As the world continues to struggle with financial turmoil and sovereign debt concerns, the global financial community is actively working to strengthen mechanisms that foster greater international cooperation.
At the forefront of this activity are international and multilateral groups and bodies such as the Basel Committee, the Financial Stability Board, the G20 Mutual Assessment Process and the International Monetary Fund (IMF), which are increasingly focused on reshaping the international monetary system in order to facilitate strong, sustainable growth and improved economic outcomes for all nations.
But this burden of responsibility does not, and should not, lie solely on the shoulders of these larger global financial groups. Indeed, building better international and regional institutions relies on the ability of individual governments to ensure their own financial sustainability.
To achieve greater insight and understanding of the impacts of government debt and fiscal policy on the global economy, KPMG conducted research on 19 of the G20 countries to see how their fiscal policy settings held up within the context of the budgetary, economic and intergenerational cycles.
To achieve this, we sourced data from the System of National Accounts (SNA) and the Government Financial Statistics (GFS) for the general government sector. The compiled data was assessed within the context of each country's fiscal policy settings in order to provide an independent and consistent view of the state of each country's government finances.
Our findings challenge the widely-held belief that the sovereign debt crisis was uniquely caused by the recent global financial crisis (GFC). In fact, our research indicates that, in most cases, levels of government debt were already reaching their limits prior to the onset of the crisis in 2007-08.
Ultimately, our paper suggests that it is the persistent lack of fiscal discipline and an inability to achieve fiscal policy targets that make fiscal practice broadly inconsistent with the attributes of a competent fiscal sustainability framework. In response, KPMG has developed an outline of the essential characteristics and attributes of a fiscal sustainability framework for the public sector. We believe that by identifying the existing challenges and providing a viable and practical framework for facilitating fiscal sustainability, we can help government policy makers and national governments adjust to the post-GFC world and create positive change for the world economy.
We encourage you to contact your local KPMG member firm or any of the contacts listed in the back of this publication to learn more about applying this framework within your jurisdiction.
It seems not a week goes by without another dire warning about sovereign debt. Indeed, ever since the GFC began to 'morph' into what became known as the eurozone debt crisis, the world has been keenly focused on sovereign debt.
Interestingly, and counter to popular opinion, the roots of the current sovereign debt crisis do not lie solely in the GFC. In fact, according to our research, the rise of sovereign debt among many of the G20 nations actually predates the GFC by some considerable time.
To be clear, budget deficits are not necessarily a bad thing. Budget deficits actually play an important macroeconomic role by providing stimulus when it is needed most and fiscal support when the national interest requires it. Persistent and high levels of debt, however, are another matter entirely. Not only does persistent debt erode a nation's ability to afford the deployment of automatic stabilizers when needed, but it ultimately leads to intergenerational inequity.
Some observers would suggest that this era of deficit spending will turn around in due course; that sovereign debt, deficit budgets and slow economic growth are simply cyclical issues that will soon disappear. According to our research, however, the challenges now facing government finance in many of the world's leading economies will likely not be solved in the short term. Government indebtedness has taken some time to accumulate and it will take a similar time frame to remedy.
The unhappy truth is that economic growth is likely to be stubbornly slow in the near-term, leading to further strain on what are already sizable quantities of government debt. Perhaps more to the point, however, most, if not all, governments will now also have to deal with the rising costs created by intergenerational aging, which is already putting new pressure onto government budgets, particularly in the areas of health, aged pensions and long-term care.
Improving fiscal sustainability frameworks
To better understand the extent of the challenge, we examined the fiscal policy settings of 19 countries1 within the G20 group of countries across the budgetary, economic and intergenerational cycles. We took 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. Across the board, we focused specifically on the general government sector (GGS), allowing us to apply an 'entity' lens rather than a macroeconomic one.
Based on these findings, we then set about developing an outline of what a truly competent fiscal sustainability framework might look like. Given the key findings summarized on the following pages, we believe this framework provides a practical and achievable road map to help governments around the world create a more sustainable, effective and efficient national economy for generations to come.
