The question of debt management remains a key concern for emerging countries

Fiscal policy was at the top of the agenda at the IMF Annual Meeting held in Washington, DC in October 2019, which was attended by ministers of finance, central bank governors and private sector executives from around the world. The event provided an opportunity for member countries to issue statements outlining their opinions on the global economic landscape, which are of considerable interest to the international investment community.

Expert Takes

Representing the European Commission, vice-president Valdis Dombrovskis and commissioner Pierre Moscovici called for a more “supportive policy mix in the current juncture”, adding that “fiscal policy should be used in an effective and timely manner in countries with fiscal space”. Meanwhile, Steven Mnuchin, the US secretary of the Treasury, argued that “with space for monetary easing diminishing in many countries, fiscal policy paired with pro-growth structural reforms that will durably raise investment, job creation and productivity will need to play a larger role”. The message from some of the global economy’s most influential figures was clear: it is time for fiscal policy to take over where monetary policy has run its course as an effective tool. For many developing economies, however, this advice is difficult to implement. A high proportion of emerging markets rely heavily on the export of commodities to secure the revenue needed for fiscal expenditure. As a result, the sharp decline in commodity prices in 2014 and 2015 continues to negatively affect fiscal conditions, contributing to creeping levels of public debt.

Countries with large external finance requirements generally find it more difficult to attract investment; consequently, the question of debt management is a central concern in 2020. Opinions vary on the correct fiscal course for any given economy, but with global growth slowing in 2019, most advice centred around the idea that nations with high levels of public debt should adopt prudent fiscal policy, while countries with fiscal space should increase public investment to support growth and rebalancing. However, the question of how public debt should be assessed leaves considerable room for disagreement. With a range of additional extrinsic factors, including the need to satisfy voters during election years and the effect of regional unrest on hydrocarbons revenue, the fiscal debate is becoming an ever more complex one.

Middle East & North Africa

In the MENA region, fiscal policy has been shaped by a slowdown in government revenue. Oil production cuts made by the Organisation of the Petroleum Exporting Countries in an effort to rebalance international oil markets have constrained the growth of Gulf Cooperation Council (GCC) economies, where hydrocarbons are the primary source of revenue. A number of governments in the region have responded to the slowdown in oil prices by adopting looser fiscal policies and increasing state spending, which has helped to encourage the growth of non-oil sectors.

However, the sustainability of this approach has come into question since 2019, when ratings agency Fitch Ratings downgraded Saudi Arabia, the largest economy in the GCC, from “A+” to “A”, citing sustained fiscal deficits as one of the main reasons for this decision. According to Fitch, the Kingdom is expected to post a fiscal deficit of 6.7% of GDP at the end of 2019, compared to 5.9% in 2018.

In North Africa, Egypt, Morocco, Sudan and Tunisia have faced a more acute undersupply of revenue. While fiscal deficits in North Africa saw an overall decline in 2018 as a result of higher commodity prices and ongoing fiscal reform, balance is a recurring priority for policy planners. However, their capacity to enact change is restricted by the prospect of social unrest in response to austerity measures.

This is particularly the case in Egypt, North Africa’s largest economy, where the government succeeded in narrowing a stubborn fiscal deficit by three percentage points between 2016 and 2018, to 9.7% of GDP. However, the country continues to face a political challenge in reducing a public expenditure bill that is significantly higher than that of other lower-middle-income countries – equivalent to 27.8% of GDP in 2018. Egypt has also faced large borrowing needs in recent years; as a result, interest payments absorbed around 70% of tax revenue in 2018. Although firming hydrocarbons prices are likely to offer fiscal relief in the short term for GCC oil producers, widening the tax base to boost revenue is a strategic priority for Egypt and other North African countries. In Morocco, which is expecting a budget deficit of 3.5%, 1% of companies are responsible for 80% of corporate income tax, while 70% of value-added tax (VAT) is derived from 0.66% of contributors. Governments across the region are also pursuing fiscal gains by improving the governance of public companies and launching privatisation programmes to release funds for their Treasuries.

