1. The Fiscal Outlook
- International Monetary Fund. Fiscal Affairs Dept.
- Published Date:
- October 2012
Weakening growth and policy uncertainties cast a shadow over the fiscal outlook, even as budget deficits narrow and recent announcements by monetary authorities provide some respite on the financial front. Countries with stronger fiscal positions and lower public debt, including several emerging market economies, can afford to pause fiscal consolidation efforts, but in others adjustment must proceed at a pace that reflects medium-term adjustment needs, the state of the economy, and financing constraints. Where financing permits, flexibility should be allowed for automatic stabilizers to play in response to moderate growth shortfalls. Should growth fall well short of current expectations, countries with space should smooth their adjustment paths over 2013 and beyond. The United States and Japan must promptly define and enact clear and credible plans to return to fiscal sustainability over the medium term and buttress investor confidence.
Fiscal adjustment is proceeding in most advanced economies, but challenges remain
Deficits are set to narrow in nearly all advanced economies in 2012 and 2013 notwithstanding weak growth (Table 1). The average annual decline in both headline and cyclically adjusted deficits for the period is expected to be about 1 percent of GDP, a rate broadly in line with earlier forecasts (Figure 1). However, this average masks significant differences across countries, with those facing greater market pressure generally implementing larger reductions in deficits.
Figure 1.Revisions to Overall Balance and Debt-to-GDP Forecasts since the Last Fiscal Monitor
Sources: IMF staff estimates and projections.
Note: Revision to the forecast refers to the difference between the fiscal projection in the October 2012 Fiscal Monitor and that in the April 2012 Fiscal Monitor.
In the two largest advanced economies, the main issue remains the absence of clear fiscal policies to tackle the large public imbalances at an appropriately sustained pace.
In the United States, the deficit would decline by more than 4 percent of GDP if the Bush tax cuts were left to expire and programmed automatic spending cuts were allowed to take hold. An even larger adjustment would be needed if the federal debt ceiling were not raised in a timely fashion. The forecast in Table 1 assumes that a political compromise will be found to avoid this “fiscal cliff” and that the headline deficit will shrink at an annual pace of 1½ percent of GDP (slightly less in cyclically adjusted terms) this year and next.
In Japan, the fiscal deficit is expected to narrow by about 1 percentage point of GDP in 2013 (about ½ percent of GDP in cyclically adjusted terms) as earthquake-related spending declines. Political gridlock could, however, lead to early tightening by delaying approval of this year’s budget funding, although this risk remains low. A phased increase in the consumption tax rate to 10 percent was fully approved by the Diet in August, and the first increase, to 8 percent, is expected in April 2014. This will not be sufficient, however, to put Japan’s record-high debt ratio on a downward path.
|2008||2009||2010||2011||Projections||Difference from April 2012|
|Overall balance(Percent of GDP)|
|Middle East and North Africa||-4.9||-5.4||-6.7||-8.9||-9.5||-8.3||-0.1||-1.0||-1.4|
|Cyclically adjusted balance(Percent of potential GDP)|
|World growth (percent)||2.8||-0.6||5.1||3.8||3.3||3.6||0.0||-0.3||-0.5|
Excluding financial sector support.
Excluding financial sector support.
Gradual progress is expected in other large advanced economies, some of which also continue to benefit from extraordinarily accommodative financing conditions.
In Canada, the fiscal position is projected to improve on the basis of stronger-than-expected revenue and relatively resilient growth, in addition to spending restrictions.
Fiscal adjustment is expected to slow to a more modest pace in Germany in the coming years. Overperformance in 2011 is allowing the fiscal balance to remain on track to comply with the structural deficit ceiling mandated by the constitutional “debt brake” rule.
In contrast, sizable adjustment is in the cards this year and next in another group of large advanced economies, against the backdrop of an already weakening economic outlook.
In France, the authorities are committed to lowering the headline deficit by more than 2 percentage points of GDP over two years. Although they have not yet identified specific measures, they intend to rely first on revenue increases in the hope of limiting negative short-term demand effects, and then to shift to more spending containment starting in 2014 to support potential growth over the medium term.
The cyclically adjusted deficit is expected to decline by about 1¼ and 1½ percent of GDP this year and next, respectively, in the United Kingdom, slightly less than initially projected because of weaker potential growth estimates.
Strong front-loaded fiscal adjustment is planned by the outgoing caretaker government in theNetherlands, where the deficit is expected to fall to 3.2 percent of GDP in 2013 under a 2½ percent of GDP consolidation package. The 2013 target implies a fiscal withdrawal of about 3 percent of GDP over 2012–13 in cyclically adjusted terms.
European countries under market pressure are implementing further significant fiscal consolidation.
