Emerging Markets Are Rolling Back Extraordinary COVID Fiscal Stimulus

Fiscal expansion supported EM growth throughout the covid crisis. In most countries, financing was not an issue and borrowing costs even fell. As the world normalizes, all EMs plan on rolling back crisis stimulus.

“We have been tracking draft budget plans in the last few months, noting that many countries aim for an ambitious fiscal adjustment that might prove socially and politically challenging,” says the Institute of International Finance.

In this note, there is an update of the monitor with the latest budget developments, focusing on Brazil’s and South Africa’s plans to manage high fiscal risk.

South Africa’s upfront adjustment in 2022 is one of the smallest in EM but medium-term plans are ambitious. They rely partly on significant wage restraint that is not unprecedented elsewhere but is in the upper range of what other countries achieved.

Brazil’s upfront adjustment will be larger than South Africa’s, even if deviations from the fiscal rule are significant. In this context, we think there is scope for Brazil’s risk premia to narrow.

In the medium-term, both countries plan on large fiscal adjustments that, while not unprecedented elsewhere, will be hard to do given anemic growth, and social and political complications.

2022 CUTS

Cuts next year are not the end of the story. Planned adjustment in 2023-24 is even larger in several cases (Exhibit 3).

In fact, many countries plan on eventually cutting spending below pre-covid levels, which will be tough given social discontent with economic outcomes around the world (Exhibit 4).

In some cases, planned cuts are significant by the standards of large fiscal adjustments. In a sample of about 200 episodes of large spending cuts that are not reversed in five years, the average country cuts 2.5% of GDP.

The likes of Chile, Colombia, and Peru plan to do even more. So would Brazil if the fiscal rule was met (Exhibit 5). South Africa’s adjustment through 2024 is also significant but backloaded. It relies heavily on wage restraint that might be hard to implement.

When benchmarked against a set of public wage bill reduction episodes elsewhere, South Africa’s plans look ambitious (Exhibit 6). Both Brazil and South Africa will struggle to implement their fiscal plans but in relative terms, we think markets are too pessimistic about the former.

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