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Fiscal Monitor Update
Nurturing Credibility While Managing Risks
to Growth
July 16, 2012
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Fiscal adjustment is proceeding generally as expected in
advanced economies, with headline and underlying fiscal deficits
that are broadly in line with projections in 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, a rate that strikes a compromise
between restoring fiscal sustainability and supporting growth.
However, continued focus on nominal deficit targets runs the
risk of compelling excessive fiscal tightening if growth
weakens. In addition, there is a risk in the United States of
political gridlock that puts fiscal policy on autopilot and
results in a sharp and sudden decline in deficits—the “fiscal
cliff.” In most advanced economies, a steady pace of adjustment
focused on the measures to be implemented rather than on
headline deficit targets is preferable, especially in light of
heightened downside risks to the outlook. In most emerging
economies, headline and cyclically adjusted deficits are
projected to remain broadly unchanged over 2012–13, which is
appropriate given these countries’ generally stronger fiscal
positions and the downside risks to the global economy. However,
some emerging economies need to be more ambitious to reduce
vulnerabilities.Underlying fiscal adjustment on track
Fiscal imbalances are being gradually corrected in line with
expectations in most advanced economies. Cyclically adjusted
deficits in 2012–13 are expected to fall by close to 1 percent
of GDP annually on average in advanced economies—about the same
amount as last year and broadly as projected in the April 2012
Fiscal Monitor—with greater reductions in countries
under market pressure (Table 1, Figure 1).
The two largest such countries are implementing sizeable
fiscal consolidation in the next two years in efforts to improve
debt dynamics and regain market confidence.
- Market turbulence has intensified in Spain due
to renewed concerns about the health of the financial system
and its possible fiscal implications (Figure 2). Despite an
ambitious and largely expenditure-based consolidation
package, revenue underperformance due to the recession and
higher spending pressures from unemployment insurance costs,
social security outlays and interest payments were expected
to push the deficit close to 7 percent of GDP this year
before the announcement of new measures on July 11. This is
about 1 percent of GDP more than projected in April, but
still about 2 percentage points of GDP below last year’s
outturn. The cyclically adjusted deficit projection had also
been revised up. This may reflect factors that are leading
to a temporary increase in the sensitivity of the budget
balance to output. Deficit targets have been revised to
