Staying the Course on Fiscal Adjustment: Fiscal Monitor Update -- June 2011
Fiscal Monitor, June 17, 2011
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- Published: June 17, 2011
- Series: Fiscal Monitor
Summary of main findings
- Consolidation is proceeding at a broadly appropriate pace in many advanced economies—particularly most of Europe and Canada—helped by recovering activity and revenues.
- In the United States, the 2011 deficit will be lower than previously forecast and similar to 2010 in cyclically adjusted terms, making the planned fiscal adjustment in 2012 less abrupt.
- Consensus on a credible medium-term fiscal adjustment plan is urgently needed in the United States; defining a more detailed medium-term adjustment plan is essential in Japan.
- Rising risk perceptions in Greece, Ireland, and Portugal underscore the need to implement their adjustment programs and to develop a comprehensive and consistent approach to crisis management in the euro area.
- In many emerging economies, fiscal consolidation is proceeding at an appropriate pace; in others, fiscal policy needs to be tightened faster than currently envisaged to reduce overheating risks.
Key revisions since April 2011 Fiscal Monitor
- Revenues better than expected in some countries owing to greater tax buoyancy and stronger equity markets, leading to sizable downward deficit revisions for the United States in 2011.
- Higher growth revisions for Belgium, France, Germany, and Turkey.
- Exceptions where outcomes worsened: natural disasters (Australia, Japan) and political instability (Middle East and North Africa).
- Some countries may cut spending faster in 2011 (Canada, Italy, Poland); the United States saw spending somewhat below expectation.
- New spending pressures include reconstruction efforts in Japan and spending in response to political turmoil in the Middle East and North Africa.
Advanced economies — Europe, United States, Japan, and others
- Europe and Canada: stronger revenue growth in some core Western European economies (notably Germany) led to lower budget deficits than projected in April 2011. Canada reiterated commitment to return the federal budget to balance by FY2014; IMF staff project general government returning to fiscal balance by 2016.
- Italy and Spain: expenditure projections revised downward due to recent outturns and expenditure control measures.
- Portugal: program envisages attaining a deficit of 3 percent of GDP only in 2013, a year later than the authorities’ original stability program; program emphasizes shifting taxation from labor to domestic consumption (“fiscal devaluation”).
- Greece: further fiscal adjustment planned to reduce the general government deficit from 10.4 percent of GDP in 2010 to 7.5 percent in 2011.
- United States:
- Post–April 15 data show stronger revenues (partly from sizable capital gains in 2010) and contained expenditures; cyclically-adjusted fiscal deficit in 2011 is no longer seen as imparting fiscal stimulus compared with 2010.
- Broad political support is needed for a comprehensive medium-term fiscal adjustment plan with objectives (e.g., an explicit debt target) endorsed by Congress.
- Two major plans (the President’s April proposal and the House Republican budget resolution) aim for about US$4 trillion in savings over the next 10–12 years, but differ in policy mix, macroeconomic assumptions, and baseline.
- The debt ceiling needs to be raised in the near term (by early August, according to U.S. authorities); raising it is necessary under all proposed plans and has occurred more than 70 times over past decades (10 times during the last 10 years).
- Japan:
- Natural disasters raise projected deficit/GDP ratios for 2011 and 2012 owing to weaker output growth and greater reconstruction costs.
- A 0.8 percent of GDP supplementary budget approved in May is included in prior projections; a further supplementary budget is expected in the second half of 2011 projected to increase spending by about 1 percentage point of GDP in 2012.
- More detailed medium-term fiscal adjustment plan (with tax measures central) is urgent.
- Australia:
- May budget estimates 2010/11 and 2011/12 deficits ½ to ¾ percent of GDP higher than foreseen in the November 2010 Mid-Year Economic and Fiscal Outlook due to lower revenues (partly from natural disasters) and larger-than-expected crisis-related losses.
- New Zealand:
- Most reconstruction costs will be covered by the national disaster fund, offshore reinsurance, and commercial insurance; the remainder financed by central government borrowing equal to 2¾ percent of 2011 GDP.
- Government aims to return to surpluses in 2014/15, one year ahead of earlier plan.
Emerging and low-income economies
- Fiscal deficits and debts are being reduced gradually overall, but some economies face overheating risks where consolidation should be tightened.
- Turkey: rapid domestic demand growth has widened the current account deficit and produced booming revenues; transient strong revenues should be saved to keep inflation in check.
