Nations need to focus on fiscal consolidation and fiscal buffers to meet future contingencies

If too much is done too soon to convince markets of one's fiscal rectitude then that could endanger growth prospects. It can also hamper the climate transition challenges. On the other side, if countries do too little then it will build up fiscal fragilities

Of late, there have been more focus and reports on debt sustainability in both advanced and developing emerging countries, particularly the less developed and low developed countries. It is a fact that due to Covid-19, and on earlier occasions like the 2008 global financial crises; volatility in commodities prices, particularly oil; quantitative easing followed for quite a long time with low interest rates to come out of the global financial crises; supply chain disruptions due to sanctions imposed on account of geo political tensions, disturbance at Red Sea that escalated freight costs and posed risks to free movement of goods and frequent climate destruction have all impacted global economy. Depreciation of weaker currency of less developed countries against the dollar have resulted in higher repayment obligation, the huge increase in interest rates in developed countries to fight inflation resulted in higher cost of borrowing for countries depending on borrowed funds. Recently there has been supply of defence items and other assistance to a country like Ukraine by the US and Europe, which again increases their negative impact on fiscal pressure of those countries. There may be specific reasons for each country in the fast changing global dynamics to resort to higher borrowings either from domestic sources or from foreign sources. Moreover there has been volatility on FDI inflows to countries depending upon foreign investment as recently global movement of funds towards FDI has reduced post-the pandemic. The other sources of foreign portfolio flows have become highly volatile due to the quantitative tightening policy and volatility in markets in search of stable effective rate of return.

These factors have taken some countries to defaulting servicing debt or defaulted needing quick restructuring solution by multilateral development institutions and additional help by developed countries. This was discussed elaborately in summits like G20 in order to arrive at quick solution. There has been a general agreement on strengthening multinational development banks by public and private capital and thereby increase their capabilities to lend on softer terms to the needy countries so that they would be on the path of development for achieving sustainable debt levels.

Another important requirement of these countries to have adequate resources to invest on climate adaptation and mitigation projects and as well reduce their dependence on fossil fuels was by focusing on making huge investments on alternative energy sources. Moreover these countries also will have to spend on human capital, social sectors and improve food security to bolster per capita income and achieve sustainable development goals (SDGs) by reducing hunger, poverty and reduce income disparities. Moreover, in these periods of uncertainty, every nation should have a clear cut fiscal consolidation plan and also ensure Fiscal buffers to meet any future contingencies.

IMF Blog has a recent article by Pierre-Olivier Gourinchas titled ‘Global Economy Approaches Soft Landing, but Risks Remain’. This has stressed the need for policy focus shift towards repairing public finances and improving medium term growth prospects. In this period of success due to control on inflation and its steady decline and growth holding up, the pace of expansion remains slow and turbulence lies ahead.

According to this article "the biggest challenge ahead of us is to tackle elevated Fiscal risks. Most countries came out of the pandemic and energy crisis with higher public debt levels and borrowing costs. Suggested measure is to bring down the public debt and deficits which will give space to deal with future shocks."

Can this be done quickly or in a phased manner? If too much is done too soon to convince markets of one's fiscal rectitude then that could endanger growth prospects. It can also hamper the climate transition challenges. On the other side, if countries do too little then it will build up fiscal fragilities until the risk of a fiscal crisis forces sudden and disruptive adjustments at a great cost. It is therefore suggested that to implement a steady fiscal consolidation with the first step of non- trivial first instalment, which should be combined with an improved and well-enforced fiscal framework, so future consolidated efforts are both sizable and credible. With global inflation coming down and fiscal tightening may be easing then the opportunity should be used to focus on economic growth and fiscal consolidation.

With uncertainty in capital flows and consequent currency volatility, emerging markets with better resilience, stronger than expected growth and stable external balances must build up stronger buffers. There is also a need to focus on further reforms to ease the most binding constraints to economic activity such as governance, business regulation and external sector reforms, which can unleash latest productivity gains, according to the author.

As stated earlier, given the geo-economic fragmentation, which is starting to affect trade and climate, we need to strive to keep our economies more interconnected as that will help in solving global challenges with multilateral cooperation.

It is illustrated better in an article in the recent RBI bulletin ‘The shape of growth compatible fiscal consolidation’ by Michael Debabrata Patra, deputy Governor RBI. This study stresses on fiscal consolidation and states that medium term complementarities between fiscal consolidation and growth in India argue for prioritising the composition of government expenditure towards developmental expenditure like health, education, skilling, digitalisation and climate risk mitigation. The study finds that targetting productive employment generating sectors, embracing energy efficient transition and investing in digitalisation could lead to a substantial decline in general government debt.

It is therefore necessary to focus on quality of expenditure as well as prioritising developmental expenditure with enhanced sources of revenue and with better and stable growth will lead to long lasting growth dividends in the long term.

(The author is former Chairman & Managing Director of Indian Overseas Bank)