In Spain, consolidation efforts aim at an adjustment of about 4 percent of GDP over 2012 and 2013, through a combination of increased indirect taxes (including the value-added tax [VAT]) and cuts in public wages and unemployment benefits. The authorities have established a special fund to help local governments service their debt, and financing from the European Financial Stability Facility (EFSF) is supporting bank recapitalization. However, preliminary data for the first half of 2012 show little progress in fiscal consolidation. Although significant fiscal measures will start taking effect in the second half of the year, the risk of missing the full-year deficit target of 6.3 percent of GDP has increased.
Fiscal adjustment in Italy is expected to top a cumulative 3.4 percent of GDP in cyclically adjusted terms over the course of 2012–13, with a large share taking place this year. The authorities have concluded a review to identify spending cuts that would allow them to shift the composition of adjustment away from tax measures. They have adopted measures to advance their growth agenda and to sell some public assets at both the national and subnational levels, with the proceeds to be used to retire public debt.
In Greece, a deeper-than-expected recession and slippages in the implementation of fiscal measures will once again complicate attainment of the ambitious deficit reduction targets. Nevertheless, the cyclically adjusted deficit will continue to post large declines.
In Ireland, continued substantial fiscal consolidation in line with the targets under IMF-supported programs has helped restore access to international capital markets. In July—six months earlier than expected—the country raised €4.2 billion in new funds by issuing its first long-term bonds since end-2010.
A small number of advanced economies are expected to take advantage of already-low debt and deficits to adopt broadly neutral fiscal positions in 2012.
In Korea, spending is being front loaded to deliver some support to growth in the first half of the year, complemented in the second half by a stimulus package of about 0.3 percent of GDP (largely through government-managed funds in some selected areas and state-owned and public-private partnerships). Fiscal consolidation is expected to resume in 2013 as growth recovers.
In Sweden, a small fiscal deficit (0.2 percent of GDP) is expected this year, as a result of the deceleration of growth and the implementation of discretionary measures to support employment (including a lowering of the VAT rate for restaurant and catering services, extra funding for infrastructure investment, and a package of active labor market measures). The budget is expected to remain in a small deficit next year as significant increases are made in investment in infrastructure and research and development.
Consolidation is on hold in most emerging market economies
With relatively stronger fiscal positions, many emerging market economies have opted to put fiscal consolidation on hold in the face of weakening demand and increased financial uncertainty, with upward revisions in deficit projections for both 2012 and 2013 with respect to the April Fiscal Monitor (Figure 1). However, policy margins vary widely across countries.
In Brazil, tax revenue shortfalls from the slowdown in economic activity and the impact of fiscal incentives have been offset in part by one-off revenues (including higher dividends from state-owned enterprises). The authorities’ primary surplus objective is expected to be achieved this year owing to the use of capital-expenditure-based adjusters.1 Going forward, the authorities continue to focus on a 3.1 percent of GDP primary surplus target.
In China, the fiscal position is expected to be largely neutral this year. With activity expected to gain momentum in the second half of the year on the back of policy efforts to accelerate projects, the overall fiscal balance for the year is likely to be in line with the current projection. Modest consolidation would resume in 2013 as growth recovers.
In India, the authorities aim to bring down the deficit of nearly 9 percent of GDP this year despite underperforming tax revenues and increased demands for social spending stemming from the poor start to this year’s monsoon. Price increases for diesel fuel, as well as new announcements on divestment and limits to certain other fuel subsidies, are significant and will help lower untargeted subsidies, but achieving the downward deficit path laid out in the 2012/13 medium-term budget will require further measures, including sustainable subsidy reform.
In Chile, the authorities remain committed to their structural deficit target of 1 percent of GDP, though the budget is expected to move into a headline deficit in 2012, largely because of lower copper and noncopper revenue and higher social spending. The government’s tax reform package, as submitted to Congress, would make permanent the increase in corporate taxes introduced after the 2010 earthquake, but would offset some of the associated revenue with reductions in personal income taxes.
In South Africa, in response to the global slowdown, the 2012 budget slowed the pace of fiscal adjustment envisaged the previous year: the cyclically adjusted deficit is expected to narrow gradually by 1¼ percentage points to 3 percent of GDP by 2015.
Fiscal policy is forecast to be strongly procyclical in the Russian Federation, with rapid spending growth pushing the federal non-oil deficit up by about 1 percent of GDP to more than 10 percent of GDP in 2012 and 2013.
Deficits are likely to rise in most low-income countries
Deficits are expected to rise in most low-income countries because of a combination of slowing external demand and the growing weight of food and fuel subsidies. In a few countries, upcoming elections are generating additional pressures on spending.
In Ghana, the higher wage bill, the reemergence of fuel subsidies, and carryover commitments from 2011 will increase the 2012 cash deficit in spite of higher revenue. Mixed fiscal performance at end-2011 has raised concerns about potential slippages ahead of the December 2012 elections.
