IMF Fiscal Monitor Update: Nurturing Credibility While Managing Risks to Growth, July 2012
Fiscal Monitor, July 16, 2012
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- Published: July 16, 2012
- Series: Fiscal Monitor
Executive summary and headline findings
- Fiscal adjustment in advanced economies is proceeding generally as expected, with headline and underlying fiscal deficits broadly in line with the April 2012 Fiscal Monitor.
- Overall, advanced economy deficits are forecast to decline by about ¾ percentage point of GDP this year and about 1 percent of GDP next year in both headline and cyclically adjusted terms.
- Continued focus on nominal deficit targets risks compelling excessive fiscal tightening if growth weakens; a steady pace of adjustment focused on measures to be implemented rather than on headline targets is preferred in most advanced economies.
- In most emerging economies, headline and cyclically adjusted deficits are projected to remain broadly unchanged over 2012–13; however, some emerging economies need to be more ambitious to reduce vulnerabilities.
Advanced economies — status, risks, and country specifics
- Underlying fiscal adjustment on track: cyclically adjusted deficits in 2012–13 are expected to fall by close to 1 percent of GDP annually on average in advanced economies.
- Spain:
- Market turbulence intensified due to financial system concerns and possible fiscal implications.
- Deficit expected to be close to 7 percent of GDP this year before measures announced on July 11.
- New deficit targets revised to 6.3 percent of GDP this year and 4.5 percent of GDP next year under the EU Excessive Deficit Procedure.
- Measures announced on July 11 include increases in VAT rates, elimination of mortgage interest deductibility under income tax, cuts in civil service pay and unemployment benefits.
- To recapitalize banks, FROB is to have access to a financial sector recapitalization loan by the EFSF for up to 9 percent of GDP (€100 billion) committed by the Eurogroup; this would be reflected in general government gross debt.
- Italy:
- Headline and cyclically adjusted deficits for 2012–13 broadly in line with expectations.
- Adjustment over next two years would allow a small structural surplus in 2013 (against the medium-term objective of a structurally balanced budget).
- Constitutional balanced budget rule coming into force in 2014; bill mandates establishment of a fiscal council; authorities plan systematic use of spending reviews.
- Greece:
- Situation remains fluid; macroeconomic deterioration and uneven reform implementation have weighed on revenues.
- Absent further policy changes, the primary deficit would trend towards 1½ to 2 percent of GDP, versus the 1 percent foreseen at the time of the Extended Fund Facility (EFF).
- Portugal:
- Deficit expected to fall to 4½ and 3 percent of GDP this year and next, respectively, achieved mainly through expenditure restraint.
- Authorities to provide capital injections into three largest banks amounting to 4 percent of GDP to meet EBA capital requirements (increasing gross debt ratio).
- Ireland:
- Authorities on track to meet program targets and reach the 3 percent of GDP EU threshold for the headline deficit by 2015.
- General government deficit target of 8.6 percent of GDP for 2012 appears likely to be met.
- Germany:
- Projected fiscal withdrawal for 2012 and 2013 unchanged since April at relatively modest levels.
- United Kingdom:
- Cyclically adjusted deficit to continue declining this year and next, but by less than last year.
- Government committed to balance the structural current budget within five years and put net debt on a declining path, with additional consolidation in 2015–17.
- France:
- New administration committed to reducing headline deficit by about 1 percent of GDP this year and 1½ percent of GDP next year to 3 percent of GDP; commitment to a balanced budget by 2017 (a year later than envisaged earlier).
- Supplementary budget includes new measures of about 0.3 percent of GDP, mainly on the revenue side.
- United States:
- Fiscal position projected to improve this year broadly in line with April 2012 projections; outlook for 2013 is a significant concern.
- Expiring tax provisions and automatic spending cuts implied by the 2011 Budget Control Act would imply fiscal withdrawal of more than 4 percent of GDP—the “fiscal cliff.”
- A more modest retrenchment in 2013—of around 1 percent of GDP in structural terms—would be a better option.
- Early action on the federal debt ceiling, expected to become binding late this year or early next, would mitigate risks.
- Japan:
- Draft bill to double consumption tax rate in stages to 10 percent by 2015 passed lower house in late June and sent to upper house.
- Tax increase is part of needed consolidation; further measures and growth-supporting reforms necessary to put debt ratio on a downward path.
Public debt dynamics and euro-area firewalls
- The average debt-to-GDP ratio among advanced economies is projected to continue to rise, surpassing 110 percent of GDP on average in 2013, although debt ratios will have peaked in several advanced economies by then.
- About one-third of advanced economies will have declining debt ratios this year; debt ratios will still exceed 2007 levels in almost all cases.
- Pooling of resources through the EFSF and contributions to paid-in capital of the ESM explain upward revisions to projected gross debt levels for 2012–13 in several euro-area countries (notably Germany: 3 percentage points of GDP; Italy: 2½ percentage points).
