Chapter

1. Recent Fiscal Developments and the Short-Term Outlook

Author(s):
International Monetary Fund. Fiscal Affairs Dept.
Published Date:
April 2013
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Deficits will continue falling in nearly all advanced economies this year, at a slightly faster overall pace than in 2012.

Fiscal deficits narrowed on average by some ¾ percent of GDP last year, both in headline and in cyclically adjusted terms (Table 1). The average pace of consolidation is projected to increase to about 1¼ percent of GDP this year. Deficits will be somewhat larger than previously projected in many advanced economies, offset by better outturns in a few others (Figure 1).

Table 1.Fiscal Balances, 2008–14
ProjectionsDifference from October 2012

Fiscal Monitor
2008200920102011201220132014201220132014
Overall balance(Percent of GDP)
World–2.2–7.4–6.0–4.5–4.3–3.5–3.0–0.10.0–0.2
Advanced economies–3.5–9.0–7.8–6.6–5.9–4.7–3.80.00.1–0.1
United States–6.7–13.3–11.1–10.0–8.5–6.5–5.40.20.70.1
Euro area–2.1–6.4–6.2–4.1–3.6–2.9–2.6–0.3–0.3–0.5
France–3.3–7.6–7.1–5.2–4.6–3.7–3.50.1–0.2–0.6
Germany–0.1–3.1–4.1–0.80.2–0.3–0.10.50.10.2
Greece–9.9–15.6–10.7–9.4–6.4–4.6–3.41.10.10.1
Ireland1–7.4–13.9–30.9–13.4–7.7–7.5–4.50.60.00.4
Italy–2.7–5.4–4.3–3.7–3.0–2.6–2.3–0.3–0.7–0.7
Portugal2–3.7–10.2–9.8–4.4–4.9–5.5–4.00.1–1.0–1.6
Spain1–4.5–11.2–9.7–9.4–10.3–6.6–6.9–3.3–0.9–2.3
Japan–4.1–10.4–9.3–9.9–10.2–9.8–7.0–0.1–0.80.2
United Kingdom–5.1–11.4–10.1–7.9–8.3–7.0–6.4–0.10.3–0.6
Canada–0.3–4.8–5.2–4.0–3.2–2.8–2.30.60.20.0
Others2.6–0.8–0.10.40.41.11.5–0.1–0.2–0.1
Emerging market economies0.0–4.6–3.1–1.7–2.1–2.2–2.2–0.3–0.5–0.6
Asia–2.3–4.3–2.9–2.6–3.2–3.2–3.0–0.4–0.7–0.7
China–0.7–3.1–1.5–1.3–2.2–2.1–1.8–0.9–1.2–1.2
India–8.6–10.1–8.7–8.4–8.3–8.3–8.41.20.80.4
Europe0.6–6.1–3.90.0–0.7–1.2–1.50.0–0.3–0.4
Russian Federation4.9–6.3–3.41.50.4–0.3–1.0–0.1–0.6–0.4
Turkey–2.3–5.6–2.3–0.4–1.5–2.2–2.30.3–0.2–0.6
Latin America–0.8–3.6–2.8–2.4–2.5–1.6–1.8–0.50.0–0.1
Brazil–1.4–3.1–2.7–2.5–2.8–1.2–1.7–0.60.40.3
Mexico–1.1–4.7–4.4–3.4–3.7–3.1–3.0–1.3–1.0–0.9
Middle East and North Africa–4.9–5.5–7.0–8.7–9.7–9.2–7.2–0.2–1.0–1.0
South Africa–0.4–5.5–5.1–4.0–4.8–4.8–4.20.20.00.0
Low-income countries–0.4–4.2–2.0–1.7–3.3–3.2–3.10.1–0.2–0.3
Oil producers7.3–2.4–0.53.32.31.40.8–0.6–0.9–0.9
Cyclically adjusted balance(Percent of potential GDP)
Advanced economies–3.7–6.2–6.3–5.5–4.7–3.6–2.90.10.10.0
United States3–5.1–8.1–8.5–7.7–6.4–4.6–3.90.40.90.3
Euro area–3.1–4.6–4.8–3.4–2.4–1.3–1.3–0.4–0.2–0.4
France–3.1–5.1–5.1–3.9–3.1–1.9–1.80.10.0–0.3
Germany–1.3–1.2–3.5–1.00.10.00.10.60.30.3
Greece–14.2–19.1–12.2–8.2–2.70.20.81.81.31.1
Ireland3–11.9–10.3–8.7–7.0–6.0–5.5–3.70.2–0.1–0.1
Italy–3.6–3.4–3.4–2.8–1.2–0.2–0.2–0.7–0.9–0.9
Portugal2–4.3–9.4–9.7–3.6–3.0–3.0–2.00.1–0.7–1.0
Spain3–5.6–10.2–8.3–7.6–5.1–4.2–5.1–0.5–1.0–2.4
Japan–3.5–7.5–7.9–8.5–9.3–9.5–6.9–0.2–0.80.1
United Kingdom–7.3–9.7–8.6–6.5–5.4–4.3–3.40.0–0.3–0.5
Canada–0.6–3.3–4.4–3.6–2.8–2.1–1.70.40.20.0
Others–0.1–2.0–1.6–1.5–1.3–0.5–0.1–0.2–0.1–0.1
Emerging market economies–1.7–3.7–2.8–1.9–2.1–2.0–2.0–0.3–0.4–0.4
Asia–2.4–3.9–2.6–1.9–2.3–2.4–2.2–0.4–0.7–0.6
China–0.5–2.6–0.9–0.2–0.9–0.9–0.7–0.9–1.1–1.0
India–10.4–10.5–9.5–9.2–8.8–8.8–8.91.40.70.6
Europe–0.3–3.9–2.9–0.3–0.6–1.1–1.40.30.0–0.1
Russian Federation3.9–3.2–1.82.00.5–0.4–1.20.1–0.3–0.4
Turkey–2.7–3.2–1.7–1.1–1.6–2.0–1.90.4–0.1–0.3
Latin America–1.6–2.7–3.1–3.0–2.7–1.7–1.9–0.7–0.2–0.2
Brazil–2.1–2.3–3.3–3.0–2.7–1.2–1.7–1.00.10.2
Mexico–1.3–3.8–3.9–3.2–3.7–3.1–3.0–1.3–1.0–0.9
South Africa–2.2–5.3–4.8–4.0–4.6–4.5–4.0–0.2–0.4–0.3
Memorandum items:
World growth (percent)2.8–0.65.24.03.23.34.0–0.1–0.3–0.1
Source: IMF staff estimates and projections.Note: All fiscal data country averages are weighted by nominal GDP converted to U.S. dollars at average market exchange rates in the years indicated and based on data availability. Projections are based on IMF staff assessment of current policies.

