Updated: May 18, 2022 9:34:15 am
The global macroeconomic situation is showing signs of macro instability reflected in increasing debt, deficits and inflation — global debt has increased sharply during the pandemic, inflation is on the rise, and macroeconomic uncertainties have increased due to the ongoing war between Russia and Ukraine. The World Economic Outlook, published by the IMF in April, expects global growth to be slower than the forecast made in January, with inflation on the rise.
Apart from the war, inflation today is the inevitable consequence of fiscal and monetary expansion that happened during the pandemic. If we consider, both the revenue foregone and additional expenditure during Covid (as provided by the IMF’s Fiscal Affairs Department), it was around 15 per cent of GDP for the advanced economies, while in emerging market economies and low-income developing countries it was around 6 and 2.5 per cent respectively. Among the G20 emerging markets, both direct and indirect fiscal support provided by governments varied between 15 and 1.9 per cent. Estimates for Brazil, Turkey, India and Indonesia were above 10 per cent of GDP (see table).
Globally, the total support comprising revenue foregone, expenditure stimulus and liquidity support was estimated to be $17,000 billion, of which government guarantees accounted for more than $4,000 billion — roughly one-fourth of the total — the downside fiscal risks of which cannot be ignored. If there is a large default, it can weaken the fiscal balance sheet in the medium term for items that are below the line at the moment.
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In the last few weeks, central banks in many countries including India have raised interest rates to deal with rising inflation. This reflects that the monetary stance is gradually moving to inflation management. That certainly does not mean that central banks have given up supporting growth. It is about the shift of focus on policies to the one that is most relevant at the moment for the macroeconomy — inflation. Why has the management of inflation become so critical? Some key data on money supply can help provide us with a perspective.
What was the increase in money supply during the last two years to support governments to deal with Covid? Information is sketchy and no direct estimate of monetary financing of the deficits during the pandemic is available. However, a sense of it can be obtained from the limited data that is available from the World Development Indicators on monetary aggregates compiled from the International Financial Statistics of IMF. The growth of the central bank’s “claims on central government” provides some idea of the additional increase in money supply due to the government operation during Covid. Even if not a precise estimate, the data on “claims on central government” reflects an increase in money supply due to the central bank’s support to the government. It showed a sharp increase among major advanced economies during 2020. In the US, immediately after the global financial crisis in 2010, the growth of central bank’s support to the government was 0.4 per cent. In the year 2020, this support increased to 9 per cent. It was above 9 per cent in the UK, 10.5 per cent in Brazil and 6 per cent in China.
Third, both domestic and external debt stock increased sharply during the pandemic. The international debt statistics published by the IMF for 2022 show that the external debt stock to the export ratio for 123 low-and middle-income countries increased from 101 per cent in 2018 to 123 per cent in 2020. The export to debt service ratio for these countries increased from 14 per cent to 17 per cent during the same period. The share of public sector external debt in total external debt increased from 37 per cent to 39 per cent during this period. During the same period, the increase in South Asia’s external debt stock as a percentage of export increased from 110 to 137 per cent, and the increase in debt service to export ratio was from 11 to 16 per cent. For Sri Lanka, the increase was from 258 to 424 per cent with an increase in debt servicing cost to export ratio from 36 to 39 per cent. Among the South Asian countries India’s external debt stock to GDP ratio remained stable at around 20 per cent, with a marginal decline in the general government external debt stock share in total external debt stock from 25.75 per cent to 24.68 per cent.
Reduction of debt takes time, but management of inflation can’t wait. Options are complex. Going forward, the global economy needs coordinated policy for monetary tightening and fiscal sustainability. There is a need to start fiscal normalisation without creating adverse distributional consequences. For this, countries need to chart out a fiscal normalisation plan to ensure that it is not abrupt and responses are sequenced in a manner that helps bring the economy back on track, enhances fiscal resources for the government for public investment in the social and economic sector and create a framework for sector-specific differentiated responses for a full recovery.
Finally, the money spent by low income developing countries to deal with Covid was far less than the advanced and emerging market economies and most of this spending was on health and emergency response. Rising debt and inflation are only going to compound macro challenges for these countries. There is a need for a quick and efficient resolution of the challenges arising due to the elevated debt levels of low-income countries. One can hope for an equitable, fair and sustained recovery post-Covid only when there is greater international cooperation to ensure more resource flow to the poorer regions of the World.
This column first appeared in the print edition on May 18, 2022 under the title ‘The inflation spiral’. The writer is former director, NIPFP
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