Governments must place greater weight on keeping their finances in shape, or risk undermining the confidence of the bond market investors that buy their debt, the IMF has cautioned.
Rising interest rates and high inflation have increased the importance of countries building resilience into their public finances so they can deal with a more “shock-prone” world, the IMF said on Wednesday in its annual Fiscal Monitor publication.
In a reversal of the message of previous years, the IMF ditched its calls for governments to borrow more, saying greater debt levels were no longer appropriate now that interest rates needed to rise to defeat the widespread inflation threat.
Vítor Gaspar, head of fiscal policy at the IMF, said: “In a shock-prone world, the trade-offs that face fiscal policymakers are much tougher than before.”
Policies that offered broad-brush support to lower energy and food prices for all were, the IMF said, costly and ineffective. Instead, governments should offer only targeted and temporary cost of living support for the most vulnerable. The wider world should also help the poorest countries cope with the higher cost of food.
“For poor countries facing concerns over food securities, the trade-offs are literally matters of life and death,” Gaspar added.
He acknowledged the recommendations were difficult for politicians to put into practice. But rising interest rates would increase the cost of servicing government debt, while any benefit from inflation in lowering debt burdens would provide only temporary respite.
“As people adapt [to rapidly rising prices], inflation premiums are reflected in the interest cost of servicing public debt and . . . [investing] in Treasury bonds becomes less attractive,” he said.
Governments should not fight monetary policymakers, who were trying to defeat inflation.
“Fiscal consolidation sends a powerful signal that policymakers are aligned in their fight against inflation,” the report said, adding that the alignment would keep inflation expectations better anchored and leave central bankers in a position where further rate rises were unnecessary.
Tax increases and spending cuts were a better alternative than losing investors’ trust. The report stated: “While politically difficult, gradual and steady fiscal tightening is less disruptive than an abrupt fiscal pullback brought on by loss of market confidence.”
The words sounded like a barely disguised criticism of the UK’s recent “mini” Budget, which contained unfunded permanent tax cuts equivalent to almost 2 per cent of national income.
However, Gaspar preferred to focus on the steps ministers had taken to address market concerns, praising the UK government for engaging with its economic institutions and promising to have a costed fiscal plan in place by the end of the month. He said he had been “reassured” by the UK government’s ambition to restore fiscal credibility.
He was also unwilling to directly criticise Germany’s broad-based energy support of up to €200bn, saying the package was too recent with the fund “not on top of the details”.