IMF WARNS OF DECADE OF RESTRAINT / THE FINANCIAL TIMES ( RECOMMENDED READING )

IMF warns of decade of restraint

By Krishna Guha in Washington

Published: November 3 2009 19:59

Sweeping spending cuts and tax increases will be required across the industrialised world over the next decade to bring public finances under control following the economic crisis, the International Monetary Fund warned on Tuesday.

The IMF projected that on current trends, even assuming some discretionary fiscal tightening next year, government debt in the advanced G20 economies would reach 118 per cent of gross domestic product in 2014.


The Fund warned against assuming that current low borrowing rates for these nations in the bond market would prevail for ever, releasing research suggesting that the projected increase in government debt would result in a roughly 2 percentage point increase in government bond yields.

“While the reaction of financial markets to the deterioration of the fiscal outlook has so far remained moderate, this should not lead to complacency,” the Fund said. “First, interest rates are now cyclically low. Second, markets in the past have reacted late – and sharply – to changes in fundamentals.”

The IMF report came as Peter Orszag, the US White House budget director, gave a speech that suggested Barack Obama’s administration intends to tighten fiscal policy by 1 to 2 percentage points of GDP over the medium term.

“Our current projections of 4 to 5 per cent of GDP in the out-years are well above the fiscally sustainable level of roughly 3 per cent,” he said, adding: “We are currently considering a number of proposals to put our country back on firm fiscal footing.”

The Fund analysis suggests that without a change of course all the leading economies except Germany will still be running large deficits in 2014, when the world economy is expected to be back to its potential level of output.

It puts this structural deficit at 6.7 per cent of GDP in the US, 6.8 per cent in the UK, 8 per cent in Japan, 5.3 per cent in Italy and 5.2 per cent in France. The analysis suggests that interest payments on the increased stock of govern­ment debt will eat up a much larger share of tax revenues post-crisis than before the crisis – twice as much in the US and UK – leaving little room for manoeuvre on public spending.

The Fund said it would take spending cuts and tax increases equivalent to about 8 percentage points of GDP to bring the debt to GDP ratio back down to 60 per cent over a decade across the industrialised G20 nations as a whole.

A less ambitious plan to stabilise debt to GDP at 80 per cent would still require a 6.7 per cent adjustment, it said. These assessments are sensitive to any increases in government borrowing costs relative to growth rates.

The IMF suggested a benchmark plan for an 8 percentage point turnround would involve allowing all stimulus measures to expire, freezing spending outside health and pensions in real terms for a decade, sharply reducing growth in spending on health and pensions to keep this in line with output growth, and tax increases worth 3 percentage points of GDP.

The IMF said “the adjustment needed in many advanced countries will be difficult but it is not unprecedented”. However, it noted that adjustment “will be more challenging than in some past episodes because it will have to be undertaken in an environment of adverse demographics and potentially sluggish potential growth”.

Copyright The Financial Times Limited 2009.