The International Monetary Fund’s (IMF) spring projections for the following year’s growth in Latin America have been too high in 13 of the last 17 years. There is a low probability that overstating growth with this frequency is due to random chance rather than to a systematic bias. The average overstatement of growth during this period is 1.6%.
In the short term, the IMF’s overly optimistic growth projections may lead countries to raise taxes or interest rates—or to cut spending—to inappropriate levels given their actual growth paths. In the long term, these projections may lead countries to follow paths they would have recognized as unfeasible if they had more realistic growth projections. In the case of Brazil, for example, the country’s current debt burden is likely to prove unsustainable if its growth rate ends up being off by the IMF’s average overstatement for the period examined. This can be seen with a simple example:
Suppose a country like Brazil tries to chart a fiscal course that is consistent with meeting its debt service obligations. Brazil currently has a debt-to-gross domestic product (GDP) ratio of approximately 60% and can borrow money at a real interest rate of approximately 12%. If the IMF projects that Brazil’s GDP will grow 3.5% annually, this signals that Brazil can keep its debt-to-GDP ratio constant if it runs a “primary budget surplus” (not including interest payments) equal to 5.1% of GDP.
However, if Brazil’s economy only grows by 2%, which would be expected given the recent bias in IMF projections, then 5.1% would be insufficient to keep the debt-to-GDP ratio constant. In this scenario, with lower GDP growth, the debt-to-GDP ratio would continue to rise. After one year, the debt-to-GDP ratio would have risen to 60.9% of GDP. This rise in the debt-to-GDP ratio would require an even larger primary budget surplus the following year. However, if the target were again based on an overly optimistic projection from the IMF, then the surplus would still be insufficient to stabilize the debt-to-GDP ratio. If Brazil continued to set surplus targets based on overly optimistic growth projections, then its debt-to-GDP ratio would rise each year, as would its primary surplus target. After ten years, its primary surplus target would reach 5.9% of GDP, and after 20 years its surplus target would hit 6.7% of GDP. This surplus would be the equivalent of the U.S. government running an annual primary budget surplus of $737 billion.
A surplus of this magnitude represents an enormous drain on an economy. It means that the tax burden has exceeded the level of expenditures necessary to maintain government services by an amount equal to nearly 7% of GDP. While the original burden resulting from a primary budget surplus of 5.1% percent of GDP is already very large, the future burden in this scenario is enormous and presents a greater probability that the country will become even more dependent on IMF loans and conditionality. Even if the current burden is viewed as acceptable, compared to the available alternatives, a government that recognized that this burden would only grow through time might choose different options. For this reason, countries seeking economic stability should revise IMF growth projections downward by 1.6%.
ABOUT THE AUTHORS
Based on a longer article by Dean Baker and David Rosnick for the Center for Economic and Policy Research. For more information on CEPR’s work, visit their website at http://www.cepr.net.
