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Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
Fiscal sustainability in developing asia
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Fiscal sustainability in developing asia

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  • 1. ADB Economics Working Paper SeriesFiscal Sustainability in Developing AsiaCharles Adams, Benno Ferrarini, and Donghyun ParkNo. 205 | June 2010
  • 2. ADB Economics Working Paper Series No. 205Fiscal Sustainability in Developing AsiaCharles Adams, Benno Ferrarini, and Donghyun ParkJune 2010Charles Adams is Visiting Professor, National University of Singapore; Benno Ferrarini is Economist,Economics and Research Department, Asian Development Bank; Donghyun Park is Principal Economist,Economics and Research Department, Asian Development Bank. The authors gratefully acknowledge theexcellent assistance of Cynthia Petalcorin and Christian Mina in constructing our database, and the equallyexcellent editorial support provided by Lagrimas E. Cuevas.
  • 3. Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org/economics©2010 by Asian Development BankJune 2010ISSN 1655-5252Publication Stock No.The views expressed in this paperare those of the author(s) and do notQHFHVVDULO UHÀHFW WKH YLHZV RU SROLFLHVof the Asian Development Bank.The ADB Economics Working Paper Series is a forum for stimulating discussion andeliciting feedback on ongoing and recently completed research and policy studiesundertaken by the Asian Development Bank (ADB) staff, consultants, or resourcepersons. The series deals with key economic and development problems, particularlyWKRVH IDFLQJ WKH $VLD DQG 3DFL¿F UHJLRQ DV ZHOO DV FRQFHSWXDO DQDOWLFDO RUmethodological issues relating to project/program economic analysis, and statistical dataand measurement. The series aims to enhance the knowledge on Asia’s developmentand policy challenges; strengthen analytical rigor and quality of ADB’s country partnershipstrategies, and its subregional and country operations; and improve the quality andavailability of statistical data and development indicators for monitoring developmenteffectiveness.The ADB Economics Working Paper Series is a quick-disseminating, informal publicationwhose titles could subsequently be revised for publication as articles in professionaljournals or chapters in books. The series is maintained by the Economics and ResearchDepartment.
  • 4. ContentsAbstract vI. Introduction 1II. Conceptual Review of Fiscal Sustainability 4III. Fiscal Diagnostics: Evolution of Key Fiscal Indicators across Asia over Time 13IV. Econometric Tests of Primary Fiscal Balance Response Functions 26V. Fiscal Stimulus Scenarios 30VI. Medium-Term Fiscal Policy Frameworks 32VII. Concluding Observations 35Selected References 38
  • 5. Abstract7KH FHQWUDO REMHFWLYH RI WKLV SDSHU LV WR HPSLULFDOO H[DPLQH WKH LVVXH RI ¿VFDOVXVWDLQDELOLW LQ GHYHORSLQJ $VLD 7R GR VR ZH ¿UVW GLDJQRVH WKH UHJLRQ¶V SXEOLF¿QDQFHV E DQDO]LQJ WKH HYROXWLRQ RI NH ¿VFDO LQGLFDWRUV RYHU WLPH DQG DFURVVVXEUHJLRQV :H WKHQ HVWLPDWH ¿VFDO SROLF UHVSRQVH IXQFWLRQV WKDW PHDVXUH WKHDGMXVWPHQW RI WKH SULPDU ¿VFDO EDODQFH WR SXEOLF GHEW SRVLWLRQV 2YHUDOO RXUUHVXOWV LQGLFDWH WKDW WKH UHJLRQ¶V SXEOLF ¿QDQFHV DUH LQ JRRG VKDSH DV D UHVXOWRI UHVSRQVLEOH ¿VFDO EHKDYLRU 1HYHUWKHOHVV IDLOXUH WR ZLWKGUDZ WKH UHJLRQ¶VDQWLFULVLV ¿VFDO VWLPXOXV LQ D WLPHO PDQQHU PD MHRSDUGL]H ¿VFDO VXVWDLQDELOLWEROVWHULQJ WKH FDVH IRU VWURQJ PHGLXPWHUP ¿VFDO SROLF IUDPHZRUNV
  • 6. I. Introduction,Q UHVSRQVH WR WKH SURQRXQFHG LPSDFW RI WKH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV RQ WUDGHDQG JURZWK ZKLFK UHDFKHG LWV FOLPD[ LQ WKH VHFRQG KDOI RI DQG WKH ¿UVW KDOI RI GHYHORSLQJ $VLD KHQFHIRUWK $VLD
  • 7. KDV EROGO GHFLVLYHO DQG TXLFNO XQOHDVKHG VL]DEOH¿VFDO VWLPXOXV SDFNDJHV1 For the most part, those packages have been skewed towardadditional spending, in particular on infrastructure investments, rather than tax cuts. Whilethe People’s Republic of China’s (PRC) US$586 or Yuan 4 trillion stimulus is the mostKLJKO SXEOLFL]HG H[DPSOH RI $VLD¶V QHZIRXQG SHQFKDQW IRU ¿VFDO DFWLYLVP JRYHUQPHQWVacross the region have aggressively boosted expenditures and slashed taxes to supportJURZWK LQ WKH ZDNH RI WKH JOREDO FULVLV $VLD¶V ¿VFDO DFWLYLVP UHSUHVHQWV DQ XQSUHFHGHQWHGresponse to an unprecedented crisis. Unprecedented because never before has thereEHHQ VXFK D VVWHPDWLF VQFKURQL]HG DQG DFURVVWKHERDUG ¿VFDO H[SDQVLRQ HYHQthough the relative magnitude and composition of the stimulus packages varies widelyacross the region. The regionwide activist countercyclical response was borne out ofsheer necessity in a situation in which plunging exports combined with limp privatedomestic demand to create a gaping vacuum in aggregate demand.There is fairly widespread but unsubstantiated belief that the region’s anticrisisFRXQWHUFFOLFDO ¿VFDO SROLFLHV KDYH ³ZRUNHG´ DQG KHOSHG WKH UHJLRQ ZHDWKHU WKH FULVLV ,Wis too early to tell whether the region’s postcrisis recovery can be sustained. However,what is certain is that the speed and strength of the region’s recovery has exceededall expectations. What makes the region’s spectacular V-shaped recovery all the moreremarkable is that it is taking place against the backdrop of a modest and fragile recoveryLQ WKH * 7KH FRPELQDWLRQ RI WZR VWULNLQJ VWOL]HG IDFWV RI $VLD¶V SRVWFULVLV HFRQRPLFODQGVFDSH LH XQH[SHFWHGO UREXVW UHFRYHU DQG UHJLRQZLGH ¿VFDO H[SDQVLRQ KDYH OHGPDQ WR DWWULEXWH WKH UHFRYHU WR WKH ¿VFDO H[SDQVLRQ DOPRVW E GHIDXOW ,W LV WUXH WKDWgovernments across the region have also pursued monetary expansion, but the impactRI PRQHWDU SROLF LV OHVV LPPHGLDWH DQG GLUHFW WKDQ WKDW RI ¿VFDO SROLF HVSHFLDOOJRYHUQPHQW VSHQGLQJ )XUWKHUPRUH LW LV XQFHUWDLQ KRZ ¿UPV DQG FRQVXPHUV UHVSRQG WRORZHU LQWHUHVW UDWHV LQ D VWDWH RI GHSUHVVHG FRQ¿GHQFH ZKLFK FKDUDFWHUL]HV FULVLV SHULRGV,W LV SUHPDWXUH WR JDXJH WKH H[DFW FRQWULEXWLRQ RI WKH ¿VFDO VWLPXOXV WR $VLD¶V UHFRYHUand there were clearly a number of other contributory factors, including the relativelyKHDOWK VWDWH RI WKH UHJLRQ¶V ¿QDQFLDO VVWHPV 1HYHUWKHOHVV WKHUH LV D SRSXODU SHUFHSWLRQWKDW WKH UHJLRQ¶V ¿VFDO VWLPXOXV PDGH D YLWDO FRQWULEXWLRQ WR WKH UHJLRQ¶V UHFRYHU1 Developing Asia refers to the developing member countries of the Asian Development Bank. In line with ADB practice, the paper disaggregates the developing member countries into various geographical subgroupings, namely Central Asia, East Asia, the Pacific, Southeast Asia, and South Asia.
