Chapter

Chapter 1 Fiscal Deficits and Debts: Developments and Outlook

Author(s):
International Monetary Fund. Fiscal Affairs Dept.
Published Date:
April 2011
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At a Glance

Fiscal deficits started to decline across all income groups in 2010, although mostly as a result of the improved macroeconomic environment. In 2011, fiscal plans are diverging significantly across advanced economies, partly reflecting differences in intensity of market pressure. Over the medium term, consolidation efforts on current policies will wind down, leaving headline and cyclically adjusted deficits in excess of precrisis levels. Countries delaying adjustment in 2011 will face more significant challenges to meet their medium-term objectives. Over the remainder of the decade, substantial further adjustment will be required to eventually restore debt ratios to prudent levels, especially in advanced economies. The challenge is even greater when the impact of trends affecting entitlement spending is taken into account. Indeed, rising spending on health care is the main risk to fiscal sustainability, with an impact on long-run debt ratios that, absent reforms, will dwarf that of the financial crisis.

Developments in 2010 and Projections for 2011

As most advanced economies shift to fiscal tightening this year, the largest ones lag

Fiscal policy continued to support economic activity in 2010. The average headline deficit in advanced economies was 7¾ percent of GDP, about 1 percentage point lower than in 2009 (Table 1.11 However, this decline reflects the reduced need for government support to the financial sector in the United States, and stronger than expected growth.2 Indeed, headline fiscal balances in almost all advanced economies were better than projected in the November 2010 Fiscal Monitor, thanks largely to some recovery in cyclical revenues and lower-than-projected spending (especially in Italy and Spain). In cyclically adjusted terms, however, the average deficit increased by ¼ percent of potential GDP in 2010, as implementation of stimulus measures peaked.

Table 1.1.Fiscal Balances, 2008-12
Difference from November
Projections2010 Fiscal Monitor
20082009201020112012201020112012
Overall Balance (Percent of GDP)
World-2.0-6.7-5.6-4.7-3.50.40.20.2
Advanced Economies-3.6-8.8-7.7-7.1-5.20.5-0.3-0.1
United States-6.5-12.7-10.6-10.8-7.50.5-1.1-0.9
Euro Area-2.1-6.4-6.0-4.4-3.60.70.70.7
France1-3.3-7.5-7.0-5.8-4.91.00.3-0.1
Germany0.1-3.0-3.3-2.3-1.51.21.41.4
Italy-2.7-5.3-4.5-4.3-3.50.60.00.1
Spain-4.2-11.1-9.2-6.2-5.60.00.70.7
Japan-4.2-10.3-9.5-10.0-8.40.1-1.1-0.3
United Kingdom-4.9-10.3-10.4-8.6-6.9-0.3-0.5-0.6
Canada0.1-5.5-5.5-4.6-2.8-0.6-1.6-0.6
Others2.0-1.00.20.91.60.90.80.7
Emerging Economies-0.6-4.9-3.8-2.6-2.20.40.70.6
Asia-2.4-4.7-4.2-3.4-2.70.40.50.5
China-0.4-3.1-2.6-1.6-0.90.30.40.3
India-8.0-10.0-9.4-8.3-7.50.20.50.9
ASEAN-5-0.8-3.7-2.7-2.8-2.40.30.10.1
Europe0.6-6.2-4.4-2.3-2.30.71.71.0
Russia4.9-6.3-3.6-1.6-1.71.22.01.2
Latin America-0.7-3.7-2.9-2.2-2.2-0.30.00.0
Brazil-1.4-3.1-2.9-2.4-2.6-1.2-1.2-0.9
Mexico-1.3-4.8-4.1-1.8-2.4-0.51.30.3
Middle East and North Africa-0.1-2.9-2.1-4.9-4.21.4-1.4-1.2
Low-Income Economies-1.4-4.2-2.9-2.6-2.40.20.40.0
Oil Producers4.7-4.4-1.41.21.31.83.42.3
G-20 Economies-2.6-7.5-6.3-5.7-4.30.5-0.10.0
Advanced G-20 Economies-4.2-9.4-8.2-8.0-5.80.5-0.6-0.4
Emerging G-20 Economies-0.4-4.8-3.6-2.5-2.10.40.60.6
Cyclically Adjusted Balance (Percent of Potential GDP)
Advanced Economies-3.3-5.5-5.7-5.5-4.20.4-0.4-0.2
United States2-4.6-6.8-7.5-8.1-5.70.4-1.0-0.8
Euro Area-2.9-4.6-4.2-3.3-2.80.70.60.6
France-3.2-5.5-5.3-4.3-3.71.00.30.0
Germany-1.0-1.1-2.4-2.1-1.50.90.81.0
Italy-2.4-3.2-2.8-2.7-2.20.70.20.4
Spain-5.3-9.7-7.5-4.7-4.60.00.70.7
Japan-3.6-7.0-7.5-8.3-7.40.0-1.1-0.5
United Kingdom-5.9-8.5-8.3-6.6-5.1-0.3-0.4-0.4
Canada0.0-3.2-4.0-3.6-2.2-0.6-1.6-0.6
Others0.5-1.5-0.8-0.30.30.50.60.4
Emerging Economies-2.4-4.6-4.1-3.2-2.7-0.10.0-0.1
Asia-3.2-5.2-4.5-3.6-2.8-0.2-0.1-0.2
China-0.9-3.4-2.9-1.8-1.10.30.40.5
India-10.2-11.0-10.0-8.8-7.7-1.3-1.6-2.0
ASEAN-5-1.5-2.8-2.0-2.6-2.21.30.50.1
Europe-0.4-4.1-3.2-2.2-2.20.51.00.8
Russia3.5-3.5-1.8-0.6-1.31.11.81.0
Latin America-1.4-2.9-3.1-2.5-2.7-0.6-0.3-0.6
Brazil-2.1-2.0-3.0-2.5-2.6-1.2-1.3-0.9
Mexico-1.8-4.4-4.1-2.1-2.7-1.40.2-0.6
G-20 Economies-3.0-5.2-5.2-4.9-3.80.2-0.3-0.3
Advanced G-20 Economies-3.4-5.6-6.0-6.1-4.50.4-0.6-0.3
Emerging G-20 Economies-2.3-4.6-4.0-3.1-2.7-0.10.0-0.2
Memorandum Items:
Overall Balance
Advanced Economies2-3.3-7.8-7.6-7.1-5.20.3-0.3-0.1
United States2-5.7-10.2-10.4-10.7-7.40.3-1.1-0.9
Sources: IMF staff estimates and projections.Note: All country averages are PPP-GDP weighted using 2009 weights. Projections are based on staff assessment of current policies. The sample of emerging economies has been extended compared with the November 2010 Fiscal Monitor. (See “Fiscal Policy Assumptions” in the Methodological and Statistical Appendix.)

