Fiscal Soundness

Sarah Aly

59680

Comparative Study:
Fiscal Soundness

The study carried out in this paper is a comparative one. It compares the fiscal soundness of 10 economies; 9 countries are members of the OECD, along with the Chinese economy. Fiscal soundness measures the capacity of a government to honor its economic obligations both in the short run and long run. Such an economic concept is particularly important because it has a direct effect on the economic stability. To compare these countries’ fiscal soundness, or their respective risks of fiscal crisis, several economic parameters are being analyzed.

The debt ratio is the most crucial variable for the assessment of sustainability. High debts to GDP ratios are a sign of potential fiscal risks. As it is shown in figure 1, China has the lowest debt ratio to GDP, amounting to 26.50% in 2012. Such a low ratio can be associated to a situation of fiscal soundness in the economy all countries, we can observe a rising trends in the debt to GDP ratios. China is followed by Poland, then Germany, followed by Spain, then France, then United Kingdom, than United States, then Italy, followed by Portugal. Finally, Japan’s economy seems to be the least fiscally sound, with the highest debt ratio amounting to 211.7 % of the GDP in 2012.

 In general countries with a ratio higher than the reference value 60% are considered to in excessive deficit. The first three countries China, Poland and Germany seem to be doing reasonably well concerning fiscal soundness.

Figure 1

Source : IMF and CIA data

Along with the debt ratio to GDP, the budget deficit ratio serves as a crucial indicator of the excessive deficits that harm economic growth and stability, and thus both indicators are complementary variables that measure best the fiscal soundness of an economy. The data of budget deficit seem to agree more or less with the conclusions drawn from the debt ratio to GDP. China and Germany are also on the lead for the best deficit ratios. In fact Germany is even neither running a deficit, nor a surplus having a 0% budget balance in 2013, while China is running a deficit of 0.7% of GDP which is a low figure compared to other countries studied. Italy has the third best budget deficit rate, and is running a budget deficit of 2.8%. Poland, France and Portugal are having comparable budget deficits (-4.3% for both Poland, and France, and a 5.0% budget deficit in Portugal). United Kingdom and United States are classified are ranked in the same position when taking into consideration both the government debt ratio and budget deficit (securing the 7th and 8th position). Spain is in the 9th position when taking into consideration the budget deficit criterion in measuring fiscal soundness, even though it was securing the 4th position the debt to GDP ratio. Japan is also doing the worst with a budget deficit of -9.3% in 2013. Achieving a budget surplus allows a country to stability its debt rate. The German budget balance can lead to the stabilization of its debt rate.

Figure 2

Source: OECD library

Current account balance is also a factor that measures fiscal soundness of an economy. Germany confirms once more its leading position regarding fiscal soundness. Indeed, Germany is running a high current account surplus amounting to 7.0% of GDP in 2012; Germany is a net lender to the rest of the world. Chinese economy is confirming its leading position as well with a current account surplus of 2.3%. Surprisingly, Japan is also running a current account surplus of 1.0%, which alleviates its fiscal challenges.  All other countries are running current account deficits as shown in figure 3, and thus are net borrowers to the rest of the world.

Source: Worldbank.com

        Another important measure of the government’s capability of meeting its obligations, or in other words, the economy’s fiscal soundness is credit rating. The credit ratings analyzed here are those given by the credit agency named Standard & Poor. It’s the agency’s opinion or rating of the likelihood that the economy will default on its debt obligations. Here again, Germany is on the lead with the highest rating amongst the 10 countries analyzed. Germany merited a stable AAA (stable means that there’s no potential downgrade). United Kingdom comes right after Germany with a rating of AAA negative (‘’negative’’ indicates a potential downgrade), then United States with a rating of AA+ stable. The ratings of United Kingdom and United States are surprising given their respective low position in fiscal soundness as predicted by the 3 abovementioned variables (debt rate to GDP, the budget deficit and the current account deficit). Their high credit rating indicates that even though these variables predict fiscal challenges met by the two countries, their historical credit record has shown their creditworthiness (their ability to pay their debt obligations). France comes right after the United States with a credit rating of AA (stable), then China with AA- stable, then Japan, followed by Poland, then Spain, then Italy, and finally Portugal. According to Standard & Poor credit agency, the three Mediterranean countries are the least likely to meet their debt obligations. The exact classification of the 10 countries is shown in figure 4.

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