Including financial sector support, estimated for Spain at 0.5 percent of GDP in 2011 and 3.3 percent of GDP in 2012.

The substantial upward revision in the 2012 fiscal outturn by the National Institute of Statistics, owing to reclassification of several large transactions, is not yet reflected in the data.

Excluding financial sector support.

Source: IMF staff estimates and projections.Note: All fiscal data country averages are weighted by nominal GDP converted to U.S. dollars at average market exchange rates in the years indicated and based on data availability. Projections are based on IMF staff assessment of current policies.

Including financial sector support, estimated for Spain at 0.5 percent of GDP in 2011 and 3.3 percent of GDP in 2012.

The substantial upward revision in the 2012 fiscal outturn by the National Institute of Statistics, owing to reclassification of several large transactions, is not yet reflected in the data.

Excluding financial sector support.

Figure 1.Revisions to Overall Balance and Debt-to-GDP Forecasts since the Last Fiscal Monitor

(Percent of GDP)

Source: IMF staff estimates and projections.

Note: “Revision to 2013 (2012) forecast” refers to the difference between the fiscal projections for 2013 (2012) in the April 2013 Fiscal Monitor and those for 2013 (2012) in the October 2012 Fiscal Monitor.

1 In the April 2013 Fiscal Monitor forecast, for Portugal, the substantial upward revision in the 2012 fiscal outturn by the National Institute of Statistics, owing to reclassification of several large transactions, is not yet reflected in the data. For Spain, the forecast includes financial sector support measures estimated at 3.3 percent of GDP in 2012.

The largest deviation from previously projected 2013 outturns is expected in Japan, where the authorities have introduced a new stimulus package amounting to 1½ percent of GDP over 2013–14, including “shovel-ready” investment projects and contributing to an increase of about 1 percent of GDP in the 2013 deficit forecast relative to earlier projections. Stimulus spending and increasing social security outlays are expected to keep the cyclically adjusted deficit above 9 percent of GDP in 2013, more than twice the advanced economy average. This will mark the fifth consecutive year in which the cyclically adjusted deficit has increased, although this reflects in part reconstruction spending following natural disasters. Implementation of the 2014–15 consumption tax increases, if confirmed, would reverse the trend but would still be insufficient to put Japan’s debt on a downward trajectory, and measures to lower the deficit over the medium term are lacking.

In Spain, the revision to the fiscal forecasts mainly reflects nonfiscal factors. The estimate of the 2012 deficit (excluding financial sector costs) of 7 percent of GDP is in line with the October 2012 Fiscal Monitor’s projection. Financial sector support amounted to approximately 3¼ percent of GDP, bringing the overall deficit to 10¼ percent. The underlying consolidation was nevertheless very sizable: an improvement in the cyclically adjusted primary balance of about 3 percent of GDP (excluding financial sector support) in the face of a large output contraction. Further substantial consolidation is projected for 2013, though the deficit forecast has been revised up by over ½ percent of GDP since the October 2012 Fiscal Monitor, reflecting the worse unemployment outlook and the lack of specified medium-term measures.

The United States, despite having averted the “fiscal cliff,” is set for a decline of 1¾ percent of GDP in its cyclically adjusted primary deficit in 2013, almost ½ percent of GDP more than in 2012, largely reflecting the automatic spending cuts (the so-called sequester) that went into effect on March 1. Currently projected at 6½ percent of GDP in 2013, the headline deficit will fall this year to about half its level at the peak of the crisis in 2009, although some of this decline is due to reduced financial sector support. The overall fiscal tightening is one of the largest in recent decades and is clearly excessive in light of cyclical considerations. Uncertainty about this year’s outturn remains. The debt ceiling will need to be raised soon, as it has been suspended only until May (pushing the effective deadline to midsummer, assuming the Treasury again resorts to the available extraordinary measures). Insufficient progress has been made toward an agreement on entitlement reforms and other much-needed measures to control the debt path over the medium term.

Adjustment is expected to continue in most other advanced economies this year largely in line with earlier projections, notwithstanding the weak economic recovery:

  • In France, a structural adjustment of 1¼ percentage points of GDP is projected, mostly focused—as in previous consolidation efforts—on selective tax increases (with an emphasis on high-income individuals). The deficit is projected to decline to about 3½ percent of GDP in 2014.

  • In the Netherlands, the 2013 deficit is projected at 3½ percent of GDP, slightly above the authorities’ target. The recapitalization of SNS REAAL will have a budgetary cost of about 0.6 percent of GDP, but this is expected to be fully offset by an increase in revenue from an auction of broadcast spectrum rights.

  • In Italy, the pace of underlying consolidation will slow to 1 percent of GDP,1 a little less than projected earlier, but enough to broadly balance the budget in structural terms. The 2012 deficit is projected to have been at the 3 percent threshold, allowing Italy to exit the EU Excessive Deficit Procedure.2

  • In the United Kingdom, the 2013 deficit forecast has been revised down by about ¼ percent of GDP, mostly reflecting the transfer of Bank of England profits to the Treasury from January 2013 (1 percentage point of GDP), partly offset by projected lower revenue collections. Despite headwinds, the government will undertake continued consolidation to reduce the cyclically adjusted deficit by another 1 percent of GDP in 2013. Some deficit-neutral measures have been introduced to support growth.

  • In Ireland, the 2012 fiscal outturn was better than expected. Additional tightening is forecast this year, underpinned by measures amounting to 2.1 percent of GDP. These include reforms in property taxes and welfare services, as outlined in the 2013 budget. Financial transactions associated with the liquidation of the state-owned Irish Bank Resolution Corporation and the associated exchange of promissory notes for long-term government bonds will result in annual interest savings of about 0.6 percent of GDP.3

  • In Portugal, fiscal consolidation is projected to continue in 2013, largely through increases in personal income and property taxation. The deficit target has, however, been revised upward from 4½ percent of GDP to 5½ percent of GDP in 2013 given the weak growth and employment outlook.

  • In Greece, continued adjustment and a renewed institutional reform agenda (with a focus on revenue administration and expenditure controls) are expected to bring the primary balance to zero in 2013. The overall deficit is expected to fall to 4½ percent of GDP this year, below the advanced economy average and 11 percentage points lower than its 2009 peak.

However, a few advanced economies facing limited fiscal pressures are adopting more neutral stances:

  • In Germany, the cyclically adjusted fiscal balance strengthened by 1 percent of GDP in 2012 on the back of buoyant revenue and lower interest payments. The cyclically adjusted balance is expected to be largely unchanged this year, with the overall deficit widening by ½ percent of GDP in 2013 as a result of the operation of the automatic stabilizers. The authorities remain on track to meet the requirements of the domestic debt brake rule.

