Governments need 'agile' fiscal policies amid high debt and inflation, IMF says

Global co-operation is necessary to tackle 'pressing and urgent' problems from food and energy crises to climate change

The IMF slashed its world growth forecast by the most since the early months of the Covid-19 pandemic, and projected even faster inflation, after the Russia-Ukraine war and China's renewed coronavirus lockdowns. BloombergShow less

Governments need more "agile" fiscal policies to address increasing commodity prices, rising inflation, slowing economic growth, high debt, tightening credit conditions and a looming climate crisis, the International Monetary Fund has said.

Global co-operation is vital to address the consequences of the Covid-19 pandemic, tackle energy and food disruption, help refugees from the Russia-Ukraine war, prepare for potential pandemics and address climate change, the lender said in its Fiscal Report on Wednesday.

"The right policy mix depends on country circumstances. Where possible, governments should provide targeted and temporary transfers to the vulnerable while allowing domestic prices to adjust, which will help spur additional supply and avoid shortages," said Vitor Gaspar, director of the Fiscal Affairs Department at the IMF.

"Where social safety nets and information systems are less complete, other measures can be considered but they should be as targeted as possible and should include clear sunset clauses."

On Tuesday, the fund lowered its 2022 growth forecast for the global economy, as Russia’s war in Ukraine severely dents economic prospects and inflation stoked by soaring commodities prices threatens to derail momentum. It now projects global growth at 3.6 per cent in 2022 and 2023, revising it down 0.8 and 0.2 percentage points from its January forecast, respectively.

"Governments face difficult choices in this highly uncertain environment. They should focus on the most urgent spending needs and raise revenue to pay for them," IMF staff said in a blog post.

For the economies hardest hit by the Ukraine-Russia conflict, fiscal policy needs to respond to the humanitarian crisis and economic disruptions, it said. Given rising inflation and interest rates, fiscal support should be aimed at those most affected.

In countries where growth is stronger and inflation pressures remain high, their governments' fiscal policy should continue the shift from support to normalisation, the IMF said.

Countries with well-developed social safety nets could deploy targeted and temporary cash transfers to vulnerable groups while allowing domestic prices to adjust

Vitor Gaspar,
IMF's director of Fiscal Affairs Department

In many emerging markets and low-income economies facing tight financing conditions or the risk of debt distress, governments will need to prioritise spending and raise revenue to reduce vulnerability.

Commodity-exporting nations that benefit from higher prices should seize the opportunity to rebuild buffers, the IMF said.

"Government responses to the surge in international commodity prices should give priority to protecting the most vulnerable. A critical objective is to avoid a food crisis while keeping social cohesion," the fund said.

"Countries with well-developed social safety nets could deploy targeted and temporary cash transfers to vulnerable groups while allowing domestic prices to adjust. This will limit budgetary pressures and create the right incentives to increase supply (such as investing in renewable energy)."

Other countries could allow a more gradual adjustment of domestic prices and use existing tools to help the most vulnerable during this crisis, while taking steps to strengthen safety nets.

Rising oil prices further highlight the urgency in accelerating the transition to clean and renewable energy, which would increase energy security and help meet the urgent climate agenda, the fund said.

"We are dramatically off-track to limit global warming to 2°C," the IMF said.

The world needs a global carbon price exceeding $75 per tonne or equivalent measures by 2030. International income tax collaboration and an international carbon price floor for the largest emitters are important steps in global co-operation, it said.

About 60 per cent of low-income countries are either at high risk of debt distress or already experiencing it. They face persistent scarring from Covid-19. They are especially vulnerable to food price rises, given the large share of food spending in their household budgets. These countries need support from the international community, according to the IMF.

"But the need for collective action is broader. Global co-operation is necessary to tackle pressing and urgent problems that the world is facing: energy and food crises, current and future pandemics, debt, development and climate change," the IMF said.

Global debt levels were already high before Covid-19. But in the first year of the pandemic, total debt (including private debt) increased by 28 percentage points of global gross domestic product — the largest one-year increase on record, the IMF said.

More than half of this surge occurred on public balance sheets. In 2021, economic recovery, narrowing primary deficits and inflation surprises helped bring down public debt-to-GDP ratios.

However, debt ratios are expected to stabilise higher than pre-pandemic levels in most countries.

The average public debt in advanced economies is projected to decline to 113 per cent of the GDP by 2024, mirroring the recovery from the pandemic-related recession. Debt is projected to continue to rise in emerging markets, mainly driven by China, reaching 72 per cent of the GDP by 2024. Among low-income developing countries, debt is expected to gradually decline to 48 per cent of the GDP by 2024.

Annual inflation in advanced economies is projected to increase to 5.7 per cent in 2022 from 0.7 per cent in 2020.

In emerging markets and developing economies, inflation is even higher, but the increase is less pronounced (from 5.2 per cent in 2020 to 8.7 per cent in 2022).

"As monetary policy pivots to fight inflation, fiscal policy must pivot to maintain debt sustainability. In other words, budget constraints are back — and they are binding," Mr Gaspar said.