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EM Monitor - the fiscal response by emerging markets to Covid 19

June 2020

EMs walk the line - analysing the fiscal response

In our last edition we covered the monetary response to Covid 19 in emerging markets. This time we look at the fiscal side: which markets are making the biggest adjustments and which seem at greater risk? The troubled trio of Brazil, Turkey, South Africa look particularly vulnerable.

Suffering CADs

As in prior episodes of high risk-aversion, it is the currencies of emerging markets that are most reliant on external investors for financing that have suffered the most. The currencies of these current-account-deficit (CAD) markets are down -13% year to date. Let’s study these markets in more detail: India, Indonesia, Malaysia, Brazil, Mexico, Colombia, Turkey & South Africa.

Not as big as you think...

At first glance, total fiscal packages for the eight countries under consideration appear large  (e.g. 8.5% of GDP for Brazil or 7.1% for Colombia). Yet a big chunk are guaranteed loans - bridge loans to companies to allow them to survive the crisis - which will not necessarily add to public debt as they should  be repaid.  ‘Should’ is the key word here, as it assumes that these firms will not default or that governments will not forgive their loans.

Release the pressure
Fig. 1 - Fiscal packages for 8 principal CAD emerging markets 
Fig.1 - table showing breakdown of fiscal expenditure divided by fiscal spending and guaranteed loans as a % of GDP for 8 key emerging markets: India, Indonesia, Malaysia, Brazil, Mexico, Colombia, Turkey, South Africa

Source: Pictet Asset Management, CEIC, Refinitiv, May 2020

Brazil at most risk

Focusing only on fiscal spending that will impact the debt level, these EMs appear to have generally struck a good balance between necessity and affordability - all apart from Brazil. 

But public debt is just one indicator we think should be considered. Using six inputs to compile our proprietary sovereign debt sustainability score,  we then track this in fig.2 below against the fiscal stimulus in the different markets.

This shows that the larger fiscal stimulus packages have come from those countries on a more sustainable debt footing. Or conversely: the higher the sovereign risk, the weaker the fiscal stimulus. Examples of high debt and low stimulus include South Africa and India. Again the notable exception is Brazil, which has just passed the second largest budget in EM after Thailand, worth BRL380bn.

Odd one out
Fig. 2 - EM fiscal spending & sovereign debt sustainability score
Chart showing fiscal expenditure for 8 key emerging  markets plotted against our proprietary debt sustainability score

Source: Pictet Asset Management, CEIC, Refinitiv, May 2020

Brazil aside, fiscal deterioration should be much smaller in emerging markets than in advanced economies.  The median direct fiscal stimulus in EM being 1.6% of GDP which compares to 4.2% for advanced economies. Moreover, EMs have generally been much more cautious in providing guaranteed loans to the private sector than in developed markets.

The path through the woods

But can you be too cautious? A clear risk is that smaller fiscal packages are ineffective and ultimately lead to a higher costs for the overall economy. This is because fiscal deterioration comes anyway as a collapse in activity leads to a loss in fiscal revenues via lower tax receipts. For example, we forecast in South Africa a nominal fall in  GDP of -3.7% in 2020 should result in a contraction of 5% in fiscal revenues.
 

A clear risk is that smaller fiscal packages are ineffective.

This is the delicate path certain current-account-deficit emerging markets will need to tread in coming months: over-stimulate fiscally and you risk raising your debt burden to unsustainable levels and crashing your currency and economy, but under-stimulate and an economic slump will shrink fiscal revenues and crash the currency.
 

The importance of a stable base

A key factor to consider is the share of domestic investors versus overseas. As fig.3 below shows, markets that score well with more than 85% of their public debt held domestically are Brazil, India & Malaysia. Others such as, Colombia, Indonesia, South Africa and, in particular, Turkey have overseas investor bases above the EM median.
Bringing it all together
Fig. 3 - EM borrowing needs & external public debt (%total public debt)
chart plotting the borrowing needs of 8 emerging markets plotted against the breakdown of external / domestic investors

Source: Pictet Asset Management, CEIC, Refinitiv

The troubled trio

Overall, Brazil has the most sizeable borrowing needs, while Turkey is the most exposed to foreign investors. South Africa however looks the most vulnerable as it has both a significant deficit to finance and a high share of its debt held externally.