Striking differences are emerging in how fiscal policy will be managed across advanced economies in 2011. The degree of tightening appears to be correlated with the extent of market pressure, as countries facing higher market interest rates are generally reducing their deficits faster (Figure 1.1).

Figure 1.1.Advanced Economies: Change in Cyclically Adjusted Primary Balances, 2010-11, and Government Bond Yields, 2010

Sources: Datastream; and IMF staff estimates and projections.

Note: The vertical axis reports the residuals from a regression for a sample of 26 advanced economies of the change in the cyclically adjusted primary balance (CAPB) between 2010 and 2011 on the level of the CAPB in 2010, the change in the CAPB between 2007 and 2010, the unemployment rate in 2010, and the increase in the unemployment rate between 2007 and 2010.

  • In the United States, fiscal adjustment is being delayed. The stimulus package adopted in December 2010 (consisting of the extension of tax cuts and emergency unemployment benefits—see the January 2011 Fiscal Monitor update for details) is projected to contribute to an increase in the general government deficit to 10¾ percent of GDP, the largest among advanced economies this year. The United States is the only large advanced economy (aside from Japan—see below) aiming at an increased cyclically adjusted deficit this year, despite a narrowing (although still large) output gap (Figure 1.2). While targeted measures to address the high social costs of still weak housing and labor markets could be justified, the composition of the stimulus package means that its growth impact will be small relative to its fiscal costs (April 2011 WEO). The deficit would be lower if the federal government were compelled to adhere to the current Continuing Resolution for a significant portion of the rest of FY2011.3

  • In Japan, the fiscal stance was expected to be broadly neutral prior to the earthquake, as the expiration of earlier stimulus measures was being offset by increases in transfers. In the aftermath of the earthquake, the government is now expected to adopt a supplementary budget to support the relief efforts, including by tapping the available cash reserves (approximately 0.3 percent of GDP). Discussions are ongoing on how to finance the support package, with alternatives ranging from issuance of new bonds to a temporary tax hike.

  • In contrast, Europe is tightening. The overall deficit in the euro area is expected to fall sharply, due to withdrawal of stimulus and the lower impact of automatic stabilizers. Tax base widening (Germany), wage bill freezes (Italy), pension reform (France and Spain), and expenditure cuts and a value-added tax (VAT) rate hike (Spain) will also contribute. Greece, Ireland, and Portugal have adopted further consolidation measures to enhance the credibility of their front-loaded plans. In the United Kingdom, cuts in real discretionary spending and a VAT rate increase will be the primary factors behind a projected decline in the cyclically adjusted deficit of 1¾ percent of GDP, the largest adjustment among major advanced economies.

  • In some other advanced economies, the consolidation continues, facilitated by the strong pickup in economic activity, with output projected close to or above potential in Australia and Korea. In these countries, buoyant cyclical revenues, complete withdrawal of the fiscal stimulus, and expenditure restraint are leading both headline and cyclically adjusted balances to improve. On the other hand, the recent earthquake in New Zealand will have a significant impact on the fiscal balance this year.

Figure 1.2.Advanced Economies: Change in Cyclically Adjusted Balance and Change in Output Gap, 2011

(Percent of potential GDP)

Sources: IMF staff estimates and projections.

Note: The output gap is defined as the difference between actual and potential GDP. If the output gap is deteriorating, there is greater spare capacity in the economy. Circles denote countries with output levels above potential in 2011. For Norway, data refer to cyclically adjusted non-oil balance.

Slippages are emerging in some economies with respect to what was envisaged in medium-term fiscal adjustment plans (Table 1.2). Shortfalls reflect new stimulus measures (United States), more pessimistic macroeconomic projections in this Fiscal Monitor (Canada and Portugal), natural disasters (Japan), and a worsened outlook for subnational governments (Canada). In contrast, Germany is expected to overperform, owing to stronger growth. Projected adjustment is close to plans in many EU advanced economies. In some cases, revisions have affected the composition of adjustment (United Kingdom). Altogether, the average deficit for advanced economies is expected to fall by ¾ percent of GDP to 7 percent. In cyclically adjusted terms, the improvement amounts to ¼ percent of GDP, far less than projected in the November 2010 Fiscal Monitor.