  • In Canada, the gradual withdrawal of fiscal stimulus is continuing and consolidation plans are being implemented, at both the federal and provincial levels, though at a more modest pace in a number of provinces.

Despite the brisk pace of fiscal consolidation in advanced economies as a group, debt ratios are projected to continue to increase in 2013, with the average ratio peaking only in 2014 (Table 2, Figure 2). This average masks significant disparities across countries: about one-half of advanced economies currently have cyclically adjusted primary balances that are less than 2 percent of GDP below debt-stabilizing levels. However, about one-third of the countries have debt ratios peaking only after 2014. In most cases—especially in European countries under market pressure—this is due to a high interest rate–growth differential (rg), but in Japan and the United States, persistent large primary deficits are the main factor. In a few instances, financial sector support is also playing a role, including in Slovenia and Spain.

Table 2.General Government Debt, 2008–14(Percent of GDP)
ProjectionsDifference from October 2012 Fiscal Monitor
2008200920102011201220132014201220132014
Gross debt
World65.775.879.579.781.179.378.6–0.2–2.2–1.9
Advanced economies81.394.9101.5105.5110.2109.3109.5–0.3–1.3–1.7
United States75.589.198.2102.5106.5108.1109.2–0.7–3.6–4.7
Euro area70.380.085.688.192.995.095.3–0.80.10.6
France68.279.282.386.090.392.794.00.30.71.1
Germany66.874.582.580.582.080.478.3–1.1–1.1–1.3
Greece112.5129.3147.9170.6158.5179.5175.6–12.2–2.4–4.7
Ireland44.564.992.2106.5117.1122.0120.2–0.62.71.8
Italy106.1116.4119.3120.8127.0130.6130.80.62.83.5
Portugal71.683.193.2108.0123.0122.3123.73.9–1.40.1
Spain40.253.961.369.184.191.897.6–6.6–5.1–2.4
Japan191.8210.2216.0230.3237.9245.4244.61.40.4–1.6
United Kingdom52.268.179.485.490.393.697.11.60.31.1
Canada71.381.483.083.485.687.084.6–1.9–0.7–0.1
Emerging market economies33.536.040.336.735.234.333.60.71.52.1
Asia31.431.440.834.432.231.030.00.41.32.2
China117.017.733.525.522.821.320.00.71.72.7
India73.375.068.566.466.866.466.7–0.7–0.31.1
Europe23.629.529.127.826.125.926.40.00.81.1
Russian Federation7.911.011.011.710.910.411.8–0.10.60.9
Turkey40.046.142.439.236.435.535.4–1.3–1.2–1.0
Latin America50.553.551.951.752.450.950.32.32.93.4
Brazil63.566.965.264.968.567.265.94.46.06.9
Mexico43.144.542.943.743.543.543.90.40.30.7
Middle East and North Africa62.364.966.870.174.978.877.11.03.63.8
South Africa27.831.335.839.642.342.743.71.0–0.6–1.3
Low-income countries40.743.642.341.442.542.041.7–0.7–0.1–0.9
Oil producers22.224.823.922.122.222.422.8–0.50.00.1
Net debt
World36.844.245.947.849.348.748.50.60.20.1
Advanced economies51.962.467.572.777.478.179.11.00.1–0.2
United States54.066.775.182.487.989.089.74.11.40.4
Euro area54.062.365.567.871.973.974.5–1.5–0.9–0.3
France62.372.076.178.884.186.587.80.30.71.1
Germany50.156.756.355.357.256.254.7–1.2–1.3–1.5
Greece112.0128.9146.9168.3155.4176.1172.2
Ireland23.041.874.594.9102.3106.2107.5–0.7–1.5–1.2
Italy88.897.299.299.7103.2105.8106.00.11.82.4
Portugal67.479.088.897.5111.6115.0116.5–1.6–4.5–2.8
Spain30.842.549.857.571.979.184.7–6.7–5.3–2.7
Japan95.3106.2113.1127.4134.3143.4146.7–1.1–1.3–2.1
United Kingdom48.163.272.977.782.886.189.6–0.9–2.1–1.3
Canada22.427.729.732.334.635.936.6–1.3–1.6–1.4
Emerging market economies23.227.928.126.724.723.622.90.71.31.8
Asia55.257.658.257.058.860.861.4–0.31.13.1
Europe22.227.728.928.025.724.824.7–0.8–0.10.0
Latin America31.234.833.932.431.130.029.2–0.10.20.7
Middle East and North Africa52.955.257.661.666.871.671.10.83.33.7
Source: IMF staff estimates and projections.Note: All fiscal data country averages are weighted by nominal GDP converted to U.S. dollars at average market exchange rates in the years indicated and based on data availability. Projections are based on IMF staff assessment of current policies.

Up to 2009, public debt data include only central government debt as reported by the Ministry of Finance. For 2010, debt data include subnational debt identified in the 2011 National Audit Report. Information on new debt issuance by the local governments and some government agencies in 2011 and 2012 is not yet available, hence debt data reflect only amortization plans as specified in the 2011 National Audit Report. Public debt projections beyond 2012 assume that about 60 percent of subnational debt will be amortized by 2013, 16 percent over 2014–15, and 24 percent beyond 2016, with no issuance of new debt or rollover of existing debt.

Source: IMF staff estimates and projections.Note: All fiscal data country averages are weighted by nominal GDP converted to U.S. dollars at average market exchange rates in the years indicated and based on data availability. Projections are based on IMF staff assessment of current policies.

Up to 2009, public debt data include only central government debt as reported by the Ministry of Finance. For 2010, debt data include subnational debt identified in the 2011 National Audit Report. Information on new debt issuance by the local governments and some government agencies in 2011 and 2012 is not yet available, hence debt data reflect only amortization plans as specified in the 2011 National Audit Report. Public debt projections beyond 2012 assume that about 60 percent of subnational debt will be amortized by 2013, 16 percent over 2014–15, and 24 percent beyond 2016, with no issuance of new debt or rollover of existing debt.

Figure 2.Fiscal Trends in Advanced Economies

Fiscal adjustment is continuing in most advanced economies, but bringing down debt ratios remains a challenge for a meaningful number of them.

Source: IMF staff estimates and projections.

Note: For country-specific details, see “Data and Conventions” in the Statistical and Methodological Appendix.

