Japan, Greece Among Nations Close to Having Unsustainable Debt, IMF Says
Greece, Italy, Japan and Portugal are the advanced economies hovering closest to unsustainable levels of government debt, International Monetary Fund staff said in a research note today.
The four nations are most at risk of needing drastic budget cuts to avoiding facing uncontrollable increases in public debt because traditional budget cuts won’t suffice, IMF staff said in the paper. The U.S. and Spain are also constrained, the report said. Still, a separate IMF report said indicators of default risk by a wealthy economy reflect “some market overreaction.”
“Since behavior can change, a finding that a country has little or no fiscal space is not a prediction that public debt will explode or that the government will default -- history is not destiny -- but rather that something must change and fiscal policy cannot proceed on a ‘business as usual’ basis,” the economists wrote. “Specifically, fiscal policy will need to react more strongly to debt than past behavior would suggest.”
Investors’ concerns about sovereign debt levels surfaced this year when Europe’s Greece-born debt crisis sent bond yields soaring in Portugal and Spain and threatened to shatter confidence in the euro. While a $1 trillion rescue plan crafted by European officials and the IMF have helped lower borrowing costs, Irish bond yields jumped to the highest since May last week after Standard & Poor’s cut the country’s credit rating on concern bailing out its banks will swell the budget deficit.
Default Risk
In the second of three reports released today, IMF economists dismissed risks of default in Europe, even as volatility “remains high” in the region’s bond market. They said that even though the fiscal adjustment needed will be “difficult,” it has been attained before.
“There is too much pessimism,” Carlo Cottarelli, who heads the IMF’s fiscal affairs department, said on a conference call today. “Every single auction in Europe is seen as a possible trigger of something bad.”
The European Union last month said Greece is on track to reduce its budget shortfall by 5.5 percentage points this year. Among austerity measures to reduce its deficit, Spain cut public-sector wages by 5 percent. Portugal has also raised taxes and cut spending.
In the past, countries that have defaulted struggled with high interest rates, which is not the case in today’s advanced economies that still have large budget deficits after interest payments on their debt, according to the study.
‘Market Overreaction’
“In our view, the risk of debt restructuring is currently significantly overestimated,” the economists wrote. “Although it is generally wise to assume that market developments reflect economic fundamentals, market overreaction does occur from time to time, with adverse implications for countries.”
For countries that have faced market pressures, average rates on the stock of government debt remains “relatively low,” giving them time to convince markets of their efforts before their total interest bill gets too high, IMF economists said.
In the case of Greece, which got a 110-billion euro ($141 billion) bailout package from IMF and the European Union, it has no need to go back to the market for the three years of the loan, they argued.
“The financial crisis has the potential of changing fiscal policy-making for decades to come,” IMF economists wrote in the third study. While fiscal adjustment is “crucial,” at the same time it “cannot be too abrupt.”
Countries that have the most leeway before reaching their debt limit include Australia, South Korea and Denmark, according to the study.
The IMF forecasts that debt in the Group of 20 advanced economies will reach 115 percent of their gross domestic product by 2015, compared with 78 percent in 2007.
To contact the reporters on this story: Sandrine Rastello in Washington at srastello@bloomberg.net;
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