Weak Global Economy Will Hamper Debt-Reduction, IMF Says

The weak global economy will make it more difficult for countries including Italy and Greece to follow Canada’s 1990s lead in large-scale debt reduction, according to the International Monetary Fund.

The external environment has been an important element for nations that embarked on fiscal plans, the IMF said today, drawing on lessons from six developed countries’ responses to high debt levels at different times in the 20th century.

Governments with high debt levels today face a world of “widespread fiscal consolidation efforts, deleveraging pressures from the private sector, adverse demographic trends, and the aftermath of the financial crisis” that’s unlikely to provide support, the IMF wrote in a chapter of its World Economic Outlook. “Expectations about what can be achieved need to be set realistically.”

The study gives historical perspective to efforts currently under way in the euro area to end a debt crisis that’s engulfed nations from Ireland to Spain. At the epicenter of the turmoil, with its economy contracting, Greece is trying to bring back its debt ratio under 120 percent of gross domestic product by 2020, from more than 165 percent last year, as part of an international bailout package that’s already forced investors to take losses in a debt exchange.

Limited Progress

The IMF study said that progress in the euro region may be limited until issues around the monetary union and the financial sector are addressed. By contrast, conditions in the U.S. are in place for fiscal consolidation, according to the Washington- based fund.

With little support from external conditions, governments must make sure that their fiscal consolidation plans also come with measures to support growth, in particular low interest rates, according to the report. They should avoid temporary measures and make in-depth changes to their economies, it said.

The chapter, called “The Good, the Bad, and the Ugly: 100 years of Dealing with Public Debt Overhangs,” looks at what happened in countries where debt rose beyond 100 percent of GDP and focuses on the U.K. after World War I, the U.S. after World War II, and Belgium, Canada, Italy and Japan in the 1980s and 1990s.

In another chapter, the IMF looked at the resilience of emerging markets. Developed economies have for the first time spent more time expanding over the last decade than their developed counterparts because of improved policies and fewer shocks, according to the study.

Still, the threat of drastic fiscal consolidation in the U.S. and a prolonged debt crisis in Europe are risks for emerging markets as well, according to the IMF.

“Should the external environment worsen again, emerging market and developing economies will likely end up recoupling with advanced economies, much as they did during the Great Recession,” the IMF said.

To contact the reporter on this story: Sandrine Rastello in Washington at srastello@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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