1 The cyclically adjusted primary balance (CAPB) needed to stabilize debt at 2012 levels.

2 Real expenditure growth is calculated using nominal expenditure growth deflated by the GDP deflator.

The fiscal stance is neutral in emerging market economies and low-income countries

With growth decelerating but gross debt declining in most regions thanks to a still-negative interest rate–growth differential, emerging market economies generally allowed automatic stabilizers to operate fully last year. Most of them plan to continue to do so this year (Figure 3). Although relatively low debt and deficits afford many emerging market economies the scope to pause the fiscal adjustment process, many still have work to do to restore policy buffers and address other medium-term concerns: the average overall balance remains some 2 percentage points of GDP weaker than precrisis levels, controlling expenditure will require politically difficult measures (for example, slowing the growth of the public wage bill in South Africa and addressing subsidies in India), and spending pressures are rising in many countries (for example, infrastructure and social benefit spending in China and age-related spending in many emerging market economies). In some cases medium-term consolidation plans are absent or are not well formulated. Moreover, many emerging market economies and low-income countries have been reluctant to adjust their domestic energy prices to international levels, resulting in significant fiscal costs (Figure 4):

Figure 3.Fiscal Trends in Emerging Market Economies

Fiscal consolidation is on hold in most emerging market economies, yet debt buildup remains modest given negative interest rate–growth differentials. However, caution is needed given rapid spending growth and looming future demands.

Source: IMF staff estimates and projections.

Note: For country-specific details, see “Data and Conventions” in the Statistical and Methodological Appendix. Real expenditure growth is calculated using nominal expenditure growth deflated by the GDP deflator.

Figure 4.Energy Subsidies in Emerging Market Economies and Low-Income Countries, 2011

(Percent of total revenue)

Source: IMF (2013a).

Note: Pretax subsidies arise when energy consumers pay a price below the cost of supply. Tax subsidies arise when consumers pay a price below the cost of supply plus an efficient tax that reflects both revenue needs and internalization of the negative externalities arising from energy consumption.

  • In the Russian Federation, the 2013 overall deficit is expected to increase by ½ percent of GDP relative to previous projections, as a result of the decline in oil prices. The country’s new oil-price-based fiscal rule mandates only a moderate fiscal tightening for 2013–14.

  • In China, the cyclically adjusted primary surplus declined by ¾ percent 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 (see below).

  • In South Africa, where the deficit still hovers at about 5 percent of GDP, the medium-term budget policy statement has reaffirmed the commitment to fiscal consolidation but with the onset of tightening delayed by a year, which translates into a neutral stance for this year. 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 Brazil, the authorities are targeting a primary surplus of 3¼ percent of GDP, which would imply a tightening of about 1¼ percent of GDP in cyclically adjusted terms. However, the primary surplus target could be reduced by up to 0.9 percent of GDP to support investment.

  • 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 ¾ percent of GDP relative to previous forecasts, which would leave the deficit almost unchanged from its 2012 level in headline and cyclically adjusted terms.

  • 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 (for example, in Libya) 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 deficits are also still larger than precrisis levels in most low-income countries, suggesting that fiscal buffers should be restored when the environment allows. Compared to 2012 levels, the fiscal performance of petroleum importers is projected to remain stable or even improve this year and next in most countries, although Ethiopia, Mozambique, and Uganda are exceptions. Lower revenue will lead to a deterioration of the medium-term fiscal positions of some petroleum exporters like Cameroon and Chad. Fiscal outcomes in some fragile states (Côte d’Ivoire, Haiti, and Sudan) are expected to improve in 2013 because of higher revenue mobilization. Despite a favorable interest rate–growth differential, debt ratios have increased significantly in some countries (e.g., Ghana and Senegal) since the mid-2000 debt relief on account of higher investment expenditure but also rapid current spending growth (including on subsidies) not matched by revenue increases (Figure 5). This situation will need to be monitored carefully.

Figure 5.Fiscal Trends in Low-Income Countries

Fiscal consolidation is also on hold in most low-income countries. Strong spending growth, due in many cases to large increases in public investment, is pushing up debt ratios markedly in a few countries, despite negative interest rate–growth differentials.

Source: IMF staff estimates and projections.

Note: Real expenditure growth is calculated using nominal expenditure growth deflated by the GDP deflator.

Fiscal institutional reforms are gaining momentum

To buoy the credibility of their adjustment efforts, a growing number of advanced and emerging market economies have improved their fiscal institutions over the past year. For example, Ireland and Portugal have begun to strengthen their medium-term budget frameworks by introducing enforceable expenditure ceilings, Sweden has established a parliamentary committee to evaluate the budget process, and Peru has set up an expert committee to propose reforms that would strengthen the macro-fiscal framework.

But the operational contours of the most ambitious reforms often have yet to be clarified.

  • In Europe, the European Commission blueprint and the Report by the President of the European Council spell out proposals to strengthen fiscal integration. The Fiscal Compact entered into force in early 2013, and some countries have already adapted national legislation accordingly.4 For example, both France and Italy have adopted the legal basis for the introduction of a structural budget balance rule at the general government level, together with provisions for an “automatic” correction mechanism in case of slippages. Concrete implementation of these measures poses significant technical and operational challenges, particularly regarding the timely estimation of structural balances and the effective coordination of fiscal policy across various government levels. Most challenging is the design of automatic correction mechanisms: the Fiscal Compact leaves member states with considerable leeway to define these mechanisms, but practical experience is limited.

  • Ongoing reforms in Europe assign an important role to fiscal councils in fostering fiscal discipline. These councils are independent institutions expected to raise the reputational costs of undesirable policies through ex ante analyses of fiscal plans, ex post economic assessments of fiscal performance, and objective studies of long-run sustainability (Box 1). A draft European regulation (part of the so-called two-pack which was voted by the European Parliament in March) stipulates that independent bodies, in addition to monitoring compliance with the structural balanced-budget rule, should produce—or at least assess—budgetary forecasts. However, the absence of well-established guidelines for the design and modus operandi of fiscal councils creates a risk that some countries could opt for superficial compliance.

  • Many emerging market economies and low-income countries are also seeking to strengthen their fiscal institutions. For example, a number of countries are now publishing reports that discuss fiscal risks (for example, Chile, Indonesia, Mexico, and the Philippines). In addition, some commodity exporters are refining their fiscal rules and are facing their own design issues. The Russian Federation adopted a new oil-price-based fiscal rule at the end of 2012 to help protect the budget from volatile oil price movements. However, the rule is being phased in only gradually, and its effectiveness could still be undermined, including through off-budget state guarantees. Pressures to loosen key parameters of the rule for expanding the expenditure envelope also remain to be contained. Elsewhere, a number of emerging market economies and low-income countries (Croatia, Kenya, South Africa, Tanzania, and Uganda) have enacted or are considering establishing fiscal councils to provide independent oversight of the budget and strengthen transparency and accountability.

Fiscal vulnerabilities remain elevated, although some key short-term risks have fallen

Notwithstanding continued fiscal adjustment and institutional reform, underlying fiscal vulnerabilities remain elevated in many advanced economies, reflecting, to varying degrees, large and still-rising debt ratios and the inadequacy of clear medium-term consolidation plans, including to address challenges in age-related spending (Table 3). In emerging market economies, vulnerabilities are generally more moderate, although deficits persist in many, and age-related spending pressures remain to be addressed in most.

