Wednesday, September 09, 2009

IMF: As economy recovers, exit strategies are key

Reporting by Lesley Wroughton; Editing by Andrea Ricci

Failure to define stimulus exit strategies could undermine the slow global recovery currently under way, senior International Monetary Fund economists said Wednesday, also warning that the surge in public debt will need to be reined in.

In a series of articles published in Finance and Development magazine, the economists argue that failing to properly plan strategies to remove stimulus could destabilize expectations and weaken the effects of the fiscal and monetary policies put in place over the past two years of the crisis.

IMF chief economist Olivier Blanchard said major advanced economies could probably not afford to provide fiscal stimulus for very much longer without structural adjustments, although he emphasized it was too early in the recovery to withdraw the stimulus.

To prolong the stimulus, he said countries will need to tackle entitlement programs with more vigor, whether rising outlays are driven by healthcare or support for an aging population.

The economists said the unprecedented fiscal and monetary response to the crisis was necessary to tackle the financial upheaval but the result was a massive surge in public debt.

IMF figures show that the ratio of debt to gross domestic product is expected to rise to 115 percent in advanced economies in 2014 from 75 percent in 2007.

Debt ratios will be close to, or exceed, 90 percent by 2014 in all seven major industrial countries except Canada, IMF data shows.

The economists said the bulk of the debt increase stems from fiscal stimulus and will require an unprecedented fiscal adjustment over the next few decades.

"Failure to address the trend of rising debt could lead to concerns that the debt will ultimately be 'inflated away' or that default is inevitable," said Carlo Cottarelli, director of the IMF's Fiscal Affairs Department, and Jose Vinals, director of the IMF's Monetary and Capital Markets Department.

"Interest rates would then rise, making the fiscal problem worse and potentially killing the recovery," they added.

A study by the IMF's Fiscal Affairs Department suggests that advanced countries with higher debt would have to maintain an average primary surplus of 4.5 percent beginning in 2014 to reduce the debt to 60 percent of gross domestic product by 2030.

The economists said the fiscal adjustment would have to go beyond pensions and health care, to revenues and expenditures, including broadening of tax bases and tax structures.

In planning stimulus exit strategies, Cottarelli and Vinals said central banks will have to look at unwinding or limiting the unconventional crisis-related practices, restructuring balance sheets and preparing to tighten monetary policy.

While it was still too soon to tighten monetary and fiscal policy, it wasn't too soon for governments to anchor expectations by defining and communication their strategies and proposed measures to ensure fiscal solvency, they added.

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