FINANCIAL REPORTING AND IR

It seems not a week goes by without another dire warning about sovereign debt. Ever since the global financial crisis (GFC) began to ‘morph’ into what became known as the Eurozone debt crisis, the world has been keenly focused on sovereign debt.

To be clear, budget deficits play an important macroeconomic role by providing stimulus when it is needed most and fiscal support when the national interest requires it. Persistent and high levels of debt are another matter. Not only does persistent debt erode a nation’s ability to afford the deployment of automatic stabilizers when needed, it ultimately leads to intergenerational inequality.

Some observers suggest that this era of deficit spending will turn around in due course – that sovereign debt, deficit budgets and slow economic growth are cyclical issues that will soon disappear. According to research conducted by KPMG, the challenges facing government finance in many of the world’s leading economies will likely not be solved in the short term.

Governments’ ongoing struggles to achieve fiscal sustainability

In addition to a clear need for updated financial frameworks, there are a number of factors – notably an inability by governments to successfully implement and sustain their fiscal policy targets – that have created today’s fiscal sustainability issues within many of the G20 countries examined.

Short-termism and political expediency

While fiscal sustainability is a widely held goal of most governments, our research suggests that success has largely been diminished by the absence of a politically bipartisan, committed and sustained program of implementation. This is not surprising. The path to restored fiscal health can rarely be achieved within the time frames ordinarily afforded to elected leadership. As a result, short-term thinking and political expediency in decision making tend to trump considerations of long-term fiscal sustainability.

Long streams of budget deficits predating the GFC

From 2002 to 2007, more than half of G20 countries posted unbroken streams of budget deficits. This may be acceptable for developing nations during the investment cycle, but the countries in view here are almost all developed ones. This suggests problems with the fiscal policy settings of these governments and embedded structural barriers to fiscal transformation.

GFC-driven automatic stabilizers

KPMG’s research suggests countries with levels of gross debt in excess of 60% of GDP prior to the start of the crisis were not only severely limited in their ability to adequately respond to the GFC, but are now facing a longer and more difficult path back to sound fiscal sustainability.

Slow return to economic growth

High levels of government debt will be further exacerbated by the impact of intergenerational aging and the ongoing shift toward the developing world, which will generally lead to continued sluggish economic growth in developed markets.

The solution: a long-term commitment to better frameworks

The rising visibility of sovereign debt over the past five years, coupled with the growing fiscal pressure created by intergenerational aging, make it clear that action must be taken to develop and implement a fiscal sustainability framework that includes the factors noted below.

Balanced fiscal policies

A fiscal sustainability framework must ensure that fiscal policy is balanced to achieve an objective of governing for the just and common good of current and future generations within the constraints of economic affordability, national security priorities, social cohesion imperatives and environmental sustainability.

Defined targets

The framework must specify and use targets set around key fiscal aggregates.

A view across budgetary, economic and intergenerational cycles

Government finances and budget settings need a more complete consideration of fiscal sustainability that spans not only the budget cycle (1-5 years), but also the economic cycle (6+ years) and the intergenerational cycle (10+ years).

Success factors and key performance indicators (KPIs)

Fiscal sustainability frameworks must include measurable and defined KPIs that can be used to monitor fiscal sustainability progress.

Coordinated regulatory, policy and financial frameworks

Fiscal sustainability objectives are often better realized when robust regulatory and financial system institutional frameworks, competent fiscal policy frameworks and rigorous fiscal management implementation practices all work together. A cohesive multi-year transformational program is vital.

Conclusion

Ultimately, the fiscal sustainability of government finances for both developed and developing countries depends on how governments manage: global economic shifts, existing government debt levels, slow world economic growth prospects, and impacts of intergenerational change upon government finances.

Governments need to demonstrate a greater commitment and capacity to control their own finances and live within their means. It is not about the size of government spending, the extent of social welfare or the level of entitlement spending that a nation’s citizenry wishes to embrace. It’s about the affordability of that embrace.

Business leaders and investors are acutely aware of the long-term impact a country’s economy has on companies, and closely monitor the fiscal sustainability of governments when making investment decisions.

For a complete summary of KPMG’s research findings, including country specific profiles, read Walking the Fiscal Tightrope: a framework for fiscal sustainability in government.