RaboResearch - Economic Research

COVID-19 policy response: Spend or lend?


  • The global COVID-19 pandemic will increase economic divergence between developed and emerging markets in the short term
  • Emerging economies are on the horns of a dilemma: choose between less intense lockdowns to maintain economic activity but result in more cases and deaths. Or impose strict lockdowns, without the fiscal firepower to mitigate the economic impact, resulting in large damage to the economy
  • Compared to developed economies, emerging markets are more constrained financially in their ability to finance appropriate fiscal packages to support their economy
  • Constraints include the potential cost of additional debt issuance. Determined by the ability of countries to absorb additional debt, the institutional quality and weaker net investment position
  • Developed economies on the other hand can rely on strong institutions that enable them to fill the holes created by the pandemic with inexpensive additional capital. Minimizing the economic impact of the virus and stimulating a swift recovery

A global pandemic with local characteristics…

The impact of COVID-19 is being felt by almost every single person in every economy across the globe. But the severity of the outbreak differs substantially between countries. This is not only related to the number of infections and deaths caused by the virus, but also to different policy responses and the way societies are organized. Governments and central banks have introduced solutions to counter the negative effects of COVID-19 on the economy. Unfortunately, there are no textbook solutions at hand, as the magnitude of this pandemic is unprecedented in the post- war era. The lack of experience with a similar situation has resulted in a heterogeneous set of monetary and policy response packages across countries. In this study we provide an overview of these different response packages, as well as their expected effectiveness in mitigating the economic fallout in the current economic environment.

...forces tailor-made policy interventions

Fiscal support measures are an important button that governments can push in order to counter the negative effects of COVID-19 on the economy. Figure 1 gives our estimates of the - unprecedented - stimulus measures announced by governments so far. This overview is based on data from a number of third-party sources and information from finance ministries and central banks. The amount of fiscal stimulus varies between countries, not only in absolute size but also relative to the size of the economy. For example, Japan has launched an enormous stimulus package of 45% of GDP, while on the other end of the spectrum Mexico has adopted a support package of 1% of GDP. The duration of measures differs as well. In Appendix A we provide more details on how we arrived at these numbers

Figure 1: Total size of fiscal stimulus packages differ greatly
Figure 1: Total size of fiscal stimulus packages differ greatlySource: RaboResearch based on various international sources

In many developed countries these fiscal stimulus packages amount to 20% of GDP or more, while in emerging economies the packages are around 10% of GDP or lower. We will discuss the support packages in greater detail in the second part of this report.  

Hard lockdown, extreme fiscal stimulus measures?

To understand more about the magnitude of the support packages in various countries, we first assess the severity of the spread of COVID-19. Differences in approach and the extent of virus penetration have led to differences in the intensity and duration of economic lockdowns.

In turn, lockdown intensity and duration determine the magnitude of the impact of the lockdown measures on the economy. On the demand side, lockdowns affect consumer confidence and the general fear of infection decreases activity and spending. On the supply side, a more stringent lockdown results in lower private consumption, fewer hours worked, falling revenues for businesses and higher unemployment - simply because businesses aren’t allowed to open. There is a clear correlation between the GDP contraction in 2020Q2 and the level of stringency (Figure 2).  

Figure 2: Lockdown stringency determines economic contraction
Figure 2: Lockdown stringency determines economic contractionSource: RaboResearch based on Oxford University, Macrobond, OECD, national sources Note: for China we use realizations for Q1 and for emerging markets we use y-o-y mutations.

To mitigate the impact of the lockdown, governments (with the help of the central bank) can provide support in the form of supplemental income, tax deferrals or temporary credit to the private sector. Figure 3 shows that, according to the Oxford University/Blavatnik Stringency index, the current[1] state of lockdowns is generally more intense in emerging markets, which are still battling the first wave of COVID-19 (Chile, India), while countries like Australia have re-imposed measures due to a second wave. Countries in Europe scaled down lockdown measures in the run-up to the summer since they had been able to control the spread of the virus. However, recently the number of cases has picked up again, and new local lockdown measures have already been imposed in European countries like Spain and The Netherlands.

