US needs to cut budget deficit soon, warns IMF

In a strong endorsement of the Government’ s plan to reduce the fiscal deficit, the IMF’s Head of Fiscal Affairs, Carlo Cottarelli said yesterday that George Osborne’s approach is “entirely appropriate” – and added that the Government's borrowing targets, the “fiscal mandate”, would be met. This is the first time a senior Fund official has explicitly and publicly endorsed Mr Osborne's forecasts.

But Mr Cottarelli was less complimentary about the US, adding that the budget deficit there should be reduced “sooner rather than later” – for fear of “very important consequences” for the rest of the world. His criticism is particularly poignant given recent bitter political wrangling in Washington over the national debt ceiling and threats to shut down the government.

The US is now 95 per cent of the way to hitting its self-imposed ceiling on the national debt – only $70bn of headroom is left compared with the limit of just over $1.4trillion ($1,430bn), with “Armageddon” the consequence unless the ceiling is lifted, according to the White House. Alarmist talk about a debt default and chaos in the bond markets is swirling around the American media. President Obama will make speech today setting out his proposals for dealing with the debt. Some Republicans are threatening to vote down the deal reached last week which calls for $38bn in spending cuts this year, widely spread from veterans’ welfare to rail projects.

In its latest ‘Fiscal Monitor’, the Fund says that Britain faces “the largest adjustment among major advanced economies” and that borrowing will be slightly higher, in relation to national income, this year and next compared with previous IMF projections, partly due to the IMF's more gloomy outlook for British growth.

Nonetheless, Mr Cottarelli urged the Treasury to stick to its course: “The UK suffered quite a lot form the crisis and was running a very large deficit. The action of the Government is entirely appropriate. Keep in mind that in 2009, 85 per cent of the deficit was financed by the Bank of England, so something needed to be done to strengthen the fiscal account and the government is taking action for this, we think the targets are going to be achieved.”

A bigger focus of IMF concern is the US. Given its size and the way its national debt is set exceed 100 per cent of GDP over the next few years – a level many economists believe could trigger a “death spiral” as the burden of supporting it becomes intolerable – the IMF focuses its attentions on the “tail risk” if America fails to deal with its challenges.

The Fund states: “The United States needs to accelerate the adoption of credible measures to reduce debt ratios." But, says the IMF, the US fiscal adjustment "is being delayed," and the IMF raised concerns that the stimulus package adopted in December 2010, including the extension of tax cuts and emergency unemployment benefits, is projected to contribute to an increase in the general government deficit to 10.75 per cent of GDP - "the largest among advanced economies this year.”

“While targeted measures to address the high social costs of still-weak housing and labor markets could be justified, the composition of the stimulus package means that its growth impact will be small relative to its fiscal costs." The IMF recommended “a down payment” in the form of deficit reduction this year that would make the government goal “compatible with a less abrupt withdrawal of stimulus later.” Th e Fiscal Monitor points out that “the president's draft budget implies a major cyclically adjusted withdrawal of about 4 percentage points of GDP in Fiscal Year 2012."

As if all that was not enough to worry Congress and the White House the IMF also say that the rising cost of pensions and healthcare in the US – the steepest rise in the developed world – will add another burden,

More broadly, the IMF concludes that “for advanced economies, steady annual progress, starting now, toward bringing debt ratios to prudent levels in the medium term is essential.” Spain is "not out of the woods", though making prgress.