The International Monetary Fund (IMF) on Wednesday said the environment faced by emerging economies has turned more challenging as deficits and debt ratios remain significantly above pre-crisis levels. Emerging market economies have overall stronger fiscal positions, Sanjeev Gupta, acting director in the Fiscal Affairs Department, told reporters at the IMF headquarters in Washington DC on the sidelines of its annual Spring Meetings.
Below are the excerpts of Sanjeev Gupta's speech
In emerging economies and low-income countries, fiscal vulnerabilities are rising, although from moderate levels.
First, the average fiscal deficit in advanced economies has nearly halved since the crisis peaked and now stands at 3.5 percent of GDP. Fiscal consolidation will continue in 2014 but at a more gradual pace, with a lesser drag on growth. The exception to this picture is Japan, where fiscal consolidation is starting this year, notably with the first stage of [collection?] tax increase that took place last week.
However, despite advanced countries’ progress in narrowing in fiscal deficits, the average debt-to-GDP ratio remains stubbornly high and will exceed a 100% of GDP even by 2019.
The composition of fiscal consolidation is shifting from revenue to expenditure measures by end-2013. Close to half of the consolidation has come from the revenue side, quite more than originally intended, but the share is expected to decline in the coming years as spending cuts take hold. The blue part of the bar reflects the revenue measures. There is, however, heterogeneity across countries, with the U.S. relying on revenue measures more than the euro area, where the scope to raise additional taxes is very limited, as was discussed in the previous issue of the Fiscal Monitor.
Emerging market economies have overall stronger fiscal positions. They initially weathered the crisis well, in large part by running down the fiscal buffers. While there is significant heterogeneity among emerging economies, deficits and debt ratios remain significantly above pre-crisis levels.
The environment faced by emerging economies has turned more challenging. In some economies, financial vulnerabilities and changes in market sentiment will likely compound fiscal challenges. For example, those economies with higher nonresident holdings may see sharper increases in interest rates as liquidity conditions in advanced countries tighten. On average, nonresident holdings amount to about one third of emerging market debt, and local currency debt has more than doubled in several emerging market economies since 2009. While this is a welcome development for domestic market deepening and overall financial development, it does come with some risks.
Fiscal space has also declined in low-income economies as revenue mobilization has lagged fast-spending growth. As a result, the average fiscal deficit remains almost 3 percentage points of GDP above pre-crisis levels. As a result, in about half of the low-income country sample, debt ratios are projected to keep increasing through 2019 and the increase in debt is expected to be sizable in some of the so-called “ frontier markets,” such as Honduras, Senegal and Zambia.
Debt buildup has had adverse consequences for LICs in the past because it was not used for growth-enhancing investments, so it seems warranted to wonder whether the story will be different this time. In other words, has the new borrowing been used to increase productive spending? The evidence here is mixed. In many countries, large increases in debt have not been associated with higher capital spending, for example, in Honduras, Sudan and Zambia. This raises concerns about the quality of spending in some low-income countries and point to the need to strengthen institutional capacity to raise the efficiency of spending.
So, what is our policy advice against this backdrop? Our policy advice for advanced countries has not changed. Fiscal consolidation must continue at a steady and gradual pace to lower debt ratios to prudent levels. The design and implementation of well-articulated, credible, medium-term consolidation plans can help in this regard, but these plans are still lacking in some countries, most notably in the United States and Japan.
Those emerging market economies with large debt and deficits and most vulnerable to market volatility should start to rein in deficits now. In other emerging market economies, fiscal reforms are still needed, even with less urgency. In low-income countries, stepped-up revenue mobilization and higher expenditure efficiency are needed to restore fiscal buffers and to create room for much-needed public services.
Expenditure reforms have a key role to play in country strategies to strengthen their fiscal positions. In advanced economies, expenditure reforms can support fiscal consolidation efforts, as there is now greater reliance on expenditure measures in advanced economies. In emerging economies and low-income countries, expenditure reforms can help respond to growing demands for better delivery of public services.
The challenge for policymakers around the globe is to ensure the sustainability of expenditure programs, maximize the efficiency of public spending, and foster equitable access to public services. Reaching these goals is not easy, but will require mobilizing political and social support. I do not think I have the time to walk through all the details of the analysis in the chapter, but let me pick up a few important conclusions.
First, any spending reform must ensure the sustainability of major budget items, particularly the government wage bill and social benefits. In advanced economies, these two items together account for 30 percent of GDP and about 80 percent of non-interest government spending. In emerging markets and low-income countries, these two items constitute 60 percent of total spending.
Second, expenditure reforms should seek to achieve efficiency gains while preserving equity. These reforms should be designed and sequenced taking into account country-specific circumstances. The reforms could be achieved through better targeting of social programs and promoting greater competition in the healthcare and education sectors.