Fiscal Implications of the Global Economic and Financial Crisis -- First Elements for an Exit Strategy
Posted by Michel Lazare
In virtually all countries, the global financial crisis has resulted in a significant deterioration of the fiscal position owing in part to a decline in fiscal revenues. How necessary they are to cushion the effect of the crisis and jumpstart recovery, fiscal stimulus packages have also contributed to a further deterioration in fiscal position and an accumulation of public debt. All this points to a possible fiscal solvency issue over time. Fiscal positions needs therefore to be monitored and the further accumulation of public liabilities needs to be carefully considered as the crisis unfolds, through the formulation and implementation of an exit strategy.
Against this background and "amid signs that global economic crisis is stabilizing, the Group of Eight (G-8) advanced economies has asked the International Monetary Fund (IMF) to do the necessary analytical work to help governments prepare “exit strategies” to unwind the huge stimulus packages that have been deployed to combat the crisis."
The IMF published a few days ago, a Staff Position Note on the "Fiscal Implications of the Global Economic and Financial Crisis" (Download Spn0913 ) which already contains some first elements of reflection on exit strategies. For instance the introduction and overview of the note (see full text below) indicates that four components are particularly important in formulating the exit strategies:
Therefore, there is an urgent need for governments to clarify their exit strategy to ensure that solvency is not at risk. In formulating such a strategy, four components are particularly important: (1) fiscal stimulus packages, where these are appropriate, should not have permanent effects on deficits; (2) medium-term frameworks, buttressed by clearly identified policies and supportive institutional arrangements, should provide a commitment to fiscal correction, once economic conditions improve; (3) structural reforms should be implemented to enhance growth; and (4) countries facing demographic pressures should firmly commit to clear strategies for health and pension reforms. While these prescriptions are not new, the weaker state of public finances has dramatically raised the cost of inaction.
The full text of the IMF Staff Position Note can be downloaded here (Download Spn0913) and the full text of its "introduction and overview" is reproduced here:
Introduction and Overview
The global financial crisis is having major implications for the public finances of most countries. Fiscal revenues are declining through the operation of automatic stabilizers and because of lower asset and commodity prices. Direct fiscal support is being provided to the financial sector, and many countries are undertaking discretionary fiscal stimulus. This is cushioning the global economy from the effects of the crisis. But it implies a fiscal deterioration that is particularly strong for advanced countries, where the increase in both government debt and contingent liabilities is unprecedented in scale and pervasiveness since the end of the Second World War. Moreover, these developments are taking place in the context of severe long-run fiscal challenges, especially for countries facing rapid population aging.
The fiscal balances of G-20 advanced countries are projected to weaken by 8 percentage points of GDP on average, and government debt is projected to rise by 20 percentage points of GDP in 2008–09, with most of the deterioration occurring in 2009. The fiscal balances of G-20 emerging market economies will deteriorate by 5 percentage points of GDP. For advanced economies, the increase in debt mostly reflects support to the financial sector, fiscal stimulus, and revenue losses caused by the crisis. For emerging economies, a relatively large component of the fiscal weakening reflects declining commodity and asset prices. Collapsing asset prices have also had adverse effects on funded components of pension systems, with potentially significant risks for public accounts over the next few years.
While fiscal balances are expected to improve over the medium term, they will remain weaker than before the crisis. Public debt-to-GDP ratios will continue to increase over the medium term: in 2014 the G-20 advanced country average is projected to exceed the end-2007 average by 36 percentage points of GDP. On current policies, debt ratios will continue to grow over the longer term, reflecting demographic forces. Moreover, for both advanced and emerging economies, the crisis has increased short- and medium-term fiscal risks, with key downside risks arising from the need for possible further support to the financial sector, the intensity and the persistence of the output downturn, and the return from the management and sale of assets acquired during the financial support operations.
This somber fiscal outlook raises issues of fiscal solvency, and could eventually trigger adverse market reactions. This must be avoided: market confidence in governments’ solvency is a key source of stability and a precondition for economic recovery. Therefore, there is an urgent need for governments to clarify their exit strategy to ensure that solvency is not at risk. In formulating such a strategy, four components are particularly important: (1) fiscal stimulus packages, where these are appropriate, should not have permanent effects on deficits; (2) medium-term frameworks, buttressed by clearly identified policies and supportive institutional arrangements, should provide a commitment to fiscal correction, once economic conditions improve; (3) structural reforms should be implemented to enhance growth; and
(4) countries facing demographic pressures should firmly commit to clear strategies for health and pension reforms. While these prescriptions are not new, the weaker state of public finances
has dramatically raised the cost of inaction.
This note reflects macroeconomic and fiscal forecasts presented with the April 2009 World Economic Outlook, as well as information on fiscal stimulus and financial and industrial sector support gathered through mid-May. It follows the request by G-20 leaders for the Fund to assess regularly the actions taken by countries to address the global crisis and accelerate the recovery.
An earlier version of the paper was discussed by the IMF’s Executive Board at a seminar on February 20, 2009. The Board paper and the companion paper on the State of Public Finances are available on www.imf.org; see IMF (2009a and 2009b). The updated, comprehensive staff study, which is the basis for this Staff Position Note, will be published in the IMF’s Occasional Papers series.