WASHINGTON (Reuters) - Budget deficits in advanced economies are on track to shrink by 1 percentage point of gross domestic product this year and slightly faster in 2013, an appropriate pace in a slow-growth environment, the International Monetary Fund said on Tuesday.
By 2015, government debt ratios are expected to stabilize for most countries, assuming that interest rates remain low and growth continues, the IMF said in its Fiscal Monitor report.
But the balance is precarious, and the UK, Italy and France are among those countries vulnerable to even small economic shocks that would worsen their debt profiles.
Others such as Spain and Japan face a rising debt burden from growth that is too slow relative to their interest rate costs, it said.
“For many advanced economies, then, stronger medium-term adjustment efforts could be called for to provide greater assurances about the resilience of the public finances,” the IMF said in its report.
The IMF warned that deeply indebted countries should avoid the shock therapy of big upfront budget cuts. Instead, when a country is growing below its potential rate, gradually phasing in fiscal adjustment over 2-1/2 years delivers a smaller negative hit to growth than up-front cuts of the same overall size, the IMF said its research found.
“Too little fiscal consolidation could roil financial markets, but too much risks further undermining the recovery and, in this way, could also raise market concerns,” the IMF said.
Moreover, highly indebted countries with a debt load above 60 percent of GDP will not necessarily see immediate benefits from budget cuts - in fact conditions at first may worsen, the IMF said.
Its models suggest that when a government introduces fiscal tightening equivalent to 1 percentage point of GDP, in the first year lower growth will more than offset any improvement to the debt ratio. Financial markets also may take time to reward fiscal tightening, meaning the country will not immediately benefit from lower interest rates.
“Therefore, if growth falls enough as a result of fiscal tightening, borrowing costs could actually rise as the deficit narrows,” it said.
Ireland, Portugal and Greece all have suffered from this problem of announcing significant fiscal measures, only to face higher costs from slower growth than forecast, requiring adjustments to their deficit outlooks.
Another challenge is that high debt levels may overstate the short-run financial pressure a country may face in managing its debt, particularly when the central bank is buying up debt.
This is reversed when central banks begin unwinding extraordinary measures for supporting their economies and begin selling government bonds. Governments could face fresh challenges in placing their debt, requiring careful communication of their strategies, it said.
About two-thirds of the increase in global fiscal deficits from stimulus plans adopted to tackle the financial crisis of 2008-2009 will be unwound by the end of this year, the IMF said. But much higher debt ratios will remain a legacy of the crisis.
General government debt in advanced economies will increase by a further 5 percentage points to average 109 percent of GDP by 2015, led by Japan, the UK and the United States, it said.
In contrast, debt ratios are expected to decline in emerging economies to 35 percent of GDP in 2013 from 38 percent on average in 2011, helped by strong growth and low interest rates.
Several emerging economies also have little room for slippage. If commodity prices fell, Russia would face increased budget costs, while Hungary’s deficit would worsen if its interest rate costs rise further.
In low-income countries, the debt-to-GDP ratios are forecast to climb in roughly half of the economies as aid recedes, although their debt loads mostly are relatively modest.
Reporting by Stella Dawson; Editing by Leslie Adler