- International Monetary Fund. Fiscal Affairs Dept.
- Published Date:
- May 2010
Navigating the Fiscal Challenges Ahead.
Prepared by the Staff of the Fiscal Affairs Department
© 2010 International Monetary Fund
IMF Fiscal Monitor Series:
Navigating the Fiscal Challenges Ahead.
- Main Themes in this Fiscal Monitor
- I. The Near- and Medium-Term Fiscal Outlook
- II. Implications of Fiscal Developments for Government Debt Markets
- III. The Fiscal Policy Outlook: Adjustment Needs and Plans
- IV. Adjustment Measures and Institutions
- 1. Fiscal Balances, 2007–15
- 2. Changes in Cyclically Adjusted Fiscal Indicators, 2007–11
- 3. Changes in Cyclically Adjusted Fiscal Indicators, 2012–15
- 4. Amounts Pledged or Utilized for Financial Sector Support
- 5. Recovery of Outlays and Net Cost of Financial Sector Support
- 6. Advanced Economies’ Gross Financing Needs, 2010
- 7. Central Bank Holdings of Government Securities
- 8. Medium-Term Fiscal Consolidation Plans
- 9. G-20 Economies: Composition of Consolidation Plans
- 10. G-20 Economies: Planned Health Care and Pension Reforms
- 11. Estimated Potential Revenue Increases in Selected Advanced G-20 Economies
- 1. Evolution of Fiscal Balances in Advanced and Emerging Economies, 2005–15
- 2. Evolution of Gross Debt and Deficit Positions in Emerging and Advanced Economies, 2007–15
- 3. General Government Gross Debt Ratios
- 4. General Government Gross Debt in G-7 Economies, 1950–2015
- 5. Emerging Economies: Distribution of Government Debt Ratios, 2007–10
- 6. Emerging Economies’ Financing Requirements in 2010 and Deviations from Past Averages
- 7. Bond Yields and EMBI Spread
- 8. Bond Yields in Selected Euro Area Economies
- 9. Relative Asset Swap (RAS) Spreads
- 10. Sovereign CDS Spreads: Advanced vs. Emerging and G-7 Economies
- 11. Advanced and Emerging Economies: Illustrative Scenario for Fiscal Adjustment
- 12. Advanced Economies: Illustrative Fiscal Adjustment Need as Function of Debt Target and Interest Rate-Growth Differential
- 13. Illustrative Fiscal Adjustment in Cyclically Adjusted Primary Balance, 2010–30
- 14. Illustrative Fiscal Adjustment and Projected Age-Related Spending Increases
- 15. Projected Real Revenue and Spending Levels, 2007–15
- 16. Projected Increases in Pension and Health Spending
- 17. The Use of Fiscal Rules around the World
- 18. Fiscal Consolidation Packages Designed to Raise Potential Output Under Different Assumptions about Credibility
- 1. Debt Dynamics in G-20 Economies: An Update
- 2. Gross versus Net Debt
- 3. Measures to Finance the Cost of Financial Sector Support
- 4. Increasing Social Expenditures and Household Consumption in China
- 5. Health Care Reforms in the United States
- 6. Past Episodes of Sustained Fiscal Revenue Increases
- 7. Fiscal Rules—Recent Developments
- 1. Update on Crisis-Related Discretionary Fiscal Stimulus in G-20 Economies
- 2. Fiscal Adjustment Requirements: Gross and Net Debt Targets
- 3. Government Debt and Growth
- 4. The Impact of the Crisis on Subnational Governments
- 5. Reforming Petroleum Subsidies
- Methodological and Statistical Annex
With increasing fiscal challenges in the aftermath of the crisis, multilateral surveillance of fiscal developments, always a key part of the IMF’s surveillance responsibilities, has gained further importance. In response, the IMF launched the Fiscal Monitor last year to survey and analyze the latest public finance developments, update reporting on fiscal implications of the crisis and medium-term fiscal projections, and assess policies to put public finances on a sustainable footing. Previous issues of the Monitor were published in the IMF Staff Position Note series (Fiscal Implications of the Global Economic and Financial Crisis in July 2009, and The State of Public Finances; Cross-Country Fiscal Monitor: November 2009). Starting with this issue, the Monitor will be a part of the IMF’s World Economic and Financial Surveys series, to complement the overviews presented in the World Economic Outlook (WEO) and the Global Financial Stability Report (GFSR).
