Wednesday, July 13, 2011

Global Gloom — Decelerating Growth & Accelerating Deficits

Recent global economic assessments and outlooks of major international agencies like the IMF, United Nations and World Bank, show slowing global growth and worsening of unresolved problems related to fiscal crises. The global economic growth after powering up to 3.9 per cent in 2010 will slow to 3.2 per cent, as high food prices, possible additional oil-price spikes, and lingering post-crisis difficulties in high-income countries pose downside risks, according to the World Bank. According to the UN new headwinds have also emerged in 2011; the earthquake, tsunami and nuclear crisis in Japan shook world financial markets and disrupted important global supply chains. The political unrest in Western Asia and North Africa has been a source of a renewed surge in oil prices and international prices of food and other primary commodities have also soared in the year.

The United States economy expanded by 2.9 per cent in 2010, driven mainly by domestic demand, while weaker net exports had a dampening effect on growth; the economy is expected to slow down or at best stagnate in the current year. In April 2011, Standard & Poor's downgraded its outlook on United States sovereign debt, underscoring the urgency for policymakers to set up a credible framework to address its public debt. According to the IMF, the deficit projection for 2011 has been revised significantly downward, as post–April 15 data on revenues have come in stronger (in part because of sizable capital gains in 2010) and expenditures have been more contained than initially projected. However, the situation stands nowhere near resolved.

In the Euro zone negative sovereign ratings actions have spread beyond Greece, Ireland, and Portugal further into other euro area countries reflecting concerns that it will be difficult to reach the political consensus necessary for fiscal consolidation and structural reforms, according to the IMF. According to the United Nations, the recovery in Western Europe continues at a modest and uneven pace. Industrial business confidence indicators have returned to pre-crisis peaks in early 2011, but economies will face strong headwinds during the remainder of the year: GDP growth in the euro area is expected to average 1.6 per cent in both 2011 and 2012. Germany is expected to grow by 2.9 per cent in 2011, while the countries most affected by the fiscal crisis—Greece, Ireland, Portugal and Spain—will either remain in recession or, at best, register very modest growth rates. The positive demand effects from slowly improving employment conditions will be dampened by the negative impact of fiscal retrenchment.

Policy Measures Adopted or Announced for 2011 in Selected European Countries
(Announced impact on 2011 general government balance in percent of GDP)


Revenue and other receipts




Reduction in tax expenditures, including property taxes and VAT; various measures to speed up collection of tax arrears and penalties; measures against fuel smuggling; renewal of Telecom licenses; and extension of airport concessions (2.4 percent of GDP)

Wage cuts and tariff increases in public enterprises; restructuring of public entities; reduction in public wage bill (e.g. through reduction in short-term contracts and attrition-based reductions in employment); health reforms (drug and other cost savings and increases in co-pay for hospitals); rationalization of entitlements, including means-testing of family benefits; and reductions in transfers to public entities outside general government, operational expenditures, and military deliveries (2.7 percent of GDP)



Revisions to PIT bands and credits; integration of health and income levies into universal social charge; tightening of various tax reliefs on private pensions contributions; and reduction in tax expenditures (1.2 percent of GDP)

Reduction in public payroll and discretionary expenditure, non-progressive social welfare benefits and capital spending (2.6 percent of GDP)



Increase in the VAT standard rate (by 2 percentage points) and PIT and CIT rates; broadening of the SSC base; introduction of a new tax on the banking sector; adoption of tolls; and revision of penalties and fees (2 percent of GDP)

Reduction in public payroll (cuts in wages and the number of employees); pension freeze; cuts in social transfers and improvement of means-testing; reduction in capital expenditures and intermediate consumption; savings in health/pharmaceutical products; and cuts in transfers to SOEs and local governments (3.7 percent of GDP)


Fiscal Monitor Update, June 2011, IMF.

Market concerns about debt sustainability remain acute in Greece, where spreads have risen by 600 basis points since end-2010, to almost 1,700 basis points in early June. In Ireland and Portugal spreads have risen by 100–230 basis points to reach more than 700 basis points. Contagion to other Euro-area countries has been more limited, with spreads broadly stable in Belgium, Italy, and Spain. Despite ongoing fiscal consolidation, however, spreads remain in the 140–260 basis points range for these countries. Purchases of government bonds by the U.S. Federal Reserve since end-2010 have amounted to US$500 billion—with total envisaged asset purchases of US$600 billion under the second round of quantitative easing slated to end in June—bringing its holdings to 15 percent of publicly-held government debt. Securities purchases by the Bank of Japan (BOJ) are continuing. The BOJ now holds 7½ percent of outstanding government debt. Meanwhile, there have been no further market interventions by the ECB since March; its holdings of government securities remain equivalent to 11 percent of the outstanding debt of Greece, Ireland, and Portugal. In contrast, the Bank of England essentially halted its net purchases of government debt about a year ago, though its stock of holdings still stands at 16 percent of outstanding U.K. sovereign debt.

At home the Indian economy has slowed down resultant on the tight monetary and fiscal policies needed for fighting accelerating inflation. The government has been banking on strong economic growth to help meet its deficit target of 4.6 per cent for the current fiscal, but a spike in global oil & commodity prices leading to a slowing economy and a rising subsidy bill could well upset the fiscal calculations. In a signal that the government is worried about the state of its finances, the finance ministry announced a host of other measures to reduce expenditure and restrict the fiscal deficit. The last time such measures were taken was in 2008-09 after the collapse of Lehman Brothers that pushed the global economy into recession, when the finance ministry had asked all departments to cut non-Plan expenditure by 10 per cent.