India can be thankful it did not go bigger on government spending
From the start of the pandemic, many emerging nations watched the US and other large developed countries “go big” on economic stimulus, and wished they could afford to follow. It turns out they were lucky if they couldn’t and wise if they chose not to. India was a bit of both: Restrained by lack of funds, it chose not to go too big.
Emerging markets which stimulated most aggressively got no payoff in a faster recovery, owing in part to the downsides of overindulging. India was not among the biggest spenders, which tended to suffer higher inflation, higher interest rates and currency depreciation, at least partly cancelling out the sugar high of stimulus.
Scanning data on the top emerging and developed markets for a statistical link between the scale of their 2020 stimulus programmes and the strength of the ensuing recovery, I found none. Even after correcting for the deeper downturns, which often produce a higher bounce-back in growth, aggressive monetary and fiscal stimulus added nothing discernible to the recovery.
This disconnect was particularly sharp in the emerging world. Dividing top emerging markets into heavy and light spenders, and including both new government spending and central bank asset purchases, the bigger spenders actually tended to suffer weaker recoveries. Through the second quarter this year, the median recovery in the 11 biggest spenders amounted to 12% of GDP, compared with 19% in the 11 lightest spenders.
India went into the crisis with a large deficit, which limited how big it could go on stimulus. Its package amounted to 10% of GDP, mid-size compared to its peers. But its payoff for moderation was one of the strongest recoveries in emerging markets.
Among the heaviest spenders were Hungary under Viktor Orbán, Brazil under Jair Bolsonaro and the Philippines under Rodrigo Duterte – all populist governments. Each spent at least 16% of GDP on stimulus, but the biggest spender by far was Greece. Demoted in 2013 from the developed to the emerging markets amid a run of financial mismanagement, Greece spent the equivalent of 67% of GDP on pandemic stimulus, apparently for naught. Like Hungary, Brazil and the Philippines, Greece got an unexceptional recovery, close to the emerging market average of around 16% of GDP.
Why is stimulus showing unclear benefits, and even backfiring in many emerging markets? The impact of stimulus in any one emerging country may now be overwhelmed by factors unique to the pandemic, including the global impact of massive stimulus in the US and other developed countries, and the fight against the virus. Goldman Sachs research found a tight link between growth and both lockdowns and vaccines: The stricter the lockdown and the slower the vaccine rollout, the bigger the hit to growth.
Moreover, overspending often back-fires, particularly in developing nations. They lack the financial resources and the institutional credibility to ramp up spending without unbalancing the economy, and end up getting punished by global markets.
Over the past year, in the heavy spending emerging markets, inflation has run over 5%, nearly a point faster than in light spenders; bond yields are up more than 142 basis points, versus 43 points in light spenders. Currency values have drifted down, while holding steady in light spenders. Based on IMF forecasts, the government deficit at the end of 2021 will also be slightly higher in heavy spenders, at nearly 7% of GDP, versus 6% in light spenders.
Comparing emerging markets on an index of these factors – inflation, currency, interest rates and deficit – highlights where the backfire effects are most pronounced. The heavy spenders that scored worst include Hungary, Brazil and the Philippines. Light spenders that scored best include Taiwan, South Korea and Mexico.
A moderate spender, India suffered mixed backfire effects, with relatively little negative impact on its inflation and interest rates, but a relatively large impact on its currency value. The red flag is a deficit of 11% of GDP, highest among major emerging markets, but this condition existed before the pandemic.
The logic of stimulus campaigns may have more to do with politics than economic conditions. In keeping with their government traditions, East Asian nations tended to be light spenders, Latin American nations tended to be heavy spenders. Emerging or developed, nations that suffered the sharpest downturns did not necessarily roll out the biggest stimulus packages.
The developing world has faced these choices before. Many emerging markets went into the crises of the late 1990s in weak financial condition, were forced to reform rather than spend their way out of trouble. Reining in deficits and debt set them up for a boom in the next decade. By 2008 they were flush, and many responded to the crisis that year by spending and borrowing heavily, which contributed to one of the worst decades on record for emerging economies.
Nations that spend in haste are often forced to repent at leisure. Those that attempted to “go big” during the pandemic probably got less added growth than they imagined and more trouble, in the form of higher deficits and debt, which will leave them with less ammunition to fight the next battle.
Source: Ruchir Sharma