By David Lawder
YOGYAKARTA, Indonesia (Reuters) – International Monetary Fund Managing Director Christine Lagarde said she saw positive and negative effects from a “complicated” U.S. tax overhaul, including a near-term growth bump that risks overheating the U.S. economy and a problematic rise in debt.
Lagarde told Reuters in an interview on Thursday that tax cuts can lift the U.S. growth rate by about 1.2 percentage points over the three years through 2020, which should help boost global growth and trade for at least a few years.
“To the extent that growth is higher in the U.S. and because the U.S. is a very open economy, it will probably increase the demand from the U.S. to the other economies around the world, and that’s also a positive,” Lagarde said during a week-long trip to Indonesia.
The massive tax overhaul, which cuts the top corporate rate from 35 percent to 21 percent and simplifies many provisions, met some of the IMF’s advice that Washington adopt a simpler, more efficient business tax code. But Lagarde warned the plan threatened to stoke inflation.
“Because of the stimulus impact that it will have on growth, and because the U.S. economy is already growing at full capacity, it might very well have an overheating impact on the economy, which could in turn increase wages – good – increase inflation and entail a tightening of monetary policy, with interest rates rising,” Lagarde said.
New Federal Reserve Chairman William Powell told U.S. lawmakers on Wednesday that he was sticking to a “gradual” approach to interest rate hikes this year.
The higher rates would nonetheless cause some capital outflows from emerging markets, Lagarde said. Sudden and massive outflows two decades ago prompted IMF bailouts and painful austerity for some southeast Asian countries, including Indonesia.
Lagarde said Indonesia was well-prepared to handle the effects of higher U.S. rates because of much stronger central bank tools that were tested during the 2013 ‘taper tantrum’, during which bond yields rose sharply as the Fed signaled it was ready to slow its bond purchases.
These tools were put to use again on Thursday as Indonesia entered the foreign exchange market to support the rupiah currency after it touched its lowest level in more than two years, about 13,800 to the dollar.
But Lagarde said a bigger concern was the increase in U.S. budget deficits and debt that she said would begin to cut the growth rate starting in 2022.
A fiscal watchdog group, the Center For a Responsible Federal Budget, has estimated the deficit could top $1 trillion as early as 2019 between the tax cuts and a spending increase passed in January.
Trump administration officials maintain that increased growth prompted by the tax cuts would minimize revenue shortfalls.
“So, you combine reduced growth, reduced revenue and you end up with probably an increased fiscal deficit which will impact on the level of debt of the United States,” Lagarde said.
“We have not advocated increasing debt nor increasing deficits. To the contrary, actually.”
(Reporting by David Lawder; Editing by Clarence Fernandez)