About the data
The data tables and much of the commentary included in this paper are based on the extensive and ongoing work done by the IMF, World Bank and Organisation for Economic Co-operation and Development (OECD). Specifically:
- The data tables provided in both the budget and economic cycle sections were sourced from the IMF World Economic Outlook database (April 2012 update).
- The data tables provided in the intergenerational cycle sections were sourced from the United Nation's World Population Prospects: The 2010 Revision database.
Additional information was sourced from a wide range of websites, particularly the government websites of relevant countries.
Online comparison tool
Visit our website to explore data for the 19 countries studied in this report. Compare up to three countries at once.
Governments' ongoing struggles to achieve fiscal sustainability
In addition to a clear need for updated financial frameworks, there are a number of additional factors, notably an inability by governments to successfully implement and sustain their fiscal policy targets, that have created today's fiscal sustainability issues within many of the G20 countries examined in our study:
- Short-termism and political expediency: While fiscal sustainability is a widely-held goal of most governments, our research suggests that, in general, success has largely been diminished by the absence of a politically bipartisan, committed and sustained program of implementation. This is not entirely surprising. The path to restored fiscal health can rarely be achieved within the time frames ordinarily afforded to elected leadership. As a result, short-term thinking and political expediency in decision making tend to trump considerations of long-term fiscal sustainability.
- Long streams of budget deficits predating the GFC: Our research finds that during the 5-year period from 2002 to 2007, more than half of the countries had posted unbroken streams of budget deficits. This may be acceptable for developing nations during the investment cycle, but the countries in view here are almost all developed countries. This suggests that in addition to short-termism, there are problems with the fiscal policy settings of these governments.
- GFC-driven automatic stabilizers: Our research suggests that countries with high levels of gross debt prior to the start of the crisis (in excess of 60 percent of GDP) were not only severely limited in their ability to adequately respond to the GFC, but are now also facing a longer and more difficult path back to sound fiscal sustainability. So while the EU's general government gross debt target of 60 percent is likely appropriate in times of economic growth, it is clear that by carrying this level of debt into times of economic crisis, countries are less able to absorb the effects of automatic stabilizers, accommodate shock events or facilitate additional stimulus when needed. Simply put, if the levels of sovereign debt in eurozone countries had been lower in the first instance, then the strength and stability of the eurozone's institutional mechanisms and fiscal arrangements would probably never have been questioned.
- Slow return to economic growth: High levels of government debt will be further exacerbated by the impact of intergenerational aging and the ongoing shift toward the developing world, which will generally lead to continued sluggish economic growth in developed markets. In turn, slow economic growth will lead to sustained levels of high debt. As general government gross debt is typically measured as a percentage of GDP, economies that are not able to grow faster than the government can grow debt will see their debt ratios increase.
- Cost of debt: It is not just the size of debt relative to GDP that matters in fiscal sustainability, but also the cost of that debt to the budget. The US and Japan, for example, enjoy low cost access to funds which invariably means that the quantum of debt remains manageable. However, should the cost of debt increase, then the affordability of that debt will become a much graver concern. This relationship has been made very clear throughout the eurozone debt crisis as countries' borrowing costs spiked due to investor concerns of default which, in turn, has made the level of debt unmanageable.
The risk of inaction is real and present
Even once current fiscal pressures subside, many of the G20 countries will find no respite due to the challenges created by:
- Intergenerational impacts: All evidence suggests that another wave of fiscal stress has started, the result of budgetary pressures caused by intergenerational aging which, in turn, will further heighten the need for sustained fiscal policy action (such as budget management and the restoration of balance sheet health) over the next 40 years. The challenge will also be felt in developing world countries, where the introduction of wider access to social security and health coverage may combine with rising age ratios to create challenging fiscal burdens for government.