East Asia

While the MENA region balances the necessity for fiscal consolidation against social concerns, East Asia has largely been content with an expansionary fiscal stance. The ability of governments to maintain elevated spending levels is underwritten by relatively high growth rates; excluding China, the region is expected to see GDP expansion of 5.1% in 2019, followed by 5.2% in 2020-21, according to the World Bank. In fiscal terms, East Asia is also relatively well positioned. According to the UN, the region’s fiscal deficits averaged a modest 1.8% between 2013 and 2018, while its debt-to-GDP ratio was 46% in 2017. In comparison, the average debt-to GDP ratio in Latin America and the Caribbean was 60% over the same period.

In the case of the Philippines, an accommodative fiscal policy is funding the Philippine Development Plan 2017-22, which aims to end poverty for 6m people through major upgrades to the nation’s infrastructure. While elevated public spending levels have resulted in concerns regarding mounting debt, the government has sought to offset this by diversifying its sources of funding, resulting in a debt-to-GDP ratio of around 40% in 2019.

The Thai government, meanwhile, issued an expansionary budget in October 2019, which will see spending increase by 7% in FY 2020. This is expected to create a slightly larger fiscal gap than budgeted for in 2019, bringing it to 2.6% of GDP. Thailand has run a budget deficit virtually every year since 1999 – with the exception of 2005 and 2006 – and will continue to do so over the medium term. The country’s Ministry of Finance estimates that it will not have a balanced primary budget until around 2026.

In Indonesia, where the focus of recent budgets has been on increasing the effectiveness of government spending, an expansionary stance also prevails. The 2020 budget allocates a total of $180bn, an increase of 3% compared to the previous year. The government plans to direct funds towards the development of human capital, infrastructure, and efficient and transparent bureaucracy, as well as the creation of a buffer in the event of a global economic downturn.

However, some economies in the region have more pressing fiscal concerns. For example, Myanmar’s alignment with the global economy continues apace and the country’s GDP growth is expected to reach 6.6% by FY 2020/21, but a large informal sector makes it difficult for the government to accrue revenue. The authorities are addressing this by reducing costs for individuals to utilise their undeclared income. The “Reduced Tax Rates for Undeclared Income” scheme, which forms part of the Union Tax Law approved in September 2019, reduces the penalties levied when the buyer of a major asset – such as a plot of land – cannot show the source of the funds.

Sub-Saharan Africa

Politics will have an influence on the fiscal conversation across much of sub-Saharan Africa in the coming years, with Ghana, Tanzania and Ethiopia holding elections in 2020, and Zambia in 2021. These countries account for around 25% of the continent’s GDP, and the tendency of governments to increase spending as the polling date nears means that the risk of fiscal slippage is high.

For much of sub-Saharan Africa, a long-anticipated expansion of GDP has yet to be realised, with growth reaching 2.5% in 2018 and expected to hit 2.9% in 2019. Slow economic expansion has placed a strain on government finances, even in East Africa, where growth has recently outperformed other parts of the continent. Consequently, fiscal deficits remain high. The UN Department of Economic and Social Affairs has attributed this to a combination of high levels of government spending on infrastructure and weak domestic resource mobilisation.

East African countries are increasingly reliant on borrowing to bridge the fiscal gap, both from the international bond market and economically expansionist China. This means that the possibility of external debt distress in countries such as Kenya, Ethiopia and South Sudan is a prominent fiscal concern. Similar debt worries are emerging in West Africa, where GDP growth is currently being driven by Nigeria and Ghana – two hydrocarbons-producing countries that are benefitting from firmer oil prices. Nigeria’s public debt grew by 12.3% in 2018, to reach N24.4trn ($79.6bn), which has brought the nation’s debt as a percentage of GDP to around 20% – approaching the 25% debt limit imposed by the government. Ghana is following an even sharper trajectory: in 2006 the nation’s external debt-to-GDP ratio stood at 26% of GDP, but sustained fiscal deficits and government borrowing pushed the level to 73% by 2016. It has since fallen slightly to 62% of GDP in 2019. However, the nation’s total debt increased by 16% year-on-year in the first quarter of 2019, reaching $38.9bn – the highest level since 2015.

