Emerging Markets
EmergingMarkets’Post-PandemicFiscalAdjustment:Expenditures
5 mins
The pandemic’s effect on economies was as varied as it was on individuals. Although all countries are in weaker fiscal positions with much larger government debts than before the crisis, several factors differentiate which emerging markets may fare better on the other side of the virus. We’ve previously assessed EM economies through four lenses—sensitivity to the virus, pre-COVID conditions, vulnerability to the global downturn, and policy responses—before taking a closer look at their specific fiscal conditions. In our prior post, we analyzed the divergence in the ability of Emerging Markets to implement a fiscal adjustment from the revenue side—i.e., the capacity that countries have to increase tax receipts. Here, we show how the other side of the fiscal picture—government expenditures—factors into our security selection process within the emerging market debt sector.
The outbreak of COVID-19 was an unprecedented exogenous shock, placing enormous pressure on all governments to increase spending on healthcare, social programs, and economic stimulus. We do not expect countries to be able to rein in this extraordinary spending quickly, particularly not EMs where virus outbreaks are still accelerating and vaccine access remains challenging. However, EMs that entered 2020 with lower spending relative to their peers have more fiscal breathing room to postpone potentially difficult political trade-offs. While a country’s debt sustainability is of course a product of many different variables, in the second part of this series we specifically focus on the spending side of the fiscal balance sheet.
Where Was Spending Already Stretched?
By calculating the average ratio of a country’s primary expenditure to GDP over 2017-2019, we can assess whether a country was spending heavily relative to its peers before the onset of the pandemic. We use primary expenditure, a measure of all government spending excluding net interest payments, rather than total expenditure to remove debt servicing costs.1 Interest payments on sovereign debt are not easily adjusted, short of debt restructuring, so primary spending provides a more accurate picture of a country’s fungible expenditures.
We plotted this spending metric against each country’s debt-to-GDP at the end of 2020 to assess which countries are spending heavily against their existing debt stock.2 We then calculated the sample averages of our two variables to divide countries into four quadrants: those that are Fiscally Stretched (high debt/high spending), Fiscally Exuberant (low debt/high spending), Fiscally Conservative (low debt/low spending), and Fiscally Prudent (high debt/low spending).3
We conducted this analysis for investment grade and high yield countries (Figures 1 and 2) and highlighted commodity exporters as well as the type of commodity exported.
FIGURE 1
Investment Grade Oil Exporters are Outspending Peers
International Monetary Fund as of May 2021.
While the fiscally stretched quadrant is the most densely populated among the IG sample, it is reassuring—and consistent with our work on revenues—that four of the seven countries are European Union members. These EU EMs are all eligible for large grants sized at over 5% of GDP and low interest loans representing another 10% of GDP through the Next Generation EU program. Thus, they have unique means of supporting and even bolstering their spending without adding significantly to their debt stock.
Additionally, oil exporting countries appear to be outspending their IG peers and may experience more difficulty reining in expenditures over the short term. However, with the exception of Qatar and Colombia, these oil exporters generally have lower debt levels.
FIGURE 2
Fiscally Conservative High Yield EMs Have Some Breathing Room
International Monetary Fund as of May 2021.
The HY universe shows more regional differentiation. Whereas nearly all Asian HY EMs exhibit lower than average primary expenditure to GDP ratios, EMs in the Central and Eastern European region and the Middle East are outspending their HY peers. Similar to the pattern seen in the IG sample, HY oil exporters—except for those located in Sub-Saharan Africa—are generally high relative spenders as well.
It is reassuring that the HY fiscally conservative quadrant is well populated. In general, these countries have been more fiscally responsible than their peers, spending less relative to the size of their economies and their debt stocks. Thus, they may have an easier time maintaining higher pandemic-era spending in the coming years before fiscal and political pressures set in.
Top 10 Most Improved
Lowering spending is often politically and practically complex, particularly in countries where the economic recovery has not yet full materialized. However, Figure 3 shows that many EMs have successfully cut expenditures over a fairly short period.
FIGURE 3
Expenditure Cuts are Complex but Possible
International Monetary Fund as of May 2021.
In some cases, such as Qatar, cuts were easier to enact due to the country’s strong fiscal position. In other cases, such as Egypt, the International Monetary Fund pushed for a reduction in expenditure. In cases such as Angola, cuts were due to a combination of domestic policies and bolstered by an IMF program. The majority of these countries are frontier markets and commodity exporters, but it is reassuring that signifcant expenditure cuts were possible across a range of countries in recent years.
In our two-part series, we have examined both sides of the fiscal coin—revenue collection capacity as well as expenditure levels—to see which EMs have fiscal space to best absorb the unprecedented challenges posed by the pandemic. By incorporating a framework for identifying those fiscally conservative countries that are best positioned to reduce their debt burdens into our country and security selection process, we can better target relative value opportunities across the EM investment universe.
1 Net interest payments are negative (i.e. interest cost is higher than interest income) for all countries in our sample except Kazakhstan, Kuwait, Oman, Saudi Arabia, and Uzbekistan.
2 We have excluded data for the expenditure/GDP ratio for 2020 because they are distorted due to the pandemic and are not representative of a country’s average fiscal pressure. Conversely, 2020 Debt/GDP represents the actual debt burden a country faces.
3 We used the same group names as in the previous post. Fiscally exuberant here should be intended as “trend fiscal exuberant” (i.e., debt would increase at current trends. Likewise, “fiscally prudent” should be intended as “trend fiscally prudent” since debt would decrease at the current fiscal stance.