Fiscal expansion was the logical response to the 2020 health and economic crisis. Alas, public deficit and debt ratios had already been historically high before. The IMF estimates that this year’s general government deficit in the developed world will reach 11% of GDP, while the government debt stock will exceed 120% of GDP. Fiscal sustainability relies on low or negative real interest rates. Yet, on smaller and lower-grade countries credit spreads have risen and become more volatile. In the large developed economies, central bank purchases help to absorb the glut of debt issuance but cannot prevent balance sheet deterioration. Concerns over sovereign credit risk or – more realistically – debt monetization are rational. Fiscal risk and related government strategies will likely be key drivers of financial market trends for years to come.

The below-quoted text and numbers are from the latest IMF fiscal monitor and some additional private and academic research sources. All are listed at the end of this post.

Cursive text and text in brackets have been added for clarity.

The post ties up with this site’s summary on systemic risk and government finances.

The scope of fiscal support

“Public sector support is provided on an extraordinary scale, including vehicles such as loans and guarantees…On the spending side, measures include extended unemployment benefits, government-funded paid sick leave, wage subsidies, targeted transfers to affected households and firms, and support to hard-hit sectors such as tourism, hospitality services, and travel. On the revenue side, measures include temporary deferral of corporate and personal income tax payments and social security contributions ranging from three months to one year, as well as temporary tax relief or exemptions, including on medical goods and services, for affected sectors and vulnerable firms and households.” [IMF]

“The Group of Twenty (G20) economies have already provided sizable fiscal support through revenue and spending measures of 3.5% of GDP on average, as of April 8, 2020, in response to the pandemic…[including] a weighted average of 5.9% of GDP among G7 economies…This amount is higher than the stimulus during the global financial crisis that began in 2008. In addition, massive packages of public-sector liquidity support, including loans and guarantees, each above 10% of GDP in France, Germany, Italy, Japan, and the United Kingdom, were announced to support financial and nonfinancial firms, including small and medium-sized enterprises. At the global level, spending and revenue measures amount to $3.3 trillion and loans, equity injections, and guarantees total $4.5 trillion.“ [IMF]

“[In the U.S.] the CARES Act amounts to around 3% of GDP stimulus this year, and will bring the fiscal deficit to a new peacetime high of 12% of GDP…[It] puts much of the U.S. economy on the government’s payroll for a few months [and] provides over $2 trillion in stimulus, directed majorly at small businesses and middle- and lower-income Americans. In addition, the CARES Act provides around $450 billion for the U.S. Treasury’s Exchange Stabilization Fund to use as loans, loan guarantees…Levered up with funds from the Fed, the U.S. government is set to provide subsidized short-term credit, potentially amounting to around $4 trillion, to a wide range of business borrowers. [It came on top of] $8.3 billion of support, largely for COVID-19 vaccine research and development, and $192 billion for free COVID-19 testing, state unemployment insurance, expanded paid sick leave, and food assistance.” [J.P. Morgan]

“The latest [U.S. fiscal] expansion [on top of the CARES act], costed by the staff at $484 billion includes $310 billion to augment the PPP-scheme (the small-business loan/grant/employment protection program)…It looks as though most of this will be disbursed in 2020 [adding] 2¼%-points to the US fiscal thrust estimate, taking it to 6.7% of GDP for 2020.” [Suttle Economics]

“In the European Union, in addition to relatively large automatic stabilizers, discretionary measures taken by member states amount to 3.1% of EU-27 GDP. Further support is provided through the EU-level initiatives, including the coronavirus investment response to help national health sectors, businesses (through working capital or guarantees), and national short-term employment schemes. Liquidity support measures such as loans or loan guarantees to businesses are common, especially in European countries (16.7% of EU-27 GDP).” [IMF]

The estimated impact on public deficits and debt ratios

“The size of the impact of COVID-19 on public finances is highly uncertain at this time and will depend not only on the duration of the pandemic but also on whether the economic recovery is swift or the crisis casts a long shadow.” [IMF]

“The pandemic and its economic consequences will cause a major increase in fiscal deficits and public debt ratios across countries [see figure below]…Overall fiscal deficits are expected to widen more in advanced economies, partly reflecting a more pronounced projected economic contraction in advanced economies than in emerging market economies…This is on top of the fiscal easing in 2019, when more than half of the advanced economies pursued expansionary fiscal policies.” [IMF]

According to the IMF fiscal monitor the average general government deficit-to-GDP ratio in the advanced economies is expected to rise from 2.6% in 2018 and 3.0% in 2019 and 10.7% in 2020. In the U.S. the deficit is projected to jump from 5.8% of GDP in 2019 to 15.4% in 2020. Other major advanced economies with particularly high expected deficit ratios include Canada (11.8% of GDP), Australia (9.7%), Spain (9.5% of GDP) and France (9.2% of GDP).
The average general government debt-to-GDP ratio in the advanced economies is expected to rise from 103.9% in 2018 to 105.2% in 2019 and 122.4% in 2020. Particularly high debt ratios are predicted for Japan (252% of GDP), Greece (201%), Italy (156%), Portugal (135%), and the United States (131%).

According to the IMF fiscal monitor the general government deficit-to-GDP ratio in the Emerging Market countries is expected to widen from 3.8% in 2018 to 4.8% in 2019 and 9.1% in 2020. Particularly high deficit ratios are expected in South Africa (13.3%), Saudi Arabia (12.6%) and China (9.9%).
The average general government debt-to-GDP ratio in the emerging economies is projected to increase from 50% in 2018 to 53% in 2019 and 62% in 2020. It is expected to increase further to 65% in 2021. Larger countries with particularly high debt-to-GDP ratios include Brazil (98%), Egypt (87%), and Pakistan (85%).