  • 8. 2 | ADB Economics Working Paper Series No. 2055HJDUGOHVV RI WKH DFWXDO FRQWULEXWLRQ RI WKH ¿VFDO VWLPXOXV WR $VLD¶V UHFRYHU WKHUHJLRQZLGH XVH RI FRXQWHUFFOLFDO ¿VFDO SROLFLHV EULQJV WR WKH IRUH WKH LVVXH RI $VLD¶V ¿VFDOsustainability.2 There are both backward and forward looking reasons for why taking stockRI WKH UHJLRQ¶V ¿VFDO VXVWDLQDELOLW LV D WLPHO DQG RSSRUWXQH H[HUFLVH DW WKLV SRLQW LQ WLPH$FFRUGLQJ WR FRQYHQWLRQDO ZLVGRP ZKDW HQDEOHG $VLD WR UROO RXW ODUJH ¿VFDO VWLPXOXVSURJUDPV VR TXLFNO DQG GHFLVLYHO ZDV WKDW LWV SXEOLF ¿QDQFHV ZHUH JHQHUDOO LQ JRRGshape when the global crisis erupted. In particular, its strong initial public debt positionsUHODWLYH WR LQGXVWULDOL]HG FRXQWULHV DQG PDQ RWKHU SDUWV RI WKH ZRUOG PHDQW WKDW WKHUHJLRQ ZDV DEOH WR DIIRUG FRVWO ¿VFDO H[SDQVLRQV VHH (XURSHDQ RPPLVVLRQ D DQG,0)
  • 9. 7KHUH DUH DOVR D QXPEHU RI DUJXPHQWV IRU ZK FRXQWHUFFOLFDO ¿VFDO SROLFZRUNV EHVW IURP DQ LQLWLDO SRVLWLRQ RI ¿VFDO VWUHQJWK )RU H[DPSOH ¿VFDO H[SDQVLRQ LQ DFRXQWU ZLWK D KLJK GHEW OHYHO FRXOG WULJJHU DGYHUVH UHDFWLRQV LQ WKH ¿QDQFLDO PDUNHWVZKLFK ZRXOG VHULRXVO KDUP EXVLQHVV FRQ¿GHQFH 7KHUHIRUH LW LV ZRUWKZKLOH WR WDNH DEDFNZDUG ORRN DW WKH FXUUHQW DQG SDVW VWDWH RI ¿VFDO KHDOWK DQG VXVWDLQDELOLW DFURVV $VLDDoing so would give us a better idea of the extent to which the conventional wisdom ofD ¿VFDOO UHVSRQVLEOH UHJLRQ LV MXVWL¿HG 6XFK DQ DQDOVLV ZRXOG DOVR DOORZ XV WR LGHQWLIdifferences across subregions and countries. An analysis of how countries have adjustedWKHLU ¿VFDO EDODQFHV LQ UHVSRQVH WR ULVLQJ GHEW OHYHOV LQ WKH SDVW ZLOO SURYLGH IXUWKHUHYLGHQFH RQ WKH ³¿VFDOO UHVSRQVLEOH $VLD´ KSRWKHVLV 7R WKH H[WHQW WKDW ZH ¿QG HPSLULFDOVXSSRUW IRU WKH KSRWKHVLV ZH ZLOO KDYH JUHDWHU FRQ¿GHQFH WKDW $VLD ZLOO WDNH HIIHFWLYHPHDVXUHV WR QRUPDOL]H SXEOLF ¿QDQFHV DV WKH ZRUOG HFRQRP UHWXUQV WR QRUPDO PRGH*RLQJ IRUZDUG $VLD¶V ¿VFDO VXVWDLQDELOLW PDWWHUV IRU D QXPEHU RI UHDVRQV )RU RQHUHJDUGOHVV RI WKH YDOLGLW RI WKH SRSXODU EHOLHI WKDW WKH UHJLRQ¶V ¿VFDO VWLPXOXV PDGH D ELJcontribution to its recovery, the stimulus will raise public debt levels and debt servicingcosts in the short term, relative to the counterfactual of no stimulus. For another, andPRUH ZRUULQJO WKHUH LV D ULVN WKDW WKH VL]DEOH GHWHULRUDWLRQ RI WKH ¿VFDO EDODQFH DV DUHVXOW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV ZLOO QRW EH IXOO UHYHUVHG HYHQ DIWHU WKHglobal crisis recedes and normalcy returns. From a broader perspective, the biggest riskLV WKDW WKH UHJLRQ¶V DQWLFULVLV ¿VFDO VWLPXOXV PLJKW WXUQ RXW WR EH D ³JDPH FKDQJHU´ WKDWIXQGDPHQWDOO DOWHUV WKH UHJLRQ¶V FRQVHUYDWLYH ¿VFDO SKLORVRSK DQG RXWORRN )RU WKHPRVW SDUW WKH UHJLRQ¶V ¿VFDO SROLF KDV EHHQ JHDUHG WRZDUG SURYLGLQJ JURZWKFRQGXFLYHpublic goods such as infrastructure and education within the government’s budgetFRQVWUDLQW 7KH JHQHUDO DYHUVLRQ WR ODUJH DQG SHUVLVWHQW EXGJHW GH¿FLWV ZDV URRWHG LQthe region’s high premium on macroeconomic stability. The only persistent exception to$VLD¶V JHQHUDOO EHQLJQ ¿VFDO VLWXDWLRQ ZDV 6RXWK $VLD $ IXUWKHU IDFWRU WKDW OLPLWHG EXGJHWGH¿FLWV KDV EHHQ WKH UHJLRQ¶V JHQHUDO UHOXFWDQFH WR SXUVXH FRXQWHUFFOLFDO ¿VFDO SROLF WRVWDELOL]H RXWSXW )RU H[DPSOH DXWRPDWLF ¿VFDO VWDELOL]HUV VXFK DV XQHPSORPHQW EHQH¿WVremain underdeveloped in the region.2 As discussed below, fiscal sustainability refers to whether government budgets can be smoothly financed without generating explosive increases in public debt. A sustainable fiscal policy is not necessarily an optimal fiscal policy but optimal fiscal policies will need to be sustainable (Horne 1991).
  • 10. Fiscal Sustainability in Developing Asia | 3,QWHUQDWLRQDO H[SHULHQFH LQIRUPV XV WKDW SROLWLFDO HFRQRP IDFWRUV PDNH LW GLI¿FXOW WRUHYHUVH ¿VFDO H[SDQVLRQ XQGHUWDNHQ GXULQJ EXVLQHVV FFOH GRZQWXUQV ZKHQ WKH FFOHmoves up again. This can lead to a ratcheting up of public spending and debt over time.For example, political opposition may stymie the reversal of tax cuts implemented duringa recession even though the economy may have come out of the recession. Similarly, theH[SDQVLRQ RI VRFLDO ZHOIDUH EHQH¿WV GXULQJ GRZQVZLQJV PD EH GLI¿FXOW WR UROO EDFN ZKHQthe economy recovers. At a broader level, intuitively, it is politically easier for governmentsto increase spending and cut taxes during recessions than to cut spending and increaseWD[HV GXULQJ ERRPV 7KLV JLYHV FRXQWHUFFOLFDO ¿VFDO SROLF DQ LQKHUHQW VWUXFWXUDO ELDVtoward higher public spending and debt over time. From Asia’s viewpoint, the popularSHUFHSWLRQ WKDW ¿VFDO VWLPXOXV SDFNDJHV DUH HIIHFWLYH LQ SURPRWLQJ UHFRYHU PD OHDGWR ¿VFDO DFWLYLVP LQ JHQHUDO DIWHU QRUPDOF UHWXUQV 7KDW LV HYHQ WKRXJK WKH ¿VFDOstimulus packages were an exceptional response to an exceptional crisis, their perceivedHIIHFWLYHQHVV PD SURYRNH SRSXODU FDOOV IRU FRXQWHUFFOLFDO ¿VFDO DFWLYLVP GXULQJ QRQFULVLVperiods.,Q DGGLWLRQ WR WKH GLUHFW HIIHFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV DQG D ³JDPHFKDQJLQJ´ VKLIWLQ WKH UHJLRQ¶V ¿VFDO SKLORVRSK WKHUH DUH D QXPEHU RI RWKHU VWUXFWXUDO IDFWRUV WKDW LPSOD SRWHQWLDOO ODUJH LQFUHDVH LQ WKH UHJLRQ¶V GHPDQG IRU ¿VFDO UHVRXUFHV LQ WKH PHGLXPterm. One is population aging, a seismic demographic transition fundamentally reshaping$VLD¶V GHPRJUDSKLF SUR¿OH :KLOH WKHUH DUH GLIIHUHQFHV DFURVV VXEUHJLRQV²WKH WUDQVLWLRQtoward older populations is much more advanced in East and Southeast Asia than in6RXWK $VLD²DOO GHPRJUDSKLF LQGLFDWRUV SRLQW WR D IDVWDJLQJ $VLD %XLOGLQJ XS PDWXUHZHOOIXQFWLRQLQJ SHQVLRQ VVWHPV ZLOO UHTXLUH D VXEVWDQWLDO DPRXQW RI ¿VFDO UHVRXUFHVAnother structural force is rebalancing the region’s growth toward domestic demand,DQ LVVXH H[SORUHG LQ JUHDW GHWDLO LQ $% E
  • 11. 7KH LPSDFW RI ¿VFDO SROLF RQ WKHUHEDODQFLQJ SURFHVV ZLOO EH GHWHUPLQHG E WKH HIIHFWLYHQHVV RI VSHFL¿F PLFURHFRQRPLF¿VFDO PHDVXUHV VXFK DV VWUHQJWKHQLQJ KHDOWK HGXFDWLRQ SHQVLRQ DQG VRFLDO SURWHFWLRQSuch measures can promote domestic consumption and hence domestic demand byGLOXWLQJ WKH SUHFDXWLRQDU PRWLYH IRU VDYLQJ $ VXSSOVLGH H[DPSOH LV UHPRYLQJ ¿VFDOincentives that favor export production (e.g., manufacturing), over production for theGRPHVWLF PDUNHW HJ VHUYLFHV
  • 12. ,Q SULQFLSOH VXFK SUREDODQFLQJ ¿VFDO PHDVXUHV QHHGnot involve a quantitative expansion of the government and can be achieved by shiftingthe composition of government expenditures. In practice, given the low-tax, small-JRYHUQPHQW SROLF HQYLURQPHQW WKDW FKDUDFWHUL]HV WKH UHJLRQ LW LV OLNHO WKDW LPSOHPHQWLQJsuch measures will require moderate expansion.7KHUH DUH DOVR WZR SROLFUHODWHG UHDVRQV ZK $VLD¶V ¿VFDO VXVWDLQDELOLW PDWWHUV DQGmatters a whole lot, at this point in time. One is immediate and concerns an exit strategy,RU WKH LVVXH RI ZKHQ DQG KRZ WR XQZLQG WKH UHJLRQ¶V DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV7KHUH LV D GHOLFDWH EDODQFH EHWZHHQ H[LWLQJ ³WRR VRRQ WRR TXLFNO´ DQG ³WRR ODWH WRRVORZO´ ZLWK ERWK HQWDLOLQJ VXEVWDQWLDO FRVWV ,Q WKH FDVH RI $VLD WKHUH LV D ULVN WKDW WKHUHJLRQ¶V UHODWLYHO KHDOWK SXEOLF ¿QDQFHV PD OXOO SROLFPDNHUV LQWR GRZQSODLQJ WKH YHU
  • 13. 4 | ADB Economics Working Paper Series No. 205UHDO FRVWV RI H[LWLQJ ³WRR ODWH WRR VORZO´ $W D PLQLPXP RXU H[DPLQDWLRQ RI WKH UHJLRQ¶V¿VFDO VXVWDLQDELOLW ZLOO UHPLQG SROLFPDNHUV DERXW WKRVH FRVWV DQG HQFRXUDJH WKHP WRfactor them in more explicitly into their policymaking calculus. The second policy-relatedPRWLYH IRU RXU DQDOVLV LV UHODWHG WR WKH ¿UVW DQG LW LV WR DOHUW WKH UHJLRQ¶V SROLFPDNHUV WRWKH QHHG IRU VWURQJ PHGLXPWHUP ¿VFDO SROLF IUDPHZRUNV WKDW SURPRWH ¿VFDO VXVWDLQDELOLWLQ WKH PHGLXP DQG ORQJ UXQ 7KH PHGLXPWHUP LPSDFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXVSDFNDJHV DORQJ ZLWK QHZ ¿VFDO GHPDQGV WKDW DUH H[SHFWHG WR DULVH LQ WKH PHGLXP WHUPmake it imperative for regional policymakers to actively explore effective and crediblemedium-term policy frameworks. Regardless of the exact timing and nature of exit fromWKH FXUUHQW ¿VFDO VWLPXOXV VXFK IUDPHZRUNV ZLOO DOVR DVVXDJH WKH SXEOLF¶V FRQFHUQV DERXWWKH WKUHDW WR ORQJWHUP ¿VFDO VXVWDLQDELOLW SRVHG E WKH VWLPXOXV7KH UHVW RI RXU SDSHU LV RUJDQL]HG DV IROORZV 6HFWLRQ ,, UHYLHZV WKH FRQFHSWV RI VWDWLFDQG GQDPLF ¿VFDO VXVWDLQDELOLW DQG VRPH DOWHUQDWLYH DSSURDFKHV WR WKHLU DVVHVVPHQW6HFWLRQ ,,, FRQVLGHUV WKH NH GLPHQVLRQV RI WKH SXEOLF ¿QDQFHV DFURVV GHYHORSLQJ $VLDIRFXVLQJ LQ SDUWLFXODU RQ ¿VFDO EDODQFHV JRYHUQPHQW VSHQGLQJ DQG UHYHQXHV DV ZHOO DVlevels of public debt. Section IV discusses the results from a number of econometric testsRI ¿VFDO VXVWDLQDELOLW EDVHG RQ SDQHO UHJUHVVLRQ WHFKQLTXHV DQG SUHVHQWV HVWLPDWHV RI¿VFDO SROLF UHVSRQVH IXQFWLRQV WR LQYHVWLJDWH WKH UHVSRQVHV RI SULPDU ¿VFDO EDODQFHV WRchanges in debt ratios. Section V presents three alternative scenarios or stress tests ofWKH SRWHQWLDOO DGYHUVH LPSOLFDWLRQV IRU ¿VFDO VXVWDLQDELOLW LI FRXQWULHV ZHUH WR SRVWSRQHfor too long the reversal of recent stimulus packages or adjust in too timid a manner.6HFWLRQ 9, GLVFXVVHV WKH UROH UREXVW PHGLXPWHUP ¿VFDO SROLF IUDPHZRUNV PLJKW SODLQ KHOSLQJ $VLD DWWDLQ DQG PDLQWDLQ ¿VFDO VXVWDLQDELOLW LQ WKH SRVWFULVLV SHULRG )LQDOO6HFWLRQ 9,, FRQFOXGHV ZLWK DQ RYHUYLHZ RI WKH PDLQ ¿QGLQJV RI RXU SDSHU DORQJ ZLWK WKHSROLF LPSOLFDWLRQV RI WKRVH ¿QGLQJVII. Conceptual Review of Fiscal Sustainability)LVFDO VXVWDLQDELOLW LV WKH VWDWH ZKHUHLQ WKH JRYHUQPHQW EXGJHW FDQ EH VPRRWKO ¿QDQFHGwithout generating explosive increases in public debt (or money supply3) over time.When this condition is met, the budget is said to be sustainable and, conversely, whenthe condition is not met.4 In some contexts, it is useful to draw an explicit distinctionEHWZHHQ VWDWLF ¿VFDO VXVWDLQDELOLW ZKHQ WKH EXGJHW FDQ EH ¿QDQFHG VPRRWKO SHULRGE SHULRG
