Macro Analysis /

Covid fiscal tracker: Stimulus measures continue to balloon

  • Since April c2/3 of countries have expanded Covid-related stimulus, pushing deficits & debt to historically high levels

  • The response of advanced economies has dwarfed emerging & frontier markets due to higher borrowing capacity

  • Consolidation is urgently required post-Covid to reduce the massive debt overhang and rebuild buffers

Covid fiscal tracker: Stimulus measures continue to balloon
Tellimer Research
30 June 2020
Published byTellimer Research

Roughly four months since the Covid crisis became a global issue, governments around the world have rolled out stimulus programmes unprecedented in breadth and magnitude. In the annex to the IMF’s June 2020 World Economic Outlook (WEO) Update, they take account of the fiscal response to Covid.

At the time of the April 2020 WEO, governments had announced fiscal measures amounting to US$8tn (see our initial thoughts – here). This has since increased to US$11tn, with more than two-thirds of governments scaling up support since April. Of this amount, roughly half is additional spending and foregone revenue that will directly affect government budgets (i.e. “above the line”). The other half is liquidity support including loans, equity injections, and government guarantees which will not have an immediate budgetary impact but could materialise on the government balance sheet down the road if guarantees are called or interventions incur losses (i.e. “below the line”).

However, the magnitude and composition of the fiscal impact varies widely by country. In advanced economies the 2020 fiscal response averages 19.8% of GDP, including 8.9% of GDP above the line and 10.9% of GDP below the line.

In larger mainstream emerging markets the magnitude of support is a much smaller 5.1% of GDP, including 3.1% of GDP above the line and 2.0% of GDP below the line.

Lastly, in low-income developing countries (LIDCs) fiscal support totals a negligible 1.1% of GDP, including 1.0% above the line and 0.1% below the line.   

Borrowing capacity dictates space for Covid-related stimulus

Intuitively, countries that have responsibly managed their debt should be rewarded with greater market access during the Covid crisis, thus enabling them to fund much larger stimulus programmes and associated deficits. A strong correlation is evident between credit rating and the size of Covid response, with each one-notch upgrade to a country’s composite credit rating increasing Covid-related stimulus by 0.45% of GDP.

However, the relationship is not always straightforward. Regressing the 2020 Covid response on the 2019 debt-to-GDP and debt service-to-revenue ratios shows that with each percentage point rise in debt service-to-revenue, the size of the Covid response shrinks by c0.3% of GDP. However, each percentage point increase in debt-to-GDP actually increases the size of the Covid response by c0.1% of GDP, suggesting that countries with a higher debt burden have actually been able to deploy more resources to fight Covid.

To control for the fact that developed countries tend to have both higher debt burdens and higher debt carrying capacity, we add the composite credit rating and a developed country dummy variable and re-run the regression. Surprisingly, the positive relationship between the debt stock and Covid response remains intact, while the relationship between debt service-to-revenue and the Covid response becomes insignificant. Meanwhile, the developed country dummy is statistically significant and implies that developed countries have been able to deploy on average a 6% of GDP larger fiscal response to Covid than their developing counterparts.

Taken together, these conclusions seem to support the requests of many frontier market policymakers for debt relief to enable them to counter the impact of Covid. While smaller stimulus packages in emerging and frontier markets partly reflect weaker debt dynamics and more limited fiscal capacity, the positive relationship between debt and Covid-related spending and relatively large impact of the developed country dummy suggest that funding availability may be dictated more by perceived rather than actual credit risk. Developed countries may thus be benefiting from “exorbitant privilege” related to their reserve currency and safe-haven status, allowing them to respond more forcefully to Covid regardless of their fiscal position.

Overall fiscal impact exceeds stimulus measures

Aside from Covid-related stimulus, the overall fiscal impact reflects several additional factors. Automatic stabilizers from taxes and social protection will help cushion the fall in household incomes but will also contribute to c1/3 of the rise in deficits as government revenues drop by 2.5% of GDP on average amid contracting economic growth. Likewise, many countries will fund part of the Covid stimulus by reallocating spending from non-priority items, helping to cushion some of the impact. This is an encouraging strategy when the majority of cuts are to non-essential recurrent spending, but could dampen future growth if the cuts come from slashing capital expenditure.

In advanced economies, 8.9% of GDP of above-the line spending will give way to a 13.3% widening of the fiscal deficit in 2020 and will increase the debt stock by 26% of GDP. This implies 4.4% of GDP deterioration from automatic budget stabilizers and a 12.7% of GDP increase in debt from automatic debt dynamics (such as the interest rate-growth differential or currency movements). The difference could also reflect projected realization of guarantees on-budget.  

In emerging economies, the overall fiscal deterioration of 5.7% of GDP is actually smaller than the 5.8% of GDP of above the line Covid measures, reflecting a greater reliance on expenditure reallocation vs. debt creation. However, the overall debt burden is still expected to rise by 10.7% of GDP, reflecting unfavourable debt dynamics. Lastly, LIDCs will see deficits widen by only 2% of GDP amid 1% of above the line Covid measures, contributing to a 5.1% of GDP debt increase.

Globally, public debt is expected to rise from 82.8% of GDP in 2019 to 101.5% of GDP in 2020 amid a widening of fiscal deficits from 3.9% of GDP to 13.9% of GDP. The 18.7% of GDP rise in debt far outstrips the 10.5% of GDP rise at the height of the GFC in 2009, while the 10% of GDP widening of fiscal deficits is more than double the 4.9% of GDP seen in 2009. As before, there are significant differences by country classification (see below), with the deterioration greater in higher-income countries.

Lessons for post-Covid policymaking

Since April, the size of the fiscal response to Covid has expanded greatly. However, advanced economies perceived to have a high debt carrying capacity have offered far greater support than their lower-income counterparts and have experimented with a greater variety of off-budget liquidity measures and guarantees. This serves as a potent example to emerging and frontier economies, who must strive to build fiscal buffers and policy credibility as the global economy begins to recover, to enable them to respond more forcefully to future shocks.

The global policy response has dwarfed that of the GFC despite a much weaker fiscal starting point, shattering conventional wisdom that a decade of procyclical (or at the very least historically loose) fiscal and monetary policy would erode the policy space needed to respond to future shocks. That said, moving forward it is essential for policymakers to roll back stimulus measures as the economy begins to recover. With public debt now averaging over 100% of GDP globally, there will be less space to deploy spending of such massive proportions in response to future shocks.

Budget deficits are expected to consolidate to 8.2% of GDP on average in 2020, a sharp drop from the 13.9% of GDP forecast for 2021 but still twice the 2019 average. While automatic fiscal stabilisers will contribute c2.5% of GDP to the consolidation as growth and revenue pick back up, a reversal of Covid-related stimulus measures will also be necessary to put debt on a sustainable path and rebuild buffers. Failure to consolidate budgets as the recovery accelerates will leave future generations with a massive debt overhang, crowding out investment and stifling growth. Policymakers must ensure that double-digit deficits and triple-digit debt are a cyclical anomaly, not the new normal, and investors may discriminate across countries accordingly in that regard.