The IMF (International Monetary Fund) on Wednesday published three staff papers on the issue of public debt and the conclusion of a paper on default in advanced countries is that it is unnecessary, undesirable, and unlikely.  

The IMF economists considered recent speculation among market participants and commentators that worsening public finances could lead to a debt default in certain advanced countries, in particular some “peripheral” European countries such as Greece and Ireland. The paper judges that the risk of debt restructuring is currently significantly overestimated, arguing that whereas debt defaults by primarily emerging markets in preceding decades have been triggered foremost by spiraling debt service costs, the current challenges to fiscally stressed advanced countries stem from their large primary deficits. Because of the long maturity of public debt in advanced countries at the beginning of the crisis, their debt service is still relatively contained: the problem is not the debt burden, but the primary deficit. The long-term drivers of public spending need to be tackled over the medium term to ensure fiscal sustainability. The study concludes that therefore defaulting on debt would make little sense for these countries.

What the IMF is simply saying is that unless the day-to day budget deficit is addressed, getting a discount from lenders on outstanding debt, isn't going to solve a public finance problem.

Ireland may collect €31bn in taxes in 2010 and spend over €50bn; that gap would only be partly closed by additional tax revenues from a recovery of growth. Asking for debt forgiveness while adding to debt every year, is not a realistic option. 

Those who advocate debt restructuring appear to see it as an alternative to structural reform, which involves challenging powerful vested interests whether for example in Ireland, in the protected private sector, the public sector and the supporters of the status quo in a failed governance system.

In the period 1973-2008, Ireland was the beneficiary of net receipts from the European Union of €40.8bn, amounting to 3% of average GDP (gross domestic product). It hit a high point in 1991 at 6.2% of GDP.

By mid-2008, when voters rejected the Lisbon Treaty, the hubris of the Celtic Tiger years that was encapsulated in Tánaiste Mary Harney's comment that in economic terms Ireland was closer to Boston than Berlin, was still strong.

In the past decade, Germany implemented painful labour and welfare reforms, which resulted in a loss of public support for the left-of-centre SPD and GerhardSchröder effectively sacrificed his chancellorship by embracing change.

Asking Germany to pick up the tab again is a bit rich given that the Croke Park deal on public service reform is only a set of headline aspirations while apart from change at the Central Bank, most other sectors are reform-free zones.

The IMF economists say in their papers that the global economic crisis has eroded the government coffers of advanced economies and countries will need to return debt levels to a sustainable path to manage fiscal risks, foster long-term growth, and create jobs in the coming years.

The Fund says governments need to develop credible fiscal plans that focus on longer-term solutions, rather than on quick fixes, to protect the fragile recovery and reassure financial markets. In some cases, a marked departure from the normal historical pattern of adjustment to rising public debt is needed to manage fiscal risks.

The research is part of the IMF’s ongoing analysis to help countries emerge out of the crisis and return to economic growth and more sustainable debt levels.

Long-Term Trends in Public Finances in the G-7 Economies, Fiscal Space, and Default in Today’s Advanced Economies: Unnecessary, Undesirable and Unlikely provide a comprehensive analysis of the fiscal challenges faced by different countries in the coming years.

Restructuring its debt is not a solution for Greece, which must instead persuade markets it is serious about reform, Poul Thomsen, deputy director and mission chief at the European Department of the International Monetary Fund told CNBC on Aug 06, 2010:

Debt surges

“Public debt levels among advanced economies have reached levels not seen before in the absence of a major war,” said Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department and one of the authors of two of the reports.

“The most indebted economies are approaching debt limits beyond which their fiscal positions may become unsustainable,” said Jonathan D. Ostry, Deputy Director of the IMF’s Research Department, and author of one of the reports.

General government debt in the G-20 advanced economies surged from 78% of GDP in 2007 to 97% of GDP in 2009 and is projected to rise to 115% of GDP in 2015.

The fiscal stimulus packages put in place to combat the worst effects of the crisis account for only one-tenth of the increase in public debt projected during 2008-15.

While debt is high, the IMF said default on sovereign debt would make little sense for advanced economies because the central problem in these countries is high primary deficits, not high debt service.

At the same time, the IMF cautioned that governments need to avoid complacency when their debt is close to its maximum sustainable level because there may be little warning from markets ahead of a very sharp spike in borrowing costs.

Legacy of issues

According to the global lender, the mismanagement of fiscal policy prior to the crisis lead to insufficient reduction of government deficits - - particularly during periods of strong growth - -and to debt accumulation, and left a legacy of debt issues for policymakers to address.

As a result, countries will need to modify their past behavior and clearly define their fiscal plans for the long-term, including pension and health care reforms. A credible future course for policy that differs fundamentally from normal historical patterns is needed when fiscal space - - the difference between current and maximum sustainable public debt - - is limited.

While countries need to adjust their expenditures and revenues over the coming years, how they adjust will depend on each country’s individual economic circumstances, the IMF said.

New policies needed when fiscal space is sparse

The economists say countries’ policy options depend in large part on how much fiscal space they have. History is not destiny, and limits to public debt are neither etched in stone nor a prediction that default is inevitable in cases of limited fiscal space. They are nevertheless a wakeup call that policy cannot proceed on a “business as usual” basis.

Credible action plans are also critical because financial markets may react with little warning in the case of countries whose fiscal space is limited. This implies the need to target debt levels that are well below the estimated debt limits, especially given the inevitable uncertainty surrounding such estimates.

Without a change to rein in large primary deficits public debt will spiral out of control, and governments could even risk their ability to tap the capital markets for sovereign borrowing. Higher debt levels also could create negative feedback effects through higher interest rates and lower economic growth, putting at risk the recovery.

The IMF says in its Fiscal Space paper, that Greece, Italy, Japan, and Portugal appear to have the least fiscal space (i.e., least scope for increasing public debt without a fundamental shift in the behavior of the primary balance), with Iceland, Ireland, Spain, the United Kingdom, and the United States also constrained in their degree of fiscal maneuver, the more so owing to the run-up in public debt projected in coming years as well as demographic pressures and the possible realization of contingent liabilities.