Governments are widely scaling back massive fiscal programs that had helped push economies through covid — a trend that, contrary to popular belief, could potentially have more impact on the global economy than monetary policy tightening by central banks, says Bloomberg. Together, governments plugged in an amount equal to 2.5% of global GDP in the form of higher spending to aid their ailing economies, a staggering five times more than the funds deployed in post-2008 financial crisis austerity measures, estimates from investment bank UBS show.

A balancing act: While fiscal tightening leads to slower growth, it could also help combat the rising inflation cropping up in many parts of the world. The government does this by raising taxes, curbing public spending, or cutting public-sector jobs. This slows down the economic cycle temporarily to balance out growth and inflation. Contractionary fiscal policy has been a go-to approach for many governments facing mounting inflationary pressure, with the reasoning that a lower debt load will help the economy recover faster.

Fiscal stimulus and a successful vaccine rollout were key drivers in the post-pandemic rebound: With the global economy estimated to be expanding at its strongest post-recession pace in 80 years, huge spending programs, primarily in a small number of wealthy economies which put in place public programs to support households and businesses, were seen as the most powerful post-covid growth engine.

But the tides are now turning: A reversal of pandemic spending by the world’s biggest-spending governments is now threatening to dent the post-covid recovery drive, with the world’s largest economy, the US, ending emergency spending, and the Biden administration’s pushing for a spending plan with more of a long-term view. In Europe, an austerity debate is just around the corner and UK officials are beginning to moralize about their duty to start narrowing deficit spending. Elsewhere, Japan is planning more spending that won’t quite match pandemic-era stimulus, China is paying more attention to its budget figures, while Brazil is debating whether to keep in place spending limits, and Mexico isn’t budging much on its tight spending approach.

Spending wasn’t all the rage for developing economies, with an inability to sustain stimulus programs and high debt levels continuing to weigh on economic recoveries. EMs that rolled out aggressive spending programs added little to their recoveries, writer-investor Ruchir Sharma writes for the Financial Times. “Emerging markets that stimulated most aggressively got no pay-off in a faster recovery, owing in part to the downsides of overindulging,” Sharma says. Risk-taking EM governments that went long ended up with higher headline inflation, rising interest rates, and a weaker currency — all of which wiped out the potential gains of stimulus spending, he explains. The impact of stimulus in EMs was also limited by covid-19, with Goldman Sachs research showing an (unsurprising) correlation between the strictness of a lockdown and pace of vaccine rollout in one country, and the detrimental effect to growth.

Why? Overspending, particularly by EMs, often produces the opposite effect. This is because EMs lack both the financial resources and institutional credibility to pull off major budget tweaks without unbalancing the economy. When an EM country overspends, it adds pressure on interest rates and inflation. This phenomenon was seen throughout the pandemic, with large spenders witnessing a slower median post-pandemic recovery rate of 12% of GDP, compared to a median rate of 19% in light spenders. An element of fiscal spending may also be political, Sharma adds, with Latin American nations traditionally being heavy spenders, while Asian countries tend to keep a tighter fiscal purse.

Here at home, fiscal stimulus was implemented on a smaller scale, starting with an EGP 100 bn stimulus package President Abdel Fattah El Sisi signed off on at the start of the pandemic that ended up exceeding its limit, with spending going towards healthcare, breaks on energy costs for industry, tourism and hospitality, monthly stipends to day laborers, and vaccine purchases. The central bank and government also instituted tourism bailout programs (here and here), while the government implemented larger stipend handouts to seasonal laborers, and the CBE provided EGP 100 bn in subsidized lending to domestic factories.

Despite the risks of fiscal tightening, monetary policy remains in the spotlight, and the mainstream narrative seems more concerned that ultra-loose monetary policy and tapering by central banks will be what derails the global economy. This is especially true for EMs, whose currencies and bonds have done well this year after the covid-19 pandemic initially saw investors pulling a record USD 83 bn from EMs. They could face stiffer competition from lower risk developed countries’ debt if interest rates rise elsewhere. The US Federal Reserve announced a few weeks back that it would begin rolling back its USD 120 bn a month bond buying program as early as this month, phasing out the asset-purchase programme completely by June 2022. Fed chair Jay Powell reassured market watchers that a rate hike was still far off, but said the Fed would take firm action should inflation threaten to get out of control.