Table 3.Assessment of Underlying Fiscal Vulnerabilities over Time
Fiscal Monitor Vintages
Nov. 2009May 2010Nov. 2010April 2011Sept. 2011April 2012Oct. 2012April 2013
Advanced economies
Australia
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Greece
Ireland
Italy
Japan
Korea
Netherlands
Portugal
Spain
United Kingdom
United States
Emerging market economies
Argentina
Brazil
Chile
China
India
Indonesia
Malaysia
Mexico
Pakistan
Philippines
Poland
Russian Federation
South Africa
Thailand
Turkey
Sources: Bloomberg L.P.; Consensus Economics; Thomson Reuters Datastream; and IMF staff estimates and projections.Note: To allow for cross-country comparability, a uniform methodology is used to assess vulnerability. In-depth assessment of individual countries would require case-by-case analysis using a broader set of tools. Based on fiscal vulnerability indicators presented in Table 4, red (yellow, blue) implies high (medium, moderate) levels of fiscal vulnerability. The methodology used to estimate the composite fiscal vulnerability indicator has been modfied relative to the October 2012 Fiscal Monitor, with a reduction in the weight assigned to shocks and a matching increase in the weight assigned to underlying fiscal vulnerabilities.
Sources: Bloomberg L.P.; Consensus Economics; Thomson Reuters Datastream; and IMF staff estimates and projections.Note: To allow for cross-country comparability, a uniform methodology is used to assess vulnerability. In-depth assessment of individual countries would require case-by-case analysis using a broader set of tools. Based on fiscal vulnerability indicators presented in Table 4, red (yellow, blue) implies high (medium, moderate) levels of fiscal vulnerability. The methodology used to estimate the composite fiscal vulnerability indicator has been modfied relative to the October 2012 Fiscal Monitor, with a reduction in the weight assigned to shocks and a matching increase in the weight assigned to underlying fiscal vulnerabilities.

Short-term risks have declined almost across the board—particularly in Europe (Figure 6)—thanks to strong policy action and improved market conditions:

Figure 6.Underlying Fiscal Vulnerability Index by Region, 2002–13

(Scale, 0–1)

Sources: Baldacci and others (2011); and IMF staff calculations.

Note: 2009 GDP weights at purchasing power parity are used to calculate weighted averages. Larger values of the index suggest higher levels of fiscal vulnerability.

  • Downside risks to debt dynamics have diminished in most advanced economies (Table 4) as fiscal tightening has proceeded and financial market conditions have improved. Sovereign spreads in the euro periphery have dropped noticeably, and long-term bond placements increased after the European Central Bank announced its Outright Monetary Transactions program (see the April 2013 Global Financial Stability Report). In emerging market economies, debt dynamics remain favorable because of low interest rate–growth differentials, although lower growth prospects have raised risks in a couple of cases (India, South Africa).

Table 4.Assessment of Underlying Fiscal Vulnerabilities, April 2013
Sources: Bloomberg L.P.; Consensus Economics; Thomson Reuters Datastream; and IMF staff estimates and projections.Note: To allow for cross-country comparability, a uniform methodology is used for each vulnerability indicator. In-depth assessment of individual countries would require case-by-case analysis using a broader set of tools. Fiscal data correspond to IMF staff forecasts for 2013 for the general government. Market data used for the Growth, Interest rate, and Contingent liabilities indicators are as of March 2013. A blank cell indicates that data are not available. Directional arrows indicate that, compared to the previous Fiscal Monitor, vulnerability signaled by each indicator is higher (), moderately higher (), moderately lower (), or lower (). No arrow indicates no change compared to the previous Fiscal Monitor.

Red (yellow, blue) implies that the indicator is above (less than one standard deviation below, more than one standard deviation below) the corresponding threshold. Thresholds are from Baldacci, McHugh, and Petrova (2011) for all indicators except the increase in health and pension spending, which is benchmarked against the corresponding country group average.

For advanced economies, gross financing needs above 17.2 percent of GDP are shown in red, those between 12.9 and 17.2 percent of GDP are shown in yellow, and those below 12.9 percent of GDP are shown in blue. For emerging market economies, gross financing needs above 20.6 percent of GDP are shown in red, those between 16.3 and 20.6 percent of GDP are shown in yellow, and those below 16.3 percent of GDP are shown in blue.

For advanced economies, an interest rate–growth differential above 3.6 percent is shown in red, one between 0.3 and 3.6 percent is shown in yellow, and one below 0.3 percent is shown in blue. For emerging market economies, an interest rate–growth differential above 1.1 percent of GDP is shown in red, one between –4.4 and 1.1 percent of GDP is shown in yellow, and one below –4.4 percent of GDP is shown in blue.

For advanced economies, cyclically adjusted deficits above 4.2 percent of potential GDP are shown in red, those between 1.8 and 4.2 percent of potential GDP are shown in yellow, and those below 1.8 percent of potential GDP are shown in blue. For emerging market economies, cyclically adjusted deficits above 0.5 percent of potential GDP are shown in red, those between –1.3 and 0.5 percent of potential GDP are shown in yellow, and those below -1.3 percent of potential GDP are shown in blue.

For advanced economies, gross debt above 72.2 percent of GDP is shown in red, that between 56.9 and 72.2 percent of GDP is shown in yellow, and that below 56.9 percent of GDP is shown in blue. For emerging market economies, gross debt above 42.8 percent of GDP is shown in red, that between 29.4 and 42.8 percent of GDP is shown in yellow, and that below 29.4 percent of GDP is shown in blue.

For advanced economies, an increase in spending above 3 percent of GDP is shown in red, one between 0.6 and 3 percent of GDP is shown in yellow, and one below 0.6 percent of GDP is shown in blue. For emerging market economies, an increase in health and pension spending above 2 percent of GDP is shown in red, one between 0.3 and 2 percent of GDP is shown in yellow, and one below 0.3 percent of GDP is shown in blue.

Risk to real GDP growth is measured as the ratio of the downside risk to the upside risk to growth, based on one-year-ahead real GDP growth forecasts by market analysts included in the Consensus Forecast. It is calculated as the standard deviation of market analysts’ growth forecasts below the Consensus Forecast mean (downside risk, or DR), divided by the standard deviation of market analysts’ growth forecasts above the Consensus Forecast mean (upside risk, or UR). This ratio is then averaged over the most recent three months. Cells are shown in red if downside risk is 25 percent or more higher than upside risk (DR/UR > 1.25), in yellow if downside risk is less than 25 percent higher than upside risk (1 < DR/UR <= 1.25), and in blue if downside risk is lower than or equal to upside risk (DR/UR <= 1).

