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Thursday, 18 April 2013 00:00
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US & Japan need large fiscal correction over 5-7 years


Though the US avoiding falling off the fiscal cliff and the persistently low bond spreads in Europe despite frequent crises in the periphery have resulted in the IMF talking of an improvement in the balance of risks in its latest Global Financial Stability Report (GFSR)—as compared to the last GFSR in October—there is still a lot of risk out there. In its hexagonal spider web, only “monetary and financial” risks are higher in April as compared to what they were in October, though the higher global “risk appetite” (cited as a positive) could well dissipate once global liquidity reduces. The IMF’s Fiscal Monitor, however, has some numbers that need careful watching and bring out quite clearly the medium-term nature of the risk. In the US, debt-to-GDP has risen from 75.5% of GDP at the time of the crisis in 2008 to 106.5% in 2012 and is projected to rise to 109.2% in 2014; for the euro area, the figures are 70.3%, 92.9% and 95.3% respectively; for Japan, this rose from 191.8% in 2008 to 237.9% in 2012 and will likely rise to 244.6% in 2014. While much lower borrowing costs in OECD countries means their sustainable debt-to-GDP levels are higher than those for developing countries, a number in excess of 80% is considered problematic—ultimately, higher servicing costs eat into GDP growth. As the Fiscal Monitor puts it about a medium-term debt-reduction plan, “the continued absence of such plans in Japan and the United States remains a significant concern”.

How does the US, for instance, move from its currently high levels of debt that make it vulnerable to shocks like those from the automatic sequester and the failure to reach a settlement on the debt ceiling? According to IMF data, the US had a primary deficit of 6.4% of GDP in 2012. Given the level of adjustment required, the IMF’s economists reckon the country needs to cut its primary deficit by around 0.9% of GDP every year till 2020 and by a slightly lower 0.8% if we’re looking at the longer 2013-2030 period. Given how US GDP collapsed from 3.1% in Q3 2012 to 0.4% in Q4 when growth in government spending fell from 3.9% in Q3 to minus 7% in Q4, that doesn’t augur too well for the future. While it puts a natural ceiling on OECD growth, it also ensures there will be a high degree of volatility in global growth for quite some time to come.


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