Table 1.2.Fiscal Balances in 2011: Medium-Term Plans and IMF Staff Projections(Percent of each projection’s GDP)
Medium-Term

Plans
Fiscal Monitor

Projections
Difference
Australia-2.7-2.5-0.7
Canada1-2.7-4.1-1.4
France-6.0-5.80.2
Germany-3.5-2.31.2
Greece-7.3-7.4-0.1
India1-6.8-8.1-1.3
Ireland-10.0-10.8-0.8
Italy-4.0-4.3-0.3
Japan2-8.0-10.0-2.0
Korea30.52.21.7
Latvia-5.3-5.30.0
Lithuania-5.8-6.0-0.2
Mexico-2.3-1.80.5
Portugal4-4.6-5.6-1.0
Russian Federation1-3.7-1.62.1
South Africa1-5.3-5.5-0.2
Spain-6.0-6.2-0.2
Turkey-4.4-1.72.7
United Kingdom1-7.5-8.1-0.6
United States1-9.2-10.5-1.3
Sources: Country authorities’ data and IMF staff projections; averages weighted by GDP at PPP.Note: The table compares the 2011 fiscal balances envisaged under the medium-term adjustment plans announced during the first eight months of 2010 (and described in Bornhorst and others, 2010) and the current IMF staff projections for the 2011 fiscal balances.

Deficits remain well above the levels that would stabilize debt ratios. Gross general government debt ratios rose in almost all advanced economies in 2010 (except in Estonia, Israel, Korea, Singapore, Sweden, and Switzerland). The increase was 6½ percentage points of GDP in Germany, owing to financial support operations (Box 1.1). Among smaller countries, the largest increases were observed in Greece and Ireland, the increase in the latter also reflecting financial sector support operations. While nearly all advanced economies will narrow their deficits in 2011 (with the largest reductions in the Slovak Republic and Spain), two-thirds will record further increases in debt (Figure 1.3), with the average breaching the 100-percent-of-GDP threshold.

Figure 1.3.Advanced Economies: Change in Overall Deficits and Gross General Government Debt, 2011

(Percent of GDP)

Source: IMF staff projections.

Note: Changes in debt and deficits refer to 2011 vis-à-vis 2010.

Box 1.1.Financial Sector Support and Recovery to Date

Despite better overall conditions, some sizable financial sector support measures have been enacted recently. Significant outlays occurred in Germany (preliminarily estimated at 7 percent of GDP), reflecting an asset transfer from Hypo Real Estate to FSM Wertmanagement (the German Asset Management Agency). In the United Kingdom, new outlays are related to additional financial support for Northern Rock (½ percent of GDP). In Ireland, bank recapitalization costs amounted to 30 percent of GDP (one-third of this has taken the form of investments by the National Pension Reserve Fund and hence does not increase general government debt). In addition, the National Asset Management Agency has issued government-guaranteed bonds equivalent to 19¼ percent of GDP for the purchase of bad assets. In Spain, the government injected capital amounting to 1.1 percent of GDP into the banking system via its bank support vehicle (FROB). Moreover, the government has extended the guarantee scheme for credit institutions until June 2011: the unused amount is 10 percent of GDP.

For a sample of advanced economies where support has been significant, the cumulative net direct cost since the beginning of the crisis amounts to 4¾ percent of GDP (see table). Most measures have expired or were not as heavily used as originally expected. By end-December 2010, the cumulative recovery of outlays stood at 1½ percent of GDP; the recovery rate (as a share of direct support) was 25 percent. The bulk of the recovery to date comes from the United States, where recovery has been fast. (The U.S. Congressional Budget Office [2010] projects the net direct cost of financial support through the Troubled Asset Relief Program at less than ¼ percent of GDP.)

Selected Advanced Economies: Recovery of Outlays and Net Cost of Financial Sector Support

(Latest available date; percent of 2010 GDP unless otherwise indicated)1

Direct SupportRecoveryNet Direct Cost
Belgium4.30.24.1
Ireland 230.01.328.7
Germany 310.80.110.7
Greece5.10.15.0
Netherlands14.48.46.0
Spain2.90.92.0
United Kingdom7.11.16.0
United States5.21.83.4
Average6.41.64.8
In billions of U.S. dollars1,5283791,149
Sources: Country authorities; and IMF staff estimates.Note: Fiscal outlays of the central government. In addition, some countries may have supported financial institutions via fiscal outlays at the subnational level or through other public sector institutions. For example, in Germany, capital injections from the Laender and KfW (development bank) amount to 1.1 percent of GDP; in Belgium, financial sector support from regional government amount to 1.6 percent of GDP.

Emerging economy deficits are falling, but are they doing so fast enough?

In 2010, deficits started declining in emerging economies, supported by sustained growth and, in some, higher commodity prices. The average general government deficit fell by 1 percent of GDP, with revenues surprising on the upside compared with the November 2010 Fiscal Monitor, in significant part owing to one-off or cyclical revenues (e.g., Brazil, India, and South Africa). Altogether, consolidation was much more contained (½ percent of GDP) in cyclically adjusted terms.

Consolidation is expected to accelerate in 2011. The average headline deficit is projected to fall by 1¼ percent of GDP (about 1 percent of GDP in cyclically adjusted terms). There are significant cross-country differences, though:

  • Adjustment in emerging Asia, except for China and India, is limited. In India, however, the improvement in the headline balance falls short of initial plans and is broadly accounted for by continued strong revenues, restraint in wages, pensions, and interest, and improvements at the subnational level. In the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand), the fiscal stance is broadly neutral, on average.

  • Fiscal consolidation in Latin America is expected to continue in 2011. In Brazil, the government has announced a package of measures totaling about 1¼ percent of GDP to achieve its fiscal target (a primary surplus of about 3 percent of GDP). Policy lending to the national development bank (BNDES) is also projected to fall, after averaging 3 percent of GDP over the 2009—10 period. In Mexico, the fiscal balance is expected to improve, owing to higher oil prices and the continuing impact of tax increases introduced in 2010.