Risks to the financing cost underpinning the fiscal projection are measured as the difference between the current 10-year sovereign bond yield and the long-term bond yield (LTBY) assumption included in the Fiscal Monitor projections. Cells are shown in red if the current bond yield is above or equal to the LTBY, in yellow if the current bond yield is 100 basis points or less below the LTBY, and in blue if the current bond yield is more than 100 basis points below the LTBY.

Fiscal contingent liabilities are proxied by banking sector uncertainty, measured as the conditional volatility of monthly bank stock returns, using an exponential generalized autoregressive conditional heteroskedastic (EGARCH) model which allows asymmetric volatility changes to positive versus negative shocks in stock returns. The rationale is as follows: bank stock returns capture market expectations of banks’ future profitability and therefore—indirectly—banks’ ability to maintain required capital. Higher volatility of bank returns can create uncertainty with respect to banks’ ability to safeguard capital (see Sankaran, Saxena, and Erickson, 2011), increasing the probability that banks will need to be recapitalized, thereby resulting in contingent liabilities for the sovereign. Cells are shown in red if current volatility is more than two standard deviations above the historical average for January 2000–December 2007, in yellow if it is above the historical average by up to two standard deviations, and in blue if it is below or equal to the historical average.

Sources: Bloomberg L.P.; Consensus Economics; Thomson Reuters Datastream; and IMF staff estimates and projections.Note: To allow for cross-country comparability, a uniform methodology is used for each vulnerability indicator. In-depth assessment of individual countries would require case-by-case analysis using a broader set of tools. Fiscal data correspond to IMF staff forecasts for 2013 for the general government. Market data used for the Growth, Interest rate, and Contingent liabilities indicators are as of March 2013. A blank cell indicates that data are not available. Directional arrows indicate that, compared to the previous Fiscal Monitor, vulnerability signaled by each indicator is higher (), moderately higher (), moderately lower (), or lower (). No arrow indicates no change compared to the previous Fiscal Monitor.

Red (yellow, blue) implies that the indicator is above (less than one standard deviation below, more than one standard deviation below) the corresponding threshold. Thresholds are from Baldacci, McHugh, and Petrova (2011) for all indicators except the increase in health and pension spending, which is benchmarked against the corresponding country group average.

For advanced economies, gross financing needs above 17.2 percent of GDP are shown in red, those between 12.9 and 17.2 percent of GDP are shown in yellow, and those below 12.9 percent of GDP are shown in blue. For emerging market economies, gross financing needs above 20.6 percent of GDP are shown in red, those between 16.3 and 20.6 percent of GDP are shown in yellow, and those below 16.3 percent of GDP are shown in blue.

For advanced economies, an interest rate–growth differential above 3.6 percent is shown in red, one between 0.3 and 3.6 percent is shown in yellow, and one below 0.3 percent is shown in blue. For emerging market economies, an interest rate–growth differential above 1.1 percent of GDP is shown in red, one between –4.4 and 1.1 percent of GDP is shown in yellow, and one below –4.4 percent of GDP is shown in blue.

For advanced economies, cyclically adjusted deficits above 4.2 percent of potential GDP are shown in red, those between 1.8 and 4.2 percent of potential GDP are shown in yellow, and those below 1.8 percent of potential GDP are shown in blue. For emerging market economies, cyclically adjusted deficits above 0.5 percent of potential GDP are shown in red, those between –1.3 and 0.5 percent of potential GDP are shown in yellow, and those below -1.3 percent of potential GDP are shown in blue.

For advanced economies, gross debt above 72.2 percent of GDP is shown in red, that between 56.9 and 72.2 percent of GDP is shown in yellow, and that below 56.9 percent of GDP is shown in blue. For emerging market economies, gross debt above 42.8 percent of GDP is shown in red, that between 29.4 and 42.8 percent of GDP is shown in yellow, and that below 29.4 percent of GDP is shown in blue.

For advanced economies, an increase in spending above 3 percent of GDP is shown in red, one between 0.6 and 3 percent of GDP is shown in yellow, and one below 0.6 percent of GDP is shown in blue. For emerging market economies, an increase in health and pension spending above 2 percent of GDP is shown in red, one between 0.3 and 2 percent of GDP is shown in yellow, and one below 0.3 percent of GDP is shown in blue.

Risk to real GDP growth is measured as the ratio of the downside risk to the upside risk to growth, based on one-year-ahead real GDP growth forecasts by market analysts included in the Consensus Forecast. It is calculated as the standard deviation of market analysts’ growth forecasts below the Consensus Forecast mean (downside risk, or DR), divided by the standard deviation of market analysts’ growth forecasts above the Consensus Forecast mean (upside risk, or UR). This ratio is then averaged over the most recent three months. Cells are shown in red if downside risk is 25 percent or more higher than upside risk (DR/UR > 1.25), in yellow if downside risk is less than 25 percent higher than upside risk (1 < DR/UR <= 1.25), and in blue if downside risk is lower than or equal to upside risk (DR/UR <= 1).

Risks to the financing cost underpinning the fiscal projection are measured as the difference between the current 10-year sovereign bond yield and the long-term bond yield (LTBY) assumption included in the Fiscal Monitor projections. Cells are shown in red if the current bond yield is above or equal to the LTBY, in yellow if the current bond yield is 100 basis points or less below the LTBY, and in blue if the current bond yield is more than 100 basis points below the LTBY.

Fiscal contingent liabilities are proxied by banking sector uncertainty, measured as the conditional volatility of monthly bank stock returns, using an exponential generalized autoregressive conditional heteroskedastic (EGARCH) model which allows asymmetric volatility changes to positive versus negative shocks in stock returns. The rationale is as follows: bank stock returns capture market expectations of banks’ future profitability and therefore—indirectly—banks’ ability to maintain required capital. Higher volatility of bank returns can create uncertainty with respect to banks’ ability to safeguard capital (see Sankaran, Saxena, and Erickson, 2011), increasing the probability that banks will need to be recapitalized, thereby resulting in contingent liabilities for the sovereign. Cells are shown in red if current volatility is more than two standard deviations above the historical average for January 2000–December 2007, in yellow if it is above the historical average by up to two standard deviations, and in blue if it is below or equal to the historical average.

  • The risks associated with contingent liabilities from the banking sector have declined in many advanced and emerging market economies, but have risen in others. These developments highlight the sizable fiscal risks that persist as long as bank balance sheets remain impaired amid incomplete financial sector reform (see the April 2013 Global Financial Stability Report). Several European countries have been facing fiscal pressures as a result of bank recapitalization needs. In Spain, where financial sector reforms are well underway, four banks were recently restructured at a fiscal cost of 3 percent of GDP (Table 5); further fiscal outlays in 2013 are expected to be small (¼ percent of GDP). In the Netherlands, the fourth-largest bank is expected to receive a capital injection—with a cost to the state of 0.6 percent of GDP—in addition to public loans and guarantees amounting to 1 percent of GDP. In Slovenia, an asset management company has been set up and is authorized to issue up to €4 billion (11¼ percent of GDP) this year in bonds backed by government guarantees to finance nonperforming asset purchases. In some countries, concerns about the quality of financial sector assets and of banks’ balance sheets have grown, including in China, given the rapid expansion of borrowing channeled to finance investment.

