10-11-2013 03:27 PM

Fiscal sustainability: Breaking BRIC piggy banks

SINCE 2009 the word “austerity” has not been too far away from the lips of finance ministers across the globe. Deficits and debt-to-GDP ratios around the world surged due to the financial crisis, and it was felt that they were fast becoming unsustainable. Once the immediate danger of the global recession passed politicians across the globe rushed to reduce their budget deficits (often using, as an excuse, the publication of a now infamous paper*written in 2010 by Carmen Reinhart and Kenneth Rogoff, suggesting that growth slows down in countries with debt-GDP-ratios of over 90%).*
Some countries had extraordinary success in tightening their fiscal balances. America, for instance, managed to cut its budget deficit from over 12% of GDP in 2010 to an estimated 4% in 2013. Others still have much more work to do. International Monetary Fund (IMF) forecasts suggest that the developed world, as a whole, will not have a balanced fiscal position until 2018, even before paying interest on government debt.
Emerging market countries and the developing world got into the act too. Between 2009 and 2011, they managed to reduce their primary budget deficits from 4.2% to 1.2% of GDP.


But as figures from the IMF’s most recent Fiscal Monitor Report*released on October 9th detail, trends in fiscal consolidation in the developed and developing worlds have diverged*since 2011. Although primary deficits in advanced economies continued shrinking from 4.7% to 2.7% of GDP between 2011 and 2013, in the developing world they have started to increase again (see chart). They have in fact doubled from 1.2% of GDP in 2011 to 2.4% in 2013, reversing, rather than mirroring, trends in the developed world. The IMF now warns that “fiscal vulnerabilities” are growing again in these countries, rather than subsiding as in the developed world. More worryingly, structural deficits have also increased again in both emerging-market and developing world economies since 2011. Although the IMF expects these to stabilise in 2014, it sees additional reductions as unlikely.

Fiscal headroom, in particular, has decreased in emerging-market economies, including the “BRICs”. This has, more often than not, been the result of external shocks rather than the result of deliberate policy choices. Lower than expected global growth rates in 2011 and 2012 reduced demand for their imports. Falling oil prices have hurt the budget positions of Russia and other oil-exporting countries, which have become increasingly reliant on high oil prices to balance their budgets. Worries about tapering this summer caused capital flight from places like India, which further impaired growth (and nudged up interest rates) and pushed its fiscal deficit up to a forecast 8.5% for the 2013/14 fiscal year.
Even countries that have looked prosperous over the last few years now seem a bit less healthy. Most strikingly, rising production costs in Brazil and China have lowered competitiveness and growth rates over the last few years. And since 2011 their economies have become increasingly reliant on deficit spending for stability. Including quasi-fiscal measures, such as local-government financing and off-budget funds, deficits in 2013 surged to 3% of GDP in Brazil and as high as 10% in China.*
Further threats to fiscal stability in emerging markets are growing. Tapering—or even the threat of it—may deliver a shock to government bond yields and deficits. As problems in India this summer have shown, increased borrowing costs can quickly cause problems in an economy with little fiscal or monetary headroom. Although the decision of the Federal Reserve last month to delay tapering has given emerging markets time to breath, this will not last forever. Emerging-world governments might do well to use the respite to make progress towards balancing their budgets, in order to reduce dependence on cheap foreign financing. Structural reforms, to boost competitiveness and growth rates, are certainly easier to make while the sun is still shining. Otherwise, putting the inevitable off may make reform later on much more painful.



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