Expert Speak Raisina Debates
Published on Oct 01, 2022

To stave off the public debt crisis, a tailored long-term macroeconomic policy response is essential to address the challenges at hand.

India’s G20 Presidency and the Macroeconomic Dilemma

The G20 established itself as a significant global economic governance body after its success at stabilising the financial market in the 2008 Global Financial crisis through a coordinated fiscal and monetary apparatus. Fast forwarding 2020, the pandemic pushed millions into poverty and deprivation. Many countries, both advanced and emerging, rolled out macroeconomic fiscal packages to curtail the effects. In its aftermath,  multiple concerns are plaguing the global economy, such as uneven economic recovery, an increase in inflationary pressures, the threat of a sovereign debt crisis, and supply chain disruptions which have been further exacerbated by Russia’s invasion of Ukraine.

Beyond DSSI, the G20 has also initiated a Common Framework for debt treatment bringing together the Paris Club and G20 official bilateral creditors.

The G20 members announced the Debt Service Suspension Initiative (DSSI) which targeted the suspension of bilateral debt, thereby, easing highly indebted countries. Beyond DSSI, the G20 has also initiated a Common Framework for debt treatment bringing together the Paris Club and G20 official bilateral creditors. However, these initiatives are ex-post responsive strategies for countries with unsustainable debts. The efficacy of these programmes in avoiding the ballooning of public debt in the first place is questionable. Thus, it is quite evident that this time around the G20’s efforts is less effective in containing the fallout of the pandemic.

How are the key macroeconomic indicators talking to each other? 

Amongst the many impacts of the pandemic, a major long-term impact is increasing global public debt and inflation. The global public debt has reached an unprecedented high of 256 percent of the GDP. Global lockdowns led to supply chain disruptions; this coupled with relief funds from governments induced demand spikes resulting in inflationary pressures. The Ukraine war and the resultant supply chain disruptions have further added to the inflation. This leaves the emerging and least developing countries in a rather peculiar position due to a lack of financial resources at their helm. High public debt and inflation are two major deterrents to any economy, pushing the country into stagflation, increasing the risk of a sovereign debt crisis, unemployment, decreasing the ability to respond to shocks, and increasing the risk of failing institutions. But when there is a trade-off, nations need to decide which one is worse. The study  “The relationship between Public Debt and Inflation in Developing Countries: Empirical Evidence based on Difference Panel GMM” stated that in the direction from public debt to inflation, public debt is directly proportional to inflation. Higher public debt will eventually lead to higher inflation, reduction in Foreign Direct Investment (FDI) and ultimately, stagflation. While the other way around, i.e., from inflation to public debt, the relationship is inverse. Thus, public debt is the greater of the two evils.

In response to the crisis, many countries released relief funds/fiscal packages during the start of the pandemic, primarily, for unproductive expenditures, and are currently increasing bank rates in response to the rising inflation. The United States’ inflation reached an all-time high of 9.1 percent in June 2022, which has made the Federal Bank adopt a hawkish monetary stance to tackle the same which has made developing countries adopt similar measures in the fear of capital flight. Thus, the efficacy of large stimulus packages to maintain macroeconomic stability has been put into question.

High public debt and inflation are two major deterrents to any economy, pushing the country into stagflation, increasing the risk of a sovereign debt crisis, unemployment, decreasing the ability to respond to shocks, and increasing the risk of failing institutions.

However, it was found in a study conducted by Anthony J. Makin in 2019, the national/state fiscal stimulation is essentially ineffective in the floating exchange rate system unless it is reducing marginal tax rates or being used in productive infrastructure. In the same study, it was also found that Australia could avert the 2008 financial crisis primarily by cutting interest rates, leading to capital outflow and depreciation of the exchange rate that eventually increased competitiveness. Increased exports helped keep the deficit in check, decreased rates induced private investment, and flexible labour policy enabled higher employment.

