Signs of Fiscal Progress: Will It Be Enough?
IMF Blog, July 18, 2012
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- Authors: Carlo Cottarelli
- Published: July 18, 2012
Summary of recent assessment
- Fiscal adjustment is continuing in the advanced economies at a speed that is broadly appropriate, and roughly what was projected three months ago.
- In emerging economies there is a pause in fiscal adjustment this year and next, which is generally appropriate given that many of these countries have low debt and deficits.
- The improvement in fiscal conditions in many advanced economies is welcome, but lower deficits alone will not be sufficient to remove countries under market pressure from the crosshairs.
Signs of progress in advanced economies
- The deficit will decline in about three quarters of advanced economies this year, and in almost 90 percent of them next year.
- Debt ratios are starting to come down: projection that one-third of advanced economies will have a declining debt ratio this year and half of them will do so next year.
- Europe: fiscal tightening in the euro area amounted to a cumulative 2½ percentage points of GDP in 2011–12; in 2013–14 it is projected to be one third of this, reducing the fiscal drag on growth.
- United States: risk that fiscal consolidation will increase dramatically next year, with the economy going over the “fiscal cliff” of expiring tax cuts and of automatic spending cuts; a much more contained deficit decline would be preferable and should be introduced in the context of a medium-term fiscal adjustment plan.
Emerging economies: pause and selective needs for adjustment
- Many emerging economies are now expected to show higher than anticipated deficits this year and next.
- The weakening in fiscal deficits reflects deceleration in economic activity in the context of relatively stronger fiscal positions.
- Most emerging economies have more fiscal space and some are using it to cushion their economies; a few countries require a more ambitious fiscal adjustment strategy.
Spreads not fully aligned with fundamentals
- Bond spreads remain very high for some euro area countries—higher than what could be explained by fundamentals like debt and deficits, growth, and inflation.
- Italy and Spain pay spreads that are some 200–250 basis points above their fundamental level.
- Even France faces market rates on longer maturities that are higher than can be explained by debt, deficits and the like.
- Fiscal fundamentals matter and countries with high debt and deficits need to continue restoring fundamentals to bring down interest rates and reduce crisis risk.
- However, fiscal fundamentals cannot do the job alone in restoring market conditions to normal.
Reasons for elevated spreads and needed European actions
- An important reason for spreads being higher than fundamentals is the challenges the euro project is facing.
- Recent European progress noted:
- European leaders agreed at their June summit on steps that, if implemented in full, will help break links between government and bank balance sheets so weak banks won’t feed back into government debt concerns.
- So far 10 of the 25 European Union member signatories have ratified the Fiscal Compact treaty to strengthen fiscal frameworks and cap structural deficits.
- The European Parliament has adopted draft regulations known as the “two-pack” to further improve fiscal policy coordination.
- Additional actions still needed:
- Increased banking and fiscal integration.
- Consideration of euro area–level actions to stabilize funding conditions in sovereign debt markets, such as reactivation of the Securities Markets Program (under which public and private debt securities are considered eligible for purchase by euro area central banks) or issuance of common euro area debt in limited amounts.
- Caveat: measures like these cannot substitute for further progress in reducing debt and deficits in countries under market pressure, but can help ensure countries realize the full market benefits of improvements in fiscal fundamentals.
Source: IMF blog post by Carlo Cottarelli, July 18, 2012.
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