Figure 3: Stringency higher in EMs
Figure 3: Stringency higher in EMs Source: RaboResearch, Macrobond, University of Oxford

In order to compare the level of lockdown stringency between countries, we use the cumulative sum of per day score on lockdown severity (Figure 4). Clearly, differences in the intensity of lockdowns between countries do not – in themselves - explain the size of the fiscal support packages. On the contrary, there seems to be a negative correlation between the two. This means that countries that experienced a longer or more intense lockdown seem to have introduced smaller fiscal stimulus packages. On closer inspection, we find that there is a split between developed economies and emerging economies, in which the latter have smaller sizes of packages relative to their economy.

Figure 4: Stringency of lockdown versus fiscal support
Figure 4: Stringency of lockdown versus fiscal supportSource: RaboResearch based on various international sources, Macrobond

Clearly, to explain the differences we have to look further and at other factors. In the next section we zoom in on the ability of countries to participate in global debt capital markets.

Debt serious

We argue that the possibility and availability of financing are key explanatory factors behind differences in fiscal support measures by countries. After all, not all governments have the luxury of an existing budget surplus. Raising taxes or cutting government spending to finance economic support measures not only sounds counterintuitive, it probably would be counterproductive as well. This, in a nutshell, explains why many, if not all, governments are turning to additional government debt issuance.

To lend or not to lend?

Naturally, there are constraints to issuing additional debt. Not all countries can issue the same amount of extra debt: in other words, investors do not want to lend additional money to everyone in unlimited amounts on similar terms. The willingness to provide financing is subject to the characteristics of specific economies.

Figure 5: Cost of debt is high in EMs
Figure 5: Cost of debt is high in EMsSource: RaboResearch, Macrobond

Firstly, the solvency of a country is one of the most important characteristics that investors assess. Countries can only issue debt if investors trust the governments to be solvent in the future and thus be able to repay their debts with interest. Investors are likely to require higher compensation (interest rates) for higher solvency risk. The solvency risk – as may also be reflected in its credit rating - increases if governments tap markets/investors for large sums. This not only increases their debt burden; potentially higher interest rates also increase the costs of lending and provide an additional constraint to the amount of debt that a country can sustainably bear. Both factors –debt burden and interest costs -  are thus limiting factors when issuing additional debt. The cost of debt issuance differs substantially between countries (Figure 5). While some developed economies like Germany and the Netherlands can even fund themselves at a discount (negative yield), countries such as Indonesia and South Africa face nominal interest rate costs of 6% or more.

Secondly, the international investment position can be a factor that constrains the amount of debt a country can take on. For example, when a country is reliant on external financing, is the market able to absorb additional debt? Net borrowers are expected to collect less interest on their investments than they are required to pay to others (see Figure 6).[2] This gap must be financed by additional debt issuance or through taxes. Hence, countries that are net international borrowers might not be able to increase their negative position as much as net lenders since additional borrowing raises the risk of being unable to service debts.[3]

A third important factor determining a country’s ability to issue additional debt is institutional quality (Figure 7). A country with higher institutional quality enjoys more credibility to make the right decisions to support the economy. Investors might therefore be more willing to lend them additional money, despite higher debt levels.

Figure 6: Net international investment position more fragile in emerging markets
Figure 6: Net international investment position more fragile in emerging marketsSource: RaboResearch, Macrobond
Figure 7: Institutional quality higher in developed economies
Figure 7: Institutional quality higher in developed economiesSource: RaboResearch, World Bank

Taking these constraints into account, we observe that emerging markets[4] are more constrained financially than developed economies by factors such as the potential cost of additional debt issuance, the willingness of investors and ability of markets to absorb additional debt, institutional quality and weaker net investment position.

