–US Needs More Ambitious Adjustment To Stabilize Public Debt
–Should Streamline Fannie, Freddie; Privatize Retained Portfolios
–Recovery In US Stronger Than Expected, Fed Pol Appropriate Near-Term

By Brai Odion-Esene

WASHINGTON (MNI) – The central challenge facing the United States
government going forward is developing a “credible” fiscal strategy
without harming the economy’s rebound from the Great Recession, the
International Monetary Fund said Thursday.

In its concluding statement of the 2010 Article IV Mission to the
U.S., the IMF said such a strategy must “ensure that public debt is put
— and is seen to be put — on a sustainable path without putting the
recovery in jeopardy.”

The statement said the timing and composition of the adjustment
will need to be carefully designed to minimize the impact on demand
while ensuring credibility.

A credible fiscal plan could have three basic elements, it said,
beginning with an upfront adjustment beginning in FY’11, with the 2%
reduction in the structural deficit proposed in the FY’11 budget broadly
appropriate.

This should be accompanied by, second, a clear commitment to the
further measures needed over coming years, for instance through
enshrining targets and/or measures in legislation.

And third, further measures to address entitlement pressures,
notably imbalances in Social Security, where the needed policies are
well known.

It warned that under current policies U.S. public debt could reach
95% of GDP by 2020. And as the impact of the aging population and rising
health care costs is increasingly felt, debt will rise further to over
135% of GDP by 2030 and continue to increase thereafter.

The IMF welcomed declarations by the U.S. government to halve the
budget deficit by 2013 as well as stabilize public debt at about 70% of
GDP by 2015, but warned that much remains to be done to achieve these
aims.

“Given that we use less optimistic economic assumptions than the
Administration, we see the need for a more ambitious adjustment to
stabilize debt than that envisioned by the authorities,” the IMF said,
“in particular, a federal primary surplus of about 3/4 percent of GDP by
2015.”

The statement said this in turn will require an underlying fiscal
adjustment — excluding the normal cyclical rebound — of about 8% of
GDP during that period, about 2.75% of GDP more than in the Obama
administration’s plans.

While the government’s plan to reduce expenditures is a step in the
right direction, the IMF said measures to raise revenue will also be
needed. These include further base broadening via cuts in deductions,
particularly for mortgage interest; higher taxes on energy; a national
consumption tax; or a financial activities tax.

The IMF repeated the claim made by Minneapolis Fed President
Narayana Kocherlakota Wednesday, echoing his argument that such a tax on
banks could also mitigate systemic risks.

“Looking beyond 2015, the aim should be to put public debt firmly
on a downward path to rebuild the room for fiscal maneuver (especially
given the risks from large funding shortfalls in state and local
government pension and health schemes).”

The IMF’s policy prescriptions for the United States mostly echoed
those for developed countries contained in the Fund’s update of its
World Economic Outlook published late Wednesday, in which it added half
a point to its global growth forecast, to 4.6%, and two-tenths to the
U.S. forecast for this year, at 3.3%.

At the same time the IMF marked down eurozone growth by a quarter
point for next year, to 1.3%, but said this year, the effects of
financial turbulence and an adjustment of the exchange rate would
balance each other.

Asian growth projections were raised by half a point for this year,
to 7.5%, with expected moderation next year to 6.8%. The forecast for
China was likewise raised half a point for this year, to 10.5%, but next
year’s was cut to 9.6% from April’s 9.9%.

The U.S. Treasury Department had no argument with the IMF’s latest
review of the U.S. economy, issuing its own echo of the IMF report
without any differing views like those it has offered for some past
Article IV releases.

The recovery in the U.S. is well established, the IMF said, and has
proven to be stronger than the fund had earlier expected. However, it
cautioned that remaining household and financial balance sheet
weaknesses — along with elevated unemployment — are likely to continue
to restrain private spending.

On the upside, the statement said consumption in the U.S. could
outperform expectations — if confidence and employment improve faster
than expected. On the downside, it said foreclosures backlog and high
levels of negative equity, combined with elevated unemployment, pose
risks of a double dip in housing.

It echoed warnings of the risks commercial real estate poses risks
for smaller banks, and that financing conditions remain tight for
smaller firms.

As for the ongoing turmoil in Europe, not only is it an “increasing
concern,” but it could potentially impact the U.S. through the financial
market and trade links, the IMF said.

Predicting inflation to be very low, and unemployment remaining
above 9% this year and the next, the IMF said the Federal Reserve had
appropriately maintained an extraordinarily low level of policy rates.

“We believe that maintaining the present high level of
accommodation is appropriate to hedge deflation risks and help to
counteract the forthcoming fiscal drag on economic activity, while also
supporting financial conditions,” it said.

Looking ahead, the statement said the Fed is “well placed” to
manage the uncertainty swirling around its exit strategy, but counseled
that continued clear communication about its strategy and operations
will be essential as the exit evolves, “particularly if it needs to sell
assets at some later stage.”

Casting its eye on other sectors of the U.S. economy, the IMF said
a key challenge will be to revitalize private securitization, to
supplement bank credit. It warned that more capital will be needed to
support additional bank lending if securitization does not pick up as
expected, as well as to accommodate the higher expected capital
standards.

On the much discussed topic of housing finance reform, the IMF
described the current system as “costly, inefficient and complex, with
numerous subsidies that do not seem to translate into a sustainably
higher homeownership rate.”

The mandates of Fannie Mae and Freddie Mac should be streamlined
and their retained portfolios should be privatized, the IMF proposed,
noting that they have been the source of past losses and are unrelated
to their core bundling and guarantee business lines.

“Those lines, which arguably provide public goods, should be made
explicitly public,” it concluded.

** Market News International Washington Bureau: 202-371-2121 **

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