6.3 percent of GDP this year and 4.5 percent of GDP next
year under the EU’s Excessive Deficit Procedure.
|
|
Table 1. Fiscal Indicators, 2008–13 |
(Percent of GDP, except where otherwise noted) |
|
|
|
|
|
Est. |
Projections |
|
Difference from April 2012 Fiscal Monitor1 |
|
2008 |
2009 |
2010 |
2011 |
2012 |
2013 |
|
2011 |
2012 |
2013 |
|
|
|
|
|
|
|
|
|
|
|
|
Overall Fiscal Balance |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advanced economies |
-3.5 |
-8.8 |
-7.6 |
-6.5 |
-5.8 |
-4.7 |
|
0.0 |
-0.1 |
-0.2 |
United States |
-6.7 |
-13.0 |
-10.5 |
-9.6 |
-8.2 |
-6.8 |
|
0.0 |
-0.1 |
-0.5 |
Euro area |
-2.1 |
-6.4 |
-6.2 |
-4.1 |
-3.2 |
-2.5 |
|
0.0 |
0.0 |
0.2 |
France |
-3.3 |
-7.6 |
-7.1 |
-5.2 |
-4.5 |
-3.9 |
|
0.1 |
0.1 |
0.0 |
Germany |
-0.1 |
-3.2 |
-4.3 |
-1.0 |
-0.7 |
-0.4 |
|
0.0 |
0.1 |
0.2 |
Greece2 |
-12.2 |
-15.6 |
-10.5 |
-9.2 |
-7.0 |
-2.7 |
|
0.0 |
0.2 |
1.9 |
Ireland |
-7.3 |
-14.0 |
-31.2 |
-13.1 |
-8.3 |
-7.5 |
|
-3.3 |
0.2 |
-0.2 |
Italy |
-2.7 |
-5.4 |
-4.5 |
-3.9 |
-2.6 |
-1.5 |
|
0.0 |
-0.2 |
0.1 |
Portugal |
-3.7 |
-10.2 |
-9.8 |
-4.2 |
-4.5 |
-3.0 |
|
-0.2 |
0.0 |
0.0 |
Spain3 |
-4.5 |
-11.2 |
-9.3 |
-8.9 |
-7.0 |
-5.9 |
|
-0.4 |
-1.0 |
-0.2 |
Japan |
-4.1 |
-10.4 |
-9.4 |
-10.1 |
-9.9 |
-8.6 |
|
0.0 |
0.1 |
0.2 |
United Kingdom |
-5.0 |
-10.4 |
-9.9 |
-8.6 |
-8.1 |
-7.1 |
|
0.1 |
-0.2 |
-0.5 |
Canada |
-0.1 |
-4.9 |
-5.6 |
-4.4 |
-3.8 |
-2.9 |
|
0.2 |
-0.2 |
0.0 |
|
|
|
|
|
|
|
|
|
|
|
Emerging economies |
0.2 |
-4.5 |
-3.3 |
-1.7 |
-1.9 |
-2.0 |
|
-0.1 |
-0.3 |
-0.3 |
China |
-0.4 |
-3.1 |
-2.3 |
-1.2 |
-1.3 |
-1.0 |
|
0.0 |
0.0 |
0.0 |
India |
-8.8 |
-9.7 |
-9.4 |
-8.9 |
-8.9 |
-8.8 |
|
-0.2 |
-0.6 |
-0.6 |
Russia |
4.9 |
-6.3 |
-3.5 |
1.6 |
0.1 |
-0.7 |
|
0.0 |
-0.5 |
-0.4 |
Turkey |
-2.4 |
-5.6 |
-2.7 |
-0.3 |
-1.7 |
-2.0 |
|
0.0 |
0.0 |
0.0 |
Brazil |
-1.3 |
-3.0 |
-2.7 |
-2.6 |
-1.9 |
-2.1 |
|
0.0 |
0.5 |
0.3 |
Mexico |
-1.1 |
-4.7 |
-4.3 |
-3.4 |
-2.4 |
-2.2 |
|
0.0 |
-0.1 |
-0.1 |
South Africa |
-0.5 |
-5.3 |
-4.8 |
-4.5 |
-4.4 |
-3.8 |
|
0.1 |
-0.1 |
-0.1 |
|
|
|
|
|
|
|
|
|
|
|
Low-income economies |
-1.0 |
-4.0 |
-2.7 |
-2.4 |
-3.0 |
-2.5 |
|
-0.1 |
-0.1 |
-0.2 |
|
|
|
|
|
|
|
|
|
|
|
General Government Cyclically Adjusted
Balance
(Percent of potential GDP) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advanced economies |
-3.8 |
-6.0 |
-6.1 |
-5.4 |
-4.7 |
-3.6 |
|
-0.2 |
-0.2 |
-0.2 |
United States4 |
-5.5 |
-7.9 |
-8.1 |
-7.5 |
-6.3 |
-5.0 |
|
-0.4 |
-0.4 |
-0.6 |
Euro area |
-3.1 |
-4.5 |
-4.6 |
-3.3 |
-2.0 |
-1.4 |
|
0.0 |
0.0 |
0.1 |
France |
-3.1 |
-5.1 |
-5.1 |
-3.8 |
-3.1 |
-2.6 |
|
0.2 |
0.1 |
0.1 |
Germany |
-1.3 |
-1.3 |
-3.4 |
-1.2 |
-0.6 |
-0.4 |
|
0.0 |
0.0 |
0.1 |
Greece2 |
-16.4 |
-18.5 |
-12.5 |
-9.0 |
-4.5 |
0.2 |
|
-2.2 |
0.1 |
2.9 |
Ireland |
-11.9 |
-10.6 |
-9.8 |
-7.7 |
-6.0 |
-5.6 |
|
… |
… |
… |
Italy |
-3.3 |
-3.0 |