  • Within emerging Europe, the improvement in the Russian Federation reflects a significant rise in oil and natural gas prices and discretionary consolidation measures. Stronger growth is likely to bring down Turkey’s deficit faster than planned. Adjustment is significant in Bulgaria, Latvia, Lithuania, and Romania. In Hungary, the structural deficit (which excludes one-time increases in revenues) is expected to widen. In several economies, debt ratios will continue to rise, despite declining deficits (Figure 1.4).

  • In the Middle East and North Africa, outcomes will hinge on policy responses to higher commodity prices and recent unrest in the region. Headline balances in oil-producing countries (in the region and elsewhere) are generally expected to improve (Figure 1.5). Deficits may widen in several oil importers, reflecting higher discretionary spending, particularly on subsidies to stabilize food and fuel prices and social transfers.

Figure 1.4.Emerging Economies: Change in Overall Deficits and Gross General Government Debt, 2011

(Percent of GDP)

Source: IMF staff projections.

Note: Increases in debt and deficits are versus 2010.

Figure 1.5.Fiscal Balances in Oil-Producing Economies, Weighted Average

(Percent of GDP)

Source: IMF staff projections.

The pace of consolidation, however, seems to fall short of what would be warranted by cyclical developments. For many emerging economies, growth is buoyant, output is close to or above potential, and inflation is rising (April 2011 WEO). Nevertheless, cyclically adjusted primary balances are often projected to be substantially weaker than before the outset of the crisis (Figure 1.6). In some economies, fiscal policies continue to be expansionary even as GDP growth is on the upturn (Figure 1.7). Fiscal policy also appears insufficiently tight when viewed relative to a composite measure of the cyclical position that includes not only the output gap but also the rate of output growth, expected inflation, and capital inflows. Based on this broader measure, Argentina, India, and Poland, in particular, are enjoying strong macroeconomic conditions while maintaining cyclically adjusted deficits exceeding 3 percent of GDP (Figure 1.8). This suggests that, in many countries, greater tightening would be appropriate.

Figure 1.6.Emerging Economies: Difference in Cyclically Adjusted Primary Balance, 2011, Compared with Precrisis Period

(Percent of potential GDP)

Source: IMF staff projections.

Note: Precrisis deficits refer to 2004–07, subject to data availability. For Nigeria and Saudi Arabia, data reflect change in primary balance as percentage of non-oil GDP. For countries with significant commodity revenues (marked with red diamonds), changes in cyclically adjusted primary balances are shown both with and without these revenues.

Figure 1.7.Emerging Economies: Change in Cyclically Adjusted Balance and Change in Output Gap, 2011

(Percent of potential GDP)

Source: IMF staff projections.

Note: The output gap is defined as the difference between actual and potential GDP. If the output gap is deteriorating, there is greater spare capacity in the economy. Circles denote countries with output level above potential in 2011. For Hungary, change in structural balance is reported.

Figure 1.8.Emerging Economies: Indicator of Cyclical Conditions and Fiscal Position

Source: IMF staff projections.

Note: The indicator of cyclical conditions is a composite based upon the following variables: 2011–12 average inflation above 2009–10 average inflation; real economic growth above long-run average; output above potential; and positive net capital inflows. A subindicator for each of these variables is scored 1 if positive, 0 otherwise. The indicator is the sum of the subindicators of these variables. For Hungary and Mexico, the level of the structural deficit is reported.

Low-income economies are rebuilding buffers, but are also facing spending pressures

Following a large countercyclical stimulus in 2009, headline fiscal deficits in low-income countries improved strongly in 2010 (Table 1.3; Figure 1.9).4 Revenues accounted for about two-thirds of the 1¼ percent of GDP improvement, reflecting the ongoing economic recovery and, for net exporters, rising commodity prices. For net commodity importers, revenues were also buoyant due to a sharp recovery in trade and associated gains in indirect taxes. On the spending side, past stimulus was mostly allowed to expire. New spending was contained, especially in regions with limited fiscal space in light of large increases in debt levels incurred during the crisis (Eastern Europe, Latin America, and the Middle East).

Table 1.3.Low-Income Economies: Fiscal Balances, 2008–12(Percent of GDP)
ProjectionsDifference from

November 2010

Fiscal Monitor
20082009201020112012201020112012
Overall Balance
Low-Income Economies-1.4-4.2-2.9-2.6-2.40.20.40.0
Asia-2.5-5.7-4.3-3.6-3.9-0.6-0.5-1.0
Africa-1.6-2.9-2.9-2.5-2.0-0.50.3-0.7
Latin America0.7-2.1-0.1-1.6-1.12.80.91.4
Middle East, Eastern Europe, and Central Asia1.0-3.9-0.8-0.5-0.22.22.42.6
Source: IMF staff projections.Note: All country averages are PPP-GDP weighted using 2009 weights.

Figure 1.9.Overall Balance in Low-Income Economies

(Percent of GDP)

Source: IMF staff estimates.