  • 14. DQG GQDPLF ¿VFDO VXVWDLQDELOLW ZKHQ WKH EXGJHW GRHV QRW OHDG RYHU WLPH3 In what follows, we abstract from monetary financing, as this has generally not been an issue in the region. Moreover, many central banks in the region, under their constitutions, are not permitted to directly finance fiscal deficits and have adopted inflation targeting frameworks, implying that low and stable inflation are the key objective of monetary policy. See BIS (2006).4 Note that fiscal sustainability is different from external sustainability. Whereas fiscal sustainability covers the government budget, external sustainability deals with whether the balance of payments can be smoothly financed without explosive increases in external debt. See Chalk and Hemming (2000) and IMF (2003) for further discussion.
  • 15. Fiscal Sustainability in Developing Asia | 5to explosive increases in public debt). Loosely, static sustainability refers to the ability ofthe government to fund its budget on a period-by-period basis (funding liquidity) whileGQDPLF VXVWDLQDELOLW LV FRQFHUQHG ZLWK YHU ORQJWHUP ¿VFDO VROYHQF5 Both staticDQG GQDPLF ¿VFDO VXVWDLQDELOLW DUH LPSRUWDQW DQG WKUHDWV WR HLWKHU RU ERWK FDQ KDYHLPSOLFDWLRQV IRU PDFURHFRQRPLF DQG ¿QDQFLDO VWDELOLW6(YHQ WKRXJK ¿VFDO VXVWDLQDELOLW LV JHQHUDOO UHJDUGHG DV YHU LPSRUWDQW WKHUH LV QRuniversal agreement about how it should best be assessed. Various approaches toDVVHVVLQJ ¿VFDO VXVWDLQDELOLW KDYH EHHQ XVHG DQG LW LV XVHIXO WR FRQVLGHU VRPH RIthe key approaches. For illustrative purposes, equation (1) describes the (ex ante)government7 budget constraint under the assumption that all government spending(including gross interest payments) is included in government expenditure (G); andthat all government receipts8 are included in revenues (Z). Abstracting from centralEDQN ¿QDQFLQJ equation (1) implies that differences between government revenuesDQG H[SHQGLWXUHV LQ DQ SHULRG WKH EXGJHW VXUSOXV
  • 16. ZLOO EH UHÀHFWHG LQ FKDQJHV LQ WKHoutstanding stock of (one period) public debt (B)10 held by the nongovernment sector. Z(t) – G(t) = - (B(t+1) – B(t)) t= 1,2, 3,………..N (1)To better focus on public debt dynamics, it is useful to separate out the interest paymentsRQ SXEOLF GHEW IURP DOO RWKHU JRYHUQPHQW H[SHQGLWXUH DQG GH¿QH 6 DV WKH SULPDU RUnondebt-interest-related) budget surplus.11 With R as the one-period nominal interest ratefactor,12 HTXDWLRQ
  • 17. FDQ EH ZULWWHQ DV IROORZV ZKHUH 6W
  • 18. WKH SULPDU ¿VFDO VXUSOXV LVGH¿QHG DV =W
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  • 21. GHQRWLQJ SULPDU JRYHUQPHQW VSHQGLQJ B(t+1) = R B(t) – S(t) t= 1,2, 3,………..N (2)5 At a fundamental level, the distinction has to do with the difference between illiquidity and insolvency (see Horne 1991, Blanchard et al. 1990, Bohn 1995).6 Financial stability can be threatened directly in circumstances, such as in much of Asia, where local banking systems hold substantial amounts of public debt. Asian bond markets and bank exposure to public debt are regularly assessed in the Asia Bond Monitor of the ADB.7 As argued in the next section, fiscal policy can be assessed for various levels of government or for the public sector as a whole. In the case of countries with significant state-owned enterprises or government linked companies, the lines between the “private” and “public” sectors can be difficult to draw and may be changing over time under reform programs.8 These would include tax and nontax revenues and, in the case of governments with asset holdings, the income on those assets.9 In any period, some part of government spending may be financed by the central bank acquiring public debt on the primary or secondary market. Such implicit monetization is netted out of equation (1) and is generally small in the region.10 Public debt refers, in general, to outstanding government borrowing, which is assumed for illustrative purposes to take the form of bonds rather than bank loans.11 Here, and in what follows, we abstract from any assets held by the government, and we do not distinguish between gross and net debt.12 That is to say, R is 1 plus the nominal interest rate.
  • 22. 6 | ADB Economics Working Paper Series No. 205According to equation (2), the dynamics of public debt are linked to the interest rate onSXEOLF GHEW DQG WKH VL]H RI WKH SULPDU VXUSOXV 6
  • 23. ,Q FLUFXPVWDQFHV ZKHQ WKH SULPDUEDODQFH LV ]HUR WKH HTXDWLRQ LPSOLHV WKDW WKH SXEOLF GHEW ZLOO JURZ DW WKH QRPLQDO
  • 24. interest rate. Conversely, the growth of the public debt will be less than the nominalinterest rate when the primary balance is in surplus. In all cases, the behavior of publicGHEW LQ UHODWLRQ WR JURVV GRPHVWLF SURGXFW *3
  • 25. ZLOO DOVR EH LQÀXHQFHG E ZKHWKHU WKHnominal interest rate is above or below the growth rate of nominal GDP (as discussedbelow).By solving equation (2) forward over time, the public debt in period t can be written asfollows:13B(t ) = Σ ∞=0 R(t , t + j )−1S(t + j ) + lim j R(t , t + T )−1B(t ,T + 1) (3) T →∞Here, B (t, T+1) is the terminal or very long-term debt stock and R(t, t+j) is the discount j ΠIDFWRU EHWZHHQ SHULRG W DQG SHULRG W M ZKLFK LV GH¿QHG DV k =0Rt + k . Generally, dynamic¿VFDO VXVWDLQDELOLW LV WDNHQ WR UHTXLUH WKDW WKH terminal debt stock (discounted at aSRVLWLYH LQWHUHVW UDWH
  • 26. DSSURDFK ]HUR DV 7 DSSURDFKHV LQ¿QLW ZKLFK FDQ EH UHJDUGHGDV UXOLQJ RXW ³3RQ]L0DGRII´ VFKHPHV LQ ZKLFK QHZ GHEW H[SORGHV RU LV UROOHG RYHULQGH¿QLWHO14 With this condition imposed, the interpretation of equation (3) is that the¿VFDO VLWXDWLRQ LV H[ DQWH GQDPLFDOO
  • 27. VXVWDLQDEOH LI WKH SUHVHQW YDOXH RI DOO SULPDUsurpluses matches the value of the current debt stock. Alternatively, if the current debtVWRFN LV ]HUR WKH UHTXLUHPHQW IRU ¿VFDO VXVWDLQDELOLW LV WKDW WKH SUHVHQW YDOXH RI DOO(noninterest or primary) government expenditures should match the present value of allgovernment revenues as given by equation (4). ∞ ∞∑ R(t, t + j )−1G(t + j ) = ∑ R(t, t + j )−1Z (t + j ) (4)j =0 j =0% YLUWXH RI LWV GHSHQGHQFH RQ WKH EHKDYLRU RI SXEOLF GHEW RYHU DQ LQ¿QLWH WLPH SHULRG¿VFDO VXVWDLQDELOLW LV D VRPHZKDW DEVWUDFW FRQGLWLRQ $V QRWHG EHORZ SROLFEDVHGDVVHVVPHQWV RI ¿VFDO VXVWDLQDELOLW LQYDULDEO GHDO ZLWK WKH EHKDYLRU RI GHEW RYHU VKRUWto medium-term time periods and are guided, in varying degrees, by the very long-termconsiderations underpinning the abovementioned terminal condition. Notwithstandingthese considerations, however, budget constraint equations such as given by equations
  • 28. DQG
  • 29. PDNH FOHDU WKDW WKH ¿VFDO VWLPXOXV LQWURGXFHG GXULQJ WKH JOREDO VORZGRZQ ZLOOneed eventually to be paid back through either higher government revenues or lower13 An alternative approach is to express the items in the budget as proportions of GDP. Under such an approach, the long-run terminal condition discussed below involves not only the nominal interest rate but also the nominal growth rate of GDP. Satisfaction of the terminal condition is related to whether the nominal interest rate is above or below the growth rate of the economy (see below for further discussion).14 See Horne (1991), Chalk and Hemming (2000), and Mendoza and Ostry (2008) for further discussion. In practice, many sustainability tests are based on the weaker condition that the long run debt ratio stabilizes over a finite horizon of 3–5 years (see below).
