November 2010 Fiscal Monitor “Fiscal Exit: From Strategy to Implementation”

Posted by Mohan Kumar and Phil Gerson

 
The November issue of the Fiscal Monitor, the Fund’s flagship fiscal publication, is now available on IMF.ORG. In addition to its regular analysis of fiscal developments and trends, this edition of the Monitor—subtitled “Fiscal Exit: From Strategy to Implementation”—has a special focus on countries’ medium-term strategies to put their public finances on a sounder footing.

The Monitor reports that the global fiscal deficit is projected to fall from 6¾ percent of GDP in 2009 to 6 percent this year. However, the decline owes much to improved economic conditions and lower financial sector support in the United States. Without these factors, the overall global fiscal balance would have worsened this year. Deficit declines are widely spread—some 60 percent of countries covered by the Monitor are projected to post smaller deficits in 2010 than last year. In 2011, 90 percent of the countries are projected to record smaller deficits, and the cyclically adjusted balance—the balance after discounting for the impact of the economic cycle—is expected to improve by 1 percentage point of GDP in advanced economies (and close to this in emerging economies). This pace of adjustment is broadly appropriate, as it strikes a balance between addressing market concerns about fiscal fundamentals and avoiding an abrupt withdrawal of support to the nascent recovery. If growth should slow significantly more than expected, countries with fiscal room should give full play to the automatic stabilizers. If necessary to sustain the recovery, some of the adjustment planned for 2011 could also be postponed.

The Monitor also highlights the continuing large public sector borrowing requirements and sovereign debt market conditions. While the large borrowing needs and deterioration in market sentiment compelled some advanced economies to tighten fiscal policy this year, others considered safe havens continue to benefit from very low interest rates. Net purchases of government securities by central banks, which were much more limited this year than last, also helped keep rates low in some of the largest economies.

A review of fiscal plans for a group of 25 countries (including all of the G-20) finds that 90 percent of them have announced that they will gradually reduce their medium-term deficits, with plans typically through 2013. The overall pace of underlying adjustment is broadly appropriate. Most adjustment plans are intended to be expenditure-based, which is also appropriate in light of the high spending level in many countries. However, few countries have explicitly committed to a long-term target for their public debt ratio, or—where such a target predated the crisis—have indicated clearly when they will achieve it. This leaves the ultimate objectives of fiscal policy unclear in many countries. More detail on the policy measures underpinning adjustment, a commitment to tackle long-term spending pressures from health care and pensions, and fundamental reforms of social spending to help protect vulnerable groups from the impact of the crisis and consolidation are also needed.

In assessing risks the Monitor focuses on the likelihood of two possible unpleasant outcomes: sovereign rollover problems at the regional or global level, and long-term stabilization of public debt at elevated levels. Overall, the risk that these events materialize remains high by historical standards for advanced economies—especially those that are already under market pressure. They are lower but nontrivial for emerging markets.

The Monitor concludes with an assessment of four topical fiscal policy questions:

• Pension reform: using the Fund’s Global Integrated Monetary and Fiscal model, it finds that increases in retirement age are the most effective option for addressing long-run cost pressures.
• Financial sector taxation: The Monitor summarizes the proposals put forward in a recent IMF report in this area, notably the “Financial Stability Contribution,” proposed by the IMF to internalize systemic risk and raise revenues to offset future financial support needs.
• Carbon pricing: Recent IMF research suggests that efficient carbon-pricing schemes could raise ¾ percent of GDP in advanced economies and 1½ percent of GDP in emerging economies within the next ten years, while targeted transfers could offset any impact on the poor.
• Value-added taxes:  How can revenues from value-added taxes (VATs) be increased to support consolidation? Advanced economies should concentrate on eliminating preferential rates. Emerging economies should concentrate on improving compliance.

Mohan Kumar and Phil Gerson are, respectively, Assistant Director and Senior Advisor in the Fiscal Affairs Department of the IMF.

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