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Continued progress in reducing advanced economy deficits and a gradually improving external environment have lowered short-term fiscal risks, according to this issue, but global prospects nevertheless remain subdued, and many advanced economies face a lengthy, difficult and uncertain path to fiscal sustainability.
The key elements of the required policy package are well known: foremost among them is setting out—and implementing—a clear and credible plan to bring debt ratios down over the medium term. Debt dynamics have remained relatively positive in most emerging market economies and low-income countries, and most plan to continue to allow the automatic stabilisers to operate fully, while pausing the underlying fiscal adjustment process. Those with low general government debt and deficits can afford to maintain a neutral stance in response to a weaker global outlook. But countries with relatively high or quickly increasing debt levels are exposed to sizeable risks, especially once effective interest rates rise as monetary policy normalises in the advanced economies and concessional financing from advanced economies declines. The widespread use of energy subsidies makes commodity prices an additional source of vulnerability in many emerging market and low-income economies; subsidy reform, higher consumption taxes and broadening of tax bases would help support consolidation efforts.
Thanks to steady consolidation following the peak of the crisis in 2009, many advanced economies are now close to achieving primary surpluses that will allow them to stabilise their debt ratios. Although this is an important milestone, it is only a first step. High debt—even if stable—retards potential growth, constrains the scope for future discretionary policy, and leaves economies exposed to further market shocks. Sharp increases in public debt have not yet provoked a surge in interest rates in many advanced economies, but lower rates are unlikely to persist indefinitely, especially as they reflect in part very relaxed monetary conditions that must eventually be reversed.
Sustained consolidation efforts to reduce debt ratios to more appropriate levels are therefore essential, although in practice it is difficult to pinpoint what constitutes a prudent amount of public debt. Several advanced economies are now within about 1 percentage point of a primary surplus that, if maintained, would bring their debt ratios to 60 per cent of GDP by 2030. But even maintaining these surpluses over time may be difficult. Altogether, about one-third of advanced economies—representing some 40 per cent of global GDP—still face major fiscal challenges. Most of these countries have never experienced debt levels similar to the current ones, and certainly not for decades. They will need to undertake unprecedented fiscal efforts to bring their debt ratios to traditional norms, even if this is to occur only over a relatively long horizon.
The amount of fiscal adjustment that each advanced economy requires depends on its initial conditions, its ultimate objectives, and the macro-economic conditions that will prevail in the interim. But to make rapid progress in bringing down debt ratios, it will be critical to maintain the minimum possible differential between the interest rate on public debt and the growth rate of the economy. In most cases, there is scope for structural reforms to raise potential growth, which would help lower the debt-to-GDP ratio more quickly both by buoying the fiscal balance and through denominator effects. Of course, faster growth will likewise help reduce the social costs of fiscal consolidation and enhance its political sustainability. And to keep interest rates low, it will be essential that highly indebted advanced economies continue to undertake policies that will maintain market confidence.