Fiscal easing is a part of optimal policy response to economic shocks or downturns

Fiscal space limited for many sovereigns, including India: Fitch Ratings

Mar 13, 2020

London [UK], Mar 13 (ANI): All the G7 plus India are among the three weakest sovereigns in terms of public finances in their rating categories, according to Fitch Ratings.
"The GDP of the three sovereigns with the weakest public finances in each rating category totals 54 per cent of world GDP, while the three strongest in each category totals just 5 per cent," said Managing Directors Ed Parker and James McCormack.
"So countries where fiscal stimulus could provide a fillip to global growth have less fiscal space available for doing so," they said in a report.
Fiscal easing is a part of optimal policy response to economic shocks or downturns, particularly for sovereigns with strong public finances.
However, fiscal loosening rarely pays for itself and persistent deterioration in public finances will increase the risk of sovereign rating downgrades, said Fitch.
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.
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, for example 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 per cent 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 per cent the year before the default and median peak was 95 per cent (in the three years centered on the default).