In 2011, the pace of fiscal consolidation is expected to slow, amid rising risks from food and fuel price increases. Headline deficits are projected to decline, on average, by ¼ percentage point of GDP. As a result of fuel price gains, sharper declines in deficits are expected among oil exporters (e.g., Chad). However, for fuel importers in particular, rising oil prices are likely to increase pressure for spending on wages and subsidies. Oil price increases since 2009 have been almost fully passed through to consumers in advanced economies, but only partially so in emerging and especially low-income economies (Box 1.2). The incomplete pass-through has led to lower tax revenues and higher subsidies, albeit with considerable variation across countries. On average, net gasoline taxes in 2010 are estimated to have declined by more than ¼ percent of GDP compared to 2009. While advanced economies saw an increase of ¼ percent of GDP, developing countries lost ½ percent of GDP in tax revenues. Revenue loss for diesel is likely to have been even higher. Likewise, rising food prices (which are now back at the peak levels attained during the food price spike of mid-2008) are damaging welfare and adding to fiscal challenges. The budgetary cost of greater food subsidies can be significant: the increase in subsidies was estimated at more than ½ percent of GDP during the 2007–08 spike in food prices, when many countries reduced taxes on food items (import duties and, to a lesser extent, VAT) or increased explicit subsidies (IMF, 2008). Recent political turmoil in the Middle East has led policymakers in many countries to consider additional social spending and public investment.

Box 1.2.Pass-Through and Fiscal Impact of Rising Fuel Prices

Pass-through of increases in international fuel prices to domestic prices has been limited in many countries in recent years (see tables and figure). In a sample of 93 countries, fewer than half fully passed through to domestic prices the run-up in world prices between end-2003 and mid-2008. Pass-through was highest for advanced European and oil-importing developing economies, and lowest in oil-exporting economies. Between mid-2008 and end-2008, despite the sharp drop in world prices, retail prices were held more stable, resulting in lower pass-through. Only nine countries (many in southeastern Europe and the Baltics) fully passed through the drop in world prices; 54 countries (developing and fuel-exporting emerging economies) passed through less than half the drop. From 2009 to end-2010, pass-through of rising international prices was once again partial, and generally lower than during the increase observed between 2003 and mid-2008, particularly for developing economies.

Pass-Through of Global Fuel Prices
End-2003

to

Mid-2008
Mid-2008

to

End-2008
End-2008 to

End-2010
Number of

Countries
By Size of Pass-Through:Number of countries
> 144938
Between .5 and 1343028
Between .25 and .57219
<.2583318
Median Pass-Through (ratio)
By Economy:
Advanced1.020.570.9831
Emerging0.740.190.7521
Developing1.020.290.6341
By Oil Trade:
Exporter0.550.020.7519
Importer1.020.480.8174
Sources: IEA; GTZ; country authorities; Thompson Reuters; and IMF staff estimates.Note: Pass-through is measured as the ratio of the change in domestic price index in local currency to the change in international spot price index, also measured in local currency, over the time horizon noted.
Net Taxes(US$ per liter)
End-Mid-End-End-Number of
2003200820082010Countries
By Economy:
Advanced0.650.861.020.9731
Emerging0.270.030.530.4521
Developing0.180.150.710.4341
By Oil Trade:
Exporter0.36-0.030.570.4319
Importer0.320.420.790.7074
Sources: IEA; GTZ; country authorities; Thompson Reuters; and IMF staff estimates.Note: Net tax measures the gap between domestic retail prices and international spot prices, adjusted for transportation and distribution margins. A pass-through of 1 would imply that the unit fuel tax level remains constant.

Crude Oil and Gasoline Price

Source: Thompson Reuters; and IMF staff estimates.

Medium-Term Outlook

Following a substantial tightening in advanced economies in 2012, consolidation efforts on current policies will wind down over the medium term, leaving headline and cyclically adjusted deficits in excess of precrisis levels. Countries delaying adjustment in 2011 will face more significant challenges to meet their medium-term objectives.

In the advanced economies, extraordinary adjustment efforts are on tap for 2012. Deficits are projected to fall by about 2 percent of GDP in the advanced economies, the largest aggregate decline in at least 40 years (Figure 1.10). In the United States, the FY2012 budget announced in mid-February maintains the president’s commitment to halve the federal deficit by the end of his first term and the authorities’ Toronto Group of Twenty (G-20) commitment to halve the 2010 deficit by 2013. The president’s draft budget implies a major cyclically adjusted withdrawal of about 4 percentage points of GDP in FY2012. While in the United Kingdom the deficit reduction will be in line with that of 2011, in the euro area the pace of deficit reduction is projected to slow, after implementation of heavily front-loaded plans in many countries in 2009—11. However, the recent agreement in the EU to set a numerical benchmark for debt reduction for countries whose debt ratios exceed 60 percent—a reduction by one-twentieth in the gap between their level of debt and the threshold—could imply a somewhat faster pace of consolidation in several countries.

Figure 1.10.Advanced Economies: General Government Primary Balance

(Percent of GDP)

Source: IMF staff estimates and projections.

Note: Weighted average (GDP at PPP) for the advanced economies, with moving weights. Excludes financial sector support in the United States. Shaded areas denote projections.

On current plans, deficit reduction in advanced economies will slow in 2013 and largely cease in 2014, leaving deficits above precrisis levels in several of them (Table 1.4; Statistical Table 1). Japan and the United States, in particular, are projected to record 2016 deficits that exceed their 2007 levels by at least 3 percent of GDP. The 2016 deficit is also projected above its precrisis level in Italy, by a smaller amount. Deficits in 2016 are expected to be close to precrisis levels in Germany and substantially below precrisis levels in France and the United Kingdom. The gross general government debt ratio is projected to peak at 107 percent of GDP in 2016, some 34 percentage points above its precrisis level (Figure 1.11; Statistical Table 7). The modest downward revision in the medium-term debt ratio compared with the November 2010 Fiscal Monitor reflects a slightly better than projected outturn in 2010 as well as somewhat more optimistic projections for the interest rate—growth differential in the years ahead. Although most fiscal adjustment is planned to come from the spending side (November 2010 Fiscal Monitor), public spending as a share of GDP is projected to remain close to 3 percent of GDP over its precrisis level in the medium term in advanced economies (Statistical Table 5).