Governments have responded to growing debt levels with attempts to limit spending: in 2018 and 2019 most economies in West Africa underwent a process of fiscal consolidation. Côte d’Ivoire, aiming for a fiscal deficit of 3% of GDP set by the West African and Economic Monetary Union, has successfully reduced its fiscal gap by lowering current transfers such as subsidies in the electricity sector.

However, like other fiscal reformers in the region, Côte d’Ivoire has also issued eurobonds and used part of the proceeds to buy back more expensive, shortterm domestic debt. While this trend has smoothed debt profiles across West Africa, growing public debt – and particularly the external debt component – is emerging as a downside risk.

For most governments, therefore, harnessing the revenue potential of Africa’s large informal sector is a strategic priority. For example, Kenya started to target start-ups, freelance workers and small vendors with a presumptive tax of 15% in 2018. The country continues to increase its revenue through a combination of formalisation efforts and the indirect taxation of informal operators through other means, such as VAT. In addition, tools such as the Kenya Revenue Authority Personal Identification Number (PIN) enable businesses and individuals to complete an electronic tax return, although many workers in the informal sector still lack a PIN.

In Ghana, where informal activity represents the largest sector of the economy but contributes only 2% of total taxes, the authorities are attempting to widen the tax base by rolling out a digital addressing system to locate potential businesses and taxpayers, as well as launching an e-platform that will allow informal sector operators to conveniently pay taxes through mobile money applications.

Latin America & the Carribean

The debt challenge is also a prominent issue in South America and the Caribbean, where a legacy of borrowing has overshadowed otherwise encouraging short-term growth prospects. After a relatively subdued growth rate in 2019 – estimated at 1.7% by the World Bank – the region is expecting 2.5% expansion in GDP in 2020, growing to 2.7% in 2021.

Continued growth in Colombia, on the back of tax reforms and infrastructure projects, and building momentum in Brazil are expected to be the primary drivers of this trend. Nevertheless, weaker performance in recent years has resulted in limited macroeconomic policy space in most markets in the region: average government debt in Latin America and the Caribbean has risen steadily since 2008, reaching 60% in 2018. Sovereign credit ratings for several countries were downgraded in late 2018, among them Argentina, Costa Rica and Nicaragua.

While the World Bank forecasts that fiscal deficits will shrink modestly over the short term, the region’s aggregate debt burden remains at its highest level since 2005. This leaves some nations vulnerable to the possibility of rising borrowing costs. In September 2019 Argentina’s Ministry of the Treasury predicted a primary fiscal surplus of 1% of GDP in 2020, but a government debt equivalent to around 86% of GDP is a costly burden on public finances. However, with a new government in place since October 2019, the country’s fiscal outlook may change.

Meanwhile, Mexico is aiming for a primary fiscal surplus of 0.7% of GDP in 2020, which would reduce its need to borrow. Despite this, the government has been compelled to defend its revenue projections for the year, which many observers – including some major credit ratings agencies – regard as overly optimistic. Should revenue fall short of targets in 2020, the government will be faced with the prospect of making greater spending cuts or abandoning the fiscal discipline that it prioritised in its first two budgets.

In the Caribbean, higher oil prices helped to return Suriname and Trinidad and Tobago to positive growth in 2018, and aggregate growth in the subregion is expected to reach 2% in 2019 and 2020. However, like their regional peers, high debt burdens have constrained fiscal policy. Political events have also impinged on the fiscal sphere: having made significant progress in reducing its fiscal deficit, which shrank from 9% of GDP in 2017 to 3.9% in 2018, T&T is expected to ease its austerity drive in 2020, which is an election year for the country.