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Thursday, March 12, 2020 / 12:38
PM / Fitch Ratings / Header Image Credit: IMFBlog
Fiscal easing will be part of the optimal policy
response to economic shocks or downturns, particularly for sovereigns with
strong public finances, Fitch Ratings says. However, fiscal loosening rarely
pays for itself, and persistent deterioration in public finances will increase
the risk of sovereign rating downgrades.
With sovereign borrowing costs at record lows and
monetary policy potentially running out of fire-power, many commentators argue
that governments should relax fiscal policy to boost GDP growth and can do so
safely without putting public debt sustainability at risk.
Fitch tends to use the term 'fiscal space' primarily
to denote the room for governments to run larger budget deficits or increase
public debt without triggering a rating downgrade. This is a narrower concept
than the IMF's: "the room for undertaking discretionary fiscal policy relative
to existing plans without endangering market access and debt
sustainability".
One gauge of this 'fiscal rating space' is how close
each sovereign's Sovereign Rating Model (SRM) output is to the threshold that
could lead to a rating downgrade and therefore what deterioration in public
finance variables would precipitate it. An increase in government debt/GDP of
10% would lead to a lower SRM result for 15 countries, in the absence of
offsetting factors.
Fitch is more likely to hold off on a downgrade if the
fiscal deterioration: is temporary (e.g. reflecting the economic cycle), the
country has a record of fiscal consolidation and/or a credible policy
framework, it will boost medium-term growth or lower contingent liabilities,
and adverse demographic trends are not severe.
All the G7 plus India are among the three weakest
sovereigns in terms of public finances in their rating categories. The GDP of
the three sovereigns with the weakest public finances in each rating category
totals 54% of world GDP, while the three strongest in each category totals just
5%. So countries where fiscal stimulus could provide a fillip to global growth
have less fiscal space available for doing so.
The improvement in western Europe's public finances
since the global financial and eurozone crises has rebuilt fiscal space in the
IMF meaning of the concept. However, sovereign ratings have also improved
strongly in recent years in parallel with lower debt burdens and gains from lower
interest rates.
Fiscal easing can provide a short-term boost to GDP
growth and a medium-term boost if it raises the capital stock. However, this
'fiscal multiplier' is not normally large enough to 'pay for itself' and
prevent a rise in public debt/GDP (relative to the counterfactual). Fitch
forecasts several countries to experience a rise in government debt/GDP in 2020
despite a real interest rate below the real GDP growth rate, e.g. owing to
large primary deficits.
A real interest rate below the real GDP growth rate is
supportive for public finances, but not sufficient to stabilise government
debt/GDP at sustainable levels. For countries with large primary budget
deficits, debt/GDP would only theoretically stabilise at very high levels. In
practice, the risk premium would be likely to rise as debt/GDP climbed towards
such levels for all but perhaps a handful of sovereigns with exceptional debt
tolerance.
Since the late 1990s, nearly four-fifths of cases when
government debt increased by 20% of GDP within a five-year period have led to
downgrades of sovereigns rated by Fitch at the time. Of 18 defaults by
Fitch-rated sovereigns, the median government debt/GDP ratio was 85% the year
before the default and median peak was 95% (in the three years centred on the
default). The lowest peak was only 23% for Dominican Republic (2005), while
Japan ('A') has serviced its debt without difficulty despite it reaching 231%,
highlighting that creditworthiness depends on many factors.
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