- Underlying causes of current sovereign debt crisis were present long before the onset of the global financial crisis of 2007-2008
- Aging populations and an interconnected ‘global’ economy will compound the deficit challenge over the medium to long-term
- KPMG proposes comprehensive fiscal sustainability framework to meet long-term financial challenges
The roots of the current sovereign debt crisis do not solely lie in the global financial crisis of 2007-2008, according to a new report, entitled Walking the fiscal tightrope: a fiscal sustainability framework for government, from KPMG International.
KPMG research of the fiscal policy settings of 19 of the G20 economies reveals that levels of government debt were already reaching their limits long before the global financial crisis hit, and the impact of aging populations and the interconnected global economy require long-term policies to prevent debt conditions from worsening.
KPMG report finds that those countries with high levels of gross debt prior to the start of the crisis - in excess of 60 percent of gross domestic product (GDP) - have been the most limited in their ability to adequately respond to the issue and are now facing a longer and more difficult path back to sound fiscal sustainability.
“Our research suggests that, in most cases, short-term thinking and political expediency tend to trump considerations of long-term fiscal sustainability,” said John Herhalt, KPMG’s Global Head of Government and Infrastructure, and a partner in the Canadian firm. “The only way to truly turn the corner on the sovereign debt crisis is for governments to commit to sustained fiscal policy implementation across the political cycle, a strategy that the so-called Fiscal Compact in the euro zone intends to create.”
While the research indicates that these deep-seated issues will not likely disappear any time soon, it also notes that the slow outlook for world economic growth in the near-term coupled with the rising costs created by intergenerational aging for many governments will further impact upon fiscal sustainability targets. This, in turn, will heighten the need for sustained fiscal policy action (such as prudent budget management and the restoration of balance sheet health) over the next 40 years.
The report finds that the greatest government debt burden is being carried by the developed world, even though both developed and developing economies command roughly the same percentage of world GDP. By 2015, the top seven developed countries included in this survey (Canada, France, Germany, Italy, Japan, UK and US) will make up 86.5 percent of the total general government sector (GGS) debt accumulated by the 19 countries, while the eight developing countries (Argentina, Brazil, China, India, Indonesia, Mexico, South Africa and Turkey) will hold only 11.6 percent.
“This finding is particularly important given the increasing interconnectedness of the global economy,” said Nick Baker, Global Head of KPMG’s Finance & Treasury practice. “Slow growth outlooks within any sizable portion of the world economy will inevitably lead to fiscal challenges in other jurisdictions, making the government debt levels of the developed world particularly worrying for the prospects of those economies in the developing world.”
KPMG’s Herhalt, Baker and other authors of the report suggest a comprehensive fiscal sustainability framework built on a core set of elements, including:
- Balanced fiscal policies to govern for the common good of both current and future generations.
- Clearly defined targets and measurements to monitor fiscal sustainability progress.
- Implementation addressing fiscal sustainability not just across the budget cycle (1-5 years), but also the economic cycle (6+ years) and the intergenerational cycle (10+ years).
- Mechanisms and institutional objectives that will serve to sustain policy across the political cycle.
- The coordination of robust regulatory and financial system institutional frameworks, fiscal policy and rigorous fiscal management practices.
“Ultimately, the fiscal sustainability of government finances for both developed and developing economies depends on managing a combination of global economic shifts; existing sovereign debt levels; potentially slower global growth; and the impact of intergenerational change upon government finances,” added Mr. Baker. “It is not about the size of government spending per se, nor is it about the extent of social welfare or the level of entitlement spending that a nation’s citizenry wishes to embrace – it is about ensuring that short-termism and political expediency do not endanger a nation’s long-term fiscal viability.”
Budget cycle data shows that Russia has maintained net fiscal lending/borrowing at sustainable levels. The years 2000 through to the onset of the GFC (2007) show a series of small to sizeable surplus results ranging from between +8.33 percent of GDP (2006) to +0.72 percent of GDP (2002). While there was a continuing surplus in 2008, the years 2009 and 2010 saw a notable deficit response to the GFC of -6.31 percent and -3.51 percent of GDP respectively. The forward estimates period (2012-15) shows a series of small deficits/surpluses ranging between +0.59 percent of GDP (2012) and -1.58 percent of GDP (2015) as the economy is managed through the budget cycle.
Fiscal policy and strategy
Budgeting procedures in Russia have undergone a transformation since the introduction of the Budget Code in 1998. Revisions to the Code were undertaken between 2003 and 2007.
The Code sets out:
- the annual budget laws and prescribes the annual budget preparation and execution time schedule
- federal and regional government responsibilities, and regulates their financial relations• a single Treasury account and (in the 2007 revision) regulations relating to a deficit target for the non-oil and gas revenue and expenditure (at 4.7 percent of GDP)*
- a medium-term fiscal framework including the requirement for 3-year budgets.
It is important to note the Russian government’s dependence on, and the part played by, oil and gas revenue in terms of its overall revenue base. The vulnerability of this revenue to world oil price fluctuations is evident in the Russian government’s forward estimates and the IMF has recently stressed the importance of strengthening the fiscal framework in Russia to specifically focus on the non-oil fiscal balances and not just the overall fiscal balance.
Economic cycle data shows that Russia has significantly reduced the level of gross debt from 59.86 percent of GDP (2000) to 11.69 percent of GDP (2010). This level of gross debt is also anticipated to continue through the economic cycle with an estimated level of 9.74 percent of GDP for 2015. Net debt figures were not available.Fiscal policy and strategyThe fiscal frameworks and reforms that have been put in place in recent years have not only been focused around areas such as deficit targets, they have also established rules for public debt. One of the mechanisms that Russia used to manage the surplus revenue from oil (when prices are high) is to set funds aside into either the Reserve Fund (RF) or the National Wealth Fund (NWF). While the RF is used as a general provisioning mechanism, the NWF is a revenue-smoothing mechanism whereby oil and gas revenue can be drawn upon over the medium to long term.
Fiscal policy and strategy
The fiscal frameworks and reforms that have been put in place in recent years have not only been focused around areas such as deficit targets, they have also established rules for public debt. One of the mechanisms that Russia used to manage the surplus revenue from oil (when prices are high) is to set funds aside into either the Reserve Fund (RF) or the National Wealth Fund (NWF). While the RF is used as a general provisioning mechanism, the NWF is a revenue-smoothing mechanism whereby oil and gas revenue can be drawn upon over the medium to long term.
In the period from 2010-25, the ratio of aged persons (over 65) to those of working age (15-64) will rise from 17.8 percent to 26.4 percent. Russia is in the medium aged ratio cohort of the G20 group of countries with population aging now becoming an emerging issue.
Fiscal policy and strategy
Russia faces long-term fiscal risks from the cost of both health and pensions, as healthcare spending could increase by between 0.7 percent and 1.6 percent of GDP between 2010 and 2030, and various studies estimate that pension spending will increase by 4 percent to 7 percent of GDP by 2030. On average, revenues will have to increase by 1 percent of GDP every 5 years during 2010-50 to meet this budgetary demand.
KPMG examined the fiscal policy settings of 19 countries within the G20 group of countries across the budgetary, economic and intergenerational cycles. The report offers a country-comparative perspective in order to highlight some of the existing fiscal policy framework elements against the trend perspective offered by each country’s relevant government financial statistics. The report focuses specifically on the general government sector (GGS) to enable the application of an ‘entity’ lens rather than a macroeconomic one. The data tables and much of the commentary included in this paper is based on the extensive and ongoing work done by the IMF, World Bank and Organization for Economic Co-operation and Development (OECD).