In Zambia, revenue shortfalls—due in part to lower copper prices—along with higher public wages and delays in subsidy reforms will push up the 2012 deficit.
In Burundi, spending cuts are planned this year to offset the decline in revenues of about 1 percent of GDP—due to a temporary elimination of taxes on some imported food products and a reduction in fuel excise collection associated with the partial pass-through of rising international prices—and an expected shortfall in international aid.
In contrast, Togo’s fiscal indicators point toward a slow rebuilding of fiscal buffers in 2012, as the government implements policy adjustments and higher-than-expected growth boosts revenue.
Adjustment should proceed to restore fiscal space, although the circumstances are demanding
Weakening growth and continued global uncertainty can make fiscal adjustment economically and politically difficult to sustain. However, in many countries debt ratios and deficits are still far too high to allow a pause in consolidation. The size and intensity of the challenges differ, but in most cases call for perseverance and flexibility. A gradual but steady pace of adjustment is needed to rebuild confidence, ideally defined in structural or cyclically adjusted terms and backed by credible medium-term commitments to let countries navigate short-term fluctuations by allowing automatic stabilizers to play. However, progress with other policies—most notably, repairing banks’ balance sheets—is also urgently needed to break the adverse feedback loops between sovereigns and banks, dispel the associated cloud over public finances, and improve prospects for sustained growth. In the euro area, recent policy announcements—including the European Central Bank (ECB) Outright Monetary Transactions and the decision to allow bank recapitalization directly through the European Stability Mechanism (ESM)—have provided some financial respite, but swift implementation of other European-level commitments (including ESM activation, harmonized banking oversight, and implementation of the Fiscal Compact) remains key to rebuilding lasting trust in the future of the common currency.
Large advanced economies should take the lead in clearing policy uncertainties. The United States should promptly define a reasonable consolidation path to avoid the “fiscal cliff.” Even a somewhat smaller adjustment than that now projected for 2013 (Table 1) would be adequate to signal commitment to fiscal rectitude in the context of a clear medium-term consolidation plan. Medium-term consolidation will need to include a reform of entitlements, the key driver of long-term spending, but must also raise revenue, given the size of the deficit and the relatively low tax ratio. Japan needs to proceed with a decisive debt reduction plan including both further revenue reform and entitlement reform. Although the recently enacted consumption tax hike will slow debt accumulation, it will not arrest it; it is estimated that an additional adjustment of 5 percentage points of GDP will be needed over the next decade to ensure a decline in the debt ratio. In the euro area, determined steps to strengthen the common fiscal framework remain of the essence. Progress toward better fiscal integration will require further progress on numerous fronts, including in particular on a robust governance framework that limits moral hazard and on a road map toward greater ex ante fiscal risk sharing.
In most advanced economies, the near-term fiscal stance has to walk the fine line between continued adjustment and supporting the recovery. Countries facing market pressure, particularly in Europe, have little choice but to press ahead with planned reforms. Countries that have more room to maneuver should let automatic stabilizers operate around the path currently envisaged in cyclically adjusted terms. Should growth disappoint, the first line of defense should be monetary policy and the free play of automatic stabilizers. If growth should fall significantly below current World Economic Outlook (WEO) projections, countries with room for maneuver should smooth their planned adjustment over 2013 and beyond. This includes projected front-loaders such as France, the Netherlands, and the United Kingdom.
In light of their lower levels of deficits and debt, the decision of many emerging market economies and low-income countries to put their consolidation efforts on hold until the global outlook has improved is appropriate. Some, however, need continued but gradual consolidation to restore the fiscal margins they used in response to the 2009 slowdown or to address more immediate risks. To reduce vulnerability to external shocks, medium-term targets should be more ambitious in the Russian Federation (given exposure to oil price volatility) and Turkey (facing large external current account deficits). In China, medium-term fiscal targets need to be more clearly specified, including through the annual publication of well-defined quantitative commitments extending beyond the current one-year horizon. In East Africa, continued gradual fiscal consolidation will support disinflation and rebuild buffers in anticipation of possible future shocks. In other countries (for example, Egypt, India, Jordan, and Pakistan), cuts in key subsidies and revenue enhancement are needed to contain the deficit. A cautious approach to debt accumulation is warranted in countries, particularly those in Africa, where debt-to-GDP ratios are approaching the levels prevailing prior to the debt restructuring episodes of 2005–06. Even countries with fiscal space should take care to control spending growth and rebuild fiscal buffers over the medium term to strengthen their resilience to shocks.
The 2012 budget targets a primary surplus corresponding to 3.1 percent of GDP, but allows for a lower outturn of up to 0.6 percent of GDP as long as spending of that amount is undertaken on specific public investment projects.