Happy IMF/World Bank spring meeting week to all who observe. That includes FT Alphaville, as there are usually some actually fascinating titbits in the various reports published in and around the economic jamboree, alongside the usual bloviating.
You can read Kristalina Georgieva’s opening remarks here (tl;dr just bland stuff about the IMF’s “Resilience and Sustainability Facility” climate initiative). She had already trailed the glum World Economic Outlook report forecasts for global economic growth before Easter.
The full WEO won’t be published until later today — with the Global Financial Stability Report coming out a bit later — but some of the early chapters that have already been released are worth a closer look.
For example, Chapter 2 deals with R*, one of FTAV’s fave subjects as well. You might already have seen the accompanying blog summary that argues that “interest rates (are) likely to return towards pre-pandemic levels when inflation is tamed”. The second chapter of the GFSR looks at shadow banking, which is interesting enough to dig into separately.
But the WEO gold mine so far is chapter 3, titled Coming down to Earth: How to tackle soaring public debt. You may be tempted to shout “2000-2022 called and wants its headline back” but the chapter does have some interesting nuggets, such as on Jamaica’s miraculous turnround.
You can read a precis in the accompanying IMF blog post, but here are the chapter’s main bullet points. Our emphasis in bold, and some thoughts at the bottom:
• First, adequately timed and appropriately designed fiscal consolidations have a high probability of durably reducing debt ratios. The average size of primary balance consolidations that reduced debt ratios in the past is about 0.4 percentage point of GDP, lowering the average debt ratio by 0.7 percentage point in the first year and up to 2.1 percentage points after five years. About half of the observed decreases in debt ratios are driven by suitably tailored consolidations.
• The effectiveness of fiscal consolidation in reducing public debt ratios is influenced by various factors. The probability of success in reducing debt ratios improves from the baseline (average) of about 50 percent to more than 75 percent when (1) there is a domestic or global expansion and global risk aversion and financial volatility are low, (2) the scope for “crowding out” effects is high (cases with initial high public debt and low private credit such that the benefits of reducing public debt can outweigh its costs), and (3) the consolidation is driven more by expenditure reductions than by revenue increases (in advanced economies).
• At the same time, because such conditions may not always hold, and partly because fiscal consolidation tends to slow GDP growth, the average fiscal consolidation has a negligible effect on debt ratios. Unanticipated transfers to state-owned enterprises (SOEs) and other contingent liabilities that get realized on government balance sheets, as well as unexpected exchange rate depreciations, which can increase the domestic value of foreign-exchange-denominated debt, can further offset debt reduction efforts.
• Debt restructuring is typically used as a last resort when other efforts to reduce debt have failed and requires careful consideration of risks and potential consequences. However, in emerging market economies and low-income countries, where most restructurings occur, restructuring can significantly reduce debt ratios by an average of 3.4 percentage points in the first year and 8 percentage points after five years.
Restructurings have historically had larger effects on debt ratios, especially in the short term, when they were (1) executed through face value reduction and (2) part of coordinated and large-scale initiatives for debt reductions (for example, the Heavily Indebted Poor Countries [HIPC] Initiative and Multilateral Debt Relief Initiative [MDRI]).
• Case studies highlight that, in practice, debt restructuring is always a very complex process that involves burden sharing among residents, domestic creditors, and foreign creditors. Restructuring can also have reputational costs, affect interest rates and future market access, and have internal distributional consequences. Therefore, debt restructurings are typically used as part of a broader policy package— often as a last resort after other efforts have failed and there is some urgency to reduce debt (or to provide clear signals that a reduction will come). It is by no means a free lunch for countries undergoing this process.
• Economic growth and inflation play an important role in reducing debt ratios. Growth reduces debt ratios not only through its effects on nominal GDP, but also because countries on average consolidate (run higher primary balances) during good times.
• In terms of policy lessons, countries aiming for a moderate and gradual reduction in debt ratios should implement well-designed fiscal consolidations, particularly when economies are growing faster and when external conditions are favorable. The debt reduction effects of fiscal adjustments are often reinforced when accompanied by growth-enhancing structural reforms and strong institutional frameworks.
• For countries aiming for more substantial or more rapid debt reduction, bold policy actions that do not preclude debt restructuring may be necessary. Fiscal consolidation may still be necessary to regain market confidence and recover macroeconomic stability. Regardless of the type of restructuring, lower debt ratios are achieved when restructuring is deep enough and is implemented together with comprehensive policy packages including IMF-supported programs.
• To ensure success of restructuring in reducing debt ratios, mechanisms promoting coordination and confidence among creditors and debtors are necessary. Improving the Group of Twenty (G20) Common Framework with greater predictability, earlier engagement, a payment standstill, and further clarification on comparability of treatment can help. Most importantly, prioritizing debt management and transparency in advance can reduce the need for restructuring and help manage debt distress, which would be in the interest both of debtor countries and of their creditors.
• Although high inflation can reduce debt ratios, the chapter’s findings do not suggest that it is a desirable policy tool. High inflation can lead to losses on the balance sheets of sovereign debt holders such as banks and other financial institutions and, more crucially, damage the credibility of institutions such as central banks.
• Ultimately, reducing debt ratios in a durable manner depends on strong institutional frameworks, which prevent “below the line” operations that undermine debt reduction efforts and ensure that countries indeed build buffers and reduce debt during good times. In the end, countries’ choices will depend on a complex set of factors, including domestic and external conditions, as well as on the fact that not all alternatives may always be available.
Basically, the IMF argues that governments tightening their belts can work — if the global economy is still humming along and the focus is on cutting expenses rather than increasing taxes. But “because fiscal consolidation tends to slow GDP growth, the average fiscal consolidation has a negligible effect on debt ratios”.
And countries tend to be too wary of restructuring, which (unsurprisingly) are a pretty good way of reducing your debts! Too bad the bankruptcy process for countries can be charitably described as a shitshow.
Source: Economy - ft.com
