Fiscal restraint may reduce risk but likely to stunt growth, says IIF

Emerging markets like the Philippines that seek to narrow ballooning budget deficits and ease their debt burden may face slower growth moving forward as they may cut back on public spending, the Washington-based Institute of International Finance (IIF) said.

But Finance Undersecretary and chief economist Gil Beltran said the Philippines’ tack to maintain its fiscal deficit and debt ratios in the “middle of the pack” of Asian emerging economies would be the “best option” to keep the country’s investment-grade credit ratings.

“Emerging markets are planning substantial fiscal consolidation in the next two years, having implemented very expansionary fiscal policy in the COVID-19 crisis. Several adjustment plans involve large spending reductions. Some are aiming to cut spending below pre-COVID-19 levels, a goal that will be politically challenging,” the IIF said in an Oct. 26 report.

More spending cuts

The IIF’s estimates showed that the Philippines’ fiscal deficit reduction targets for the period 2021 to 2023 would be equivalent to more than 3 percent of gross domestic product (GDP), and would mainly come from spending cuts rather than increases in tax and nontax revenues.

The IIF also estimated that the Philippines’ fiscal impulse, which measures how the fiscal policy stance was changing, would cut less than 1 percent in potential GDP in the next three years. In contrast, the Philippines’ fiscal expansion last year due to more public spending against COVID-19 added less than 1 percent to GDP.

“The [emerging markets’] fiscal impulse is swinging from very positive last year to negative for an extended period. This is not growth supportive and is a bit of a fiscal cliff for emerging markets … Fiscal restraint obviously reduces debt risk, but will come at a growth cost,” the IIF said.

The IIF’s computations showed that for every $1 to be reduced from public spending when emerging markets fiscally consolidate, GDP would also be cut by $0.50. Using this formula, the Philippines’ fiscal consolidation was estimated to result in a less than 1-percentage point policy drag on growth in 2022 and 2023.

“Recovery from COVID-19, and in some cases high commodity prices, will cushion the impact of fiscal adjustment on growth partially. However, fiscal adjustment is one of the reasons why emerging markets’ growth may fall back to subdued pre-COVID-19 levels soon. We think a few countries will want to avoid this kind of painful adjustment and relax fiscal targets soon,” the IIF said.

“Lower spending is complicated from many angles. At a time when social discontent runs high in many countries, it will be politically tough. Then, we know it is likely to be bad for growth. How much depends on the nature of cuts. Eliminating wasteful spending may be ‘costless’ but cutting back on subsidies to the poor may hit consumption significantly,” it added.

Balancing act

Beltran said fiscal management was a delicate balancing act.

“Spend too much and the debt rises, resulting in reduced growth in the future. Spend too little and growth will not be hit right away, but in the future you can grow faster because you don’t need to allocate funds for debt service,” said Beltran, who leads the crafting of the Department of Finance’s “playbook” of fiscal strategies that the next administration may implement to raise more revenues and revert the budget deficit to prepandemic levels or about 3 percent of GDP.

“The best option is to be somewhere in the middle, which is what we are doing now,” he added. The government next year will start to narrow the budget deficit alongside expectations of faster economic growth and increased revenue take.

—Ben O. de Vera