-3.1 |
-2.7 |
-0.5 |
0.7 |
|
0.0 |
-0.2 |
0.0 |
Portugal |
-3.6 |
-8.8 |
-9.1 |
-2.9 |
-2.1 |
-0.9 |
|
-0.2 |
-0.1 |
-0.1 |
Spain3 |
-5.6 |
-9.7 |
-7.6 |
-7.3 |
-5.0 |
-3.9 |
|
-0.4 |
-1.1 |
-0.3 |
Japan |
-3.5 |
-7.4 |
-7.9 |
-8.2 |
-8.8 |
-7.9 |
|
0.0 |
-0.1 |
0.1 |
United Kingdom |
-7.2 |
-9.7 |
-8.4 |
-6.6 |
-5.5 |
-4.2 |
|
-0.3 |
-0.4 |
-0.4 |
Canada |
-0.6 |
-2.6 |
-4.1 |
-3.4 |
-3.0 |
-2.2 |
|
0.2 |
-0.2 |
0.0 |
|
|
|
|
|
|
|
|
|
|
|
Emerging economies |
-1.5 |
-3.6 |
-3.1 |
-1.9 |
-1.7 |
-1.7 |
|
0.0 |
-0.1 |
0.0 |
China |
0.0 |
-2.4 |
-1.5 |
0.0 |
0.0 |
0.2 |
|
0.0 |
0.0 |
0.0 |
India |
-8.8 |
-9.8 |
-9.6 |
-9.1 |
-9.0 |
-8.7 |
|
0.0 |
-0.2 |
0.0 |
Russia |
3.9 |
-3.3 |
-2.2 |
1.7 |
-0.2 |
-1.1 |
|
0.1 |
-0.4 |
-0.3 |
Turkey |
-3.2 |
-4.7 |
-3.4 |
-1.8 |
-2.8 |
-2.8 |
|
0.0 |
0.0 |
0.0 |
Brazil |
-2.1 |
-2.2 |
-3.2 |
-2.8 |
-1.5 |
-2.0 |
|
-0.1 |
0.6 |
0.3 |
Mexico |
-1.3 |
-3.8 |
-3.9 |
-3.2 |
-2.4 |
-2.2 |
|
0.0 |
-0.1 |
-0.1 |
South Africa |
-2.3 |
-5.1 |
-4.5 |
-4.1 |
-3.7 |
-3.3 |
|
0.1 |
-0.1 |
-0.1 |
|
|
|
|
|
|
|
|
|
|
|
General Government Gross Debt |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advanced economies |
81.6 |
95.4 |
101.5 |
105.6 |
110.0 |
112.2 |
|
0.0 |
0.8 |
1.0 |
United States |
76.1 |
89.9 |
98.4 |
102.8 |
106.7 |
110.7 |
|
-0.1 |
0.1 |
0.5 |
Euro area |
70.2 |
80.0 |
85.8 |
88.1 |
91.4 |
92.4 |
|
0.0 |
1.4 |
1.4 |
France |
68.3 |
79.2 |
82.4 |
86.1 |
88.2 |
90.1 |
|
-0.2 |
-0.9 |
-0.7 |
Germany |
66.9 |
74.7 |
83.5 |
81.2 |
82.2 |
80.1 |
|
-0.3 |
3.3 |
2.7 |
Greece2 |
112.6 |
129.0 |
144.5 |
165.4 |
162.6 |
171.0 |
|
4.6 |
9.4 |
10.1 |
Ireland |
44.2 |
65.1 |
92.5 |
108.2 |
117.6 |
121.2 |
|
3.2 |
4.4 |
3.5 |
Italy |
105.8 |
116.1 |
118.7 |
120.1 |
125.8 |
126.4 |
|
0.0 |
2.5 |
2.6 |
Portugal |
71.6 |
83.1 |
93.3 |
107.8 |
114.4 |
118.6 |
|
1.0 |
2.0 |
3.3 |
Spain3 |
40.2 |
53.9 |
61.2 |
68.5 |
90.3 |
96.5 |
|
0.0 |
11.2 |
12.5 |
Japan |
191.8 |
210.2 |
215.3 |
229.9 |
234.5 |
240.0 |
|
0.1 |
-1.3 |
-1.1 |
United Kingdom |
52.5 |
68.4 |
75.1 |
82.3 |
88.6 |
92.7 |
|
-0.2 |
0.2 |
1.3 |
Canada |
71.1 |
83.6 |
85.1 |
84.7 |
85.4 |
82.7 |
|
-0.3 |
0.7 |
0.8 |
|
|
|
|
|
|
|
|
|
|
|
Emerging economies |
33.3 |
35.4 |
40.1 |
36.4 |
34.2 |
32.7 |
|
0.0 |
0.3 |
0.5 |
China |
17.0 |
17.7 |
33.5 |
25.8 |
22.0 |
19.4 |
|
0.0 |
0.0 |
0.0 |
India |
75.2 |
72.2 |
67.7 |
67.1 |
68.0 |
68.6 |
|
-1.0 |
0.4 |
1.8 |
Russia |
7.9 |
11.3 |
11.8 |
12.0 |
11.5 |
11.3 |
|
2.4 |
3.1 |
3.4 |
Turkey |
40.0 |
46.1 |
42.2 |
39.4 |
36.0 |
34.6 |
|
0.0 |
0.0 |
0.0 |
Brazil |
63.5 |
66.9 |
65.2 |
64.9 |
64.2 |
61.7 |
|
-1.2 |
-0.9 |
-1.4 |
Mexico |
43.1 |
44.5 |
42.9 |
43.8 |
42.7 |
42.9 |
|
0.0 |
-0.1 |
0.0 |
South Africa |
27.4 |
31.5 |
35.3 |
38.7 |
40.2 |
41.3 |
|
-0.1 |
0.2 |
0.5 |
Low-income countries |
40.8 |
42.5 |
40.2 |
39.3 |
41.6 |
39.7 |
|
0.4 |
0.9 |
0.3 |
|
|
|
|
|
|
|
|
|
|
|
