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by Don Alexander, MBA
Associate, RSD Solutions Inc.
The IMF’s noted in its’ Interim Fiscal Monitor (July 2012) that fiscal adjustment is proceeding generally as expected in advanced economies, with headline and underlying fiscal deficits that are broadly in line with projections made in the April 2012. In advanced economies with easier market access, fiscal adjustment in 2012–13 is broadly on track to meet medium-term targets. Overall, advanced economy deficits are forecast to decline by about ¾ percentage point of GDP this year and about 1 percent of GDP next year in headline and cyclically adjusted terms, a rate that strikes a compromise between restoring fiscal sustainability and supporting growth.
Deficits in emerging economies are expected to be somewhat weaker than projected in April, as some draw on fiscal space in response to slowing economic activity. No significant fiscal consolidation is on tap in 2012–13, reflecting generally stronger fiscal positions than in advanced economies and downside risks to global growth. However, some emerging economies need to be more ambitious to reduce vulnerabilities.
Europe developments remain a problem where sovereign debt is in a negative feedback loop with the banking sector. The continued focus on nominal deficit targets runs the risk of compelling excessive fiscal tightening if growth weakens. The two largest such countries, Italy and Spain, are implementing sizeable fiscal consolidation in the next two years in efforts to improve debt dynamics and regain market confidence. Market turbulence has intensified in Spain due to renewed concerns about the health of the financial system and its possible fiscal implications. Italy’s headline and cyclically adjusted deficits for 2012–13 continue to be broadly in line with expectations could achieve a small structural surplus in 2013. The situation in Greece remains in flux with revenue under pressure and slow pace of reforms.
Elsewhere, there is a risk in the United States of political gridlock that puts fiscal policy on autopilot and results in a sharp and sudden decline in deficits—the “fiscal cliff.” The United States’ fiscal position is projected to improve, but the outlook for 2013 remains a significant concern. Expiring tax provisions and automatic spending cuts mandated by the 2011 Budget Control Act would imply a fiscal withdrawal of more than 4 percent of GDP—the so-called ‘fiscal cliff’—which would severely affect growth in the short term. A more modest retrenchment in 2013—of around 1 percent of GDP in structural terms—would be a better option.
In most advanced economies, a steady pace of adjustment focused on the measures to be implemented rather than on headline deficit targets is preferable, especially in light of heightened downside risks to the outlook. Japan’s budget deficit and high debt level remains a problem and aging population defies any near-term solutions. The proposal to increase the consumption tax sends a positive signal of commitment to fiscal adjustment and reform. However, the tax increase would remain only part of the consolidation necessary to put the debt ratio on a downward path.
Governments face the task of credibly dealing with large fiscal adjustment needs in a time of slow and uncertain growth. Reconciling these needs may be challenging, but following some basic fiscal principles (to be adapted on a case- by-case basis) should help.
The risk remains that fiscal deficits persist accompanied by stagnant growth posing a challenging environment for risk management.
For more on this follow the link: www.imf.org/external/pubs/ft/fm/2012/update/02/fmindex.htm
