IMF Fiscal Monitor Update: As Downside Risks Rise, Fiscal Policy Has To Walk a Narrow Path, January 2012
Fiscal Monitor, January 23, 2012
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- Published: January 23, 2012
- Series: Fiscal Monitor
Overview and central message
- Deficits in many advanced economies fell significantly during 2011, and most plan substantial adjustment in 2012. Continued adjustment is necessary for medium-term debt sustainability, but should occur at a pace that supports adequate growth in output and employment.
- Given the large adjustment already in train in 2012, 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. 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.
Fiscal outcomes in advanced economies in 2011
- 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 1¼ percent of GDP in cyclically adjusted terms.
- Germany accounted for a large share of euro-area improvement: the cyclically adjusted deficit fell by 2¼ percent of GDP.
- Spain’s cyclically adjusted balance strengthened substantially; France and Italy posted more modest improvements because announced measures will not take full effect until next year.
- The cyclically adjusted balance also fell substantially in the United Kingdom and the United States; it rose marginally in Japan owing to reconstruction costs related to the natural disaster.
- European program countries:
- Greece: headline deficits larger than expected; cyclically adjusted deficit exceeded expectations despite an improvement of 3 percentage points of GDP relative to 2010.
- Portugal: fiscal target met through a one-time partial transfer of banks’ pension fund assets; underlying adjustment in 2011 was smaller than expected, although cyclically adjusted adjustment was still sizable at 4 percentage points of GDP.
- Ireland: headline outturns on track; cyclically adjusted balance improved by 2 percent of GDP.
Projections and major measures in the pipeline
- United States:
- The cyclically adjusted deficit is forecast to fall sharply in 2012, by around 1½ percent of GDP, conditional on Congress extending payroll tax relief and long-term unemployed benefits beyond end-February.
- Without these extensions, the cyclically adjusted deficit would decline by over 2 percentage points of GDP—the largest annual fall in at least four decades.
- A credible medium-term plan should feature measures that contain entitlement spending and raise revenues.
- Japan:
- Projected to be the only large advanced economy to implement a fiscal expansion in 2012, reflecting reconstruction costs.
- Total reconstruction costs are budgeted at about 4 percent of GDP over 2011–13, financed initially through bond sales.
- Proposed tax measures include a temporary increase in the corporate tax rate for 3 years and increases in personal income tax rates spread over 25 years; the government plans to submit a tax reform bill including a proposal to double the consumption tax rate to 10 percent by 2015.
- The consumption tax increase alone will not be sufficient to put the debt ratio on a downward path; an adjustment path that allows debt ratios to begin declining by the middle of this decade is called for.
- United Kingdom:
- Actual and potential GDP growth estimates revised down, weakening projected headline and cyclically adjusted balances.
- The government will accommodate the weakened cyclically adjusted balance and let automatic stabilizers operate freely over the next three years, reshuffling the composition of adjustment to be more growth-friendly.
- The cyclically adjusted deficit is still expected to fall markedly in 2012; further spending cuts in 2015–17 have been announced to maintain the commitment to balance the current cyclically adjusted budget within five years.
- Germany:
- Fiscal targets for 2012 expected to be slightly stronger than envisaged earlier, locking in over-performance from 2011.
- Spain:
- New government announced a first package of measures of 1.1 percent of GDP (spending cuts and temporary tax increases on income, capital, and high-value homes), plus a limited increase in social spending and tax expenditures.
- A draft budget for 2012 to be submitted to Parliament by end-March.
- Italy:
- Adjustment package approved in December will augment by 1¼ percent of GDP the fiscal consolidation envisaged over 2012–14.
- Combined with July and September packages, results in a fiscal effort of 3¼ percent and 1¼ percent of GDP in 2012 and 2013, respectively.
- Measures include reintroduction of real estate taxes on primary residences and pension reforms (tightening eligibility for early retirement, reducing pension indexation, accelerating increase in retirement ages).
- Annual pension spending is forecast to fall over the next twenty years by 1¾ percentage points of GDP (best performance among advanced economies, where average spending is forecast to rise by 1¼ percentage point of GDP).
- France:
- Additional fiscal package for 2012–16 amounting to 1 percent of GDP, of which measures equal to 0.3 percent of GDP will be enacted in 2012.
- Revenue measures are front-loaded and make up more than half the adjustment; pension reform modestly accelerated (retirement age of 62 taking effect one year earlier, in 2017); health care spending growth norm tightened.
- Greece, Portugal, Ireland:
- Greece: authorities to enact new revenue and expenditure measures to correct policy slippages.
- Portugal: 2012 budget incorporated new adjustment measures including spending cuts, broadening of the VAT tax base under the standard rate, and reduction in tax expenditures.
- Ireland: overall balance target for 2012 remains broadly unchanged despite a sizeable downward revision to growth; cyclically adjusted balance expected to strengthen by 0.7 percent of GDP.
Risks of too-rapid consolidation and market interactions
- Too rapid consolidation during 2012 could exacerbate downside risks because the pace of consolidation is considerable given the weak economic environment.
