The pandemic stimulus has backfired in emerging markets

Ruchir Sharma

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From the start of the pandemic, many emerging nations watched the US and other large developed countries “go big” on economic stimulus, and wished they could afford to follow. It turns out they were lucky if they couldn’t and wise if they chose not to.

Emerging markets that stimulated most aggressively got no pay-off in a faster recovery, owing in part to the downsides of overindulging. The big spenders tended to suffer higher inflation, higher interest rates and currency depreciation, at least partly cancelling out the sugar high of stimulus.

Scanning data on the top emerging and developed markets for a statistical link between the scale of their 2020 stimulus programmes and the strength of the ensuing recovery, I found none. Even after correcting for the deeper downturns, which often produce a higher bounceback in growth, aggressive monetary and fiscal stimulus added nothing discernible to the recovery.

This disconnect was sharpest in emerging markets, from China to Chile. Dividing the top emerging markets into the most and least aggressive spenders, the heavy spenders typically suffered weaker recoveries. Throughout the second quarter this year, the median recovery in the big spenders amounted to 12 per cent of gross domestic product, compared with 19 per cent in the light spenders.

Among the heaviest spending emerging markets were Hungary under Viktor Orban, Brazil under Jair Bolsonaro and the Philippines under Rodrigo Duterte — all populist governments. Each of these nations spent at least 16 per cent of GDP on stimulus, including both new government spending and asset purchases by the central bank.

At the top of the big spender list by far is Greece, which was demoted in 2013 from the developed to the emerging markets amid a run of financial mismanagement. It spent the equivalent of 67 per cent of GDP, apparently for naught. Like Hungary, Brazil and the Philippines, Greece got an unexceptional recovery, close to the emerging market average of about 16 per cent of GDP.

Why is stimulus showing unclear benefits, and even backfiring in emerging markets? The impact of stimulus in any one emerging country may now be overwhelmed by factors unique to the pandemic, including the global impact of huge stimulus in the US and other developed countries, and the continued fight against the virus. Research by Goldman Sachs found a tight link between growth and both lockdowns and vaccines: the stricter the lockdown and the slower the vaccine rollout, the bigger the hit to growth.

Moreover, overspending often backfires, particularly in developing nations. They lack the financial resources and the institutional credibility to ramp up spending without unbalancing the economy, and end up getting punished by global markets.

Over the past year, in the heavy spending emerging markets, inflation has run above 5 per cent, nearly a point faster than in light spenders; bond yields are up more than 142 basis points, versus 43 points in light spenders. Currency values have drifted down, while holding steady in light spenders. Based on IMF forecasts, the government deficit at the end of 2021 will also be slightly higher in heavy spenders, at nearly 7 per cent of GDP, versus 6 per cent in light spenders.

Comparing emerging markets on an index of these factors — inflation, currency, interest rates and deficit — highlights where the backfire effects are most pronounced. The heavy spenders that scored worst include Hungary, Brazil and the Philippines. Light spenders that scored best include Taiwan, South Korea and Mexico.

The logic of stimulus campaigns may have more to do with politics than economic conditions. In keeping with their government traditions, East Asian nations tended to be light spenders, Latin American nations tended to be heavy spenders. Emerging or developed nations that suffered the sharpest downturns did not necessarily roll out the biggest stimulus packages.

The developing world has faced these choices before. Many emerging markets went into the crises of the late 1990s in weak financial condition, were forced to reform rather than spend their way out of trouble, and reining in deficits and debt set them up for a boom in the next decade. By 2008 they were flush, and many responded to the crisis that year by spending and borrowing heavily, which contributed to one of the worst decades on record for emerging economies.Nations that spend in haste are often forced to repent at leisure. Those that attempted to “go big” during the pandemic probably got less added growth than they imagined and considerably more trouble, in the form of higher deficits and debt, which will leave them with less ammunition to fight the next battle.