Memorandum: |
|
|
|
|
|
|
|
|
|
|
World Growth (Percent) |
2.8 |
-0.6 |
5.3 |
3.9 |
3.5 |
3.9 |
|
0.0 |
-0.1 |
-0.2 |
|
Sources: IMF staff estimates and
projections. Note: All
fiscal data country averages are weighted by nominal
GDP converted to U.S. dollars at average market
exchange rates in the years indicated and based on
data availability. Projections are based on IMF
staff assessment of current policies.
1
For overall fiscal balance and cyclically adjusted
balance, positive values indicate a smaller fiscal
deficit; for gross debt, positive values indicate a
larger debt.
2
For Greece, projections to be revised.
3
For Spain, projections do not reflect the measures
announced on July 11, 2012.
4
Excluding financial sector support. |
|
The new targets, respectively 1 and 1½ percentage points
above the previous ones, appropriately accommodate the weak
growth outlook. On July 11, the government announced a series of
measures—including increases in VAT rates, the elimination of
mortgage interest deductibility under the income tax, and cuts
in civil service pay and unemployment benefits—to help achieve
the new targets. To recapitalize the banking system, Spain’s
bank support fund—Fondo de Reestructuración Ordenada Bancaria (FROB)—is
to have access to a financial sector recapitalization loan by
the European Financial Stability Facility (EFSF) for up to 9
percent of GDP (€100 billion) committed by the Eurogroup, which
would be reflected in the general government gross debt.
However, once a single supervisory system is established in the
euro area, the European Stability Mechanism (ESM) will be
allowed to inject capital directly into the banks.1
- Italy’s headline and cyclically adjusted
deficits for 2012–13 continue to be broadly in line with
expectations. Fiscal adjustment over the next two years
would allow the authorities to achieve a small structural
surplus in 2013 (against the medium-term objective of a
structurally balanced budget2).
This focus on structural fiscal targets is enshrined in a
recently approved constitutional balanced budget rule coming
into force in 2014. The bill amending the Constitution also
mandates the establishment of a fiscal council whose remit
and institutional features will be defined in secondary
legislation currently under discussion. The authorities plan
to use spending reviews more systematically to identify
fiscal savings; a first phase, approved in July, legislates
spending cuts in order to rebalance the earlier fiscal
consolidation package away from tax increases.
In the three euro area countries with programs supported by
EU/IMF lending, adjustment is proceeding, but the recent
deterioration in the political and economic climate in Greece
serves as a warning about the potential onset of “adjustment
fatigue,” which remains a threat to continued program
implementation.