The projections included in this Fiscal Monitor are based on the same database as used for the April 2010 WEO and GFSR. The fiscal projections for individual countries have been prepared by IMF desk economists and coincide with those in the WEO. They refer to the general government unless these data are not available. Short-term fiscal projections are based on officially announced budgets, adjusted for differences between the national authorities and the IMF staff regarding macroeconomic assumptions. The medium-term fiscal projections incorporate policy measures that are judged by IMF staff as likely to be implemented. For countries supported by an IMF arrangement, the medium-term projections are those under the arrangement. In cases where the IMF staff has insufficient information to assess the authorities’ budget intentions and prospects for policy implementation, an unchanged structural primary balance is assumed, unless indicated otherwise.
The Fiscal Monitor is prepared by the IMF Fiscal Affairs Department under the direction of Carlo Cottarelli, Director of the Department, and Philip Gerson, Senior Advisor. This issue is coordinated by Manmohan S. Kumar and Mark Horton. Other contributors include: Emre Alper, Emanuele Baldacci, Fabian Bornhorst, Carlos Caceres, Reda Cherif, Ben Clements, David Coady, Gabriela Dobrescu, Julio Escolano, Annalisa Fedelino, Oriel Fernandes, Lorenzo Forni, Marc Gerard, Raquel Gomez Sirera, Jan Gottschalk, Julia Guerreiro, Borja Gracia, Fuad Hasanov, Jiri Jonas, Daehaeng Kim, Paolo Mauro, Junhyung Park, Iva Petrova, Andrea Schaechter, Anita Tuladhar, and Jaejoon Woo. Maria Delariarte and Nadia Malikyar provided excellent editorial assistance.
The analysis has benefited from comments and suggestions by staff from other IMF departments. Both projections and policy considerations are those of the IMF staff and should not be attributed to Executive Directors or to their national authorities.
The global crisis has entailed major output and employment costs, and in many economies, particularly the advanced ones, it has left behind much weaker fiscal positions. A timely and simultaneous application of supportive fiscal and monetary policies prevented a far worse outcome. As economies gradually recover, it is now urgent to start putting in place measures to ensure that the increase in deficits and debts resulting from the crisis, mostly from the loss of output and revenues, does not lead to fiscal sustainability problems. Yet, as policymakers begin to implement strategies for exiting from crisis-related intervention policies, care should also be taken to ensure that policy actions do not undermine the recovery. I am convinced that there is much that countries can do now to strengthen confidence in long-term fiscal sustainability without weakening growth prospects.
This is the first issue of the Fiscal Monitor as part of the World Economic and Financial Surveys. The inclusion of the Monitor along with the World Economic Outlook and the Global Financial Stability Report in this series signals the importance that the International Monetary Fund gives to comprehensive and high-quality cross-country analysis of fiscal trends and issues. The Monitor provides a timely analysis of fiscal developments in advanced, emerging, and low-income economies. One of the key messages in this issue is that fiscal strategies should aim at gradually—but steadily and significantly—reducing public debt ratios, rather than just stabilizing them at their elevated postcrisis levels. Failing to do so would ultimately weaken the world’s long-term growth prospects. In many countries, fiscal adjustment will require a sizable, and sometimes unprecedented, effort. The Monitor presents a broad outline of policies to achieve this adjustment, while enhancing economic efficiency.
I hope that you will find the Fiscal Monitor a useful contribution to the analysis of fiscal policy issues, and a good complement to our other publications in support of multilateral surveillance.
Main Themes in This Fiscal Monitor
Fiscal risks have risen, especially in advanced economies, for three reasons: underlying fiscal trends have further deteriorated since the November Monitor; financial markets have increased their focus on fiscal weaknesses; and progress in defining fiscal exit strategies has been slow.
In this context, while a widespread loss of confidence in fiscal solvency remains for now a tail risk, its potential costs are such that the risk should not be ignored. Even in the absence of such a dramatic development, without progress in addressing fiscal sustainability concerns, high levels of public indebtedness could weigh on economic growth for years. This issue of the Monitor presents new evidence on the links between debt and growth: it suggests that based on current projections, if public debt is not lowered to precrisis levels, potential growth in advanced economies could decline by over ½ percent annually, a very sizable effect when cumulated over several years.