- EFSF disbursements directly increase gross liabilities of guarantor countries in proportion to capital shares; existing loans represent slightly more than 1 percent of euro-area GDP in mid-2012.
- Recently announced financing of the Spanish bank recapitalization will initially be channeled through an EFSF loan to the sovereign, increasing euro-area debt by an additional ¾ percent of GDP.
- ESM slated to become operational in July 2012 once ratified; ESM initial lending capacity of €500 billion and total subscribed capital of €700 billion, of which €80 billion paid-in capital to be phased in with a maximum of five installments.
Emerging economies — assessment and country highlights
- Headline and cyclically adjusted deficits in emerging economies projected to remain broadly unchanged over 2012–13; some are drawing on fiscal space in response to slowing activity.
- Brazil:
- Overall balance for 2012 expected to be ½ percent of GDP stronger than envisaged earlier, mainly due to lower interest payments.
- Despite measures estimated at about 0.4 percent of GDP to support selected sectors, authorities expected to achieve the 3.1 percent of GDP primary surplus target.
- Mexico:
- Fiscal consolidation projected to advance gradually in 2012–13; in 2013 authorities expected to return to balanced budget target.
- China:
- Fiscal consolidation expected to be put on hold this year; headline deficit of around 1¼ percent of GDP; resumption of consolidation slowly in 2013.
- South Africa:
- Improving revenue and gradual withdrawal of stimulus should contribute to a decline in the cyclically adjusted fiscal deficit by 0.9 percent of GDP over the next two years.
- Russia:
- Fiscal policy remains procyclical; non-oil deficit expected to increase by about 1 percentage point to 10½ percent of GDP this year.
- 2012–14 medium-term budget does not provide meaningful improvement in non-oil deficit, leaving vulnerability to petroleum market developments.
- Turkey:
- Revenue shortfalls related to slowing activity expected to increase overall deficit by 1½ percent of GDP this year, leaving structural primary deficit broadly unchanged.
- A tighter fiscal stance seems appropriate looking to 2013 and beyond to help reduce large current account deficit.
- India:
- Overall deficits for 2012–13 revised upward to almost 9 percent of GDP, more than ½ percentage point higher than in April 2012 Monitor, mainly due to higher fuel subsidies and revenue shortfalls.
- Determined reduction in costly subsidies recommended to signal credible fiscal turnaround and spur private investment.
Reconciling credibility and growth — principles and policy recommendations
- Anchor expectations with detailed medium-term plans aimed at lowering debt ratios and backed by binding legislation or fiscal frameworks; among large advanced economies, the United States and Japan still lack such plans.
- Pace of adjustment:
- Where market financing remains sustainable, adjustment should take place at a steady pace defined in cyclically adjusted terms.
- An annual pace of adjustment of about 1 percentage point of GDP on average appears broadly adequate for advanced economies in 2011–13, though country-specific imbalances matter.
- Targets in cyclically adjusted terms allow automatic stabilizers to operate.
- Recalibration in case of major shocks:
- Pace of underlying adjustment should not be changed for relatively contained growth variations.
- In case of a major shock, fiscal policies may need recalibration in countries with fiscal space, with contingency plans prioritizing temporary revenue and expenditure measures with highest payoffs to activity.
- Composition of adjustment:
- Priority to cutting spending where expenditure is high and tax burdens limit scope for revenue increases.
- Cuts should target unproductive outlays identified through comprehensive expenditure reviews.
- Where room for revenue increases exists (e.g., United States and Japan), widen bases by eliminating exemptions and special treatment rather than just raising rates.
- Fiscal policy can be adjusted to better support employment—for instance, revenue-neutral reductions in the labor tax wedge.
- Some emerging economies (Egypt, India, Indonesia, Saudi Arabia) could benefit from eliminating fuel and other subsidies.
- Turkey, Russia, and South Africa should prevent expenditure growth from outpacing medium-term income growth.
- Reforms for long-term spending trends:
- Reforms affecting pensions and health care are important to strengthen fiscal credibility.
- EC 2012 Ageing Report estimates over 2010–30 pension costs increase by 0.5 percent of GDP and health care costs by 0.7 percent of GDP; IMF staff notes health care cost pressure likely underestimated by about 1 percent of GDP due to technological change.
- Euro-area stabilization measures:
- Fiscal policy alone cannot stabilize market conditions; sovereign spreads exceed what fundamentals justify, calling for reforms to affect expectations.
- Delinking sovereigns’ and banks’ balance sheets is critical.
- European leaders agreed on steps to address the crisis; establishment of single supervisory mechanism would allow ESM to recapitalize banks directly.
- Progress toward deeper fiscal integration and a full-fledged banking union remains necessary.
- Fiscal Compact ratification and “two-pack” draft regulations strengthen fiscal governance; proposals for a more complete union to be developed.
IMF Fiscal Monitor Update: Nurturing Credibility While Managing Risks to Growth, July 2012.
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