- The situation in Greece remains fluid.
Macroeconomic deterioration and uneven reform implementation
have weighed on revenues this year, while financing
constraints are leading to under-execution of budgeted
expenditures. 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).
- Fiscal adjustment is proceeding as targeted in
Portugal, where the deficit is expected to fall to
4½ and 3 percent of GDP this year and next, respectively,
with this decline to be achieved mainly through expenditure
restraint. The adoption of a medium-term expenditure
framework—with indicative expenditure ceilings—is expected
to strengthen program implementation. The authorities are
also to provide capital injections into three of the largest
banks (amounting to 4 percent of GDP) to meet capital
requirements set by the European Banking Authority,
increasing the ratio of gross debt to GDP (but not the
measured deficit).
- In Ireland, the authorities are on track to
meet the program targets and keep pace with the objective of
reaching the 3 percent of GDP EU threshold for the headline
deficit by 2015.3
The general government deficit target of 8.6 percent of GDP
for 2012 appears likely to be met, especially given the
slightly better than expected fiscal performance through
May.
In advanced economies with easier market access, fiscal
adjustment in 2012–13 is broadly on track to meet medium-term
targets.
- Projected fiscal withdrawal in Germany for 2012
and 2013 is unchanged since April at relatively modest
levels.
- In the United Kingdom, the cyclically adjusted
deficit will continue to decline this year and next, but by
less than last year, which is fitting given the weak growth
outlook. The government has appropriately maintained its
commitments to balance the structural current budget within
five years and to put net debt on a declining path, with
additional consolidation in store in 2015–17.
- In France, the new administration has committed
to reducing its headline deficit by about 1 percent of GDP
this year and 1½ percent of GDP next year to 3 percent of
GDP, in line with earlier projections (with a commitment to
a balanced budget by 2017, a year later than envisaged
earlier).4
With a view to reaching these targets, the supplementary
budget includes new measures of about 0.3 percent of GDP,
mainly on the revenue side, to compensate for revenue
shortfalls. The underlying adjustment implicit in these
targets is appropriate under the baseline scenario. However,
in the event that growth disappoints, these targets could
entail an excessive structural adjustment. Thus a shift to
structural deficit targets could be desirable.
- The United States’ fiscal position is projected
to improve this year (broadly in line with the April 2012
Fiscal Monitor projections), but the outlook for
2013 remains a significant concern.5
Expiring tax provisions (such as income and payroll tax cuts
and limitations on the reach of the Alternative Minimum Tax
through an adjustment of the income threshold) and automatic
spending cuts mandated by the 2011 Budget Control Act would
imply a fiscal withdrawal of more than 4 percent of GDP—the
so-called ‘fiscal cliff’—which would severely affect growth
in the short term.6
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, which is expected to
become binding late this year or early next, would mitigate
risks of financial market disruptions and a loss in consumer
and business confidence.
- Following a political agreement in Japan, the
draft bill to double the consumption tax rate in stages to
10 percent by 2015 passed the lower house in late June and
has been sent to the upper house. This welcome development
sends a positive signal of commitment to fiscal adjustment
and reform. However, the tax increase would remain only part
of the consolidation necessary to put the debt ratio on a
downward path. To support further fiscal consolidation and
mitigate the negative economic impact of the consumption tax
increase, adjustment measures should be complemented by
efforts to raise growth through structural measures,
supportive monetary policy, and fiscally-prudent,
growth-friendly tax and expenditure reforms.
The decline in deficits is gradually affecting public debt
dynamics. While the average debt-to-GDP ratio among advanced
economies is projected to continue to rise over the next two
years, surpassing 110 percent of GDP on average in 2013, debt
ratios will by then have peaked in several advanced economies
(Figure 3). Already this year, about one-third of advanced
economies will have declining debt ratios, although debt ratios
will still exceed their 2007 levels in almost all cases. In the
euro area other than Greece, gross debt dynamics in 2012–13 will
be negatively (and temporarily) affected by the pooling of
resources to support countries in crisis (Figure 4, box). Of
course, the corresponding acquisition of assets leaves net debts
unchanged.
