Lowering Public Debt

• Author: Harald Finger and Azim Sadikov
• Position: a Senior Economist and an Economist in the IMF's Middle East and Central Asia Department.

LAST year’s global recession may have yielded to a global recovery, but at least in one respect its legacy is here to stay. In many countries, public debt as a percentage of gross domestic product (GDP) has increased rapidly since the onset of the global crisis and is slated to rise even more in the coming years because it will take time to reduce government fiscal deficits from their current high levels. Once the recovery has taken a firm hold and no longer depends on life support provided by large-scale fiscal stimulus, the focus must turn to bringing down debt. Past experience shows it can indeed be done, but this task will likely become more challenging going forward.

Tale from the Middle East

Lebanon is an example of a country that was able to achieve a large reduction in the government debt–to-GDP ratio. Years of high fiscal deficits during the 1990s and a succession of shocks in the early to mid-2000s propelled government debt to 180 percent of GDP by 2006, among the highest debt ratios in the world. But over the next three years, Lebanon brought that ratio down by about 30 percentage points, a sizable and rapid improvement that few would have predicted in 2006.

How did Lebanon do it? The tale starts with a strong economic rebound. In 2006, Lebanon’s economy was battered by armed conflict with Israel, and the ensuing prolonged political stalemate left the country without a functioning parliament for more than a year (political tensions culminated in street fighting in the spring of 2008). But the economy started to turn around in 2007, in an astounding decoupling from the tense political environment. Confidence and—consequently—economic activity began to recover, reinforced by a new and ambitious fiscal reform agenda and (limited) financial backing by regional and Western donors.

A political reconciliation agreement reached in Doha in 2008 by rival Lebanese factions facilitated a strong rebound in tourism and construction. Large inflows into the banking system ensued—a signal of newly restored confidence—and even strengthened during the global financial crisis. Real GDP grew at an average annual rate of 8 1/2 percent during 2007–09. Although Lebanon’s ambitious fiscal agenda was never fully implemented, strong growth, fiscal discipline, and some donor support allowed for primary fiscal surpluses—which exclude interest payments—of 1 1/2 to 3 percent of GDP during this period, which cut its debt ratio significantly (though government...