- China: gradual withdrawal of stimulus is envisaged in the year’s budget.
- Poland: expenditure cuts of about 1 percent of GDP are being implemented in 2011.
- Latin America:
- Overall fiscal balance projected to improve in 2011 compared with 2010; average overall deficits expected to fall to 2½ percent of GDP and debt to about 50 percent of GDP, but debt is not much different from the 1980–2010 average and remains above that of emerging Asia and emerging Europe.
- Fiscal rules often not defined in cyclically-adjusted terms (except Chile); consideration should be given to redefining fiscal rules on cyclically-adjusted targets to discourage procyclicality.
- Brazil: stimulus withdrawal on track to meet the 3 percent of GDP primary surplus target in 2011; slight downward revision to overall balance reflects a higher projected interest bill.
- Mexico: consolidation driven by spending restraint and stronger revenues; from 2012 onward, compliance with balanced-budget rule expected to reduce public debt/GDP ratio gradually.
- Colombia: expected spending increases on infrastructure and reconstruction offset by higher tax revenues; establishment of a fiscal rule under discussion in Congress.
- Peru: fiscal deficit expected to stay in line with the 0.5 percent of GDP target under the fiscal responsibility law.
- India: high fuel and food prices have pushed up fuel and food subsidies; projections for the 2012 deficit have been revised upward compared with April 2011; fiscal deficit projected to fall gradually over coming years but remain high; debt ratio will decline moderately mainly due to rapid output growth.
Privatization, institutions, and fiscal rules
- Greece announced a plan to raise privatization revenues equivalent to 6½ percent of GDP over two years (cumulative); cumulative revenues in excess of 5 percent of annual GDP in a two-year period have been collected in about 20 past episodes in Europe.
- Fiscal adjustment in Europe is accompanied by strengthening institutions and rules (examples: U.K. fiscal council; Germany balanced-budget constitutional rule). A draft EU Directive under review addresses weaknesses in national budgetary institutions and procedures; envisaged deadline for translating the Directive into national legislation is end-2013.
Government bond markets, spreads, and central bank purchases
- Sovereign bond yields in the largest advanced economies remain at very low levels despite global events and negative sovereign outlooks for the United States and Japan; this provides little incentive to reduce deficits.
- Market concerns acute in Greece: spreads rose by 600 basis points since end-2010 to almost 1,700 basis points in early June.
- Ireland and Portugal: spreads have risen by 100–230 basis points to more than 700 basis points.
- Some Baltic and eastern European countries (Latvia, Lithuania, Romania) saw spreads decline by 50–70 basis points since early 2011 (to about 200 basis points).
- Central bank purchases of government securities:
- U.S. Federal Reserve purchases since end-2010 have amounted to US$500 billion, with total envisaged asset purchases of US$600 billion under QE2 slated to end in June, bringing its holdings to 15 percent of publicly-held government debt.
- Bank of Japan holdings: 7½ percent of outstanding government debt.
- European Central Bank holdings equivalent to 11 percent of the outstanding debt of Greece, Ireland, and Portugal (no further market interventions since March).
- Bank of England stock of holdings stands at 16 percent of outstanding U.K. sovereign debt (net purchases largely halted about a year ago).
- Unwinding large central bank portfolios could present challenges given sizable sovereign financing requirements; central banks may opt to hold a substantial portion to maturity.
Policy recommendations and priorities
- Forge consensus on credible, medium-term fiscal adjustment plans in countries with large deficits and high debt—particularly the United States and Japan.
- Focus adjustment measures on:
- Reforming entitlements,
- Promoting efficiency (for example, broadening the tax base via elimination of tax expenditures),
- Addressing growth of current spending in a targeted way to contain short-term growth costs of consolidation.
- In emerging and commodity-exporting economies with buoyant revenues, save transient revenue gains to avoid overheating and to build fiscal buffers.
- Consider redefining fiscal rules on cyclically-adjusted targets to reduce procyclicality of fiscal policy.
- Implement announced consolidation measures and strengthen budget institutions and fiscal rules (including measures to improve transparency, medium-term orientation, realistic forecasts, and monitoring of fiscal risks).
- For euro-area crisis management, work cooperatively to reach final agreement on a comprehensive and consistent pan-European approach.
International Monetary Fund. Staying the Course on Fiscal Adjustment: Fiscal Monitor Update — June 2011
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References
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