Britain's deficit is constraining public finances, says IMF report

'Quick fix' to bring down £45bn net debt would be unwise, Chancellor is told

Britain's public finances remain "constrained" and among the most precarious of the major advanced economies, the International Monetary Fund (IMF) warned yesterday.

Ranking nations by their "fiscal space" – the insulation that they have against a further unforeseen shocks to their economic systems – the IMF said the UK was only one notch above those countries most commonly thought of as being bust.

In its latest research, the IMF said: "Greece, Italy, Japan and Portugal appear to have the least fiscal space, with Iceland, Ireland, Spain, the UK and the US also constrained in their degree of fiscal manoeuvre, the more so owing to the run-up in public debt projected in coming years."

In what could be interpreted as a lukewarm endorsement of the Coalition Government's programme of deficit reduction, the fund also argues that searching for a "quick fix" would be unwise. Many economists have criticised the Chancellor, George Osborne, for announcing £6.2bn of immediate cuts soon after coming to power. The IMF report says: "Advanced economies must pursue long-term policy reforms to reduce public debt levels over the coming decades and ensure future fiscal sustainability, according to three papers published today by the IMF.

"In order to protect the fragile economic recovery, support growth and job creation and provide reassurance to capital markets, fiscal adjustment plans must be clearly defined but with a focus on the medium term rather than seeking a quick fix."

However, the IMF also said it was unlikely that even Greece and other highly-indebted states would renege on their debts as they struggled to tame their deficits. "In our view, the risk of debt restructuring is currently significantly overestimated," the fund said. "Although it is generally wise to assume that market developments reflect economic fundamentals, market overreaction does occur from time to time, with adverse implications for countries' borrowing costs and debt dynamics."

The IMF's intervention comes amid other evidence that Britain is heading for a "double-dip" recession, which will hit tax revenues and raise public sending on unemployment benefits.

The latest survey of business confidence in the manufacturing sector, carried out by the Chartered Institute of Purchasing and Supply (CIPS), shows a further slippage.

While an index reading above 50 implies continued expansion, the pace of that growth seems set to slow by the end of the year – the CIPS survey being one of the more reliable leading indicators of economic trends.

The drop in the composite index in August, from 56.9 to 54.3, was the third consecutive monthly fall and leaves the index at its lowest level since November 2009. The decline has been driven by a slowdown in new domestic orders, while performance in export markets has been stronger.

David Noble, the chief executive of the CIPS, said: "The looming public-sector spending cuts are keeping manufacturers on tenterhooks and slowing the pace of the recovery. Businesses are taking a more cautious approach to new orders, with growth of order books slowing sharply in August.

"The Government spending review in October should bring more clarity to the situation. Looking forward, employment levels look encouraging for the second half of the year – but we must not be too hasty as we are still a long way off from a full recovery."

The pound fell almost a cent against the dollar after the CIPS released its figures and the City predicted interest rates would have to remain low.

"The manufacturing sector is still expanding but at a much slower pace," said Hetal Mehta, at Daiwa Capital Markets. "The marked deceleration in new orders does not bode well for output in coming months, and subdued growth in export orders – indicative of a slowing global economy – poses downside risks to the UK outlook."