  • 30. Fiscal Sustainability in Developing Asia | 7H[SHQGLWXUHV 7KLV LV D FRQVHTXHQFH RI WKH ³QR IUHH OXQFK´ FRQGLWLRQ LPSOLHG E GQDPLF¿VFDO VXVWDLQDELOLW DQG WKH SRVLWLYH GLVFRXQW IDFWRU 5
  • 31. XQGHUOLQJ WKH DQDOVLV157HVWLQJ ZKHWKHU WKH ¿VFDO VXVWDLQDELOLW FRQGLWLRQ WKDW WKH H[ DQWH
  • 32. JRYHUQPHQW EXGJHWKROGV RYHU WLPH LV QRW HDV WR DSSO LQ SUDFWLFH 1RW RQO LV WKHUH WKH GLI¿FXOW WKDWWKH FRQVWUDLQW KROGV RYHU DQ LQ¿QLWH XQREVHUYDEOH
  • 33. WLPH KRUL]RQ EXW WKHUH DUH DOVRGLI¿FXOWLHV UHODWHG WR WKH IDFW WKDW WKHUH DUH IHZ WKHRUHWLFDO UHVWULFWLRQV RQ WKH YDOXHVof government spending and revenues. With the possible exception of some extremeboundary conditions, such as revenue should not exceed GDP, or that there be a certainminimum level of noninterest-related government spending, there are, in principle, anLQ¿QLWH QXPEHU RI ZDV LQ ZKLFK WKH VXVWDLQDELOLW FRQGLWLRQ PLJKW EH VDWLV¿HG16 Hence,IRU H[DPSOH LI D JRYHUQPHQW ZDV FXUUHQWO UXQQLQJ D ODUJH ¿VFDO GH¿FLW ZLWK SXEOLF GHEWULVLQJ VKDUSO LW ZRXOG EH GLI¿FXOW WR FRQFOXGH WKDW VXVWDLQDELOLW ZDV QHFHVVDULO YLRODWHG7KLV LV EHFDXVH WKH JRYHUQPHQW PD EH SODQQLQJ WR FXW VSHQGLQJ DQG UXQ ODUJH ¿VFDOsurpluses in the very distant future so as to satisfy the sustainability condition over time.$QG DUJXDEO HYHQ LQ WKH PRVW H[WUHPH FDVHV RI ¿VFDO H[WUDYDJDQFH WKHUH FRXOG DOZDVbe some future level of government spending and taxes to ensure that conditions such asHTXDWLRQ
  • 34. DUH VDWLV¿HGBased, inter alia, on these types of considerations, it is therefore frequently argued that¿VFDO VXVWDLQDELOLW DQDOVLV LV PRUH RI DQ ³DUW´ WKDQ D ³VFLHQFH´ 6XFK DQDOVLV GHDOVQRW VR PXFK ZLWK ZKDW FRXOG KDSSHQ LQFOXGLQJ ZKHWKHU WKHUH PD EH D ¿VFDO FULVLV LQthe event policy is not sustainable),17 as with what will happen based on factors suchDV SDVW H[SHULHQFHV ZLWK ¿VFDO DGMXVWPHQW ,Q WKHVH FLUFXPVWDQFHV HVWLPDWHV RI ¿VFDOSROLF UHDFWLRQV²ZKLFK PHDVXUH KRZ JRYHUQPHQWV KDYH WUDGLWLRQDOO UHVSRQGHG WR ULVLQJGHEW OHYHOV²FDQ EH LPSRUWDQW WRROV LQ DVVHVVLQJ WKH SURVSHFWV IRU ¿VFDO VXVWDLQDELOLW DVdiscussed below.$VVHVVPHQWV RI ¿VFDO VXVWDLQDELOLW KDYH WHQGHG WR DGRSW RQH RU PRUH RI D QXPEHU RIinterrelated approaches. For the most part, the assessments have focused on dynamicrather than static sustainability, although there was some discussion of the latter in lastyear’s Asia Economic Monitor $% D
  • 35. 7KH Asia Economic Monitor noted thatWKHUH KDG EHHQ D QXPEHU RI ³IDLOHG´ SXEOLF GHEW DXFWLRQV LQ WKH FRQWH[W RI VHHNLQJ WR¿QDQFH VRPH RI WKH ¿VFDO VWLPXOXV SDFNDJHV LQ WKH UHJLRQ LQ DQG LW UHYLHZHG WKH15 A little reflection also makes clear why fiscal sustainability needs to be discussed with reference to the ex ante (rather than ex post) government budget constraint. Necessarily, the ex post government budget constraint must be satisfied since spending must always match receipts when allowance is made for arrears. And, in the case of longer-term public debt, its market value would be expected to take into account whether there was fiscal solvency, implying that the intertemporal budget constraint might always hold in mark to market terms. In ex ante terms, however, the government budget need not be balanced over time, and issues of dynamic fiscal sustainability arise when public debt grows at potentially explosive rates (Horne 1991, IMF 2003).16 See discussion in Chalk and Hemming (2000) and Bohn (1991, 1995, 1998).17 Threats to fiscal sustainability need not necessarily lead to fiscal crises as conventionally defined. Instead, they might lead to debt monetization and inflation, or to (formal or informal) debt restructuring. Moreover, the implications of unsustainable fiscal policy would be expected to depend as well on whether there is an accompanying problem of external debt sustainability.
  • 36. 8 | ADB Economics Working Paper Series No. 205circumstances and implications of these failures. If the government is not able to sell (orUROO RYHU
  • 37. LWV SXEOLF GHEW DV D UHVXOW RI ³IDLOHG´ DXFWLRQV VWDWLF ¿VFDO VXVWDLQDELOLW ZLOO EHviolated. The Asia Economic Monitor, however, did not judge this to be a major issue inthe region during the global crisis.18%URDGO WKUHH GLIIHUHQW VHWV RI DSSURDFKHV WR DVVHVVLQJ GQDPLF ¿VFDO VXVWDLQDELOLW FDQEH LGHQWL¿HG VHH %ODQFKDUG HW DO HOXVXQ HW DO
  • 38. 2QH DSSURDFK LQYROYHVtime series tests in which the (formal) time series properties of variables such as primaryand nonprimary government spending and revenues, interest payments, and public debtVWRFNV DUH DVVHVVHG VHH IRU H[DPSOH 7UHKDQ DQG :DOVK DQG +DXJ Hostland and Karam 2006). In some instances, the focus is on whether the debt stock(or the debt stock in relation to GDP) is a stationary variable based on the applicationof standard unit root tests. In line with some of the oldest approaches to assessing¿VFDO VXVWDLQDELOLW RPDU
  • 39. WKHVH WHVWV HIIHFWLYHO FRQVLGHU ZKHWKHU SXEOLF GHEWor the ratio of public debt to GDP is stationary (in a statistical sense) and exhibits meanreverting tendencies. Effectively, these types of tests involve determining whether thetime series for a variable such as the debt stock (or the debt ratio) exhibits the kind ofH[SORVLYH EHKDYLRU WKDW PLJKW EH H[SHFWHG LQ WKH HYHQW WKDW ¿VFDO SROLF LV XQVXVWDLQDEOHIn another time series approach, the literature on asset price bubbles is applied to testwhether the time series for debt stocks include a bubble term (or unstable root) such asPLJKW EH IRXQG LQ WKH FDVH RI ¿VFDO SROLF EHLQJ XQVXVWDLQDEOH +DPLOWRQ DQG )ODYLQ +RUQH KDON DQG +HPPLQJ
  • 40. ,Q DGGLWLRQ WKHUH DUH WHVWV RI WKH FRLQWHJUDWLQJrelationships that would be expected to hold among various variables in the event that¿VFDO SROLF LV VXVWDLQDEOH DV JLYHQ LQ HTXDWLRQ
  • 41. 7KHVH WHVWV LQYROYH FRQVLGHULQJZKHWKHU FHUWDLQ ¿VFDO YDULDEOHV VXFK DV JRYHUQPHQW VSHQGLQJ DQG WD[HV VKDUH FRPPRQVWRFKDVWLF WUHQGV FRQVLVWHQW ZLWK WKH GQDPLF JRYHUQPHQW EXGJHW FRQVWUDLQW DQG ¿VFDOsustainability.By their nature, time series tests are backward looking (in so far as they use historicalGDWD
  • 42. DQG RQO PHDVXUH LQGLUHFWO WKH H[WHQW WR ZKLFK WKH FRQGLWLRQV IRU ¿VFDOVXVWDLQDELOLW DUH VDWLV¿HG ([SOLFLWO RU LPSOLFLWO WKH DSSURDFKHV DOVR DVVXPH WKDW WKHGLVWDQW IXWXUH ZLOO ³ORRN OLNH´ WKH SDVW DQG WKDW SROLFLHV WKDW ZHUH VXVWDLQDEOH LQ WKH SDVWwill continue to be sustainable in the future. In practice, the time series approaches to¿VFDO VXVWDLQDELOLW KDYH QRW EHHQ YHU FRPPRQ IRU DW OHDVW WKUHH UHDVRQV )LUVW WKHVHapproaches typically require relatively long time series of data that are frequently notDYDLODEOH LQ WKH ¿VFDO DUHD HVSHFLDOO DV UHJDUGV SXEOLF GHEW20 Secondly, the power ofunit root tests tends to be relatively low (especially in small samples) in distinguishing,LQ SDUWLFXODU EHWZHHQ VLWXDWLRQV LQ ZKLFK ¿VFDO SROLF PD EH FORVH WR EHLQJ VXVWDLQDEOHDQG ZKHQ LW LV XQVXVWDLQDEOH $QG ¿QDOO DV DUJXHG E %RKQ DQG
  • 43. WKH OLQNV18 Viet Nam, in particular, experienced some failed debt auctions but these were judged to have reflected a temporary mispricing of initial issuance.19 See, for example, Adedeji and Thornton (2008).20 This problem is mitigated to some degree through the use of panel cointegration techniques that make use of cross sectional as well as time series data (Adedeji and Thornton 2008).