- Fiscal policy in many countries is already tighter with respect to the cycle than projected in the September 2011 Fiscal Monitor, partly because a lack of affordable additional financing has compelled some euro-area economies to introduce new measures to attain headline deficit targets rather than allow automatic stabilizers to operate.
- Further declines in cyclically adjusted deficits could be undesirable from a growth perspective and possibly from a market perspective:
- While smaller deficits and debt ratios generally lead to lower borrowing costs, advanced economies with faster output growth are also currently benefiting from lower spreads, reflecting market concerns about feasibility of consolidation in a weak-growth environment.
- Hence, further tightening during a downturn could exacerbate market tensions through its negative impact on growth.
Policy guidance — advanced economies and the euro area
- Short-term stance:
- Allow automatic stabilizers to operate freely where solvency concerns permit and financing for higher deficits can be realized.
- Countries with very low interest rates or other sources of fiscal space, including some in the euro area, should reconsider the speed of near-term consolidation.
- Medium-term priorities:
- Implementation of credible medium-term debt reduction plans remains a priority given high debt levels.
- United States: medium-term plan should include entitlement containment and revenue measures.
- Japan: requires an adjustment path that brings debt ratios to begin declining by the middle of the decade.
- Financing and institutional support:
- For countries adjusting appropriately from a medium-term perspective but facing very high market rates, availability of adequate financing through the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) and credible mechanisms to ensure medium- and long-term fiscal discipline could provide an important confidence boost.
- The new European fiscal compact (agreed in early December) includes:
- A new fiscal rule capping the structural deficit at ½ percent of GDP with an automatic correction mechanism;
- Stronger monitoring and assessment of budgetary plans by the European Commission;
- Ex ante reporting of national debt issuance plans to the European Commission.
- Countries need to ratify the new measures quickly; over time, stronger fiscal integration and governance should be complemented by some fiscal risk sharing across the euro area.
Fiscal stances and policy in emerging market economies (EMs)
- In emerging economies, deficits fell by about 1 percent of GDP in headline terms and about ¾ percent in cyclically adjusted terms in 2011.
- Russia saw a dramatic increase in the cyclically adjusted balance due to higher oil revenues; Mexico saw a lesser increase.
- Current stances in 2012 vary:
- Some EMs have adopted looser fiscal stances amid weakening activity; others are tightening.
- Emerging economies with rapidly widening output gaps and declining inflation may have room to make policy more supportive, given relatively low debt levels.
- Others with high debt and large deficits have little space beyond allowing automatic stabilizers to operate.
- Commodity- and external-financing-dependent emerging economies need to assess risks of a large and protracted decline in such financing sources.
- Country-specific notes:
- China: policy expected to be broadly neutral in 2012; fiscal support could continue by deferring consolidation plans, through lower social contributions and consumption taxes; scope to accelerate investment in social housing; fiscal support should be on-budget and promote transparency and accountability.
- Brazil: maintaining fiscal discipline to support easing monetary policy is the main countercyclical tool; a primary surplus target of 3.1 percent of GDP set for 2012, implying a ½ percentage point adjustment of the cyclically adjusted balance; targeted fiscal steps worth around 0.2 percent of GDP in 2011–12 announced.
- India: cyclically adjusted deficit projected to fall by about ½ percent of GDP in 2012; space for loosening fiscal policy is limited due to still-high deficits and debt. Any expansion in response to a substantial fall in output should be small and focused on high-multiplier items such as indirect taxes and backlogged capital projects rather than additional subsidies.
Key statistics and figures highlighted in the Update
- Advanced economies: fiscal deficits fell in 2011 by about 1 percent of GDP overall.
- Euro area headline deficit fell by 2 percent of GDP in 2011; cyclically adjusted terms improved by 1¼ percent of GDP.
- Germany: cyclically adjusted deficit fell by 2¼ percent of GDP in 2011.
- Greece: improvement of 3 percentage points of GDP in 2011 relative to 2010, but headline deficits larger than expected.
- Portugal: underlying cyclically adjusted adjustment in 2011 was 4 percentage points of GDP.
- Ireland: cyclically adjusted balance improved by 2 percent of GDP in 2011.
- United States: cyclically adjusted deficit projected to fall by around 1½ percent of GDP in 2012 (or decline by over 2 percentage points of GDP without policy extensions).
- Japan: total reconstruction costs about 4 percent of GDP over 2011–13; proposed temporary corporate tax increase for 3 years; personal income tax increases spread over 25 years; proposed doubling of the consumption tax to 10 percent by 2015.
- Italy: December package augments consolidation by 1¼ percent of GDP; combined fiscal effort of 3¼ percent of GDP in 2012 and 1¼ percent of GDP in 2013; pension spending forecast to fall by 1¾ percentage points of GDP over twenty years.
- France: additional fiscal package for 2012–16 amounting to 1 percent of GDP, with 0.3 percent of GDP enacted in 2012.
- Brazil: primary surplus target of 3.1 percent of GDP for 2012; targeted fiscal support around 0.2 percent of GDP in 2011–12.
- India: cyclically adjusted deficit projected to fall by about ½ percent of GDP in 2012.
Source: IMF Fiscal Monitor Update: As Downside Risks Rise, Fiscal Policy Has To Walk a Narrow Path, January 2012.
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