Table 1.4.Medium-Term Projections(Percent of GDP)
2000-0720072016
Overall Balance
Advanced Economies-2.0-1.1-3.5
Emerging Economies-2.1-0.1-1.2
Cyclically Adjusted Balance
Advanced Economies-2.1-1.6-3.3
Emerging Economies-2.2-1.1-1.6
Cyclically Adjusted Primary Balance
Advanced Economies-0.20.2-0.4
Emerging Economies0.41.2-0.0
Gross General Government Debt
Advanced Economies71.073.1107.3
Emerging Economies43.136.030.1
Sources: IMF staff estimates and projections.

Figure 1.11.General Government Gross Debt Ratios

(Percent of GDP; 2009 PPP-GDP weighted averages)

Source: IMF staff estimates and projections.

For emerging economies, the baseline medium-term scenario remains benign. The average headline deficit for emerging economies is projected to fall by ½ percent of GDP in 2012, one-third the reduction in 2011. Under current projections, the average deficit for emerging economies is expected to converge to 1¼ percent of GDP by 2016, compared to rough balance prior to the crisis. The average debt-to-GDP ratio is expected to ease to 30 percent of GDP in 2016, below both historical averages and precrisis levels. However, this decline stems primarily from prospects of favorable growth and relatively low interest rates, as primary balances are expected to remain weak (see Chapter 3 for a discussion of the related fiscal risks).

In low-income economies, fiscal balances are expected to return to precrisis levels over the medium term, rebuilding the buffers that mitigated the impact of the crisis. Fiscal adjustment in the medium term will gradually reverse the countercyclical policies implemented during the crisis. Among noncommodity and commodity exporters, deficit reductions are expected to be achieved through continued revenue growth. Among fuel exporters, spending moderation will also be required as the short-term boost in oil revenues dissipates. General government gross debt is expected to stabilize at close to 40 percent of GDP, below precrisis levels.

Longer-Term Adjustment Needs

Especially in advanced economies, substantial further adjustment will be required over the remainder of the decade to eventually restore debt ratios to prudent levels. The challenge is even greater when the impact of trends affecting entitlement spending is taken into account. Indeed, rising spending on health care is the main risk to fiscal sustainability, with an impact on long-run debt ratios that, absent reforms, will dwarf that of the financial crisis. Even with reforms, entitlement spending pressures in some countries are likely too large to be fully contained, and offsetting measures will be needed elsewhere. In many emerging and low-income economies the challenge will be to improve coverage of health and pension systems in a fiscally sound manner.

In advanced economies, longer-term adjustment needs remain large. The customary illustrative exercise conducted in the Fiscal Monitor reports the level to which the cyclically adjusted primary balance must improve by 2020, and subsequently be maintained until 2030, for advanced economies to gradually reduce their debt to 60 percent of GDP (approximately the median precrisis level) by 2030 (Table 1.5a) (40 percent for emerging economies, also the median precrisis level) (Table 1.5b). On average, the required improvement in the cyclically adjusted primary balance between 2010 and 2020 amounts to about 8 percent of GDP. The necessary measures rise to about 12 percent of GDP when one takes into account the projected increase in age-related spending between 2010 and 2030 (Statistical Table 9).

Table 1.5a.Advanced Economies: Needed Fiscal Adjustment—An Illustrative Scenario(Percent of GDP)
Current WEO Projections, 2010Illustrative Fiscal Adjustment Strategy to Achieve Debt Target in 2030
Gross DebtPrimary

Balance
Cyclically

Adjusted PB
Cyclically

Adjusted PB in

202030
Required Adjustment

between 2010 and

2020
Required Adjustment

and Age—Related

Spending, 2010–30
Australia22.3-4.3-4.20.14.37.7
Austria69.9-1.9-0.91.52.46.7
Belgium97.1-1.30.43.43.18.7
Canada84.0-4.9-3.40.94.47.9
Czech Republic39.6-3.9-2.90.93.84.4
Denmark44.3-4.6-3.20.94.26.2
Estonia6.6-0.33.50.0-3.5-3.1
Finland48.4-3.2-0.20.70.96.6
France81.8-4.8-3.23.06.28.4
Germany80.0-1.1-0.31.92.24.4
Greece142.0-3.2-3.17.410.514.0
Hong Kong SAR4.64.95.0-1.6-6.6
Iceland96.6-2.55.02.2-2.82.4
Ireland96.1-29.7-6.16.312.414.4
Israel77.9-0.8-0.80.91.7
Italy119.0-0.31.44.63.24.6
Japan220.3-8.4-6.76.613.314.0
Korea30.93.63.7-0.7-4.40.5
Netherlands63.7-3.7-2.71.44.29.5
New Zealand31.6-4.9-3.90.54.49.4
Norway54.38.48.910.01.15.9
Portugal83.3-4.6-3.13.36.410.6
Slovak Republic42.0-7.0-6.10.97.08.9
Slovenia37.2-4.0-2.71.03.77.7
Spain60.1-7.8-6.31.98.210.3
Sweden39.6-1.20.00.30.30.6
Switzerland55.00.70.80.2-0.6
United Kingdom77.2-7.8-5.93.49.313.5
United States91.6-8.9-6.25.111.317.5
Average (PPP-weighted)96.6-5.9-4.03.87.811.8
G-20102.9-6.4-4.54.18.612.8
Sources: IMF staff estimates and projections.Note: The table reports gross debt; CAPBs are reported in percent of nominal GDP (in contrast to the conventional definition in percent of potential GDP). General government data are used where available. In the illustrative fiscal adjustment strategy, the CAPB is assumed to improve in line with Fiscal Monitor projections in 2011–12 and gradually from 2013 until 2020; thereafter, it is maintained constant until 2030. The fifth column shows the CAPB adjustment needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 60 percent (no shading, “lower debt”), or to bring the debt ratio to 60 percent in 2030 (shaded entries, “higher debt”). The analysis is illustrative and makes some simplifying assumptions: in particular, up to 2015, an interest rate–growth differential of 0 percentage points is assumed, broadly in line with WEO assumptions, and 1 percentage point afterward regardless of country-specific circumstances. The last column adds the projected increase in health care and pension spending between 2010 and 2030 (see Statistical Table 9 and Appendix 1), which will require offsetting measures. Illustrative scenarios for Australia, Canada, Japan, and New Zealand are based on their net debt ratios (see Statistical Table 8 for net debt data); for Japan, a net debt target of 80 percent of GDP is assumed, which corresponds to a target of 200 percent of GDP for gross debt. For Norway, maintenance of primary surpluses at the projected 2012 level is assumed (primary balance includes oil revenue whereas elsewhere in this document the non-oil balance is shown). For the United States, the CAPB excludes financial sector support recorded above the line.
Table 1.5b.Emerging Economies: Needed Fiscal Adjustment—An Illustrative Scenario(Percent of GDP)
Current WEO Projections, 2010Illustrative Fiscal Adjustment Strategy to Achieve Debt

