Cutting spending too soon could derail recovery: IMF

As governments rushed out funding to prevent an economic collapse amid the coronavirus pandemic, global public debt swelled to the highest in history, but the IMF warned on Friday that cutting back too soon could undermine the recovery.

Government spending “will need to remain supportive and flexible until a safe and durable exit from the crisis is secured,” IMF fiscal policy chief Vitor Gaspar and chief economist Gita Gopinath said in a blog post.

Even with record low interest rates worldwide, the debt figures are staggering -- surpassing the size of the global economy, and deficits in advanced economies five times higher than pre-pandemic estimates for 2020.

The health crisis and the business shutdowns to contain the spread of COVID-19 demanded “a massive fiscal response” of close to $11 trillion to help support households and prevent bankruptcies,” the authors said.

“But the policy response has also contributed to global public debt reaching its highest level in recorded history, at over 100 per cent of global GDP, in excess of post-World War II peaks.” And, they cautioned, “we are not out of the woods.” The Washington-based crisis lender, which historically has always advocated for governments to restrain spending, is in the unusual position of urging officials to flood their countries with cash while also sounding the warning about pitfalls ahead, especially if cases rebound.

“While the trajectory of public debt could drift up further... an earlier-than-warranted fiscal retrenchment presents an even greater risk of derailing the recovery, with larger future fiscal costs,” they warned.

In the wake of the 2008 global financial crisis many governments shut down their stimulus programs at the first sign their economies had stabilised, which led to a slow, sluggish recovery.

Now the “need for continued fiscal support is clear,” Gaspar and Gopinath wrote, but countries also will need to find a way to finance it without debt becoming unsustainable.

That includes improving tax collection, making taxes more progressive, so those with higher incomes pay more, and eliminating subsidies on fuel while adopting revenue measures such as carbon pricing.

In addition, in the face of “profound” transformations of their economies, governments should focus their efforts on sectors that will survive the crisis, rather than those that will shrink, such as air travel, including possibly nationalising industries temporarily.

“Even as many countries tentatively exit the Great Lockdown, in the absence of a solution to the health crisis, huge uncertainties remain about the path of the recovery,” they said.

“Many of the jobs destroyed by the crisis will likely not return.”

Ukraine must preserve the independence of its central bank under the next governor as part of a $5 billion International Monetary Fund deal, the IMF’s country representative told a local news site in comments published on Friday.

National Bank of Ukraine Governor Yakiv Smoliy quit on July 1, complaining of “systematic political pressure”, weeks after Ukraine secured the IMF deal to fight an economic slump caused by the coronavirus pandemic.

His exit rattled the market, forced the government to abort a 12-year Eurobond placement worth $1.75 billion and raised doubts over whether international backers, including the IMF, would freeze loans.

Ukraine’s dollar-denominated bonds have been under pressure since Smoliy’s departure and fell again on Friday, with some issues losing more than 1 cent in the dollar to trade at levels last seen in early June.

The IMF’s Goesta Ljungman did not directly comment on whether Ukraine was violating the IMF deal but said “the fact that the management of the NBU openly says that it is subject to political pressure should be of concern to all.”

In the most detailed remarks from the IMF since Smoliy’s resignation, Ljungman said keeping the central bank independent was vital to maintain sound monetary and fiscal policies and sustainable economic growth.

“There are well-established links between central bank independence and economic performance,” he said in an interview with Liga.net.

He said a framework for central bank independence established in 2015 in line with best international practices had helped Ukraine recover quickly from an economic crisis in 2014-2015.

The leaders of the International Monetary Fund and the World Bank on Thursday confirmed that they were preparing to hold their annual meetings in October largely online given the coronavirus pandemic.

Agencies