  • 44. Fiscal Sustainability in Developing Asia | 9EHWZHHQ WKHVH WHVWV DQG ¿VFDO VXVWDLQDELOLW LV QRW QHFHVVDULO YHU FORVH DQG VRPH EDVLFtime series tests do not fully exploit the implications of uncertainty in deriving appropriateWHVWV RI ¿VFDO VXVWDLQDELOLW21More fundamentally, a shortcoming of the time series approaches is that they do notH[SOLFLWO LGHQWLI WKH ¿VFDO SROLF UHDFWLRQ IXQFWLRQV WKDW XQGHUOLH WKH GDWD $V D UHVXOWWKH GR QRW VKHG PXFK OLJKW RQ WKH NLQGV RI ¿VFDO SROLFLHV WKDW PLJKW GHOLYHU VXVWDLQDELOLWor identify why sustainability may not have held in the past. The next two approachesIRFXV GLUHFWO RQ ¿VFDO SROLF EHKDYLRU DV UHÀHFWHG LQ WKH SULPDU ¿VFDO EDODQFHAnother set of tests can be referred to primary balance tests as they involve estimating³GHFLVLRQ UXOHV´ IRU SULPDU ¿VFDO EDODQFHV DQG LQ SDUWLFXODU IRU KRZ SULPDU EDODQFHVUHVSRQG WR FKDQJHV LQ SXEOLF GHEW DQG RWKHU YDULDEOHV %RKQ KDON DQG +HPPLQJ
  • 45. 7KHVH WHVWV DUH DOVR EDFNZDUG ORRNLQJ LQ VR IDU DV WKH PRGHO ¿VFDO GHFLVLRQ UXOHVbased on past behavior. They have the desirable feature, however, in that they focus on¿VFDO UHVSRQVHV DQG LQ SDUWLFXODU RQ KRZ WKH SULPDU ¿VFDO EDODQFH DV D PHDVXUH RIWKH ¿VFDO DGMXVWPHQW HIIRUW
  • 46. LV DGMXVWHG DV SXEOLF GHEW LQFUHDVHV ,QWXLWLYHO WKH EDVLV IRUthese tests is that a tendency for primary surpluses to increase as public debt increaseover time will tend to support (dynamic) sustainability.The approach can be illustrated using the explicit uncertainty framework adopted by%RKQ
  • 47. DQG %DUWROLQL DQG RWWDUHOOL
  • 48. LQ ZKLFK HTXDWLRQ
  • 49. DERYH LV HIIHFWLYHOreplaced by equation (5): ∞B(t ) = E ∑ E j u ’(c (t + j )) / u ’(c (t ))S(t + 1) + lim Et E T +1u ’(c (t + j + 1)) / U ’(c (t ))B(t + t + 1) (5) j =0 T →∞Here E is the (mathematical) expectations operator22 and u’ (c (t + j))/u’ (c(t)) denotesthe marginal rate of substitution between consumption (c) in two adjacent time periods.Equation (5) is analogous to equation (3) but applies when uncertainty is explicitlymodeled and the (one period) discount factor is replaced by the potentially time-varyingmarginal rate of substitution in consumption. Using equation (5) the condition forsustainability is that the terminal debt stock discounted by the expected marginal rate ofVXEVWLWXWLRQ LQ FRQVXPSWLRQ DSSURDFKHV ]HUR DV T → ∞ , which implies that equation (6)holds. ∞B(t ) = E ∑ E j u ’(c (t + j )) / u ’(c (t ))S(t + 1) (6) j =0,W LV SRVVLEOH IROORZLQJ %RKQ
  • 50. WR ZULWH WKH UHODWLRQVKLS EHWZHHQ WKH SULPDUsurplus and public debt in a simple linear based decision rule as in equation (7) below.In equation (7), lower case letters are used to denote the public debt (b) and primarysurplus (s) as proportions of GDP, P GHQRWHV WHPSRUDU VWDWLRQDU
  • 51. LQÀXHQFHV RQ WKH21 Bohn (1998), in particular, has argued that some of the time series tests may reject sustainability in circumstances where fiscal policy is sustainable.22 All expectations are conditional on information through the current period.
  • 52. 10 | ADB Economics Working Paper Series No. 205primary balance to GDP ratio,23 and H LV D ZKLWH QRLVH HUURU WHUP 7KH FRHI¿FLHQW Umeasures the response of the primary balance to changes in the debt ratio while Emeasures the response of the primary balance to the temporary factors included in P.24s(t ) = ρ b(t − 1) + βµ (t ) + ε (t ) ε ⋅ (0,σ 2 ) (7)%RKQ
  • 53. DUJXHV WKDW D VXI¿FLHQW FRQGLWLRQ25 IRU ¿VFDO SROLF WR EH VXVWDLQDEOH²DQGIRU HTXDWLRQ
  • 54. WR KROG²LV WKDW U be positive in value. And, to avoid explosive increasesin public sector assets over time (i.e., situations in which gross debt is unbounded andDSSURDFKHV QHJDWLYH LQ¿QLW
  • 55. U should also be less than unity. Based on the estimation ofHTXDWLRQV VXFK DV
  • 56. KSRWKHVHV DERXW WKH VLJQ DQG VL]H RI U can be tested statisticallyKDON DQG +HPPLQJ %RKQ ,0) DQG 0HQGR]D DQG 2VWU
  • 57. (TXDWLRQ
  • 58. LV WKH NH HTXDWLRQ IRU DVVHVVLQJ ¿VFDO VXVWDLQDELOLW LQ WKLV IUDPHZRUN VLQFHLW GHWHUPLQHV ZKHWKHU WKH SULPDU EDODQFH UHVSRQGV LQ D VWDELOL]LQJ PDQQHU WR FKDQJHVin the debt ratio. A value for the response parameter U EHWZHHQ ]HUR DQG XQLW LPSOLHVWKDW WKH SULPDU VXUSOXV LQFUHDVHV DV WKH GHEW UDWLR ULVHV ZKLFK LV VXI¿FLHQW IRU GQDPLFsustainability. And the closer U LV WR XQLW WKH ODUJHU RU PRUH IRUFHIXO LV WKH ¿VFDOpolicy response to increases in the debt ratio. Conversely, if U LV ]HUR RU QHJDWLYH WKHimplication is that higher debt ratios lead either to no response of the primary surplus; orWR D VPDOOHU SULPDU VXUSOXV ,Q VXFK FLUFXPVWDQFHV ¿VFDO SROLF PD EH XQVXVWDLQDEOHif it leads to explosive public debt ratios.26 Based on this reasoning, (estimated) valuesof the U FRHI¿FLHQW DORQJ ZLWK WKH UHVSRQVH RI SULPDU EDODQFHV WR WHPSRUDU VKRFNV DVcaptured through the P WHUP FDQ EH XVHG WR ³VFRUH´ ¿VFDO SROLF UHVSRQVHV )RU H[DPSOHa value of U WKDW LV FORVH WR XQLW FDQ EH VFRUHG DV D ³IRUFHIXO´ SROLF UHVSRQVH DQG DYDOXH FORVH WR ]HUR DV D ³GDPSHG´ UHVSRQVH 7KH HVWLPDWHG YDOXHV RI E, on the otherKDQG PHDVXUH WKH UHVSRQVH RI ¿VFDO SROLF WR WHPSRUDU IDFWRUV VXFK DV WKH EXVLQHVVcycle (as measured, say, by gaps between actual and potential output); or to temporaryVZLQJV LQ SULPDU
  • 59. JRYHUQPHQW VSHQGLQJ DV GLVFXVVHG E %DUUR
  • 60. Notwithstanding the role the U FRHI¿FLHQW SODV LQ GHWHUPLQLQJ WKH SURVSHFWV IRU GQDPLFVXVWDLQDELOLW LW QHHGV WR EH UHFRJQL]HG WKDW WKH EHKDYLRU RI GHEW UDWLRV RYHU WKH VKRUWWR PHGLXP WHUP KRUL]RQV DOVR GHSHQGV LPSRUWDQWO RQ WKH EHKDYLRU RI WKH JDS EHWZHHQthe interest rate on public debt and the growth rate of the economy. In circumstancesZKHUH WKH JURZWK UDWH LV DERYH WKH LQWHUHVW UDWH VKRUWWHUP GHEW WR *3 VWDELOL]DWLRQFDQ RFFXU HYHQ ZKHQ WKH SULPDU EDODQFH LV LQ GH¿FLW ,Q VXFK FLUFXPVWDQFHV D IDLOXUHRI WKH SULPDU EDODQFH WR LQFUHDVH DV GHEW LQFUHDVHV²ZKLFK LV VXI¿FLHQW IRU YHU ORQJ23 As discussed below, these temporary influences include temporary government spending shocks and the deviation of output from trend.24 Note that E and P can be appropriately dimensioned vectors.25 The reason why this is a sufficient (and not necessary) condition is that there may be nonlinear decision rules that are consistent with sustainability. In addition, in circumstances where nominal interest rates are below the growth rate of the economy, debt-to-GDP ratios can decline even in the presence of a primary deficit.26 Sustainability will also be influenced by whether the nominal interest rate is above or below the growth rate of nominal GDP.
  • 61. Fiscal Sustainability in Developing Asia | 11VXVWDLQDELOLW ZKHQ WKH LQWHUHVW UDWH LV DERYH WKH JURZWK UDWH²ZLOO QRW QHFHVVDU SUHFOXGHa stable debt-to-GDP ratio in the near term. As we note below,27 in some subregions andcountries, the debt ratio has been stable even in circumstances when the primary balanceKDV EHHQ LQ GH¿FLW 2YHU ORQJ WLPH SHULRGV KRZHYHU ¿VFDO VXVWDLQDELOLW ZLOO EH VXSSRUWHGby the primary balance increasing as the debt ratio rises.,I WKH ¿VFDO VLWXDWLRQ LV VXVWDLQDEOH ρε (0,1) ), the long-run expected value of the debt ratiocan be written as in equation (8) below. _E (b(t )) = ( − µ + (1 − ρ )cov(1 + φ, b(t − 1)) / ρ (1 + φ ) − φ (8)Here I is the difference between the nominal interest rate and the nominal growth rate ofthe economy (assumed to be positive in the very long run), the term cov (..) represents acovariance term, and a bar is used to denote a long-run value of a variable. This equationdetermines the expected value of the long-run debt ratio, which depends critically not onlyon the value of U but also on the gap between the nominal interest rate and the nominalgrowth rate of the economy.0RUH JHQHUDOO WKH SULPDU EDODQFH IUDPHZRUN IRU ¿VFDO VXVWDLQDELOLW FDQ EH H[WHQGHGin a number of directions including allowing for nonlinear or lagged relationships betweenthe primary surplus and public debt, or by allowing for the response parameter (U) tovary over time. As regards nonlinearity issues, a particular interesting possibility is thatthere are threshold effects whereby the response of the primary balance to the debt stockPLJKW LQFUHDVH RU GLPLQLVK DV GHEW OHYHOV ULVH DV SDUW SHUKDSV HLWKHU RI ³ZDNH XS FDOOV´RU RI ³DGMXVWPHQW IDWLJXH´28 The presence of such effects would raise the possibility thatWKH LPSOLFDWLRQV RI ¿VFDO VOLSSDJHV GHSHQG RQ WKH GHEW OHYHOV DW ZKLFK WKH RFFXU DQGthat the resulting adjustment path could be different depending on the initial level of debt.A third of tests can be described as scenario or stress tests and have been widely usedby the International Monetary Fund, World Bank, and Asian Development Bank. TheseWHVWV DUH EDVHG RQ ³ZKDW LI´ RU ³VWUHVV WHVW´ WSH PRGHOLQJ HLWKHU ZLWK UHVSHFW WR WKHLPSOLFDWLRQV IRU ¿VFDO VXVWDLQDELOLW RI FRQWLQXLQJ ZLWK FXUUHQW ¿VFDO SROLFLHV DV GH¿QHG Ethe primary balance) or of identifying the gap between the primary balance required toSURGXFH ¿VFDO VXVWDLQDELOLW DQG WKH FXUUHQW ¿VFDO SROLF VHWWLQJVThe application of these scenario approaches can be illustrated by noting that theproportional change in the public debt ratio will (approximately) depend on the differencegap between (one plus) the nominal interest rate and (one plus) the growth rate ofnominal GDP (I
  • 62. WRJHWKHU ZLWK WKH SULPDU ¿VFDO VXUSOXV DQG WKH GHEW UDWLR 7KLV LV JLYHQ27 See discussion in Section II.28 An extreme example of this would be the Debt Laffer curve effect in which there is a tipping point beyond which higher debt produces a reduction in the primary surplus ( U0). This case would be a fiscal policy analogy to the original Bulow-Rogoff model of sovereign debt problems and the Debt Laffer curve (Blanchard and Fischer 1989).