Even as the global economy improves, fiscal balances in the advanced economies are, on average, worsening. While World Economic Outlook projections for 2010 output growth in the advanced economies have increased by a full percentage point since the last issue of the Monitor, updated projections in Section I of the Monitor show that after discounting for reduced financial sector support operations, both headline and cyclically adjusted (CA) fiscal deficits in these countries will increase in 2010—relative both to the 2009 outturn and to projections made six months ago. Based on current likely policies, the advanced economies will continue to run sizable primary deficits over the medium term, leading the average general government gross debt ratio—which has already ballooned by close to 20 percent of GDP since the onset of the crisis—to rise by a further 20 percentage points by 2015, reaching about 110 percent of GDP. The outlook is more favorable among emerging economies, where the CA fiscal balance is expected to improve this year relative to last. Even among these economies, however, the projected improvement in the CA balance this year is barely half that projected in November. Over the medium term, these economies continue to be expected to run primary deficits. As long as the interest rate-growth differential stays favorable for them, debt ratios should stabilize or decline. However, these economies will still be exposed to interest rate and growth shocks, including as a result of fiscal spillovers from advanced economies. The fiscal outlook is also improving in low-income economies relative to last year but, again, at a slower pace than expected six months ago.
These developments are occurring amid heightened market sensitivity to variations in fiscal performance across countries. Section II shows that many countries will be facing historically high financing requirements this year, making them especially susceptible to market pressures. Events in Europe are providing the clearest demonstration of the increased attention being paid by markets to differences in underlying fiscal conditions across countries, as borrowing conditions now vary across euro area members to an extent that would have been unimaginable in the recent past. In this environment, the costs of policy missteps, or of a perception of a lack of preparedness, would be high.
Many countries face large retrenchment needs going forward. Section III provides updated estimates of the adjustment in the primary CA balance needed to lower gross general government debt below 60 percent of GDP by 2030 in advanced economies: the estimate is high—8¾ percentage points of GDP on average, about ¾ of a percentage point more than in the last issue of the Monitor—but hides important differences across countries, with many of the larger economies confronting above-average adjustment needs. The task is even more difficult than it appears from the headline numbers, as many countries are projected to face increases of 4 to 5 percentage points of GDP in spending for health care and pensions over the next two decades. The measures needed to address these spending pressures will have to be undertaken in addition to those required to achieve the targeted improvement in the primary balance. The adjustment needed to restore debt to prudent levels (40 percent of GDP) in emerging economies is significantly smaller, at 2½ percentage points of GDP. Here too, however, there are important variations across countries.
To date, few countries have made significant progress in exiting from fiscal stimulus, and where countries have announced deficit reduction targets, details about the measures underlying adjustment are often lacking. Many of those that have made progress were facing acute financing pressures that made delay infeasible. The optimal timing of stimulus withdrawal will vary depending on macroeconomic and fiscal conditions. Some countries with weaker fiscal credibility are already facing market pressures, and should tighten fiscal policy this year. An early tightening is also needed in countries facing a rapid recovery. Other countries can wait until 2011. However, all countries should introduce structural measures now to strengthen their medium-term fiscal trends.
Section IV explores the spending, revenue, and institutional measures that could support fiscal adjustment. Among countries where demographic trends are unfavorable, health and pension reforms—for example, improved cost containment in health care and increases in retirement ages—are more urgent. These reforms take time to yield savings but can provide confidence about the direction of long-term fiscal trends. Freezes on nonentitlement spending could generate savings of about 3 percent of GDP over the next decade on average. For countries facing very large adjustment needs, increasing revenues may also prove necessary. The section discusses a package of tax increases that are relatively less distortionary—including elimination of below-standard VAT rates and increases in tobacco and alcohol excises, carbon taxation, and property taxes—that could yield almost 2½ to 3 percentage points of GDP in advanced economies. Introducing a VAT or raising standard VAT rates in some countries could also yield sizable revenues. Finally, tax evasion remains significant in many countries, and fighting it should be a priority. Institutional arrangements, such as fiscal rules or enhanced medium-term frameworks, could also play a useful role in ensuring that fiscal consolidation is implemented.