Act Now, Act Together
IMF Blog, April 13, 2016
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- Authors: Vitor Gaspar, Luc Eyraud
- Published: April 13, 2016
Worsening public finances
- The April 2016 Fiscal Monitor shows public debt continues to rise worldwide; fiscal deficits have gone up in many countries.
- On average, public debt now exceeds the level observed during the Great Depression and is approaching the level immediately after World War II.
- In emerging markets and low-income countries, fiscal deficits in 2016 are projected to be even higher than in 2009 during the global financial crisis.
- The fiscal positions of commodity exporters have been especially hard hit by the collapse in revenues.
- In the Middle East and North Africa, the cumulative fiscal balances of oil exporters alone are set to deteriorate by a staggering $2 trillion in the next five years, compared to the pre-crisis period 2004–08.
- Major structural and cyclical forces affecting public finances:
- Continued weakness in global activity and entrenched low inflation pressures in advanced economies.
- The decline in commodity prices (about 35 percent in the past 12 months and 65 percent since mid-2014 for oil).
- The slowdown in trade.
- Emerging market and developing economies facing higher interest rates and dwindling capital inflows.
- Rising risks across almost all regions.
Three challenges
- Policymakers must adapt to new realities; "no one-size-fits-all." Appropriate responses vary across countries depending on the nature of the fiscal challenge.
- Challenge 1: Avoiding the low growth-low inflation trap
- Advanced economies face the triple threat of low growth, low inflation, and high public debt, creating potential self-reinforcing downward spirals.
- Recommended three-pronged approach:
- Expansionary monetary policy.
- Growth-friendly fiscal policy (examples: higher infrastructure investment; using public funds to compensate losers from reform to support implementation).
- Productivity-enhancing structural reforms.
- In countries with fiscal space, budgets could do more to support aggregate demand; where fiscal space is lacking, governments should protect growth by avoiding cuts to highly productive public spending and scaling down less efficient programs.
- If global macro conditions worsen substantially, individual country responses may be insufficient; policymakers should act quickly and act together with coordinated demand- and supply-side policies, implemented simultaneously to amplify benefits.
- Challenge 2: Addressing the big and lasting drop in revenues
- Between 2014 and 2016, about two-thirds of all countries experienced a decline in their revenue-to-GDP ratios.
- Commodity exporters saw the largest revenue shortfalls—an average of 7 percent of GDP for oil exporters.
- With commodity prices likely to remain low for some time, producers must reduce public spending and align it with lower revenues.
- Adjustment can be less painful by:
- Mobilizing non-commodity revenues.
- Cutting poorly targeted and wasteful spending, including reforming fuel subsidies.
- Countries that have accumulated financial assets and face less market pressure can consolidate at a more gradual pace.
- Challenge 3: Achieving development goals with constrained budgetary resources
- Almost half of low-income developing countries have a tax ratio below 15 percent of GDP.
- Low revenue mobilization limits funding for pro-growth spending and is often associated with weak institutional capacity.
- Building minimum tax capacity supports broader state and legal capacity; stable, broad-based taxation governed by clear rules is necessary for an effective budget process.
- Combined with improvements in expenditure efficiency, better revenue mobilization can help achieve the Sustainable Development Goals by enhancing health and education services and developing infrastructure.
- Practical measures for low-income countries include introducing or expanding the value added tax or the property tax, and strengthening tax compliance—areas where the IMF provides extensive technical assistance.
Medium-term objectives
- Two main objectives all countries should pursue over the medium term:
- Enhancing the resilience of public finances
- Make public finances less sensitive to shocks (e.g., drops in commodity prices or currency depreciations) by:
- Improving disclosure and analysis of risks through comprehensive, reliable, and timely public reporting.
- Developing and implementing risk management strategies to reduce the probability of adverse events and limit government exposure (example: introducing caps on government guarantees).
- Creating adequate cushions in budgets—"provisions"—as safety margins to cope with unexpected events.
- Promoting sustainable growth
- Raising medium-term growth is necessary everywhere; in advanced economies, a sustained increase in growth of 1 percentage point could bring debt ratios to pre-crisis levels within a decade.
- An IMF study suggests reforms of tax and expenditure policies could lift medium- to long-term growth by ¾ of a percentage point in advanced economies and even more in developing economies.
- Fiscal measures that support innovation and productivity can be powerful:
- Fiscal support to private research and development costing 0.4 percent of GDP to the budget can deliver 5 percent higher GDP in advanced economies in the long run.
- Summary conclusion: Policymakers, individually and in concert, still have adequate policy tools to restore vigorous growth and build healthy, resilient public finances.
Source: Act Now, Act Together — Vitor Gaspar, Luc Eyraud, April 13, 2016 (web overview).
Content in this bundle
- Fiscal Policy and Long-Term Growth; IMF Policy Paper, April 20, 2015