Table 5.Selected Advanced Economies: Financial Sector Support(Percent of 2012 GDP, except where otherwise indicated)
Impact on gross public debt and other supportRecovery to dateImpact on gross public debt and other support after recovery
Belgium7.41.55.9
Cyprus10.00.010.0
Germany112.82.010.8
Greece19.74.315.4
Ireland240.54.436.1
Netherlands14.610.04.6
Spain37.32.94.4
United Kingdom6.71.55.2
United States4.84.20.5
Average7.03.73.3
$US billions1,729914815
Sources: National authorities; and IMF staff estimates.Note: Table shows fiscal outlays of the central government, except in the cases of Germany and Belgium, for which financial sector support by subnational governments is also included. Data are cumulative since the beginning of the crisis—latest available data up to February 2013. Data do not include forthcoming support.

Support includes here the estimated impact on public debt of liabilities transferred to newly created government sector entities (about 11 percent of GDP), taking into account operations from the central and subnational governments. As public debt is a gross concept, this neglects the simultaneous increase in government assets. With this effect taken into account, the net debt effect amounted to just 1.6 percent of GDP, which was recorded as deficit.

The impact of the direct support measures is mainly on net debt, as significant recapitalization expenses were met from public assets. Direct support does not include asset purchases by the National Asset Management Agency (NAMA), as these are not financed directly through the general government but with government-guaranteed bonds.

Direct support includes total capital injections by the Fondo de Reestructuración Ordenada Bancaria (FROB) and liquidity support.

Sources: National authorities; and IMF staff estimates.Note: Table shows fiscal outlays of the central government, except in the cases of Germany and Belgium, for which financial sector support by subnational governments is also included. Data are cumulative since the beginning of the crisis—latest available data up to February 2013. Data do not include forthcoming support.

Support includes here the estimated impact on public debt of liabilities transferred to newly created government sector entities (about 11 percent of GDP), taking into account operations from the central and subnational governments. As public debt is a gross concept, this neglects the simultaneous increase in government assets. With this effect taken into account, the net debt effect amounted to just 1.6 percent of GDP, which was recorded as deficit.

The impact of the direct support measures is mainly on net debt, as significant recapitalization expenses were met from public assets. Direct support does not include asset purchases by the National Asset Management Agency (NAMA), as these are not financed directly through the general government but with government-guaranteed bonds.

Direct support includes total capital injections by the Fondo de Reestructuración Ordenada Bancaria (FROB) and liquidity support.

  • Although still large, gross financing needs in advanced economies have declined, mainly reflecting lower deficits (Table 6). Financing requirements have been reduced significantly in Greece with the debt buyback and increased concessionality from European partners (including through maturity extensions) and in Ireland thanks to a promissory note exchange. Financing needs are set to increase in many emerging market economies in 2013 because of higher levels of maturing debt. Gross financing needs are particularly high in Egypt, Pakistan, Jordan, and Hungary, reflecting short maturities and, in some cases, high deficits (Table 7).

Table 6.Selected Advanced Economies: Gross Financing Needs, 2013–15(Percent of GDP)
201320142015
Maturing debtBudget deficitTotal financing needMaturing debt1Budget deficitTotal financing needMaturing debt1Budget deficitTotal financing need
Japan49.29.859.051.67.058.649.05.854.8
Italy25.32.627.825.82.328.226.22.128.3
United States18.66.525.220.35.425.819.94.124.0
Portugal217.55.523.017.84.021.817.82.520.3
Spain14.16.620.715.36.922.216.36.622.9
Greece14.94.619.519.23.422.513.52.215.7
Belgium15.82.618.416.22.118.315.91.717.6
France13.43.717.114.13.517.615.62.618.1
Canada13.32.816.114.32.316.515.21.716.8
Ireland35.08.313.26.25.111.33.82.66.4
United Kingdom6.17.013.06.66.412.98.55.614.1
Netherlands8.63.412.09.13.712.812.23.315.6
Slovenia5.06.911.85.74.310.09.14.113.3
Czech Republic8.42.911.38.92.811.79.82.612.5
Slovak Republic7.93.211.16.03.09.05.92.98.8
Denmark7.32.810.17.82.310.09.01.910.9
New Zealand7.91.99.78.30.58.77.9–0.37.6
Austria6.32.28.46.51.58.05.81.16.9
Germany7.90.38.27.90.18.15.50.05.5
Finland5.82.07.96.11.37.46.40.77.1
Iceland6.61.37.86.70.67.31.3–0.60.7
Sweden3.40.84.33.60.54.06.2–1.25.1
Australia3.11.14.23.30.23.43.2–0.32.9
Switzerland3.5–0.23.33.5–0.53.13.0–0.72.3
Korea3.1–2.40.73.1–2.60.43.0–2.70.3
Norway4.3–12.3–8.04.3–11.1–6.84.0–10.0–6.0
Average17.94.822.719.13.923.018.73.021.8
Sources: Bloomberg L.P.; and IMF staff estimates and projections.Note: For most countries, data on maturing debt refer to central government securities. For some countries, general government deficits are reported on an accrual basis (see Table SA.1).

Assumes that short-term debt outstanding in 2013 and 2014 will be refinanced with new short-term debt that will mature in 2014 and 2015, respectively. Countries that are projected to have budget deficits in 2013 or 2014 are assumed to issue new debt based on the maturity structure of debt outstanding at the end of 2012.

Maturing debt is expressed on a nonconsolidated basis.

Ireland’s cash deficit includes exchequer deficit and other government cash needs and may differ from official numbers because of a different treatment of short-term debt in the forecast.

Sources: Bloomberg L.P.; and IMF staff estimates and projections.Note: For most countries, data on maturing debt refer to central government securities. For some countries, general government deficits are reported on an accrual basis (see Table SA.1).

Assumes that short-term debt outstanding in 2013 and 2014 will be refinanced with new short-term debt that will mature in 2014 and 2015, respectively. Countries that are projected to have budget deficits in 2013 or 2014 are assumed to issue new debt based on the maturity structure of debt outstanding at the end of 2012.

Maturing debt is expressed on a nonconsolidated basis.

Ireland’s cash deficit includes exchequer deficit and other government cash needs and may differ from official numbers because of a different treatment of short-term debt in the forecast.