Target in 2030
Gross DebtPrimary

Balance
Cyclically

Adjusted PB
Cyclically

Adjusted PB in 2020-30
Required

Adjustment

between 2010

and 2020
Required

Adjustment and

Age-Related

Spending, 2010-30
Argentina47.81.50.90.5-0.41.6
Brazil66.12.42.41.5-0.92.0
Bulgaria18.0-3.3-0.60.10.71.6
Chile8.8-0.3-1.90.32.2
China17.7-2.1-2.40.32.73.7
Colombia36.5-1.0-0.80.21.0
Hungary80.4-0.32.13.11.02.3
India72.2-4.7-4.73.48.18.9
Indonesia26.90.80.80.2-0.60.2
Jordan60.5-3.0-3.12.96.0
Kazakhstan11.41.90.5-0.4-0.9
Kenya50.5-3.9-3.11.64.7
Latvia39.9-6.5-2.6-0.12.54.4
Lithuania38.7-6.1-4.41.66.09.2
Malaysia54.2-3.6-3.92.56.48.8
Mexico42.7-1.8-1.10.51.64.8
Morocco49.90.50.61.91.3
Nigeria16.4-5.7-5.6-1.14.5
Pakistan56.8-1.6-1.61.02.63.2
Peru24.30.60.70.0-0.7
Philippines47.3-0.10.00.50.51.5
Poland55.7-5.3-5.12.17.27.6
Romania35.2-5.1-4.00.44.47.6
Russia9.9-3.2-1.50.21.87.5
South Africa36.3-3.1-2.31.13.35.1
Thailand43.3-1.9-1.60.82.3
Turkey41.70.5-0.60.00.65.1
Ukraine40.5-4.1-1.70.72.39.5
Average (PPP-weighted)36.5-2.0-1.91.02.94.5
G-2035.2-1.9-1.81.02.84.8
Sources: IMF staff estimates and projections.Note: In computing the primary balance, policy lending was excluded from primary expenditure. CAPBs are reported in percent of nominal GDP. In the illustrative fiscal adjustment strategy, the CAPB is assumed to improve in line with Fiscal Monitor projections in 2011-12 and gradually from 2013 until 2020; thereafter, the CAPB is maintained constant until 2030. The fifth column shows the CAPB adjustment needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 40 percent, or to bring the debt-to-GDP ratio to 40 percent in 2030. The analysis is illustrative and makes some simplifying assumptions: in particular, up to 2015, an interest rate-growth differential of 0 percentage points is assumed, broadly in line with WEO assumptions, and 1 percentage point afterward regardless of country-specific circumstances. For large commodity-producing countries, even larger fiscal balances might be called for in the medium term than shown in the illustrative scenario given the high volatility of revenues and the exhaustibility of natural resources. The last column adds the projected increase in health care and pension spending between 2010 and 2030 (Statistical Table 9), which will require offsetting measures. For Ukraine, the primary deficit excludes costs related to bank recapitalization and the gas utility.

Required adjustment exceeds 5 percent of GDP in one-third of the advanced economies. Japan, Ireland, the United States, and Greece all confront adjustment needs of 10 percent of GDP or more. For Japan and Ireland, the challenge stems from large current deficits combined with the need to run large future surpluses to service a sizable debt. For the United States, the pressure comes from the large deficit. For Greece, considerable progress has already been made in reducing the primary deficit, but significant further adjustment is needed to stabilize and then reduce the debt ratio. Compared with the November 2010 Fiscal Monitor, adjustment needs have been revised notably upward for Greece, New Zealand, and Portugal and downward for Austria, Belgium, Canada, Finland, and the Netherlands.

These adjustment needs are sensitive to assumptions about interest rate—growth differentials and about the extent to which past stimulus will be automatically reversed. The assumption of a uniform long-term interest rate—growth differential r–g in the baseline exercise (Table 1.5a; Figure 1.12, panel a) may be unduly favorable to highly indebted countries because it ignores the impact of high debt on growth and interest rates (see also Chapter 3). Using country-specific differentials that are assumed to be positively linked to countries’ debt ratios, adjustment needs increase by 2 percent of GDP in Greece and Japan and by 1 percent in Italy. By contrast, in most advanced economies, the 2010 cyclically adjusted primary balance includes temporary discretionary stimulus measures. Assuming these measures are unwound upon expiration (Figure 1.12, panels c and d) reduces additional adjustment needs significantly in the United States, Japan, and Germany.