Deficits in emerging economies are expected to be somewhat
weaker than projected in April, as some draw on fiscal space in
response to slowing economic activity. No significant fiscal
consolidation is on tap in 2012–13, reflecting generally
stronger fiscal positions than in advanced economies and
downside risks to global growth.
- In Brazil, the overall balance for 2012 is
expected to be ½ percent of GDP stronger than envisaged
earlier, mainly on account of lower interest payments.
Despite recently announced measures to support selected
industrial sectors and investment (estimated at about
0.4 percent of GDP), the authorities are still expected to
achieve the 3.1 percent of GDP primary surplus target.
- Fiscal consolidation is projected to advance gradually
in Mexico in 2012–13, in line with earlier
projections. In 2013, the authorities are expected to return
to their balanced budget target.
- In China, fiscal consolidation is expected to
be put on hold this year—which is appropriate in light of
slower growth and a strong fiscal position (headline deficit
of around 1¼ percent of GDP)—before resuming slowly in 2013.
- In South Africa, improving revenue performance
and a gradual withdrawal of fiscal stimulus should
contribute to a decline in the cyclically adjusted fiscal
deficit by 0.9 percent of GDP over the next two years, in
line with earlier projections.
That said, some emerging economies should pursue more
ambitious consolidation strategies, reflecting macroeconomic or
fiscal considerations.
- In Russia, fiscal policy will continue to
exhibit a strong procyclical bent. With oil revenue
windfalls financing expenditure growth, this year’s non-oil
deficit is expected to increase by about 1 percentage point
to 10½ percent of GDP, despite the closing of the output
gap. Meanwhile, the 2012–14 medium-term budget does not
provide for a meaningful improvement in the non-oil deficit,
making public finances highly vulnerable to petroleum market
developments.
- In Turkey, revenue shortfalls related to
slowing activity are expected to increase the overall
deficit by 1½ percent of GDP this year, leaving the
structural primary deficit broadly unchanged. Looking
forward to 2013 and beyond, a tighter fiscal stance seems
appropriate to help reduce the large current account
deficit.
- In India, overall deficits for 2012–13 were
revised upward to almost 9 percent of GDP, more than ½
percentage point higher than in the April 2012 Fiscal
Monitor, mainly due to higher fuel subsidies and
revenue shortfalls. A determined reduction in costly
subsidies would be a strong signal of a credible fiscal
turnaround. It would also allow relaxation of financial
restrictions, spurring private investment and growth.
Reconciling Credibility and Growth
Governments face the task of credibly dealing with large
fiscal adjustment needs in a time of slow and uncertain growth.
Reconciling these needs may be challenging, but following some
basic fiscal principles (to be adapted on a case- by-case basis)
should help:7
Effects of EU Firewalls on Gross Public Debt Ratios
Pooling of resources through the EFSF and
contributions to the paid-in capital of the ESM largely
explain upward revisions to projected gross debt levels
for this year and next compared to the April 2012
Fiscal Monitor in several euro area countries,
notably Germany (3 percentage points of GDP) and Italy
(2½ percentage points).1
EFSF disbursements directly increase gross
liabilities of the countries guaranteeing the EFSF’s
debt in proportion to these countries’ capital shares in
the European Central Bank (ECB) adjusted to exclude
countries with EU/IMF supported programs. Existing loans
represent slightly more than 1 percent of euro area GDP
in mid-2012, with a corresponding increase in EFSF
guarantors’ debt. In the case of Italy and Spain, this
represents 1.6 percent of GDP. The recently announced
financing of the Spanish bank recapitalization will
initially be channeled through an EFSF loan to the
sovereign, increasing the euro area debt by an
additional ¾ percent of GDP. Of course, these additions
to public debts are by nature temporary and matched by
an accumulation of assets.
Because it predates the EFSF, the first Greek program
was largely financed by €80 billion in bilateral loans,
pooled by the European Commission (EC) in proportion to
countries’ ECB capital shares. Disbursements to Greece
amounted to ½ percent of euro area GDP, though loans
provided by Italy, Portugal, and Spain were higher in
proportion to their GDP.
