By Jean-Marc Fournier, Vitor Gaspar, Paulo Medas and Roberto Accioly Perrelli
Pandemic and war-related spending imperatives respond to high debt and tight budget constraints.
Just as increased vaccinations offered hope, Russia’s invasion of Ukraine disrupted the global economic recovery. One of the most visible global effects has been the acceleration in energy and food prices, triggering concerns about episodes of food shortages and increasing the risks of malnutrition and social unrest. Global food prices have surged 33.6% in March compared to the previous year, according to the Food and Agriculture Organization of the United Nations.
our latest Tax monitor explains how governments, faced with record debt and rising borrowing costs, can best meet urgent needs. He insists on the call for greater global cooperation.
Highly uncertain fiscal outlook
Economies around the world have accumulated layer upon layer of the legacy of past shocks since the global financial crisis. Extraordinary fiscal measures in response to the pandemic have led to rising budget deficits and public debt in 2020.
Additionally, the outlook remained uncertain as the world navigated an unprecedented environment, with rising inflation and a growing divergence in recoveries, then Russia invaded Ukraine, pushing geopolitical risks higher.
Global deficits and debt are down from record highs, but the risks surrounding the outlook are exceptionally high and vulnerabilities are growing. Global public debt is expected to decline in 2022 and then stabilize at around 95% of gross domestic product over the medium term, 11 percentage points higher than before the pandemic. Big inflation surprises in 2020-21 have helped lower debt ratios, but as monetary policy tightens to rein in inflation, sovereign borrowing costs will rise, reducing policy space. public spending and increasing debt vulnerabilities.
In advanced economies, deficits are expected to shrink and policies shift from pandemic support to structural transformation. The fiscal outlook in Europe faces exceptional uncertainty given the the war in Ukraine and its fallout. In most emerging markets, deficits will narrow, but with large variations from country to country. Low-income countries, already scarred by the pandemic, have very limited fiscal space as they are hit hard by the fallout from war.
The various shocks have also posed new risks to public finances. Governments are under pressure to deal with rising energy and food prices. To ease the burden on households, ensure food security and prevent social unrest, most governments have announced measures to limit the rise in domestic prices. However, such actions could have significant fiscal costs and exacerbate global supply and demand mismatches, putting further pressure on international prices and potentially leading to energy or food shortages. This would further harm low-income countries that depend on imported energy and food.
Moreover, the fight against poverty has suffered a setback, particularly in emerging markets and low-income countries. Compared to pre-pandemic trends, the COVID-19 crisis pushed an additional 70 million people globally into extreme poverty in 2021. In many advanced economies, households were protected by direct government support or job retention programs. Households have been spending less and saving more due to social distancing, mobility restrictions and uncertainty about the future. This excess savings provides an important buffer but, if spent quickly, could still contribute to inflationary momentum. The situation is much worse in other countries with large numbers of poor people, where rising inflation could push more people into poverty and exacerbate the food crisis.
Manage crisis after crisis
Governments face tough choices in this highly uncertain environment. They should focus on the most pressing spending needs and raise revenue to pay for them.
We recommend agile budgeting strategies tailored to each country’s circumstances:
- In the economies hardest hit by the war in Ukraine and sanctions against Russia, fiscal policy must respond to the humanitarian crisis and economic disruption. Given rising inflation and rising interest rates, budget support should be targeted to the most affected and priority areas.
- In countries where growth is stronger and inflationary pressures remain high, fiscal policy should continue its shift from support to normalization.
- In many emerging markets and low-income economies facing tight financing conditions or the risk of debt distress, governments will need to prioritize spending and increase revenue to reduce vulnerabilities.
- Commodity exporters benefiting from higher prices should take the opportunity to replenish reserves.
Government responses to soaring international commodity prices should prioritize protecting the most vulnerable. A key objective is to avoid a food crisis while preserving social cohesion. Countries with well-developed social safety nets could deploy targeted and temporary cash transfers to vulnerable groups while allowing domestic prices to adjust. This will limit budget pressures and create the right incentives to increase supply (such as investment in renewables). Other countries could allow for a more gradual adjustment of domestic prices and use existing tools to help the most vulnerable during this crisis, while taking steps to strengthen safety nets.
Fossil fuel price hikes further underscore the urgency of accelerating the transition to clean, renewable energy, which would increase energy security and help meet the pressing climate agenda – we are significantly behind in limiting warming climate at 2 degrees Celsius.
About 60% of low-income countries are either at high risk of debt distress or already suffer from it. They face lingering scars from COVID-19. They are particularly vulnerable to food price increases, given the large share of food expenditure in their household budgets. These countries need the support of the international community.
But the need for collective action is broader. Global cooperation is needed to tackle the pressing and urgent issues facing the world: energy and food crises, current and future pandemics, debt, development and climate change.