Cost Of Recovering

Economists at BNP Paribas are focusing on "Fiscal Jitters" today, while the problem was very clear some months ago ... Well, we have nice capital gains in the risky asset markets now, so a basis for taxes is created?

Well, let' s move to the folks at BNP Paribas, who have following considerations:

1. The deterioration of public finances over the past two years has been unprecedented. According to the IMF, public deficits globally widened from an estimated 0.5% of GDP in 2007 to 6.7% of GDP in 2009 (Chart 1). The deterioration was even greater for advanced economies, given the bigger role of automatic stabilisers. The public deficit in advanced economies is estimated in excess of 8.5% of GDP this year, from 1.2% of GDP in 2007.

Click on chart to enlarge, courtesy of BNP Paribas.

2. This deterioration has not been merely cyclical. Indeed, about half of the deficit widening over the past two years was due to discretionary measures and/or more structural trends in expenditures and revenues.
3. Public debt is estimated to rise sharply over the next few years across all advanced economies, with the exception of Australia and Canada. The worst affected economies are those in which growth has been most reliant on consumer and domestic demand. Our estimates, for example, suggest that in the absence of corrective action, the UK and the US could end up with net debt at a level comparable with, or even above, that of Italy by 2015.
4. These trends do not take into account unfunded public pension liabilities and unfunded future health-care liabilities. In a number of countries these are significant due to unfavourable demographic trends, implying the risk of an even worse outlook for public-sector finances. The EU Commission, for example estimates that age-related public expenditure in the eurozone will increase on average by 4.8 percentage points of GDP by 2060.
5. Large corrections of fiscal balances are therefore needed in order to reverse the unfavourable trends in public debt. According to IMF’s estimates, the average adjustment of the primary surplus required to stabilise the debt-to-GDP ratios of advanced economies to their post-crisis levels is between 3.5% and 5.2% of GDP. But, if the aim is to reduce the average debt to 60% of GDP, the adjustment required could be as high as 9.1% of GDP.
6. These estimates are consistent with the effort required in past significant fiscal adjustments (which are described in Table 1).

Click on table to enlarge, courtesy of BNP Paribas.
BNP Paribas draws conclusions:

- The needed fiscal adjustment is a significant risk for the sustainability of the undergoing economic recovery in the medium term.
- We are not likely to see any significant fiscal adjustment until at least the end of 2010, with the UK probably the only notable exception. This could be an increasing source of concern for the markets.
- Last but not least, in line with the principles set up by the IMF, fiscal consolidation ‘should be a top policy priority’ while ‘monetary policy can adjust more flexibly when normalisation is needed’. This is one of the reasons – combined with unspectacular growth in the medium term and persistently low and slowing core inflation – why
we believe that the market went ahead of itself in pricing in rate hikes in advanced
economies.

In fact, the situation with government finances may be much worse, if one assumes also the off-balance sheet liabilities.

Click on chart to enlarge, courtesy of Societe Generale.
Governments are risking the confidence ...