The public debt in COVID times

The COVID pandemic is the first major public health crisis that has engulfed the whole world in this century, in modern times, with disastrous impact on public finances of all countries.

So, the fact that the Philippine public debt to the GDP ratio has risen dramatically in the last two years is not a development unique to the country.

All countries have experienced varying degrees of deterioration of their fiscal positions.

Size of the public debt and the fiscal deficit. In recent years, the Philippine debt to GDP ratio up until 2020 was kept below 40 percent of GDP. In 2019, this was 38 percent.

When the pandemic hit, the debt to GDP ratio rose quickly to 51.6 percent in 2020. The ratio has already hit 63 percent of GDP in November this year.

This indicator of the public debt tells us more about the size of the public debt in relation to the productive capacity of the economy as measured by GDP.

The fiscal deficit also rose. It is a measure of the fiscal position that relates the ability of the tax system to finance government expenditures. During the immediate pre-pandemic year, the fiscal deficit was 3.4 percent of GDP. Before that, the deficit was even lower.

When the pandemic hit the country, the fiscal deficit to GDP ratio soared to 7.6 percent, indicating the joint effects of the GDP contraction due to the lockdown policies and the decline in tax revenues arising out of the income contraction. Current estimates of the deficit projected to 2021 is that it has reached 8.3 percent.

The fiscal deficit to GDP is a different indicator of the budgetary position. It gives information about the performance of the budget balance, the gap between tax generation and the size of expenditures made by government.

Such fiscal numbers would immediately ring alarm bells under normal economic times.

But the fact is that most countries have suffered a similar experience of the deterioration of their fiscal position during their battle against the pandemic. The numbers may differ by country indicating the degree of severity of their particular experience.

Interest on public debt and growth rate. Olivier Blanchard, M.I.T.’s emeritus macroeconomist who once was the IMF’s chief economist, demonstrated in a series of papers that the costs of government debt may be smaller than usually assumed under normal discussions of fiscal policy. Analyzing the situation when the interest on the public debt is lower than the growth rate of the economy – a situation observed for the most part in advanced economies like the United States, European countries, and Japan – he finds that the cost of the GDP growth rate exceeds the interest cost of the public debt.

The main point in Blanchard’s work is simple. When a country’s growth rate is higher than the interest rate on its debt, the fiscal costs of sustaining its debt levels are very low. If the government does not raise taxes to finance the higher debt, the ratio of debt to GDP will decrease rather than rise over time.

Early this year, the Economist published an article based on these ideas and asked, “Should emerging economies worry about the size of their public debt?” The answer to the question was less certain. Some of the emerging economies, like India, confidently asserts their plan that they expand their debt.

In general, finance ministers tend to be more careful about forward plans. It is related to their choices of borrowing strategies.

Applying this same reasoning on the issue of public debt during the pandemic, Blanchard, in a short piece, analyzes the implication of the same model to the range of countries affected by the pandemic. He makes the point that his findings apply to advanced countries like the US, Europe, and Japan. He is much more qualified about emerging countries. They have differing circumstances.

Blanchard is more direct in assessing the situation for emerging economies. Thus, he says:

“I am less sanguine about emerging market and developing economies. Many of them were already struggling before the COVID-19 crisis and have now been hit not only by the virus, but also by the fall in commodity prices (if they are exporters) and large capital outflows by investors who need liquidity at home.

“Some of them do not have the fiscal space to react to these combined shocks and will need help in the form of grants to fight the virus, and adjustment programs to adapt to the other shocks.

“Helping these economies is a major and urgent issue, not only for their own sake, but also for the evolution of the pandemic and thus for the rest of the world.”

Philippine public debt again. The rapid climb of the public debt was occasioned by the strong lockdown measures designed to prevent the spread of the COVID virus, especially in the major productive areas of Luzon, centered in the National Capital Region and in the Calabarzon and in other productive regions.

Recent relaxations of the lockdown measures has seen a slow return to normalcy in some areas. Sources of strength of the Philippine economy are showing signs of recovery. Exports have picked up over the previous years, but this might be the sign of resurgence in that sector. The window for economic recovery has opened to stimulate the return of growth. In this, the passage of the still pending reforms is held up in Congress.

However, OFW remittances have shown a strong pickup, so that the economy is at least experiencing a return of its sources of strengths to prop up the fiscal position. The election period, which is just beginning, is a vibrant component of the aggregate demand of the Philippine economy.

The Treasury has been careful to spread the sources of borrowing to finance the public debt. In the course of a long development, it has tapped the domestic financial market for the short-term needs of government finance. In terms of the big needs for financing the fight against the pandemic and the financing of infrastructure development, it sought loans from external funds and development institutions for access to long term finance.

References:

Blanchard, Olivier, “Designing the fiscal response to the COVID-19 pandemic,” Peterson Institute for International Economics, April 8, 2020.

“Should governments in emerging economies worry about their debt?” Economist, Feb. 11, 2021.

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