“Although the macroeconomic effects of the pandemic are uncertain and the size of discretionary fiscal policy responses to COVID-19 may still rise, they will affect the overall balance and public-debt-to-GDP ratios over the medium term.” [IMF]

The resulting financial risks

“Although a sizable increase in deficits this year is necessary and appropriate for many countries, the starting position in some cases presents vulnerabilities…Global debt (public and private) reached $188 trillion (226% of GDP) in 2018, according to the IMF Global Debt Database. Average public debt of advanced economies had plateaued at about 100% of GDP in the 2010s, compared with 74% in 2007, and is now set to rise substantially as a result of the crisis. Meanwhile, it had steadily risen in emerging markets and developing economies.” [IMF]

“Evidence from the US to show that not only do the markets expect the low interest rates to persist into the future, but they also expect the use of negative interest rates down the line.” [Lilley & Rogoff]

“For many frontier and emerging markets and, at times, some advanced economies, borrowing costs have risen sharply and have become more volatile since the coronavirus began spreading globally…[A] notable development is a further widening of sovereign and corporate spreads, with a decline in borrowing costs for sovereigns that are considered to be safe and a simultaneous sell-off of assets that are perceived as risky. Spreads in many advanced and emerging market economies have risen sharply since the declaration of COVID-19 as a global health emergency.” [IMF]

High debt and rising debt service costs make it more difficult to conduct countercyclical fiscal policies. Likewise, as access to financing has become challenging for firms, and as the public sector steps in with loans and guarantees, related fiscal risks have risen… Downside risks include the following: (1) a more severe economic fallout from widespread infections and repeated outbreaks; (2) large swings in commodity prices; (3) prolonged stress in global financial markets; (4) renewed social unrest; and (5) extreme weather events. These risks are intertwined and could reinforce one another, exacerbating the drag on growth and exerting negative effects on public finances.” [IMF]

The case for monetary financing

“Policymakers today can learn from how governments coped with the economic and fiscal stresses associated with viral outbreaks over the past century…Coronavirus-related public health restrictions have been swifter, stricter, and more global than under any previous epidemic. Annual output losses from coronavirus could, therefore, be at least as big as the high single- or double-digit peak losses seen during the Spanish flu and Ebola outbreaks…Governments need to look to how they finance themselves for protracted periods in which expenditures are likely to far exceed revenues…The rising costs and decreasing revenues for governments will…be challenging, and will likely require assistance from central banks as well as international and regional institutions…Central banks may have to provide temporary liquidity directly to governments to finance their deficits.” [Hughes]

“A swift and well-targeted policy response…is needed to minimise the indirect, and likely more persistent, economic effects of the coronavirus crisis. One approach would be for governments to step in and provide affected firms (and self-employed workers) with the funds to keep meeting their payroll and unavoidable expenses, without raising their financial liabilities… Massive purchase of the newly issued debt by the central bank through an expanded quantitative easing programme would certainly facilitate its absorption but would not prevent the increase in governments’ debt ratios, with the risks of putting some countries’ public finances on an unsustainable path…Fortunately, there is an alternative to a strategy based on higher taxes and/or more government debt in order to finance such an emergency fiscal programme, albeit one that has remained a taboo among most economists and policymakers – namely, direct, unrepayable funding by the central bank of the additional fiscal transfers deemed necessary, an intervention commonly known as ‘helicopter money’…Money-financed fiscal interventions are a powerful tool … policymakers should resort to them only in emergency situations … Unfortunately, that emergency is currently upon us …If ever, the time for helicopter money is now.” [Gali]

“The creation of emergency authority for central banks and the formation of a COVID policy committee could help establish the policy as a one-off, emergency money-financed plan, giving the central bank the authority to act quickly and then revert to the ‘no money-printing’ norm as the crisis subsides.” [Yashiv]

“The extraordinary operations that are underway in most countries in response to the COVID-19 shock have raised fears that large-scale monetisation will result in a major inflation episode… So far, there is no evidence that central banks have given up, or are preparing to give up, on their price stability mandate. It may eventually happen if the fiscal cost of the crisis proves to be unbearable, but the size of the current public bond purchases should not be regarded as indicative of future excess monetisation.” [Blanchard & Pisani-Ferry]

Sources

Blanchard, Olivier and Jean Pisani-Ferry, “Monetisation: Do not panic”, 10 April 2020

IMF, “Fiscal Monitor – April 2020”

Galí, Jordi, “Helicopter money: The time is now”, 17 March 2020

Hughes, Richard, “Safeguarding governments’ financial health during coronavirus: Learning from past viral outbreaks”, March 29. 2020

J.P. Morgan Global Research, “A Breakdown of the CARES Act”, April 14, 2020

Lilley, Andrew and Kenneth Rogoff, “Negative interest rate policy in the post-COVID-19 world”, April 17, 2020

Eran Yashiv, “Breaking the taboo: The political economy of COVID-motivated helicopter drops”, 26 March 2020

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Ralph Sueppel is founder and director of SRSV, a project dedicated to socially responsible macro trading strategies. He has worked in economics and finance for over 25 years for investment banks, the European Central Bank and leading hedge funds. At present, he is head of research and quantitative strategies at Macrosynergy Partners.