IMF Warns US, Other Countries on Dangers of Soaring Debt

Wednesday, 01 Sep 2010 02:55 PM

Investors have overestimated the risk of default in debt-burdened advanced economies, the International Monetary Fund said on Wednesday.

Repairing public finances is a daunting task that will pressure global economic growth, but countries have successfully adjusted before and they can do it again, the IMF said in a set of policy papers focusing on the fiscal condition of major developed economies.

"Although the fiscal fundamentals look challenging, current market indicators of default risk seem to reflect some market overreaction," the IMF said.

Over the past three decades, there were 14 instances in which advanced economies managed deficit reductions of the magnitude that will soon be needed in most rich countries.

"Admittedly, this will be the first time that most advanced economies have to adjust simultaneously by such large amounts, implying a nontrivial drag on economic growth," it said.

"Judging from past experience, such a major adjustment will no doubt be difficult, but is possible."

Investors have driven up the price of insuring against a debt default in several European countries. Greece, Spain and Portugal have also seen their borrowing costs jump because of concerns about debt sustainability.

The IMF offered a rebuttal of some of the most commonly raised arguments that a default or restructuring is inevitable, particularly in severely indebted countries such as Greece.

It said countries that default typically struggle with high interest burdens. For most rich countries, the primary problem now is the sheer size of the deficit, not the interest bill.

Even countries that are paying higher rates have time to adjust because the average maturity of their government debt is seven years.

The IMF also examined which countries were running out of fiscal room and must quickly shift their focus to curbing deficits.

The list of countries with little or no fiscal space included well-known trouble spots such as Greece, Portugal, Italy and Japan.

"An absence of fiscal space should be not be taken to mean that some form of fiscal crisis is imminent, or even likely, but it does underscore the need for credible adjustment plans," the IMF said.

Among the countries the IMF deemed "constrained" were the United States, Britain, Ireland, Spain and Iceland.

The findings were based on a historical study of how well countries had adjusted to debt increases in the past, so the IMF stressed that behavior can — and must — change.

It said countries nearing their upper fiscal limits would need to take timely steps to "increase the probability that public debt will remain on a sustainable path and convince markets that fiscal policy is not proceeding on a 'business as usual' basis."

Among the countries with the most fiscal room were Australia, Denmark, Korea, New Zealand and Norway.

The IMF warned in May that high government debt burdens may constrain growth for years as countries cut spending and raise taxes to reduce deficits.

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