Debt and deficits forced 40% of global economies to suspend fiscal rules amid pandemic

However, governments must strike the right balance between providing emergency support and maintaining credibility of their fiscal policies, the IMF says

The Omicron variant of Covid-19 is creating an obstacle course for the global economy, which a revised IMF forecast says will grow this year by only 4.4 per cent. AFP

Mounting debt burden and deficits fuelled by the Covid-19 crisis led many governments to suspend fiscal rules but they must strike a balance between emergency spending and credible fiscal policies, the International Monetary Fund said.

About 40 per cent of economies including the European Union, Jamaica, Paraguay and the UK that have fiscal rules – limits on spending, deficits or debt that signal a government’s commitment to prudence – have activated "escape clauses" since the outbreak of the pandemic, the IMF said in a blogpost on Thursday.

This compares with 5 per cent exercising the same option during the global financial crisis, when these options were often not part of the fiscal framework of governments. The escape clauses allow deviation from the set limits and without them countries must resort to ad hoc suspensions or modifications of their fiscal practice.

"The widespread use of escape clauses was one of the novelties in this crisis, which helped provide policy room to respond to the health crisis," IMF senior economist W Raphael Lam and fiscal affairs division chief Paulo Medas said in the blogpost.

"But the unprecedented fiscal actions have led to large and widespread deviations from deficit and debt limits."

The fund lowered its global economic growth forecast for this year as Omicron continues to spread unabated and supply chain disruption stokes inflation amid higher energy prices.

The lender, which estimates the global economy to have grown by 5.9 per cent in 2021, revised down its 2022 output projections to 4.4 per cent, half a percentage point lower than its estimate in October, according to its World Economic Outlook released on January 25.

Although fiscal consolidation is expected in many emerging market and developing economies in 2022, high post-pandemic debt burdens will be a challenge for years to come, it said.

Global debt soared to $226 trillion in 2020, the largest 12-month debt surge since the Second World War, and it continues to rise.

The rules-based fiscal framework has come under pressure during the pandemic, with countries using various methods to adapt their regulations in response to the crisis, including activating the escape clauses, suspending fiscal rules temporarily and modifying limits.

While fiscal rules have allowed for a forceful response to the pandemic, they have not prevented a large and persistent debt build-up over time. Almost all countries with deficit rules exceeded the limits by an average of 4 per cent of their gross domestic product in 2020, the fund said.

Debt deviations also reached unprecedented levels. The median deviation reached 50 per cent of GDP in advanced economies and 26 per cent of GDP in emerging market and developing economies, partly reflecting high pre-pandemic debt levels.

"The policy challenge is whether and how countries should return to the limits and the fiscal rules, while ensuring credibility of the fiscal framework," IMF officials said.

There is an opportunity now to further strengthen fiscal frameworks.

"While each country will choose its own path, international experience suggests that a sound, rules-based framework will need to rely on strong political commitment, including a better record of compliance, creating incentives to build buffers during good times and designing effective mechanisms to manage large shocks in bad times," they said.

Updated: January 27, 2022, 10:00 PM