The fiscal cat will soon be on the prowl and belling it won’t be easy, says Akrur Barua of Deloitte.
Long after COVID-19 is defeated, the physical and emotional scars of the pandemic will continue to haunt people. But that won’t be the only thing that policymakers will have to worry about in the months and years ahead. Getting government finances back to health may be one of the toughest tasks that policymakers the world over face in the medium to long term. Governments have been forced to step in at an unprecedented scale—to tackle the virus, aid vulnerable households, and provide relief to businesses affected by the pandemic. And while these measures have brought relief to health care efforts and economic activity, they have also led to a sharp rise in government deficit and debt levels across the globe.
While deteriorating fiscal health is low in the order of policymakers’ worries at this moment, it does present a steep challenge for medium- to long-term economic fundamentals. Lessons over the past decade, from emerging markets to advanced nations, should be a grim reminder that at some time over the next few years, fiscal prudence will have to take precedence. And it won’t be an easy task, for sure. Widening income and wealth inequality will make it difficult for governments to cut down on benefits even as higher taxes to fund current expenditure may not result in intended increases in revenue in economies with weak taxation structure. Unorthodox policies may be a way out for some—central banks’ financing part of government debt will likely go against age-old economic fundamentals but may find more takers in certain economies. For others, fiscal reforms are a way out, but they need to start early as the costs of pushing the can down the road are high as the last decade revealed.
The economic fallout of the current pandemic has been harsher than anything in recent memory. In 2009, due to the global financial crisis, world GDP fell by about 0.1%, according to the International Monetary Fund (IMF). This time around, the IMF estimates, the contraction is much harsher—4.4% in 2020. And unlike in 2009 when emerging economies took up the burden of driving global growth, this time around they too likely contracted due to the pandemic. While the global economy is expected to recover this year, much will depend on the trajectory of the pandemic. Even as hope is rekindled with rollout of vaccines, covering a sizeable section of the population to achieve herd immunity will take time—maybe another year or even two. The sharp spread of the virus in many parts of the world in recent months has forced some governments—like in the United Kingdom and other parts of Europe—to reintroduce social-distancing restrictions, yet another sign that a return to pre-COVID-19 normal is still some time away.
COVID-19 and its economic fallout have impacted fiscal health of governments in three ways. First, governments across the world have incurred large health care–related expenditure to counter the pandemic, especially on virus testing, contact tracing, and vaccine development and procurement. The IMF estimates that additional spending or revenue foregone in the health sector through October 2020 totaled 1.5% of GDP in the United Kingdom, 1% in Japan, and 0.9% in Canada. This year, governments’ expenditure on vaccinations will likely go up, especially in emerging economies with large populations, such as China and India, where the task of inoculating people below the poverty line will largely fall on governments.
Second, economic contraction has meant that revenue growth for governments fell sharply in 2020. In the United States, gross federal government receipts fell 39.7% year-over-year in Q2 2020. Although receipts rebounded in Q3, they were down again slightly in October and November, underscoring the importance of economic growth to government revenues. Similarly, state and local government revenues in the United States have been hit as well. In Germany, tax revenues were down by 8% in the first 11 months of 2020 compared to a year before, while in China, a nation that fared relatively better economically than many others last year, general government revenues fell 5.3% during that period.
Third, to counter the economic downturn and provide relief for impacted households and businesses, governments across the world have enacted record amounts of stimulus in addition to support from monetary authorities. In the United States alone, the total fiscal and monetary stimulus—spread almost equally between the two—amounts to about US$6.5 trillion or a little more than 30% of GDP. In Japan, the total value of the stimulus, including for health care, is 11.3% of GDP and is being complemented by liquidity support worth 23.7% of GDP. Emerging economies too have engaged in strong fiscal intervention to cushion the economic fallout of the pandemic, although the degree of stimulus on average is less than advanced economies. Among key emerging economies, Brazil’s fiscal package was the largest at 8.3% of GDP, followed by South Africa (5.3%) and China (4.6%). Other economies, like India and Turkey, have opted for more liquidity support through monetary authorities than large amounts of fiscal stimulus. In fact, central banks across the world have been active with asset purchases with the scale of purchases far outpacing that during the downturn of 2008–2009.
By Akrur Barua
About the author: Akrur Barua is manager for Deloitte Services India Pvt. Ltd.
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