In two separate studies titled “Macroeconomic Determinants of Public Debt in the Philippines” by John Louie Manalo, Mark Villamiel and Eloisa Dela Cruz and “The relationship between Public Debt and Inflation in Developing Countries: Empirical Evidence based on Difference Panel GMM” by Nguyen Van Bon, it was empirically tested that public debt is inversely proportional to FDI and inflation is inversely proportional to trade openness. Thus, a globally coordinated and empirically tested long-term macroeconomic policy response is essential to address the macroeconomic challenges at hand.

Mapping future trajectory

The finance track under the Indonesian presidency in the G20 surveillance note suggests that macroeconomic policy should be tailored according to every country’s different inflation expectations and the level of recovery. Economies that have a tight labour market and higher inflation expectations should implement a tighter monetary policy. Whereas economies which have relatively softer labour policies and have well-anchored inflation expectations can act slowly. Lastly, economies that fear downside risk of economic activity such as China should adopt a dovish stance.

With respect to fiscal policy, for countries where the recovery is lower and has a high debt to GDP ratio—fiscal consolidation is a must. Reallocation of budget towards priority areas targeted support, and reduction in poorly targeted subsidies are warranted. Economies that are recovering should roll back fiscal packages. Additionally, as suggested by the note, ‘Growth-enhancing reforms can facilitate the reallocation of resources to expanding sectors and help strengthen the recovery.’ Enacting and implementing structural reforms in the area of education, female labour force participation, easing and facilitating the entry of new firms and trade facilitation would help mitigate the adverse impact of the pandemic and reduce scarring.

To that end, India in its G20 presidency has a colossal balancing role to play. India’s priority areas must include tackling ballooning public debt, rising inflation, carrying forward the ongoing Indonesian agenda towards health, digital transformation, green transition, and overall macroeconomic coordination. Instead of keeping a short-term approach, G20 in India’s presidency must further a holistic, reformational, and structural approach as suggested in the G20 surveillance note.

Economies that are recovering should roll back fiscal packages. Additionally, as suggested by the note, ‘Growth-enhancing reforms can facilitate the reallocation of resources to expanding sectors and help strengthen the recovery.’

To encourage higher engagement of Multilateral Development Banks (MDBs), central banks and the private sector is critical in mobilising finance for green transition to achieve the pledged target of US$ 100 billion every year and for digital transformation. The report titled ‘Boosting MDBs investing capacity’ suggests improvement in five areas to increase the impact of MDBs. It recommends adapting the approach to define risk tolerance, giving more credit to callable capital, the expansion of uses of financial innovations such as shifting loan risks to willing counterparties, and mobilising financial markets as sources of development finance, etc. In addition to that, the report suggests improvement in credit rating agency assessment of MDB financial strength and increasing access to MDB data for shareholders, rating agencies, etc.—making data more accessible and comparable will allow regular capital reviews and enable fine assessment of MDB strength and elucidate their financial model. Enhancing the investment capacity of MDBs will mobilise more capital in the requisite direction and will lift some fiscal pressure off low-income countries.

Moreover, more than two years into the pandemic, around 30 percent of the world’s population is still not vaccinated. The African continent has the lowest number of vaccinated people pointing to the harsh reality of inequality. It is the moral duty of advanced economies to use their Special Drawing Rights to supply vaccines to poor countries. Furthermore, India in its G20 presidency must also push for easing trade and investment restrictions at related apex institutions such as the World Trade Organisation. Higher trade and investments would keep inflation and public debt in check. Lastly, it is crucial to follow a coordinated and transparent monetary policy that enables faster growth rather than following a reactionary approach by just focusing on transitory inflation. These steps would limit emerging and least developed economies from borrowing, keeping public debt in check.

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Contributor

Apoorva Lalwani

Apoorva Lalwani

Apoorva Lalwani was an Associate Fellow with ORFs Geoeconomic Studies Programme. Her research focuses on data localisation multi-modal connectivity and WTO issues and their impact ...

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