Building blocks for swift economic reconstruction

In the previous section we discussed the size of the fiscal stimulus packages between countries. In this section, we take a closer look at the composition of these packages. There are numerous ways to put money to use and the choices that countries make may shed further light on why fiscal responses differ.

We distinguish three main building blocks of which most fiscal policy stimulus consists: direct fiscal transfers, tax deferrals, loans & guarantees.

We explore the different focus in allocation of resources within these categories since they may  ultimately have different implications for the budget and the transfer of money to specific parts of the economy. After all, not all measures are equally likely to be absorbed in the real economy or are expected to increase the public deficit permanently. Hence, the choices governments make affect their effectiveness in mitigating the negative economic impact of COVID-19.

Box 1: The three main building blocks of fiscal stimulus policy

Direct fiscal transfers/investments: This category covers direct expenditure by government. Expenditures can come, for example, in the form of cash handouts to households, infrastructure investments, salary compensation to employers, or public health investments. Governments can choose these policies to prevent households from falling into poverty, stimulate private spending, invest in future employment or economic growth. These policies have a direct effect on the budget balance since their cost materializes directly and, normally, does not have to be repaid to the government. Direct fiscal transfers increase the country’s debt burden, limiting future fiscal space for government stimulus. Of course, some of these investments might pay off and strengthen fiscal metrics via VAT receipts, income tax or economic growth.

Tax deferrals/waivers: This category impacts the revenue side of the budget balance. Many companies experienced immediate cash flow and liquidity problems due to lockdowns. Tax deferral measures could be effective in this particular situation to bridge the temporarily diminished cash flow of companies. Tax measures generally come in two forms: tax deferral, which means taxes have to be paid at a later point in time; and tax waivers in which case taxes do not have to be paid during a certain period.

In case of tax deferrals, the impact on the budget might be limited. However, there might be an impact on revenues if companies that were granted tax deferrals go bankrupt. In case of tax waivers, the expenditure is more similar to direct expenditures and, hence, will likely increase a country’s debt burden.

Governments can also impose a moratorium on certain loan repayments. The effect is similar to other tax deferrals, since it helps companies to overcome liquidity problems. However, there should be countermeasures to provide liquidity to the lenders, otherwise the loan moratorium could result in a significant deterioration of the balance sheets of financial institutions and trigger a financial crisis.

Unfortunately, tax deferrals are not consistently reported by governments. In this report we have used quantitatively reported tax measures whenever reported.

Loans and guarantees: This category is more indirect in nature. In periods of crisis, healthy companies might need bridging capital, for example additional working capital, to overcome the period of a sudden extreme drop in revenues due to lockdown measures. By using guarantees and loans, governments can provide liquidity to the private sector and stimulate banks to continue their business in providing credit. Since the loans and guarantees need to be paid back at a later stage, these are not actual expenditures. The main costs consist only of providing the liquidity (for example, interest costs) and potential impairment costs (in case the loan is not paid back or the government has to invoke the guarantee to the financial institution). Otherwise these measures do not affect the budget balance on the longer term. A negative side-effect is that no clear distinction is made between healthy and unhealthy companies. This may cause an increase in “zombie” companies, thereby decreasing productivity and lower potential economic growth in the longer term. Moreover, here too, bankruptcies would imply that not all the money flow back to the government.

Stacking building blocks: How do governments spend the money?

The choices governments make in allocating their resources are likely to affect the performance of the economy in the short, medium and long term. In order to be able to predict implications and the potential effect of the fiscal stimulus, we analyze the composition of the support packages (Figure 8). As expected, the diverse nature of global economies has led to a wide variety in the composition of fiscal stimulus. A key observation is that the difference in loans & guarantees seems to mainly explain the gap in the size of fiscal stimulus packages between developed economies and emerging markets.

