May 30, 2024
World Economy

Why Our World Needs Fiscal Restraint in Biggest-Ever Election Year

The global economic and financial outlook has improved in the last six
months. Inflation has fallen, financial conditions have eased, and risks to
the outlook are balanced. However, many countries continue to struggle with
high public debt and fiscal deficits amid new challenges from high real
interest rates and dimming medium-term growth prospects.

latest Fiscal Monitor calls for governments to avoid slippages and focus more on rebuilding
buffers and safeguarding fiscal sustainability over the medium term.

Fiscal policy shifted to be more expansionary last year after a rapid
improvement in debt and deficits in the prior two years. Only half of the
world’s economies tightened fiscal policy last year, down from about 70
percent in 2022.

Four years after the start of the pandemic, public spending, excluding
interest payments, remained about 3 percentage points of gross domestic
product above prepandemic projections in advanced economies, excluding the
United States, and 2 percentage points above them in emerging market
economies, excluding China. This spending level reflects the slow unwinding
of crisis-era fiscal policies and the introduction of new support measures,
alongside new industrial policy measures including subsidies and tax
incentives. Higher nominal interest rates pushed up interest payments in
most economies.

Global public debt edged up to 93 percent of GDP in 2023
and remained 9 percentage points above the prepandemic level. The increase was
led by the two largest economies, United States and China
, where debt rose by over 2 and 6 percentage points of GDP respectively.

These two economies also shape global fiscal developments and outlook.
Slowing growth in China could weigh on global growth and trade, posing
fiscal challenges for countries with strong trade and investment linkages.
High and volatile government bond yields in the United States would lead to
tighter financing conditions in the rest of the world.

Moderate fiscal tightening is expected to resume this year, but significant
uncertainty remains.

In 2024, a record number of countries, home to more than
half of the world’s population, are holding national elections. History shows
governments tend to spend more and tax less during election years. Deficits in
election years tend to exceed forecasts by 0.4 percentage points of GDP,
compared to non-election years. In this great election year, governments should
exercise fiscal restraint to preserve sound public finances.

While we project modest fiscal tightening over the medium term, it will be
insufficient to stabilize public debt in many countries. Our chapter shows
that, under current policies, primary deficits—which exclude interest
expenses—will remain above debt-stabilizing levels in 2029 in about a third
of advanced and emerging market economies and in almost a quarter of
low-income developing countries. The size of necessary further adjustments
varies. The required average reduction in primary deficits is particularly
large for emerging markets with rising public debt-to-GDP ratios in our
projections. We estimate it at 2.1 percentage points of GDP. The country
groups in this paragraph include the two largest economies—the United States
and China—in the appropriate aggregate.

Without further efforts, the return of fiscal policy to its prepandemic
normal may take years. Spending pressures to address structural
challenges—including demographic and green transitions—are becoming more
pressing, while slowing medium-term growth prospects and high real interest
rates are likely to further constrain fiscal space in most economies.

Countries need decisive efforts to safeguard sustainable public finances and
rebuild fiscal buffers. The pace of consolidation should be calibrated
depending on fiscal risks and macroeconomic conditions that each country
faces. Countries will need to act resolutely in cases where sovereign risks
are elevated and fiscal credibility is lacking.

Governments should immediately phase out legacies of crisis-era fiscal
policy, including energy subsidies, and pursue reforms to curb rising
spending while protecting the most vulnerable. Advanced economies with aging
populations should contain spending pressures for health and pensions
through entitlement reforms and other measures.

Revenue should keep up with spending over time. In advanced economies,
targeting excessive profits as part of the corporate income tax system could
further bolster revenues. Emerging market and developing economies could
raise their tax revenue potential by broadening tax bases, improving the
design of their tax systems, and strengthening revenue administration. Such
measures could, in ideal circumstances, yield as much as an additional 9
percent of GDP, our research shows.

The foundations for sound and sustainable public finances require a
medium-term approach to budgetary planning and execution. All countries can
benefit from enhanced transparency of public finances and greater use of
modern technology, known as GovTech. For countries in severe debt distress,
orderly and timely debt restructuring is important. Continued international
cooperation, including through the Group of Twenty Common Framework and the
Global Sovereign Debt Roundtable, is crucial to facilitate an efficient debt
restructuring process.

This blog is based on Chapter 1 of the April
2024 Fiscal Monitor

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