5 | ||
|
India |
74.7 | 74.3 | 67.4 | 65.8 | 65.3 | 64.4 | 0.9 | 1.1 | 1.2 | ||
|
Russia |
7.9 | 11.0 | 11.7 | 10.5 | 11.2 | 12.1 | -1.1 | -0.9 | -0.5 | ||
|
Brazil |
63.5 | 66.9 | 65.2 | 66.0 | 64.2 | 62.0 | 1.0 | 0.2 | -0.5 | ||
|
Mexico |
43.1 | 44.7 | 42.9 | 42.7 | 43.2 | 43.5 | -0.2 | -0.4 | 0.0 | ||
|
South Africa |
27.4 | 31.5 | 35.3 | 37.9 | 40.0 | 41.5 | 1.1 | 1.5 | 2.0 | ||
|
Low-income economies |
39.2 | 42.4 | 40.8 | 40.0 | 40.3 | 40.2 | -2.1 | -1.3 | -1.5 | ||
|
G-20 economies |
66.4 | 73.3 | 78.2 | 77.8 | 78.5 | 78.4 | 0.7 | 1.7 | 2.4 | ||
|
G-20 advanced |
87.6 | 100.1 | 106.4 | 110.2 | 114.6 | 117.4 | 1.1 | 2.2 | 2.9 | ||
|
G-20 emerging |
34.8 | 35.9 | 40.8 | 37.1 | 35.3 | 33.8 | 0.1 | 0.8 | 1.5 | ||
|
Memorandum: |
|||||||||||
|
World Growth (percent) |
2.8 | -0.6 | 5.2 | 3.8 | 3.3 | 3.9 | -0.1 | -0.7 | -0.5 | ||
|
Sources: IMF staff estimates and projections. Note: All country averages are PPP-GDP weighted using rolling weights. Projections are based on IMF staff assessment of current policies. 1 For overall fiscal balance and cyclically adjusted balance, + indicates a smaller fiscal deficit; for gross debt, + indicates a larger debt. 2 Excluding financial sector support. |
|||||||||||
Nevertheless, market interest rates in some advanced euro area economies remain at very high levels, although they have moderated somewhat in recent weeks (Figure 1). By contrast, some large advanced economies thus far remain immune from market pressures, with interest rates that are well below historical levels (Figure 2). See the January 2012 Global Financial Stability Report Update for details.
While deficits and debt in many advanced economies are high, the pace of consolidation projected in 2012 is considerable given the weak economic environment (see the January 2012 World Economic Outlook Update). Moreover, fiscal policy in many countries is already tighter with respect to the cycle than had been projected in the September 2011 Fiscal Monitor (Figure 3), partly because a lack of affordable additional financing is compelling some euro area economies to introduce new measures to attain existing headline deficit targets, rather than allowing the automatic stabilizers to operate.
Further declines in cyclically adjusted deficits could be undesirable not only from a growth perspective, but possibly from a market perspective as well. While smaller deficits and debt ratios do lead to lower borrowing costs, other things equal, advanced economies with faster output growth are also currently benefiting from lower spreads (Figure 4). This likely reflects in part concerns about the feasibility of fiscal consolidation and solvency in an environment of very weak growth.2 Thus, further tightening during a downturn could exacerbate rather than alleviate market tensions through its negative impact on growth.
In the near term, sufficient fiscal adjustment is in train in most advanced economies, and they should allow the automatic stabilizers to operate freely, so long as solvency concerns allow and financing for higher deficits can be realized. Among those countries, those with very low interest rates or other factors that create adequate fiscal space, including some in the euro area, should reconsider the pace of near-term fiscal consolidation. However, implementation of credible medium-term debt reduction plans remains a priority, as high debt levels make these countries vulnerable should interest rates increase. For the United States, such a plan should feature measures that contain entitlement spending and raise revenues. In Japan, an adjustment path that allows debt ratios to begin declining by the middle of this decade is called for.
In some countries, however, market interest rates remain very high despite the significant fiscal consolidation that has been implemented or is in the pipeline. For countries that are adjusting at a rate that is appropriate from a medium-term perspective, the availability of adequate financing—through the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM)—along with credible mechanisms to ensure that these countries remain committed to fiscal discipline over the medium and longer term, could provide an important confidence boost while market perceptions gradually adjust to strengthened fundamentals.
In this context, the new European fiscal compact agreed to by a majority of EU countries in early December is a welcome step toward deeper fiscal integration, although further action is needed. Measures include a new fiscal rule (capping the structural deficit at ½ percent of GDP) with an automatic correction mechanism in case of deviations, to be enshrined in each country’s national legal system; stronger monitoring and assessment of budgetary plans by the European Commission; and ex ante reporting of national debt issuance plans to the European Commission.
Countries need to ratify the new measures quickly to ensure the effectiveness of these agreements. Furthermore, over time, stronger fiscal integration and governance will have to be complemented by some fiscal risk sharing across the euro area.
Deficits in emerging economies fell by about 1 percent of GDP in headline terms and about ¾ percent in cyclically adjusted terms in 2011. Higher oil revenues led to a dramatic increase in the cyclically adjusted balance in Russia, and to a lesser extent Mexico, but declines in cyclically adjusted deficits were recorded in all other major emerging economies last year, as well.
A looser-than-expected fiscal stance is accompanying the weakening economic environment in some emerging economies this year, but others are tightening policy instead (Figure 5). Some emerging economies with rapidly widening output gaps and declining inflation have room to make policy more supportive of economic activity, given relatively low debt levels. In others, however, high debt and lingering large deficits mean there is little space for more than the operation of automatic stabilizers should growth slow further. Emerging economies highly dependent on commodity revenues and external inflows also need to assess cautiously risks of a large and protracted decline in such financing sources.3
1 See “The Challenge of Public Pension Reform in Advanced and Emerging Economies” (http://www.imf.org/external/pp/longres.aspx?id=4626).
2 In principle, the temporary deceleration of growth that normally accompanies a fiscal tightening should not affect long-term solvency risks (for which potential growth matters). However, after four years of high volatility markets seem to be focusing at present on short-term developments and therefore seem to react negatively to even temporary decelerations in growth.
3 Fiscal policy is only one element of the policy response to the slowdown. The Update of the World Economic Outlook discusses the overall policy framework for emerging economies.