Figure 8: Breakdown of fiscal packages as % GDP
Figure 8: Breakdown of fiscal packages as % GDPSource: RaboResearch based on various international sources

Direct support

As observed in Figure 8, direct support (as % of total fiscal package) tends to be higher in emerging markets. Generally speaking, emerging markets have lower levels of social security. Countries with modest structural social security systems seem to have allocated a relatively larger part of fiscal support measures towards direct support (see Figure 9).

Figure 9: Lower social contributions require larger direct support
Figure 9: Lower social contributions require larger direct supportSource: RaboResearch, IMF

This needs to be done to prevent domestic households from being fully out of income and possibly slipping into poverty. Countries that are relatively poor have a larger share of people who earn low incomes and risk slipping into poverty. This calls for direct action to provide them with vital supplies like food and water. But also to maintain their expenditures to prevent a domino-effect. Urgent cases arise in some emerging markets like Indonesia where direct spending allocated towards households is needed to support their community.

The Australian government has chosen to support employers and employees with hundreds of dollars a month per employee. However, they are an exception as in Australia employers pay no social contribution. This means there is no systematic funding for these social protection costs, which must therefore be borrowed. In countries with higher social security payments these are collected on a structural basis and distributed within the existing social benefit system.

In case of a relatively well-endowed social security system it is less efficient to allocate extra funds directly towards households and employers: they might save this extra income, which would reduce its impact on the real economy.

The total size of fiscal stimulus packages for EMs is already constrained and therefore smaller than that of developed economies, leaving little fiscal space for other fiscal measures. In addition, these costs cannot be recovered, due to the nature of the spending, and will therefore accumulate into additional debt for these countries. This will reduce the remaining fiscal space to further stimulate the economy in the coming years to help recover from the crisis and stimulate economic growth.

Job retention schemes

Figure 10: Tax revenue governments
Figure 10: Tax revenue governmentsSource: RaboResearch, Macrobond, IMF

In most OECD countries large shares of the direct expenditures are directed towards job retention schemes. At the height of the pandemic almost 50 million jobs were protected by job retention schemes which were introduced by policymakers to prevent a sudden spike in unemployment and avert the economic damage this would cause. Countries with lower job protection are particularly vulnerable to shocks like the pandemic since laying-off employees is not costly. The retention schemes are effective due to the temporary nature of the crisis. Governments want to minimize uncertainty for individuals and businesses to maintain private expenditures and prevent termination of jobs that are viable in the longer term.  

Tax deferrals

In case of temporary cash flow problems, tax deferrals and loan moratoria are effective measures to temporarily alleviate the burden of fixed costs and might prevent extra costs (interest costs on additional debt) for companies. This increases their chance of survival and supports the economic recovery. The Netherlands serves as a good example, as it has a relatively large share of freelancers (ZZP).Temporarily lowering costs by, for example, tax deferrals, might alleviate the suffering of this group and prevent them filing for bankruptcy in large numbers. Such a shock would be devastating for the Dutch economy.

However, there are some fiscal implications. Tax deferrals granted by governments reduce government income, while on the expenditure side of the budget balance large amounts are needed to support the economy. Countries with higher tax revenue to GDP ratios (Figure 10) probably have a broader tax base. This increases their flexibility to defer specific taxes that, for example, were imposed to create incentives for companies or individuals. These are no longer needed or prioritized in the face of the pandemic. In this way, governments can temporarily relieve pressure on companies’ balance sheets through tax schemes.

Of course, tax income that is missed due to deferrals or moratoria is already budgeted for and is probably allocated toward predetermined investments. Governments must decide if they want to make changes in their budgets, which can easily result in resistance in the political arena. Countries with proven track records of political parties working together (the German cooperative or the Dutch polder model, for example) might be better able to alter the Budget. This may explain why tax deferrals are a large part of the total fiscal package. The same holds for more centrally led countries like China.  

Another solution is to issue extra short-term debt to cover delayed tax revenues. This raises inequality between developed and emerging economies since the latter face higher costs. The taxes are collected at a later point in time and can be used to repay the extra debt. However, this comes at a risk, as taxes cannot be collected in full if companies default, thus turning deferrals into expenditures, with higher debt levels as a result.