  • 63. 12 | ADB Economics Working Paper Series No. 205by equation (8) where denotes a proportional change and I denotes the differencebetween the nominal interest rate and the growth rate of nominal GDP. ∆b(t ) = I (t ) − s(t ) / b(t ) (8)8QGHU WKH ¿UVW WSH RI H[HUFLVH WKH WLPH SDWK IRU WKH GHEW UDWLR LV SURMHFWHG RQ WKH EDVLVof a given set of assumptions about the primary surplus (for example, which is constantin relation to GDP) and the gap between the nominal interest rate and the nominalgrowth rate (I
  • 64. ,Q WKH HYHQW WKDW WKLV SURGXFHV DQ ³H[SORVLYH´ LQFUHDVH LQ WKH GHEW UDWLRRYHU D JLYHQ WLPH KRUL]RQ WKH DVVXPHG RU FXUUHQW ¿VFDO SROLF VWDQFH ZRXOG EH MXGJHGunsustainable. This is because it might violate the terminal condition on debt and leadto the debt-to-GDP ratio increasing beyond bounds. Conversely, in the second type ofexercise, the approach would be to compute the primary surplus required to deliver agiven sustainable path for the debt ratio over the medium term (for example, that the debtUDWLR EH FRQVWDQW
  • 65. $Q JDS EHWZHHQ WKLV VXUSOXV WKH GHEWVWDELOL]LQJ VXUSOXV
  • 66. DQG WKHDFWXDO SULPDU VXUSOXV ZRXOG WKHQ EH VHHQ DV LPSOLQJ WKH DPRXQW RI ¿VFDO DGMXVWPHQWUHTXLUHG WR GHOLYHU ¿VFDO VXVWDLQDELOLW7KHVH DSSURDFKHV DUH LOOXVWUDWHG LQ HTXDWLRQ
  • 67. ZKHUH WKH ¿VFDO JDS Z
  • 68. LV GH¿QHG DV WKHdifference between the sustainable primary balance (ss) and the actual balance (sa),ZLWK WKH IRUPHU GH¿QHG DV WKH EDODQFH UHTXLUHG WR KROG WKH GHEW UDWLR FRQVWDQW DW LWVcurrent level.30ω (t ) = [(R(t ) − η (t ))b − s a (t )]
  • 69. %RWK WKHVH WSHV RI VFHQDULR RU VWUHVV WHVWV DUH XVHIXO IRU VKHGGLQJ OLJKW RQ ¿VFDOsustainability. As in the case of the primary-balance approach to sustainability discussedabove, the gap between the nominal interest rate and the nominal growth rate of theeconomy (I) plays a key role. A common assumption is that this gap term will be positivebut, as noted in subsequent sections, there are several Asian economies that have grownfaster than the nominal interest rate over several years and in which I has been negative.$V GLVFXVVHG LQ 6HFWLRQ ,,, D FRPPRQ DVVXPSWLRQ LQ PDQ ¿VFDO VFHQDULR H[HUFLVHV LVthat the nominal interest rate exceeds the nominal growth rate of the economy. In theDEVHQFH RI VXFK D FRQGLWLRQ²ZKLFK FRXOG LPSO D GHSDUWXUH IURP GQDPLF HI¿FLHQF²very long-run terminal conditions on debt may no longer be binding and public debt canbecome unbounded.31 Accordingly, because a positive interest rate gap is necessaryIRU PHDQLQJIXO LQ¿QLWH KRUL]RQ VFHQDULRV LW LV VRPHWLPHV DVVXPHG WR KROG HYHQ RYHU29 If the economy is dynamically efficient, the modified golden rule implies that the nominal interest rate (or, at least the nominal marginal product of capital) will exceed the growth rate of nominal GDP and hence that I will be strictly positive. See Blanchard and Fischer (1989) for further discussion.30 Constancy of the debt ratio is a simplifying assumption. Alternative approaches could allow for any sustainable debt path.31 See Blanchard and Fischer (1989) for further discussion of dynamic efficiency and the modified golden rule. When an economy satisfies the modified golden rule, the nominal interest rate will exceed the nominal growth rate of the economy.
  • 70. Fiscal Sustainability in Developing Asia | 13the short to medium run (IMF 2003). Over a few years, however, the possibility thateconomies may grow more rapidly than the interest rate on public debt must beconsidered, even if this raises issues about very long-run terminal conditions.Even though the model-based and scenario approaches are different, there are a numberof connections between them that can be usefully exploited. Both approaches addressWKH OLQN EHWZHHQ WKH ¿VFDO DGMXVWPHQW HIIRUW PHDVXUHG WKURXJK WKH SULPDU EDODQFH
  • 71. and the debt ratio. In the primary balance approach, the policy response parameter forthe primary balance (U) is estimated from the data, whereas in the scenario approaches,WKH SDUDPHWHU PD EH LPSRVHG IURP ³RXWVLGH´ DFFRUGLQJ WR ZKDW LV MXGJHG QHFHVVDUWR SURGXFH ¿VFDO VXVWDLQDELOLW ,Q SULQFLSOH WKH HVWLPDWHG DGMXVWPHQW SDUDPHWHUV IURPthe model-based approaches to sustainability can be used to enrich the scenario-basedDSSURDFKHV WR ¿VFDO VXVWDLQDELOLW DQG DFFRXQW FDQ DOVR EH WDNHQ RI GHEW WLSSLQJ SRLQWVin which the parameter may be different at various debt levels. These are the approachesWDNHQ LQ WKH ¿QDO VHFWLRQ RI WKH SDSHUIII. Fiscal Diagnostics: Evolution of Key Fiscal Indicatorsacross Asia over Time7KLV VHFWLRQ UHYLHZV ¿VFDO EDODQFHV SXEOLF VSHQGLQJ DQG UHYHQXHV DQG SXEOLF GHEW(in relation to GDP) across the region and over time, with particular attention to theEUHDNGRZQ RI ¿VFDO SRVLWLRQV LQWR SULPDU DQG QRQSULPDU FRPSRQHQWV WKH UHODWLRQVKLSEHWZHHQ SULPDU ¿VFDO EDODQFHV DQG SXEOLF GHEW UDWLRV DQG WKH OLQNV EHWZHHQ DFWXDODQG GHEW VWDELOL]LQJ SULPDU ¿VFDO EDODQFHV ,Q DGGLWLRQ WKH VHFWLRQ UHYLHZV NH IHDWXUHVRI FRXQWULHV¶ ¿VFDO SRVLWLRQV LQFOXGLQJ WKH UHODWLRQVKLS EHWZHHQ SXEOLF GHEW UDWLRV DQGYDULRXV PHDVXUHV RI HFRQRPLF VL]H YRODWLOLW DQG UHYHQXH UDWLRV7KH DVVHVVPHQW RI SXEOLF ¿QDQFHV LQ WKH UHJLRQ LV D GDXQWLQJ FKDOOHQJH DQG WKHUH DUHKXJH GLI¿FXOWLHV DVVHPEOLQJ D FRPSUHKHQVLYH VHW RI ¿VFDO DQG SXEOLF GHEW GDWD IRU DOOthe developing country members of the ADB. Not only are there familiar problems ofoccasional missing observations over time and across countries, there are also a numberRI VHULRXV VKRUWFRPLQJV DV UHJDUGV WKH DYDLODELOLW RI FRQVLVWHQW DQG FRPSUHKHQVLYH ¿VFDOdata in some countries and, in particular, as regards public debt obligations. In addition,only a very limited number of countries publish public sector asset positions (as well asSXEOLF GHEW GDWD
  • 72. PHDQLQJ WKDW ¿VFDO VXVWDLQDELOLW DQDOVLV QHHGV IRU WKH PRVW SDUW WREH EDVHG RQO RQ RQH SDUW RI WKH ¿VFDO SLFWXUH OLDELOLWLHV UDWKHU WKDQ DVVHWV32). In addition,even in the case of countries that report interest payments on debt, consistent data arenot generally available for the actual interest rates on public debt and the extent to whichdebt may be serviced at concessional or market interest rates. Moreover, to the extent32 Income on (any) public asset is implicitly recorded under government revenue.
