Fiscal Risks Retreat as Deficits Continue to Fall: IMF Fiscal Monitor

World deficit declined to 4.3% of GDP in 2012 and is expected to decline further to 3.5% this year. Meanwhile projected figures for India for 2013 leaves the deficit unchanged from its 2012 level in both headline and cyclically adjusted terms at 8.3% and 8.8% of GDP respectively.

A gradually improving global economy and progress toward reducing deficits in advanced economies have lowered short-term fiscal risks, yet many countries still face a long road back to fiscal health.

In its Fiscal Monitor, the International Monetary Fund (IMF) sees an improved picture across most of the world in terms of countries getting a handle on their deficits. Many countries have also taken important first steps to bring overall debt down to levels needed to ensure strong and vibrant economies.

Deficits in advanced economies fell by 0.75% of GDP in 2012. They dropped both in headline and in cyclically-adjusted terms, and are projected to fall at a faster pace in 2013. The report attributes much of the improved picture to concerted efforts by governments to bring spending under control following the peak of the crisis in 2009, as well as a gradually improving external environment. The IMF forecasts continued improvement in global economy with economic growth worldwide expected to reach 3.3% in 2013.

Long-term outlook

Bringing public debt back to prudent levels poses a long-term challenge, according to the IMF report, but it is a challenge that can be successfully met. Debt ratios are declining or stabilizing in about two thirds of advanced economies, but further adjustment efforts will be needed in the remaining third—representing 40% of global GDP. In some countries, particularly several European countries under market pressure, debt ratios will not peak until after 2014, as seen in the projections for France, Italy, and Spain.

In both the United States and Japan, the continued absence of a clear and credible medium- and long-term consolidation plan remains a concern. Stimulus spending and increasing social security outlays in Japan are expected to keep the deficit there at a level more than twice the advanced economy average. In the US, an agreement on entitlement reforms and other much-needed measures to control the debt has yet to be reached.

Institutional reforms, such as fiscal rules, independent monitoring agencies, and medium-term spending frameworks, can buoy the credibility of fiscal adjustment packages and their political acceptance. Countries such as Ireland and Portugal have begun making institutional reforms by introducing limits on government spending, and ongoing reforms across Europe are calling on fiscal councils to play a strong and independent role in fostering fiscal discipline.

The overall debt situation in most emerging market economies and low-income countries remains more favorable than in advanced economies, owing in part to relatively low levels of debt and deficits combined with low interest rates and growing economies. Under these conditions, many emerging market economies have had the scope to pause their fiscal adjustment. Yet, as the IMF report notes, medium-term pressures like infrastructure and age-related spending mean that these countries need to adopt a cautious approach to budget decisions going forward.

In Brazil, the authorities are targeting a primary surplus of 3.25% of GDP, which would imply a tightening of about 1.25% of GDP in cyclically adjusted terms. However, the primary surplus target could be reduced by up to 0.9% of GDP to support investment.

In the Russian Federation, the 2013 overall deficit is expected to increase by 0.5% of GDP relative to previous projections, as a result of the decline in oil prices.

In India, subsidy reduction measures, other spending cuts, and tax administrative measures recommended by the government-appointed Kelkar Commission will contribute to a reduction in the projected 2013 deficit of about 0.75% of GDP relative to previous forecasts, which would leave the deficit almost unchanged from its 2012 level in headline and cyclically adjusted terms.

In China, the cyclically adjusted primary surplus declined by 0.75% of GDP in 2012 and is expected to remain unchanged in 2013. Recorded gross debt and deficits remain low, though they exclude the actual and contingent liabilities arising from local government operations.

In South Africa, where the deficit still hovers at about 5% of GDP, the medium-term budget policy statement has reaffirmed the commitment to fiscal consolidation. The authorities are aiming to deliver about half of the future adjustment through containment of the wage bill, but additional measures are not yet defined.

In the Middle East and North Africa, amidst political instability and volatile oil prices, fiscal vulnerabilities are on the rise. Pressures from public sector wages and on subsidies have caused a deterioration of the fiscal balances of most oil importers and non– Gulf Cooperation Council oil exporters. Many oil importers have exhausted their fiscal buffers.

Fiscal consolidation is also on hold in most low-income countries, and deficits in most countries are still larger than pre-crisis levels. Strong spending growth, due in many cases to large increases in public investment, is leading to higher debt-to-GDP ratios in countries like Ghana and Senegal.

Fiscal Balances                                                                                     (in percentage)

Source: IMF

Warm regards,

Dr. S P Sharma
Chief Economist