Prime Minister Manmohan Singh had already sounded at the recent India Economic Summit, organised by the World Economic Forum, that given the clear signs of an upturn in the economy “we will take appropriate action next year to wind this (stimulus) down.”

The Commission, the European Union’s executive arm, had on November 11 already set deadlines between 2012 and 2014/15 for 13 EU countries to slash budget gaps to below 3 per cent of GDP. While India and the EU appear to be first off the block to unwind the fiscal stimulus, policy makers in the US, Japan, Australia and other G-20 nations are in no hurry to bite the bullet. And the IMF too seems to be toeing the general view of going slow on withdrawing the stimulus. However, the fund wants monetary policy to be tighten sooner than later in developing economies to counter the threat of rising inflation.

In a recent report titled, Global Economic Prospects and Principles for Policy Exit, the Fund has stated that the global recovery is uneven and not yet self sustaining, particularly in advanced economies. “Financial conditions have continued to improve, but are still far from normal. Despite recent momentum, the pace of recovery is likely to be sluggish, since much remains to be done to restore financial systems to health, while household balance sheet adjustment and bank deleveraging will be drags on growth. Downside risks have reduced somewhat. A key risk is that policy support is withdrawn before the recovery can achieve self-sustaining momentum, and that financial reforms are left to languish,” the report stated. Following are edited extracts from the report, wherein the fund has laid out key principles to be followed for policy exits.

The timing of exit from stimulus should depend on the state of the economy and the financial system, and should err on the side of further supporting demand and financial repair. Communicating strategies and their contingencies will help anchor expectations and allay market fears.

Forceful fiscal and monetary stimulus and financial sector support have helped ease financial stress and played an important role in supporting activity, but may need to be maintained for some time: One of the key lessons from experiences of similar crises is that withdrawing policy stimulus too early can be very costly, particularly if the financial system remains vulnerable and prone to adverse shocks. Further advancing the process of financial restructuring and balance sheet repair (including bank recapitalisation) remains a priority to achieve a healthy financial system.

Basic principles and plans for the exit and beyond should be established early and communicated clearly and consistently by policymakers to the public: Markets have shown signs of concern about uncertainty over future policy paths, suggesting the need for greater clarity in authorities’ plans. While some degree of ambiguity is unavoidable, as exit policies will need to be contingent on highly uncertain economic developments, strong communication strategies will help anchor expectations, facilitating the achievement of price and financial stability and sustainable growth. To be credible, exit should be based on conservative growth assumptions.

With some exceptions, fiscal consolidation should be a top policy priority; monetary policy is more easily able to adjust to achieve the desired level of overall stimulus.

For most countries, the risks presented by keeping stimulus in place too long suggest that adjustment is a key priority: Maintaining fiscal stimulus longer than needed has obvious and immediate consequences for debt accumulation. In many advanced economies, monetary policy can afford to remain accommodative for an extended period, given subdued price pressures. In a number of emerging economies, by contrast, monetary policy may have to tighten sooner—and might therefore be more synchronous with or even lead fiscal consolidation—if there are signs of rising inflation or incipient financial vulnerabilities, including credit booms.

Fiscal exit strategies should be transparent, comprehensive, and communicated clearly now, with the goal of lowering public debt to prudent levels within a clearly-specified timeframe.

Commentary: A high degree of transparency in fiscal accounts is more important than ever. Actions to bolster fiscal frameworks and institutions could include reforms of budgetary processes, more frequent and comprehensive reporting requirements, medium-term expenditure frameworks, and fiscal rules.

Targeting an appropriate debt ratio of GDP, taking into account longer-term spending pressures, would help build public awareness and address market concerns regarding fiscal sustainability:

Composition of stimulus

G-20 economies have pursued wide-ranging policy measures aimed at alleviating the crisis

Stabilising debt ratios at their likely post-crisis levels will not be sufficient: This is especially true for those economies facing rising pressure on public finances from key entitlement programs and demographic change. High debt ratios would impede fiscal flexibility and raise interest rates.

Stronger primary balances should be the key driving force of fiscal adjustment, beginning with actions to ensure that crisis-related fiscal stimulus measures remain temporary.

Commentary: Temporary measures provided through crisis-related stimulus (comprising the bulk of support) should be allowed to expire, once the economy has strengthened sufficiently. However, expiry of stimulus and unwinding of automatic stabilisers alone will not prevent debt ratios from rising.

Stronger fiscal adjustment during “good times” will be needed than in the past: Utilising the economic upswing to help consolidate public finances will require resisting spending and revenue slippages. Any revenue overperformance should be saved to further reduce debt ratios.

Medium-term reforms—notably of entitlement spending—should contribute to fiscal adjustment from an early stage, but alone will not be sufficient: In rapidly-aging economies, major action is needed just to avoid a rise in pension and health entitlement spending in relation to GDP due to demographic and technological changes. Keeping spending in these areas stable in relation to GDP through reforms is an appropriate goal. The needed primary improvement will need to come from other savings. Beyond health and pensions, a possible objective is to maintain real primary spending constant in per capita terms through reforms such as improved expenditure prioritisation, value for money enhancements, and elimination of energy subsidies.

Revenue measures should focus on reducing special treatment and combating evasion and avoidance: (which would be less distortionary than raising statutory tax rates). In the many countries where fiscal adjustment needs to go further, tax increases would be needed to reduce debt to more manageable levels and to increase policy space.

Unconventional monetary policy does not necessarily have to be unwound before raising policy rates.

Commentary: Maintaining unconventional monetary policy measures does not necessarily constrain increases in policy rates. Indeed, policy rates may need to rise before unconventional monetary stimulus is fully withdrawn:In particular, to the extent that credit markets remain impaired, monetary tightening may need to be led by raising of policy rates: This is becoming increasingly relevant for many emerging economies, notably in Asia, that are already witnessing relatively vigorous rebounds of activity.

Central banks have the necessary tools to reabsorb liquidity: A wide range of instruments can be used to withdraw excess reserves, including reverse repurchase operations and issuing central bank paper. Some unconventional central bank measures can be unwound simply by not renewing them, as financial market functioning improves.

There may be scope to reduce central bank holdings of government securities, since these markets are quite liquid: However, any such transactions will need to take account of overall macroeconomic conditions, notably threats to economic recovery or price stability.

International policy spillovers and cross-border collaboration

Interest rate differentials are already generating capital flows into economies with higher yields. Such inflows complicate monetary policy management, requiring difficult choices for authorities: for instance, allowing exchange rates to appreciate; adopting tighter fiscal policy and lower rates than would be the case without capital inflows; accumulating reserves and sterilising flows; or employing controls on capital inflows. In this context, allowing a rapid appreciation of the real exchange rate will help limit capital inflows by reducing “one-way” bets, and also facilitate a rebalancing of demand needed in emerging economies with large external surpluses.