Loans and Guarantees

The lockdowns have halted economic activity in many sectors. When revenues decline for a sustained period of time, or when fixed costs are too high, companies might need additional working capital to bridge this period.

In addition to tax deferrals, governments can create liquidity or stability funds to help to prevent bankruptcies due to liquidity issues and to support the market for investments and loans. This measure can be effective in countries where intensive lockdowns directly impact companies’ revenues. The advantages of using support funds are that healthy companies have easy access to additional capital to bridge the period of declined income. Governments have the advantage that the costs of lending are lower than the costs of direct support since governments only face costs when companies actually default.

Guarantees and support loans are especially relevant in countries which are largely reliant on sectors severely impacted by lockdowns, like the travel industry, hospitality, the domestic trade sector or certain branches in services sector. In these countries, healthy companies are more likely to face liquidity issues and need bridging capital to survive the severe drop in income caused by government restrictions. Financial institutions might be hesitant to provide these loans, especially if this exposes them to increased risk in certain sectors. In this situation, the government can provide guarantees and support. For example, Germany has adopted an “unlimited” stability fund. Other options are to specifically help companies that are deemed vital to the economy, as in the case of KLM or other airline companies.

Zombie firms

The risk here is that you mess with “the invisible hand” which, under normal circumstances, weeds out the unhealthy companies in times of crisis. If the guarantee funds are unable to distinguish between healthy companies and zombie firms, this will negatively influence productivity and economic recovery, according to the BIS. This could prove to be very important with regard to the effect on the real economy and thereby on swift recovery. For example, in Germany this is already becoming a debate.

The role of the central bank

It is not only governments that play an important role in providing stability using, for instance, guarantees and bridging loans. Central banks have a similar role, with the aim to stabilize the economy by providing sufficient liquidity to the system.

Moreover, central banks have cut interest rates where that was still possible (Figure 11), thereby stimulating bank lending to companies, investment and spending. Where interest rates were already low or negative, central banks have resorted to more unconventional monetary policy, such as quantitative easing or monetary financing. This has certainly been the case for the US, the Eurozone, Japan and the UK (Figure 12). The ECB has its own Asset Purchase Programme for the countries that are part of the monetary union. We constructed a separate variable[5] (which excludes the Asset Purchase Programme that had already restarted before the pandemic emerged). But emerging economies also use unconventional monetary policy. For example Indonesia, where the central bank financed part of the fiscal stimulus package on favorable terms.

Figure 11: Interest rates are higher for EMs
Figure 11: Interest rates are higher for EMsSource: RaboResearch, Macrobond
Figure 12: Monetary stimulus package
Figure 12: Monetary stimulus packageSource: RaboResearch based on various international sources

While unconventional monetary policy can certainly help in times of grave distress, it must meet certain conditions. Firstly, inflation should be low since unconventional monetary policies may put upward pressure on inflation (e.g. through currency weakness or otherwise). Secondly, central banks’ independence is very important. If governments interfere in monetary policy, this will reduce risk appetite among investors. The probability of depreciation will increase, which, in turn, will lower returns on initial investments. This can be compensated for by higher interest rates, but that has adverse effects on the borrowing capacity of governments and results in higher costs of credit.

The Fed and ECB can increase their balance sheet (by buying bonds), essentially creating extra money, while their currency remains strong and inflation is kept at bay. The situation is different for emerging markets since they have to be more prudent in order to satisfy global investors with regard to their level of inflation and the independence of central banks. We can see this difference in Figure 12.

The central bank as the great un-equalizer

Countries which are backed by strong central banks are assured of lower costs of debt since the central banks provide a safety net. They act not only as lender of last resort by ensuring liquidity, but also keep costs of additional debt affordable. Central banks can extend their balance sheet and artificially keep yields on government bonds low by buying government bonds and extending their balance sheet. In some specific cases, central banks and governments can even work together and print money.