__________________________________
1 A second firewall, the European
Financial Stabilization Mechanism (EFSM), allows the EC
to borrow up to €60 billion on behalf of the European
Union. The corresponding bond issuances do not affect
national public debts. Euro area countries must also
capitalize the ESM, slated to become operational in July
2012 once ratified by national parliaments. The ESM will
have an initial lending capacity of €500 billion and a
total subscribed capital of €700 billion, of which €80
billion will be in the form of paid-in capital to be
phased in with a maximum of five installments. Part of
these capital contributions has already been
incorporated into debt projections, as mentioned
earlier. |
- To anchor market expectations, country authorities need
to specify adequately detailed medium-term plans aimed at
lowering debt ratios and backed by binding legislation or
fiscal frameworks. Among large advanced economies, both the
United States and Japan still lack such plans.
- Within these plans, and to the extent that market
financing remains at sustainable rates, adjustment should
take place at a steady pace defined in cyclically adjusted
terms. On average, an annual pace of adjustment of about 1
percentage point of GDP—as in advanced economies in
2011–13—seems to be broadly adequate in reconciling the need
to address the challenge of fiscal consolidation while
managing risks to growth, although the appropriate pace of
adjustment for each country should reflect the size of the
overall fiscal imbalance. Defining targets in cyclically
adjusted terms allows automatic stabilizers to operate, thus
mitigating possible shocks. In Europe, several countries
have explicitly adopted structural balance targets,
including Germany, Italy, and the United Kingdom, and the EC
has increasingly used the flexibility embedded in the
corrective arm of the Stability and Growth Pact to formulate
recommendations in structural terms—except in the case of
program countries, where limited financing makes headline
targets necessarily more binding.
- The pace of underlying fiscal adjustment should not be
changed in response to relatively contained variations in
the growth outlook. This position is consistent with the
long-standing view that fiscal policy is not an effective
instrument for fine tuning the cycle. However, in case of a
major shock to the recovery, fiscal policies may need to be
recalibrated in countries with fiscal space, in the context
of a reassessment of the overall macroeconomic policy mix.
To ensure a timely fiscal response, contingency plans should
be ready, prioritizing temporary revenue and expenditure
measures with the highest payoffs in terms of economic
activity (see the April 2012 Fiscal Monitor).
- The composition of fiscal adjustment should be guided
primarily by the need to foster the economy’s growth
potential over the longer term and by country-specific
factors. Specifically, priority should be given to cutting
spending in countries where expenditure is already high and
correspondingly heavy tax burdens limit the scope for
raising revenues without adversely affecting economic
efficiency and growth. Ideally, cuts should target
unproductive outlays identified through comprehensive
expenditure reviews. Figure 5 illustrates that for most
advanced economies, expenditure restraint is indeed part of
their consolidation plans. Where there is room for revenue
increases, as in the United States and Japan, opportunities
should be exploited to widen bases by eliminating exemptions
and unwarranted special treatment under the tax code rather
than just raising rates. Fiscal policy in many countries can
also be adjusted to better support employment—for instance,
through revenue-neutral reductions in the labor tax
wedge—which would also boost potential growth.8
Some emerging economies (notably Egypt, India, Indonesia,
and Saudi Arabia) could benefit from eliminating fuel and
other subsidies,9
while Turkey, Russia, and South Africa should take measures
to prevent expenditure growth from outpacing the economy’s
medium-term income growth.
- Reforms affecting long-term spending trends remain
important to help strengthen fiscal credibility.10
For advanced Europe, the EC’s recently issued 2012
Ageing Report reiterates the risks to fiscal
sustainability arising from demographic changes. The
Report estimates that over 2010–30, pension costs would
increase by 0.5 percent of GDP, and health care costs by
0.7 percent of GDP. While the pension projections are
broadly consistent with those prepared by the IMF staff,11
the increase in public expenditure on health care is likely
underestimated by about 1 percent of GDP as the cost
pressure arising from technological change is not fully
taken into account.12
However, fiscal policy alone cannot stabilize market
conditions in the euro area. Current sovereign spreads are well
above what could be justified on the basis of fiscal and other
long-term fundamentals (Figure 6), suggesting that wide-ranging
reforms durably affecting expectations—discussed in more detail
in the WEO and GFSR Updates—are needed. In
particular, it will be critical to delink sovereigns’ and banks’
balance sheets. The European leaders agreed at their June summit
upon significant steps to address the immediate crisis, which,
if implemented in full, will help break these adverse links. In
particular, once a single supervisory mechanism is established,
the ESM would be able to recapitalize banks directly. These
initiatives are steps in the right direction, but will need to
be complemented by more progress toward deeper fiscal
integration and a full-fledged banking union. In the meantime,
there has been notable progress in ongoing initiatives to
strengthen fiscal governance in the last few months. To date, 10
of the 25 EU member signatories have ratified the so-called
Fiscal Compact treaty, which mandates the adoption by 2014 of
rules-based national fiscal frameworks capping structural
deficits. The recent adoption by the European Parliament of two
draft regulations aimed at further enhancing fiscal policy
coordination in the euro area (known as the “two-pack”) is also
welcome, and swift approval by the Council would be desirable.