Figure 1.12.Advanced Economies: Sensitivity Tests on Fiscal Adjustment Needs

(Percent of GDP)

Sources: IMF staff estimates and projections.

Note: The baseline fiscal adjustment need for a uniform interest rate-growth differential across countries corresponds to the illustrative fiscal adjustment scenario depicted in Table 1.5a. The alternative scenario with country-specific interest rate-growth differentials uses country-specific projections for the interest rates (computed as the implied interest rate from fiscal interest expenditures) and GDP growth rates up to 2016. Afterward an interest rate-growth differential of 1 percent is assumed for the average of advanced economies, whereas country-specific differentials are determined as a function of their postcrisis (2016) indebtedness relative to the advanced economy average. Specifically, a country with a postcrisis debt ratio that is higher by 10 percentage points than the average is assumed to have a higher interest rate-growth differential by 0.25 percentage points, and correspondingly for countries with lower-than-average postcrisis indebtedness. The assumptions of a 1 percent average differential and a scaling factor of 0.25 are conservative compared to empirical estimates of the link between indebtedness and interest and growth rates outlined above. That is, this scenario illustrates possible developments under the premise of credible fiscal adjustment policies; with lower credibility (that is nonuniform across countries), interest rate-growth differentials would likely be higher (and more differentiated). Panels c and d show the adjustment needs excluding the impact of discretionary stimulus measures implemented during 2010; data on discretionary stimulus measures are from Box 1.1 of the November 2010 Fiscal Monitor and are available only for G-20 countries.

Although substantial fiscal consolidation remains in the pipeline, adjustment will need to be stepped up in most advanced economies, especially to offset the impact of age-related spending. The average projected adjustment of 3½ percent of GDP between 2010 and 2016 amounts to less than half that needed through 2020. Post-2016 gaps are larger than 3 percent of GDP for several advanced economies, including Belgium, Ireland, Japan, Spain, and the United States. Thanks to stronger planned adjustment, Germany is projected to implement the required adjustment by 2014 (Figure 1.13). Korea’s cyclically adjusted primary balance already exceeds that needed to achieve its illustrative debt target, while in a few advanced economies (including Australia, the Netherlands, New Zealand, and Sweden), planned adjustment exceeds calculated needs in this illustrative scenario.

Figure 1.13.Selected Advanced Economies: Illustrative Adjustment Needs and Projected Fiscal Adjustment

(Percent of GDP)

Source: IMF staff estimates and projections.

Note: The figure compares the estimated adjustment needs between 2010 and 2020 to achieve debt targets in 2030 (see note in Table 1.5a) and the projected change in the cyclically adjusted primary balance between 2010 and 2016 for the countries with positive residual adjustment needs beyond 2010. The 2010-16 projected adjustment exceeds illustrative needs in Australia, Denmark, Hong Kong SAR, Iceland, Israel, Korea, the Netherlands, New Zealand, Sweden, and Switzerland.

In emerging economies, adjustment needs are generally smaller than in advanced economies, but with some important exceptions. Adjustment needs in emerging economies average about 3 percent of GDP. However, illustrative adjustment needs exceed 6 percent of GDP in India, Malaysia, and Poland. In Latvia and South Africa, the illustrative required adjustment is projected to be implemented and exceeded by 2016.

From an even longer-term perspective, spending on pensions—and especially, health care—constitutes a key challenge to fiscal sustainability. Over the past three decades, public spending on health care has risen rapidly in most advanced and emerging economies (Figure 1.14). Among advanced economies, health care spending growth has been more rapid in countries that started out with lower spending levels, as the result of “imitation” effects and technological diffusion of new health procedures (IMF, 2010a). Indeed, nondemographic factors such as rising income, technological advances, and health policies and institutions are the main reasons behind rising public spending-to-GDP ratios. New IMF staff projections suggest annual spending on public health will rise by an average of 3 percentage points of GDP in the advanced economies over the next 20 years, with an increase of 5 percent of GDP in the United States and 2 percent on average in Europe (Figure 1.15).5

Figure 1.14.Public Health Spending in Advanced and Emerging Economies

(Percent of GDP)

Sources: OECD Health Database; WHO; and IMF staff estimates.

Note: Sample periods for the advanced and emerging economies are chosen based on data availability. Data for 2008 refer to 2008 or latest year available. Averages are unweighted.

Figure 1.15.Advanced Economies: Projected Increases in Public Health Care Spending, 2011-30

(Percent of GDP)

Sources: OECD Health Database; and IMF staff estimates and projections.

The net present value of the flow of spending increases over the next 40 years is close to 100 percent of today’s GDP, three times the estimated impact of the financial crisis on advanced economy public debt.

In view of these large projected increases in public health care spending, Appendix 1 analyzes experience with reform efforts and their potential impact. Unfortunately, recent reforms in advanced economies are unlikely to make a major dent in long-term trends.6 International experience suggests that there is scope to contain expenditure through greater use of market mechanisms, spending caps, supply constraints, price controls, and other reforms to slow the growth of spending. However, the impact of these reforms may still fall short of what is needed in some advanced economies to stabilize public health spending as a share of GDP. This means that further adjustment measures elsewhere in the budget will be required to control the growth of public spending. Compared to health care, medium-term pressures from pension spending appear more manageable, reflecting in part the impact of reforms that have already been implemented (IMF, 2010b).

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