Figure 3. G-20 Countries: General Government Debt Ratios, 2000–14 (In percent of GDP)

The International Monetary Fund (IMF) warned on Tuesday that sweeping spending cuts and tax increases will be required across the developed world over the next decade to bring public finances under control following the economic crisis. The Fund projected that on current trends, allowing for some discretionary fiscal tightening next year, public debt in the developed economies of the G-20 countries will rise to 118 per cent of gross domestic product (GDP) by 2014.

The State of Public Finances Cross-Country Fiscal Monitor: November 2009

The IMF said fiscal policy will continue to provide substantial support to aggregate demand in most countries this year, but a tightening is projected to commence next year in G-20 emerging markets. Globally, overall deficits are expected to narrow from 6.7 per cent of GDP this year to 5.6 per cent in 2010. Across the G-20, the average overall deficit is projected at 7.9 per cent of GDP this year - - well above its pre-crisis level - - and 6.9 percent of GDP next year. Much of the projected fall in the deficit in 2010 reflects declining losses from financial sector support operations in the United States. Net of these - - which are unlikely to have a direct impact on aggregate demand - -the deficit is projected to widen in advanced G-20 economies in 2010, with reduced discretionary anticrisis measures more than offset by larger automatic stabilisers as the output gap widens further and by increases in other types of spending especially in the United States, Japan and the United Kingdom.

By contrast, fiscal policy is projected to begin tightening in emerging G-20 economies next year, reflecting a combination of reduced anticrisis spending (lower by 0.6 percentage points) and expected consolidation beyond the withdrawal of crisis-related stimulus in Brazil, Mexico, and Turkey, supported by a pick-up of growth. Higher commodity prices will also contribute to lower overall deficits in for example Russia and Saudi Arabia.

The Fund warned that assuming that current low borrowing rates in the bond market would prevail for ever, publishing 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 analysis suggests that without a change of strategy, all the leading economies except Germany will be running large deficits in 2014, when the world economy is expected to have returned to its potential level of output.

The Fund says the structural deficit in the US is at 6.7 per cent of GDP; 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. It signals that interest payments on the increased stock of public debt take 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 flexibility on public spending.

The IMF says credible exit strategies for advanced countries will need to go well beyond the non-renewal of stimulus measures. Weak pre-crisis structural fiscal positions in many countries have been further eroded by underlying spending pressures. To get debt below 60 per cent by 2030 will require raising the average structural primary balance by 8 percentage points of GDP over 2010-20 and then keeping it there for a further decade. This could be achieved by a combination of non-renewal of stimulus measures; a freeze in real per capita spending excluding pensions and health; reforms to keep the growth of pension and health spending in line with that of GDP; and tax increases averaging about 3 percentage points of GDP for advanced G-20 countries.

The G-20 countries are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, United Kingdom, and United States. Of these, the emerging economies comprise Argentina, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, and Turkey.