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The rise of EM fiscal risks

The latest IMF Fiscal Monitor quantifies the significant deterioration in emerging market government finances. The average deficit-to-GDP ratio in EM is expected to reach 4.7% of GDP this year while the average debt ratio is approaching 48%. The structural deficits of many commodity exporters seem too large to sustain if commodity prices fail to recover. Moreover, dangers from contingent liabilities related to banks and the massive EM corporate debt stock have increased.

IMF Fiscal Monitor, April 2016.

This post ties in with the rising systemic risk from government finances.

The below are excerpts from IMF monitor. Headings, links and cursive text have been added.

Deteriorating fiscal numbers

Fiscal positions have worsened significantly in the past year. Many of the risks identified in previous Fiscal Monitors have materialized…Nowhere have the revisions been more pronounced than in emerging market and middle-income economies, where fiscal deficit ratios in 2015–16 are now expected to exceed, on average, the levels observed in 2009 at the beginning of the global financial crisis…Among emerging market and developing economies, commodity exporters experienced the largest deterioration in their fiscal positions.”


The IMF estimates that overall EM general government deficit has widened from 2.4% in 2014 to 4.5% in 2015. It is expected to rise further to 4.7% in 2016. For comparison: after the great financial crisis it had peaked at 3.7% of GDP. Countries with particularly large 2015 deficits include Saudi Arabia (16.3%) and Brazil (10.3%).

The gross government debt stock in the emerging world has risen from below 40% of GDP in 2010-13 and 41.5% in 2014 to 45.4% in 2015 and is expected to climb further to 49% by 2017. Countries with particularly large debt ratios include Brazil (76%) and India (67%).

“The 2015 number was the largest deficit since the 1990s and the largest yearly deterioration since the beginning of the global financial crisis. Although China accounted for one-third of the overall deficit increase, this trend was broad-based, affecting about two-thirds of the countries in the sample. Driving this deterioration was a sharp slowdown in growth and several aggravating factors—notably plummeting commodity prices, tighter external funding conditions, and decelerating capital inflows…Revenue shortfalls were higher in oil exporters with small or no currency adjustments (Kuwait, Libya, Saudi Arabia), whereas countries that let their currencies depreciate (Colombia, Mexico, Russia) partly recouped the losses in domestic currency.”


Rising fiscal risks

“Fiscal risks have increased in the past year, particularly in emerging market and developing economies, where vulnerabilities are aggravated by lower commodity prices, tighter financial conditions, and geopolitical tensions…In commodity exporters, which have suffered the largest declines in revenue, the financing gap that has opened is likely to be long lasting, reflecting persistently lower commodity prices. However, the fiscal measures currently being considered are often inadequate for achieving the needed medium-term adjustment.”

The deterioration of the global economic outlook has raised the likelihood that contingent liabilities may materialize…In emerging market economies, corporate debt of nonfinancial firms has quadrupled in the past decade. In these countries, weaker growth, higher borrowing costs, and deteriorating corporate balance sheets could put pressure on the debt nexus between corporations, financial institutions, and the government. With the continued decline in commodity prices, resource companies are facing strong headwinds, and state-owned enterprises with links to the resource sector may require government support.”

“In China, the government has recently taken steps to mitigate the fiscal risks stemming from off-budget local borrowing by reducing the use of finance vehicles and converting existing liabilities into municipal bonds with more favorable term and rate conditions. Nevertheless, as in other emerging markets, contingent liability risks remain, particularly in the event of a further slowdown in growth and in real estate, because of high levels of overall credit and the low profitability of state-owned enterprises.

Notes on contingent liabilities

“Contingent liabilities are obligations that are not recorded on government balance sheets and that arise only in the event of a particular, discrete situation (such as a crisis). Often these obligations are not even explicit government guarantees, but are implicit; they involve a moral obligation or expected responsibility of the government that is not established by law or contract but is based on public expectations of intervention, such as after a crisis. Examples include support to troubled banks deemed too big to fail, support to weak state-owned enterprises, or legal claims.”

“Government contingent liabilities have been one of the largest sources of fiscal risk during the past few decades…. [A historical] review finds that the probability for a country to experience a materialization is roughly 9 percent in any given year. It also shows that a country can expect to be affected once every 12 years on average, at a cost of roughly 6 percent of GDP.”

“Financial sector support has been the most costly type of materialization. Bank recapitalizations and other forms of support to troubled financial institutions cost about 10 percent of GDP, on average, per episode (each of which can last several years)… Other important types of contingent liability materializations over the past 25 years have been bailouts of troubled state-owned enterprises or subnational governments, which led to average fiscal costs of about 3 percent and 4 percent of GDP, respectively.”


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