The economic and financial crisis is affecting the fiscal accounts of virtually every country. Public sector support for the financial system, fiscal stimulus and the automatic stabilizers, as well as the revenue decline from the downturn in commodity and asset prices, are leading to sharp increases in deficits and debt stocks around the world. Expansionary fiscal policy continues to be necessary in the short term to stimulate economic recovery. But it is now essential that governments reassess the state of their public finances in light of the global crisis and adopt strategies that will ensure medium- and long-term fiscal sustainability. Many of the advanced economies most affected by the crisis are also those where age-related spending will increase markedly in the coming years, adding particular urgency to the need to identify medium-term consolidation strategies. This new paper, which focuses mainly on advanced and emerging market economies, employs projections based on the April 2009 World Economic Outlook to quantify the fiscal implications of the crisis for a cross-section of countries. The authors assess the post-shock fiscal balances and debt outlook, and suggest ways for governments to clarify their strategies for maintaining fiscal solvency.
The financial and economic crisis is affecting the fiscal accounts of virtually all IMF members through several channels. First, many countries have supported the financial sector directly, primarily through “below-the-line” operations affecting governments’ assets and liabilities, as well as operations giving rise to contingent liabilities. Second, the growth deceleration, coupled with asset and commodity price declines, is affecting revenues (and, in some cases, spending). Third, discretionary stimulus has been used to support aggregate demand. Moreover, the losses suffered by funded pension schemes may involve contingent liabilities for the state. For many countries, these developments come in the context of a projected long-term deterioration in fiscal balances reflecting demographic changes. Indeed, in these countries, fiscal policy before the crisis was expected to focus on prepositioning the fiscal accounts to make room for increased aging-related spending. The opposite has happened.
Government support to the financial sector can take various forms, with different implications for gross and net debt. Operations undertaken directly by the government typically entail an upfront rise in gross government debt, though not necessarily a change in net worth and the deficit, given the related acquisition of assets. Over time, the fiscal impact will critically depend on the realization value of the acquired assets (i.e., recoveries from their sale). Other operations—those undertaken by the central bank or guarantees—have less immediate implications for the fiscal accounts, but may also have important costs over the medium term. For all, a transparent treatment in the fiscal accounts is necessary (see Box 2.1 and Appendix I).
The recession (and actions to alleviate it) will involve fiscal costs through three channels: automatic stabilizers; other nondiscretionary effects going beyond the normal impact of the cycle, including from lower asset prices, financial sector profits, and commodity prices; and discretionary fiscal stimulus. Some of these effects will be short-lived; others will be longer lasting or even permanent. For example, the cyclical impact of automatic stabilizers will reverse with recovery, and some discretionary measures may explicitly incorporate sunset provisions. By contrast, tax breaks may be difficult to reverse, and while revenues associated with “normal” long-term trends in commodity and asset prices will resume, those associated with above-normal price levels before the crisis will not.
The paper discusses key incentive-related issues of the sovereign debt restructuring mechanism recently outlined by the IMF First Deputy Managing Director. The structure of incentives in the mechanism should be consistent with the principle of favoring market-oriented, voluntary solutions to financial crises. The paper frames the mechanism in the context of involving the private sector in financial crisis resolution (PSI), and identifies the conditions for setting up an appropriate incentive structure. The paper explores issues relating to the functioning of the mechanism, including access policy on IMF resources; the power to activate the mechanism; its relation with intermediate PSI instruments; and its impact on investment in emerging markets.
This paper analyzes the economic effects of weak claims enforcement for Cyprus. Claims enforcement in Cyprus is considerably less efficient than in most European Union countries. The banking crisis, which led to a spike in the number of pending litigious civil and commercial cases, could be a factor in the low enforcement efficiency. For Cyprus, piecemeal reform of the enforcement framework may have limited success, and a wholesale review is likely needed. Adding updated components may not fit well with the underlying civil procedure. Instead a comprehensive review, with a focus on limiting case suspensions allowed under interim applications and considering an alternative compensation basis for lawyers should be considered.
This Selected Issues paper analyzes Spain’s sustainable growth rate. It sheds some light on Spain’s medium-term growth prospects by looking into the key factors driving potential growth, both in the past and likely in the future, and international experience of countries in the aftermath of financial crisis. The paper suggests Spain is likely to face a long period of moderate growth (about 1½–2 percent) and high unemployment, but policy action—especially that directed toward reducing structural unemployment and raising productivity—could lead to much better outcomes.