  • 73. 14 | ADB Economics Working Paper Series No. 205WR ZKLFK VRPH FRXQWULHV LVVXH SXEOLF GHEW WR ³FDSWLYH´ ORFDO EXHUV VXFK DV ORFDO EDQNVpension funds etc.), the true economic costs of servicing that debt may be different fromthe recorded costs.There is also the problem that countries do not generally report contingent (off-balanceVKHHW
  • 74. DQG SURVSHFWLYH ¿VFDO OLDELOLWLHV %DVHG RQ H[SHULHQFH (XURSHDQ RPPLVVLRQD $%
  • 75. WKHVH DUH RIWHQ WKH NH IDFWRUV LQ LQÀXHQFLQJ ¿VFDO VXVWDLQDELOLWRYHU WLPH DQG DUH ZKHUH WKH ³¿VFDO VXUSULVHV´ RIWHQ RFFXU33 The omission of contingent¿VFDO OLDELOLWLHV LPSOLHV WKDW WKH DSSURDFK DGRSWHG LQ WKH SDSHU DUJXDEO UHSUHVHQWV WKH³EHVW FDVH´ LQ VR IDU DV WKH DFFRXQWLQJ IRU FRQWLQJHQW OLDELOLWLHV ZRXOG OLNHO OHDG WR WKHpossibility of higher rather than lower future debt ratios, and potentially larger threats to¿VFDO VXVWDLQDELOLWAt the most fundamental level, there is also the issue of how broadly or narrowly theSXEOLF VHFWRU VKRXOG EH GH¿QHG ,GHDOO ¿VFDO VXVWDLQDELOLW DQDOVLV VKRXOG FRYHU DOODVSHFWV RI SXEOLF VHFWRU RSHUDWLRQV DQG DFWLYLWLHV WKDW KDYH ¿VFDO LPSOLFDWLRQV VXJJHVWLQJa very broad and comprehensive approach. Such comprehensiveness is probably bestDFKLHYHG E IRFXVLQJ RQ WKH RYHUDOO SXEOLF VHFWRU²LQFOXGLQJ DOO DFWXDO DQG TXDVL VWDWHRZQHG HQWHUSULVHV DQG JRYHUQPHQWOLQNHG FRPSDQLHV²EXW LW LV IUHTXHQWO GLI¿FXOW WRGUDZ WKH OLQH LQ GH¿QLQJ WKH SXEOLF VHFWRU34 and comprehensive data for the entire publicVHFWRU LV IUHTXHQWO GLI¿FXOW WR REWDLQ $QG HYHQ LQ WKRVH FDVHV ZKHUH LW LV RQO IHDVLEOH WRcover the (formal) government sector, there are often issues related to the availability ofdata for different levels of government (central, state, and local) and its consistency overWLPH 7KHUH DUH QR VLPSOH VROXWLRQV WR WKHVH DQG UHODWHG ³ERXQGDU´ SUREOHPV LQ GH¿QLQJWKH SXEOLF VHFWRU $QG IUHTXHQWO LW LV QHFHVVDU WR EDVH WKH DQDOVLV RQ D ³QDUURZ´GH¿QLWLRQ RI JRYHUQPHQW GXH WR ODFN RI GDWD IRU EURDGHU GH¿QLWLRQV RI WKH SXEOLF VHFWRU)RU SXUSRVHV RI WKH SDSHU DQQXDO GDWD ZDV DVVHPEOHG RQ JRYHUQPHQW ¿VFDO SRVLWLRQVand debt (and other variables) for over 30 developing member countries of ADB fromWKH HDUO V WKURXJK :KHUH SRVVLEOH GDWD IRU WKH JHQHUDO JRYHUQPHQW ZDVXVHG EXW LQ VHYHUDO LQVWDQFHV FHQWUDO JRYHUQPHQW GDWD KDG WR VXI¿FH ,Q VRPH FDVHVVHULHV KDG EUHDNV RU JDSV DQG YDULRXV DSSURDFKHV ZHUH XVHG WR ³JDS ¿OO´ WKHVH VHULHVEven with these approaches, however, the panel data that was collected is somewhatunbalanced, with the most comprehensive time series coverage generally occurring in themore developed countries in the region.3533 Much of the deterioration in fiscal positions during the Asian financial crisis was associated with bailouts of distressed banks and other financial institutions.34 This is especially the case in economies transitioning from central planning and state ownership to a market economy.35 Implicitly, this can lead to a large country bias in which the large countries for which data are available have a disproportionate effect on the results.
  • 76. Fiscal Sustainability in Developing Asia | 15One key question that arises in presenting (and interpreting) large amounts of countrydata concerns the way in which the data are aggregated to produce subregionalaggregates. Generally, the aggregates in the Asian Development Outlook $% E
  • 77. are based on gross national income weighting in which large countries implicitly receivea larger weight than small countries. Even though such an approach is appropriate forDJJUHJDWLQJ YDULDEOHV VXFK DV *3 LW LV QRW FOHDU ZKHWKHU LW VKRXOG EH XVHG IRU ¿VFDOYDULDEOHV ZKHUH WKHUH LV QR PHDQLQJIXO FRQFHSW RI D UHJLRQZLGH ¿VFDO SRVLWLRQ %DVHGRQ WKHVH WSHV RI FRQVLGHUDWLRQV²DQG DOVR EHFDXVH WKH HPSLULFDO DQDOVLV LQ WKH QH[WVHFWLRQ LV EDVHG RQ LQGLYLGXDO FRXQWU H[SHULHQFH²WKH ¿VFDO DJJUHJDWHV IRU WKH UHJLRQpresented in this section are all unweighted (rather than weighted) averages of data forindividual countries and subregions.36,Q DGGLWLRQ WR FRQVLGHULQJ ¿VFDO EHKDYLRU LQ GLIIHUHQW FRXQWULHV WKH FURVV VHFWLRQDOGLPHQVLRQ
  • 78. WKH SDSHU FRQVLGHUV DOVR KRZ ¿VFDO H[SHULHQFH KDV HYROYHG RYHU WLPH WKHWLPH VHULHV GLPHQVLRQ
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  • 82. 37The reason for these particular decompositions is that the Asian crisis representedD ZDWHUVKHG IRU ¿VFDO SROLF IRU PDQ FRXQWULHV LQ WKH UHJLRQ DV PDQ FRXQWULHVH[SHULHQFHG ODUJH FULVLVUHODWHG ¿VFDO VOLSSDJHV 7KH XQZLQGLQJ RI WKHVH ¿VFDO VOLSSDJHVZDV D SULPDU IRFXV RI PDQ FRXQWULHV¶ ¿VFDO SROLFLHV LQ WKH OHDGXS WR WKH JOREDO FULVLVLQ 1HHGOHVV WR VD KRZHYHU GLIIHUHQW UHJLRQV LQ $VLD KDYH GLIIHUHG VKDUSO ZLWKUHVSHFW WR WKHLU XQGHUOLQJ RU VWUXFWXUDO
  • 83. ¿VFDO SRVLWLRQV DQG WKHLU HYROXWLRQ RYHU WLPH7DEOH , DQG DOVR %R[
  • 84. GLVSOD NH ¿VFDO LQGLFDWRUV IRU WKH UHJLRQ RYHU WKH WKUHHVXESHULRGV UHIHUUHG WR DERYH DQG IRU ± DV D ZKROH ,Q OLQH ZLWK $%¶VFODVVL¿FDWLRQ WKH UHJLRQ LV EURNHQ GRZQ LQWR ¿YH VXEUHJLRQV HQWUDO $VLD (DVW $VLD WKH3DFL¿F 6RXWKHDVW $VLD DQG 6RXWK $VLD38 %RWK RYHUDOO DQG SULPDU ¿VFDO EDODQFHV LQTable I are measured as the difference between receipts and spending so that a positiveVLJQ LPSOLHV D ¿VFDO VXUSOXV ZKLOH D QHJDWLYH VLJQ LPSOLHV D GH¿FLW6HYHUDO REVHUYDWLRQV FDQ EH PDGH RQ WKH EDVLV RI WKH ¿VFDO LQGLFDWRUV LQ 7DEOH ,L
  • 85. )RU WKH SHULRG DV ZKROH WKHUH LV D UHODWLYHO QDUURZ GLVSHUVLRQ RI ¿VFDO EDODQFHV across the region. $FURVV WKH UHJLRQ ¿VFDO EDODQFHV DUH LQ VPDOO GH¿FLW RYHU WKH HQWLUH ± SHULRG EXW WKH GH¿FLWV DUH VRPHZKDW KLJKHU LQ WKH 3DFL¿F and especially in South Asia (at over 5% of GDP). With the exception of Central36 Given this approach, there is the possibility that the aggregated data may be distorted by large outlier observations in very small countries. Both mean and median values were considered for data presentation, however, and made little difference.37 Preliminary estimates and forecasts of fiscal positions (including recent fiscal stimulus packages) for 2009 and 2010 are presented and discussed in the final section.38 The countries included in each group are listed in the notes accompanying the tables and charts.39 All balances are measured as the difference between revenues and expenditures with the implication that a positive sign denotes a surplus while a negative sign denotes a deficit.
  • 86. 16 | ADB Economics Working Paper Series No. 205 and South Asia, which were not very badly affected by the Asian crisis,40 other VXEUHJLRQV VDZ WKHLU ¿VFDO GH¿FLWV LQFUHDVH LQ WKH ODWH V EXW WKH GH¿FLWV ZHUH then generally pared back.(ii) Across the entire period, there is a wide range of experience as regards primary ¿VFDO EDODQFHV ZLWK VRPH VXEUHJLRQV DYHUDJLQJ VXUSOXVHV DQG RWKHUV DYHUDJLQJ GH¿FLWV 6RXWKHDVW $VLD KRZHYHU LV WKH RQO VXEUHJLRQ UXQQLQJ D ODUJH SULPDU surplus, while subregions such as South Asia have on average been running UHODWLYHO ODUJH DQG SHUVLVWHQW SULPDU GH¿FLWVLLL
  • 87. :LWK WKH H[FHSWLRQ RI WKH 3DFL¿F ZKHUH JRYHUQPHQW VSHQGLQJ DQG UHYHQXHV KDYH been close to or above 40% of GDP, the average levels of government spending and revenues across the region are relatively low and clustered mainly at the low end of the 20–25% of GDP range. These ratios are well below the averages in many other part of the world and, in particular, in developed Europe (IMF 2003, (XURSHDQ RPPLVVLRQ D
  • 88. Table 1: Fiscal Indicators, Ratio to GDP, 1990–2008 (percent ) Subregion Period Public Primary Fiscal Government Goverment Interest Debt Surplus Surplus Expenditure Revenue Payments Central Asia 1 35.10 −4.70 −7.00 21.00 14.00 1.30 2 68.70 −3.50 −5.50 20.20 14.70 1.40 3 34.50 1.00 0.20 25.00 25.20 0.80 All periods 38.00 0.30 −0.70 24.30 23.60 0.90 East Asia 1 17.30 −0.80 −1.40 18.20 16.70 1.00 2 35.20 −3.50 −3.70 23.80 19.00 1.70 3 32.20 0.90 0.20 21.80 22.00 1.00 All periods 27.00 −0.20 −0.80 20.70 19.70 1.10 The Pacific 1 39.00 1.90 −0.20 38.70 38.50 2.40 2 36.70 −0.50 −2.10 36.40 34.30 2.20 3 40.20 −1.70 −2.40 42.70 40.10 1.50 All periods 39.50 −0.40 −1.70 40.70 38.90 1.80 Southeast Asia 1 48.30 4.80 2.40 19.40 21.80 2.80 2 57.60 −1.00 −2.40 21.40 18.70 2.10 3 56.70 0.30 −1.70 20.70 19.10 2.20 All periods 53.90 1.70 −0.40 20.30 20.00 2.40 South Asia 1 63.60 −2.60 −6.00 27.50 21.60 3.30 2 62.00 −1.90 −5.00 24.00 19.10 3.10 3 65.10 −2.10 −5.10 25.50 20.50 2.90 All periods 64.20 −2.30 −5.40 26.10 20.80 3.1040 Fiscal developments in Central Asia during the 1990s were influenced importantly by the international treatment of the debts of the former Soviet Union.