Among other proposals, the two-pack mandates harmonized national
fiscal rules under nonpartisan oversight, establishes common
budget timelines, and enhances surveillance by the Commission.
Nevertheless, these steps would usefully be complemented by
plans for fiscal integration, as anticipated in the report of
the “Four Presidents” submitted to the summit. It is encouraging
that the leaders have asked the Council President to develop
proposals for a more complete union over the next three months.
Ultimately, this could mean sufficiently large resources at the
center matched by proper democratic controls and oversight.
Introduction of a limited form of common debt, with appropriate
governance safeguards, could provide an intermediate step
towards greater fiscal integration. Issuance of such securities
could, at first, be relatively small and restricted to shorter
maturities, and could be conditional on more centralized control
(e.g., limited to countries that deliver on policy commitments;
veto powers over national deficits; pledging of national tax
revenues). Common bonds/bills financing could, for example, be
used to provide the backstops for the common frameworks within
the proposed banking union (see the GFSR Update).
1 IMF staff projections currently include the maximum
amount of the loan in the debt but not in the deficit.
2 The structural budget balance is equal to the
cyclically adjusted balance adjusted for one-off measures. As
one-off measures are typically not included in projections,
structural and cyclically adjusted balances are expected to be
equivalent in 2012–13.
3 Changes to the 2011 deficit compared to the April
2012 Fiscal Monitor reflect a revision to include part
of the bank recapitalizations (already accounted for in the debt
ratio) in the deficit.
4 IMF staff projections in Table 1 are based on
current policies and do not take into account forthcoming
additional measures that will be taken to reach the 3 percent
deficit target.
5 Changes in the cyclically adjusted balance in
2011–12 with respect to the April 2012 Fiscal Monitor
are due mainly to revisions to the estimate of potential GDP.
6 The IMF staff’s baseline scenario incorporates a
1¼ percent of GDP reduction in the structural primary balance in
2013, largely on account of expiring stimulus measures and some
savings in defense spending. The Bush tax cuts and certain other
revenue provisions are expected to be extended fully for at
least one year, while the automatic spending cuts are assumed to
be replaced by other measures over the medium term.
7 Of course, other policies must work in tandem with
fiscal policy to mitigate downside risks to growth and boost
activity and employment in the longer term. These policies are
discussed in more detail in the WEO and GFSR
Updates.
8 See IMF, “Fiscal Policy and Employment in Advanced
and Emerging Economies” (forthcoming).
9 See IMF, “Recent Developments in Fuel Pricing and
Fiscal Implications” (forthcoming).
10 It will be equally important not to reverse
previously introduced reforms. For instance, France has recently
cut back the pension age to 60 for some long-time workers, at an
estimated cost of 0.1 percent of GDP by 2017, fully covered by
higher labor taxes.
11 See IMF, “The Challenge of Public Pension Reform in
Advanced and Emerging Economies,” IMF Policy Paper (Washington,
2011), available via the Internet:
http://www.imf.org/external/pp/longres.aspx?id=4626
12 This issue had already been raised with respect to
the previous Ageing Report; see B. Clements, D. Coady,
and S. Gupta, eds., The Economics of Public Health Care
Reform in Advanced and Emerging Economies (Washington: IMF
2012), available via the Internet:
http://www.imf.org/external/pubs/ft/books/2012/health/healthcare.pdf
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