- Global economic interconnectedness: As economies become increasingly interconnected, slow growth outlooks within any sizable portion of the world economy will inevitably lead to fiscal challenges in other jurisdictions. But as the balance of trade shifts to the developing world, our research suggests it is the developed world economies that are creating the most significant sovereign debt challenges. Indeed, of the debt that will have been accumulated by the 19 countries in our study by 2015, an estimated 86.5 percent will be held by the top seven select developed countries (Canada, France, Germany, Italy, Japan, UK and US). The eight developing countries in our study (Argentina, Brazil, China, India, Indonesia, Mexico, South Africa and Turkey) will hold only 11.61 percent. This is not a matter of comparative size. Both this select developed country group and the developing country group will command 36 percent and 32 percent of world GPD by 2015 respectively, making them roughly equal in their weighting within the global economic order.
The solution: Better frameworks—and an improved commitment to adhere to them long term
With the rising visibility of sovereign debt over the past 5 years, coupled with the growing fiscal pressure created by intergenerational aging, it is clear that action must be taken to develop and implement a fiscal sustainability framework that includes:
- Balanced fiscal policies: A fiscal sustainability framework must ensure that fiscal policy is balanced to achieve an objective of governing for the just and common good of current and future generations within the constraints of economic affordability, national security priorities, social cohesion imperatives and environmental sustainability.
- Defined targets: Ultimately, the framework must specify and use targets set around key fiscal aggregates. While not foolproof, targets are nonetheless a well-used approach among G20 countries.
- A view across budgetary, economic and intergenerational cycles: There is a clear and present recognition that government finances and budget settings need a more complete consideration of fiscal sustainability that spans not only the budget cycle (1-5 years), but also the economic cycle (6+ years) and the intergenerational cycle (10+ years).
- Success factors and key performance indicators (KPIs): Fiscal sustainability frameworks must include measurable and defined KPIs that can be used to monitor fiscal sustainability progress. These include the attainment of defined targets as discussed above, as well as market-driven indicators such as the attainment of government AAA credit ratings.
- Committed and sustained implementation: There is a significant difference between developing a fiscal sustainability framework and properly implementing it, the latter being the bigger challenge. Achieving practical results requires politically bipartisan commitment to prioritize and improve government finances for both current and future generations. Governments must strive to develop the appropriate mechanisms and institutional objectives to ensure sustained implementation across the political cycle.
- Coordinated regulatory, policy and financial frameworks: Fiscal sustainability objectives are often better realized when robust regulatory and financial system institutional frameworks, competent fiscal policy frameworks and rigorous fiscal management implementation practices all work together.
Ultimately, the fiscal sustainability of government finances for both developed and developing countries depends on how governments manage the combination of:
- global economic shifts
- existing government debt levels
- slow world economic growth prospects
- impacts of intergenerational change upon government finances.
Governments need to demonstrate a greater commitment and capacity to control their own finances and to live within their means. It is not about the size of government spending, or the extent of social welfare or the level of entitlement spending that a nation's citizenry wishes to embrace. It's about the affordability of that embrace.
If restraint and sound fiscal management cannot be extracted from the existing political and economic institutions of a nation, then there may be a need to design further mechanisms that separate a nation's fiscal policy settings and long-term fiscal responsibility obligations from the political process. Such a pathway may become necessary for no other reason than to ensure that short-termism and political expediency do not unduly impact a nation's fiscal legacy.
Thankfully, governments are increasingly recognizing these challenges and, in some cases, responding, as evidenced by the recent move (in March 2012) by eurozone member countries to sign the so-called 'Fiscal Compact', which requires member states to seek to place key fiscal restraining limits into their national constitutions in order to better ensure balanced budgets and the adherence to debt ceiling protocols.
1 The G20 member country not included is Brussels (representing the remaining European Union (EU) member states). Since the UK, France, Germany and Italy are included as separate G20 countries in their own right, further representation from EU member states was deemed unnecessary, given that many fiscal policies are 'Treaty driven'.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.