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Postcard from São Paulo: the Latest Global Fiscal News–and Some of It’s Actually Good

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In São Paulo, Brazil last Friday we launched our latest assessment of the state of government finances, debts, and deficits.  While many countries are slogging through a tough fiscal time, there is some good news, including in the United States where the deficit will be lower this year than previously expected.  I will also give you an assessment of how the new information affects our sense of what needs to be done in the future.

Let me start by talking about the advanced economies where, as is well known, the fiscal accounts are generally weaker, reflecting large increases in deficits and debt ratios since the start of the crisis in 2008. 

Most of these economies were planning to tighten fiscal policy this year, and the good news is that in the bulk of these adjustment looks to be solidly on track. Most advanced economies, especially Canada and in Europe, are making good progress in reducing their budget deficits. In some cases, such as Germany and Italy, they are even ahead of schedule. Given the evidence that the recovery in Europe has strengthened, these countries should continue with their fiscal adjustment plans.

Of course, the situation in some countries in Europe remains difficult, as reflected in rising financial market spreads in Greece, Ireland, and Portugal, as well as Cyprus. In Greece and Portugal, in particular, downward revisions to growth and other factors have implied the need for additional cutbacks.

Some good news

In the United States, recent fiscal news is good: strong revenue growth and a slower pace of expenditure means that the deficit will actually fall slightly this year, rather than increasing as expected. This means that the amount of fiscal adjustment that will be required to achieve the 2012 deficit target is smaller, and less likely to be detrimental to growth.

What remains missing in the United States is political consensus on the tools and targets to bring down debt and deficits, as part of a credible medium-term adjustment plan with objectives endorsed by Congress. Without such a plan, yield on U.S. government paper would sooner or later start reflecting a risk premium, which would not be good for the United States and the world economy.

The exceptions to the positive recent developments are in the Pacific: Japan, Australia, and New Zealand; all countries that were affected by serious natural disasters. The case of Japan is particularly noteworthy: a supplementary budget of about ¾ percent of GDP enacted after the tsunami was already reflected in the April issue of the Fiscal Monitor. A further supplementary budget is now expected that will increase spending next year by about 1 percent of GDP.

As a result, Japan will have the largest fiscal deficit among all major advanced economies this year and next.  This further weakening of the fiscal accounts makes the definition of a clear and detailed medium-term fiscal adjustment path even more urgent.

Many emerging economies are experiencing rapid growth, in some cases fuelled by favorable strong capital inflows that are boosting asset prices, and by high commodity prices. Some of these economies are making very good progress in tightening fiscal policy.

However, some emerging economies still have sizable deficits, especially India, but also Turkey, Mexico, and Brazil; even though our sense is that these economies are operating at very close to full capacity. Indeed, in 2012 one would like to see more tightening to reduce the risk of overheating in all four of these countries.

Developments in Latin America

As I was in São Paulo, there was a great deal of interest in developments in the region. There is certainly much to be pleased about how Latin America has weathered the global financial storm. A great deal has been done, for example, by strengthening fiscal institutions and improving the structure of public debt.

As a result, contagion from the crisis in the advanced economies was minimal, which is a welcome change from the past. Nevertheless, it is important to sound a note of caution: as detailed in the Fiscal Monitor, the overall deficit for Latin America remains higher than in the mid-1990s and is not much different from its historical average.  Public debt ratios in Latin America remain above those in emerging Asia and emerging Europe.

Many countries in Latin America will also face significant spending pressures in the future as infrastructural spending has been cut excessively over time and health care and pension spending are expected to rise. This means that considerable additional work will be required to strengthen fiscal sustainability and lay a solid foundation for the future.