In Modern Monetary Theory (MMT) it is argued that sovereign currency-issuing governments can finance budget deficits by printing money, with rising inflation as the only limiting factor. In this report we elaborate in more detail on MMT and consider conditions to take into account when assessing the impact of MMT. The very basic conclusion is that for economies with certain characteristics (current account surplus, fiscal deficit, good institutional quality) money printing can be a viable option. Some developed economies meet these requirements.

Countries with central banks that are not in the position to use these unconventional tools are less able to create large stability funds. This is the situation for most emerging economies. None of the emerging economies meets the requirements for sustainable money printing, so MMT is no solution. If they did, it would at best provide short-term relief, but in the longer term would most probably result in a plummeting of the local currency and spiking inflation, as shown in a scenario analysis for India.


These differences in possibilities create a wedge in economic welfare between developed and emerging economies. The impact of COVID-19 can be mitigated by developed economies due to their larger support and guarantee packages, backed by central banks. In emerging economies there are fewer resources available to help healthy companies survive the lockdown phase by, for example, government guarantees on bridging loans. Ultimately, this would likely result in more companies defaulting, making the economic slump deeper and recovery slower. But on the flip side it would probably weed out zombie firms from the economy, increasing productivity and competitiveness in the longer term.

An unequal spectrum: it’s an unfair world after all..

Our analysis of fiscal packages shows that developed and emerging economies face an unbalanced spectrum of opportunities to battle the economic impact of COVID-19. In most European countries the monetary and fiscal support packages to fight the COVID-19 crisis range between 30% to more than 45% of GDP, while countries in Latin America and Asia have adopted packages of around 20% and 10%, respectively.

Developed economies have more flexibility in the composition of their support packages compared to emerging markets. While emerging markets face more market constraints in order to fund the additional fiscal deficits; their fiscal toolbox to battle negative consequences of COVID-19 is therefore more limited than developed economies. The speed of the post-COVID-19 recovery will be determined by how well the different fiscal measures (direct spending, tax deferrals and government guarantees) are tailored to characteristics of the local economy. The ability of central banks to support the central government plays a key role in enabling governments to support their economy.

Under these extreme circumstances the already unequal balance between developed and emerging economies becomes painfully clear. The pandemic not only underscores the global inequality, but also aggravates it.  

Appendix: Methodology dataset

At the time of writing there are several global institutions that have created overviews of monetary and/or fiscal response from governments. However, there is much variety in the way governments and central bank categorize certain policy measures, which automatically causes differences in figures from different global sources. Therefore, to ensure consistency, we constructed our own database for the purpose of this publication.

An additional advantage of constructing our own database is that it enables us to use categories that we find important. The database is maintained by our country analysts who use a combination of global and local sources. The information on all countries is aggregated in one file to create a consistent overview. The table below provides further details on the categorization and sources which were used to construct the figures in this publication.

* Tax deferrals are not consistently reported by governments. They are either described qualitatively without reporting a figure or described and reported as a separate figure. In this report we have separated the tax measures whenever possible, but in some countries these might be part of the direct fiscal support package. 

** The data is updated until 1st of September 2020.

Table 1: Explanation dataset
Table 1: Explanation dataset Source: RaboResearch


[1] In this study we use data up to 28 September 2020 in the stringency index

[2] For this example we assume that interest rates on countries’ investment portfolios are equal.

[3] The US is often seen as being an exemption here since it provides the global reserve currency. As such, US debt is more attractive than other currency-denominated debt.

[4] Although one could argue that tolerance levels of what is acceptable with regard to penetration of the virus (cases, hospitalizations, fatalities) differs among countries. Population in developed economies might demand lower thresholds and therefore accept greater economic costs.

[5] The number for EU in figure 12 is constructed: average of (((total package ECB * capital key country X)/ GDP country X)-1) where X= Austria, Belgium, Finland, France, Greece, Ireland, Italy, Netherlands, Portugal, Spain).


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