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 countries that are vulnerable to even small economic shocks that would worsen their debt profiles.
The IMF forecast Italy and Spain will both miss their budget deficit goals this year and next because of weak growth, but it stopped short of calling for further belt-tightening.
“We feel that the Spanish government has struck the right balance between supporting growth and moving forward with fiscal consolidation,” Joerg Decressin, deputy director of research at the IMF, said.
The IMF expects a public deficit of 6 percent for Spain in 2012 compared with a government target of a 5.3 percent, and a deficit of 5.7 percent in 2013 compared with a 3 percent goal.
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,” it said.
Along these lines, Italy is moving to delay by a year its plan to balance the budget in 2013 due to a weakening economic outlook, according to a draft document due to be approved by the government on Wednesday obtained by Reuters.
The IMF, which said it expected Rome to balance its budget not before 2017, urged it not to adopt additional corrective measures due to the weak economy.
The fund predicts Italy’s deficit to fall this year to just 2.4 percent of output and to stand at 1.5 percent in 2013, a full percentage point above the revised forecast in the draft.
The draft raises Italy’s 2012 deficit target to 1.7 percent of GDP from 1.6 percent.
“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.
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.
But several emerging economies 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 and Antonella Ciancio; Editing by Leslie Adler