Table 7.Selected Emerging Market Economies: Gross Financing Needs, 2013–14(Percent of GDP)
20132014
Maturing debtBudget deficitTotal financing needMaturing debtBudget deficitTotal financing need
Egypt26.111.337.425.18.733.8
Pakistan26.27.033.224.77.131.9
Jordan27.04.831.825.85.331.1
Hungary17.93.221.016.63.420.0
Brazil15.91.217.115.41.717.2
Ukraine12.24.516.69.65.415.0
Morocco10.25.515.711.04.215.1
India4.48.312.74.38.412.7
South Africa7.34.812.07.34.211.5
Romania9.52.111.69.21.710.9
Poland8.23.411.67.12.910.0
Mexico7.73.110.87.83.010.8
Malaysia6.24.010.26.13.79.8
Turkey7.22.29.48.72.311.0
Argentina16.02.78.76.52.49.0
Lithuania6.02.68.64.52.36.8
Thailand5.52.78.26.43.49.8
Philippines6.70.87.56.90.97.8
China14.12.16.23.31.85.1
Bulgaria2.51.43.91.20.61.8
Colombia2.81.03.83.30.94.1
Indonesia0.82.83.70.92.23.1
Latvia1.91.33.16.60.87.4
Russian Federation1.20.31.61.11.02.1
Chile1.0–0.10.91.10.11.2
Peru2.2–1.80.42.1–1.60.5
Kazakhstan2.0–4.9–2.91.9–4.5–2.5
Average6.12.68.85.72.58.3
Source: IMF staff estimates and projections.Note: Data in table refer to general government. For some countries, general government deficits are reported on an accrual basis (see Table SA.2).

For details, see “Data and Conventions” in the Methodological and Statistical Appendix.

Source: IMF staff estimates and projections.Note: Data in table refer to general government. For some countries, general government deficits are reported on an accrual basis (see Table SA.2).

For details, see “Data and Conventions” in the Methodological and Statistical Appendix.

Over the past year, some progress has also been made in addressing longer-term challenges, although in many countries these remain formidable. Age- and health-related spending is expected to rise over the next 20 years by more than 4 percent of GDP in advanced economies and by 3 percent of GDP in emerging market economies. Recent reforms in the Czech Republic, Greece, Latvia, and Poland should enhance the sustainability of their public pension schemes. In Colombia and France, recently adopted measures could increase spending, although in France this would be offset by higher social security contributions. Containing the increasing costs of health care remains the greatest challenge, as illustrated by the case of the United States, where the expected savings from the Affordable Care Act are small because increased revenues will largely be spent on expanding coverage. This holds true even after a recent Supreme Court decision that allows states to opt out of extending coverage is accounted for.5Although the recent agreement on measures to avoid the fiscal cliff in the United States is welcome, there has been insufficient progress in defining the longer-term fiscal adjustment path, including necessary entitlement reforms and other measures to restore medium-term fiscal sustainability.

Remaining fragilities still call for further, appropriately paced fiscal consolidation in many countries.

  • Short-term adjustment should be calibrated to the size of the fiscal imbalance, cyclical conditions, and financing constraints (Box 2). From that perspective, the pace of structural fiscal adjustment under baseline scenarios for 2013 in advanced economies is broadly appropriate, but with some caveats: in Japan, where the stimulus being undertaken will support the short-term recovery but (even though it is temporary) further increase fiscal vulnerabilities, and in the United States, where the automatic spending cuts (sequester) that came into effect on March 1 will result in a consolidation that—at 2 percent of GDP in headline terms—is both excessive and inefficiently structured, owing to the across-the-board nature of the automatic cuts. In addition, in the United Kingdom, where the recovery is weak owing to lackluster demand, consideration should be given to greater near-term flexibility in the fiscal adjustment path.

  • Although separating cyclical from structural factors remains a challenge, especially in the still-uncertain economic environment in many advanced economies, fiscal policy should focus on structural rather than nominal balances, since a single-minded focus on headline targets—where not mandated by hard financing constraints—could lead to procyclical policies that would accelerate any downturn. This risk is particularly high in the euro area, where the current nominal targets under the Excessive Deficit Procedure would imply excessive adjustments in the Netherlands and Spain. Direct recapitalization of banks through the European Stability Mechanism would be key to severing definitively the perverse feedback loops between banks and sovereigns in the euro area.

  • In higher-debt countries, notably Japan and the United States, specific medium-term plans are urgently needed to put debt ratios on a firm downward trajectory. A mix of entitlement reforms and revenue-raising efforts (for example, through widening of bases and increases in energy taxation) could provide a basis for defining clear targets and explicit paths (ideally in cyclically adjusted or structural terms) for reaching them within a specific time frame. In the United States, there has been progress on fiscal consolidation through discretionary spending caps and modest tax increases, but more remains to be done. Other high-debt advanced economies could benefit from more specificity in their medium-term plans. Credible commitments to long-term fiscal consolidation, possibly supported by binding numerical fiscal rules, enhanced transparency, tighter budget procedures, and greater independent oversight of the budget, are critical to address the risks of eroding confidence and avoid a surge in interest rates with a negative impact on the economy and on debt dynamics.

  • The stronger fiscal position of most emerging market economies has allowed them to pause fiscal adjustment in the context of slowing growth, but many of these economies should return to rebuilding policy space when the environment allows. Reform priorities vary across countries.

    • In some cases (including Egypt, India, and Jordan), high public debt ratios and high deficits call for more immediate fiscal action to safeguard against adverse debt dynamics should the interest rate–growth differential become less favorable, for example, because of a lower growth potential or the rising cost of private or official financing (the latter a sizable risk for low-income countries). Further structural reform, including subsidy reform, higher revenue from consumption taxes, and broader tax bases, would facilitate faster consolidation.

    • Commodity exporters (e.g., Algeria, Iraq, Libya) must strengthen nonresource revenue and establish fiscal frameworks to limit short-term volatility and ensure long-term fiscal sustainability (IMF, 2012b).

    • In most low-income countries, revenue mobilization should be stepped up to keep pace with expenditure growth, for example, by improving customs and tax administration, eliminating exemptions, and implementing broad-based value-added and corporate income taxes (IMF, 2011b).

    • In many emerging market economies and low-income countries, reforms to energy subsidies are needed urgently, as subsidies aggravate fiscal imbalances; crowd out priority spending like investment, education, and health; distort resource allocation; reinforce inequality (as they are typically captured mostly by higher-income households); and exacerbate global warming and worsen local pollution by promoting overconsumption of fuel products. Although there is no single recipe for successful subsidy reform, country evidence suggests that a combination of phased price increases, targeted measures to protect the poor, and institutional reforms that depoliticize energy pricing can lead to successful outcomes (Appendix 1).

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