  • 89. Fiscal Sustainability in Developing Asia | 17Box 1: Various Fiscal Indicators Debt/GDP Ratio by Subregions and Periods Debt/GDP Ratio by Subregions and Periods (mean values, percent) (median values, percent) Central Asia Central Asia East Asia East Asia 1990−1997 The Pacific 1990−1997 The Pacific Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia East Asia East Asia 1998−1999 The Pacific 1998−1999 The Pacific Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia East Asia East Asia 2000−2008 The Pacific 2000−2008 The Pacific Southeast Asia Southeast Asia South Asia South Asia 0 20 40 60 80 0 20 40 60 80 Debt/GDP Ratio by Subregions and Years Debt/GDP Ratio by Subregions and Years (mean values, percent) (median values, percent)80 8060 6040 4020 20 0 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Year Central Asia East Asia The Pacific Central Asia East Asia The Pacific Southeast Asia South Asia Southeast Asia South Asia Debt/Revenue Ratio by Subregions and Periods Debt/Revenue Ratio by Subregions and Periods (mean values, percent) (median values, percent) Central Asia East Asia Central Asia East Asia 1990−1997 The Pacific 1990−1997 The Pacific Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia East Asia East Asia 1998−1999 The Pacific 1998−1999 The Pacific Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia East Asia East Asia 2000−2008 The Pacific 2000−2008 The Pacific Southeast Asia Southeast Asia South Asia South Asia 0 100 200 300 400 500 0 100 200 300 400 500 Debt/Revenue Ratio by Subregions and Years Debt/Revenue Ratio by Subregions and Years (mean values, percent) (median values, percent)600 600400 400200 200 0 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Year Central Asia East Asia The Pacific Central Asia East Asia The Pacific Southeast Asia South Asia Southeast Asia South Asia
  • 90. 18 | ADB Economics Working Paper Series No. 205(iv) Public debt ratios in the region display considerable heterogeneity and variation over time. Across much of the region, public debt ratios have on average been relatively low (below 40–50% of GDP) with the notable exceptions of Southeast and South Asia. In the case of Southeast Asia, the ratio has been in the range of 50–60% of GDP in the period since the Asian crisis. In South Asia, on the other hand, the ratio has been persistently above 60%. Public debt rose sharply in HQWUDO $VLD LQ WKH ODWH V EXW WKHQ IHOO VKDUSO LQ WKH FRQWH[W RI D QXPEHU RI ¿VFDO DGMXVWPHQW DQG GHEW UHVWUXFWXULQJ SURJUDPV(v) Across the region, interest payments on the public debt have been around 1-3% of GDP and show no clear tendency to increase over time. Generally, subregions with the highest debt to GDP ratios also have the highest levels of interest SDPHQWV WR *3 5HÀHFWLQJ GLIIHUHQW IXQGLQJ FRVWV KRZHYHU UHODWHG LQWHU DOLD WR the access to concessional funding, the relationship between interest payment and debt is not always very close.)LJXUH SURYLGHV DQRWKHU SHUVSHFWLYH RQ ¿VFDO SRVLWLRQV LQ WKH UHJLRQ 7KH FKDUWGLVSODV DYHUDJH RYHUDOO
  • 91. ¿VFDO EDODQFHV DQG GHEW ERWK DV D UDWLR WR *3
  • 92. DFURVVHDFK RI WKH ¿YH VXEUHJLRQV RYHU WKH HQWLUH WLPH SHULRG ± ,Q SULQFLSOH WKHREVHUYHG UHODWLRQVKLS EHWZHHQ WKH RYHUDOO ¿VFDO EDODQFH DQG WKH GHEW UDWLR DFURVV WKHsubregions could be either positive or negative. The relationship would be negative ifWKH VXEUHJLRQV ZLWK KLJK SXEOLF GHEW UDWLRV ZHUH UXQQLQJ VPDOOHU ¿VFDO VXUSOXVHV RYHUthe period. Conversely, if subregions with higher public debt ratios were running larger¿VFDO VXUSOXVHV WKHQ WKH UHODWLRQVKLS ZRXOG EH D SRVLWLYH RQH $FFRUGLQJO WKH QDWXUH RIWKH UHODWLRQVKLS EHWZHHQ ¿VFDO EDODQFHV DQG GHEW SURYLGHV LQIRUPDWLRQ DERXW ZKHWKHU¿VFDO DGMXVWPHQW DFURVV WKH VXEUHJLRQV LV FRQVLVWHQW ZLWK VWDELOL]LQJ UHVSRQVHV RI ¿VFDObalances to debt.41Figure 1: Fiscal Balances and Debt (1990–2008 averages) 0 sea eaa ceaFiscal Surplus (% GDP) paa −2 Linear regression line (excluding South Asia) −4 soa −6 30 40 50 60 70 Debt (% GDP)41 Note that the causation between the fiscal balance and the debt ratio runs in both directions. Larger fiscal deficits can lead to larger increases in debt ratios and, conversely, countries can seek to reduce fiscal deficits in order to stabilize or reduce public debt ratios.
  • 93. Fiscal Sustainability in Developing Asia | 19Inspection of Figure 1 reveals that there is a slight positive relationship between overall¿VFDO VXUSOXVHV DQG SXEOLF GHEW DFURVV WKH UHJLRQ ZKHQ 6RXWK $VLD LV H[FOXGHG 7KLVimplies that, over the entire period, most subregions with higher public debt ratiosWHQGHG WR UXQ ODUJHU ¿VFDO VXUSOXVHV RU VPDOOHU ¿VFDO GH¿FLWV RQYHUVHO LQ 6RXWK $VLDin particular, a high debt ratio over the entire period is accompanied by relatively large¿VFDO GH¿FLWV DQG WKHUH LV OLWWOH HYLGHQFH LQ WKLV VXEUHJLRQ RI ORQJUXQ ¿VFDO DGMXVWPHQWbeing under way. The time snapshots for the subregions included in the following charts)LJXUH
  • 94. EURDGO FRQ¿UP WKHVH SDWWHUQV WKURXJK WKH QDWXUH RI WKH UHODWLRQVKLS EHWZHHQ¿VFDO EDODQFHV DQG GHEW UDWLRV YDULHV DFURVV WKH ¿YH VXEUHJLRQV IRU WKH WKUHH VXESHULRGV± ± DQG ± (VVHQWLDOO WKH GLIIHUHQW UHODWLRQVKLSV DFURVV WKHWKUHH VXESHULRGV UHÀHFW WKH IDFW WKDW SHULRGV VXFK DV ± ZHUH SHULRGV ZKHQ GHEWincreased sharply during the Asian crisis. On the other hand, periods such as after 2000KDYH EHHQ SHULRGV RI ¿VFDO DGMXVWPHQW HVSHFLDOO LQ (DVW DQG 6RXWKHDVW $VLDFigure 2: Fiscal Balances and Debt(averages by periods and subregions) sea 2 0 eaacea paaFiscal Surplus (% GDP) eaa sea −2 paa paa sea eaa −4 soa soa cea −6 soa cea −8 20 30 40 50 60 70 Debt (% GDP) 1990-1997 1998-1999 2000-2008$QRWKHU SHUVSHFWLYH RQ WKH QH[XV EHWZHHQ ¿VFDO SROLF DQG SXEOLF GHEW LV SURYLGHG Econsidering the behavior of primary balances across subregions and over time. Figures DQG GLVSOD WKH UHODWLRQVKLS EHWZHHQ WKH SULPDU ¿VFDO VXUSOXV DQG SXEOLF GHEW ERWKDV D SHUFHQWDJH RI *3
  • 95. IRU WKH ¿YH VXEUHJLRQV RI GHYHORSLQJ $VLD RYHU WKH HQWLUH ±2008 time period. The behavior over the three subperiods is displayed in Figure 4.
  • 96. 20 | ADB Economics Working Paper Series No. 205Figure 3: Primary Fiscal Balances and Debt (1990–2008 averages) 1Primary Fiscal Surplus (% GDP) sea cea 0 paa eaa Linear regression line (excluding South Asia) −1 −2 soa 30 40 50 60 70 Debt (% GDP)Figure 4: Primary Fiscal Balances and Debt (averages by periods and subregions) 4 seaPrimary Fiscal Surplus (% GDP) 2 paa cea eaa 0 eaa paa sea paa −2 sea soa soa soa eaa cea −4 cea 20 30 40 50 60 70 Debt (% GDP) 1990-1997 1998-1999 2000-2008In interpreting the two charts, it is useful to note that a positive relationship betweenSULPDU VXUSOXVHV DQG GHEW LPSOLHV WKDW ¿VFDO SROLF KDV EHHQ VXSSRUWLQJ VXVWDLQDELOLWThis is because a positive relationship can be interpreted as implying that the primaryVXUSOXV LQFUHDVHV RU WKH SULPDU GH¿FLW LV UHGXFHG
  • 97. DV WKH GHEW UDWLR LQFUHDVHVConversely, a negative (or no) relationship between these variables may not be consistentZLWK ¿VFDO VXVWDLQDELOLW RYHU YHU ORQJ WLPH SHULRGV42 As shown in Figures 3 and 4, thereis a relatively strong positive relationship between primary surpluses and debt acrossthe region when South Asia is excluded. This conforms to the pattern for the regionsGLVFXVVHG DERYH ZLWK UHJDUG WR WKH UHODWLRQVKLS EHWZHHQ WKH RYHUDOO
  • 98. ¿VFDO EDODQFHVand debt. As evident from Figure 4, this pattern holds for the most part across the three42 Over short periods during which the interest rate is below the growth rate of the economy, however, the fiscal positions may “appear” sustainable and the debt ratio may be falling.
  • 99. Fiscal Sustainability in Developing Asia | 21VXESHULRGV VLQFH RQFH DOORZDQFH LV PDGH IRU WKH $VLDQ FULVLVUHODWHG EORZRXW RI¿VFDO SRVLWLRQV LQ WKH ODWH V7KH UHODWLRQVKLS EHWZHHQ DFWXDO DQG GHEWVWDELOL]LQJ SULPDU EDODQFHV DV GLVSODHG LQFigure 5,43 SURYLGHV DQRWKHU SHUVSHFWLYH RQ ¿VFDO VXVWDLQDELOLW 6LQFH ¿VFDO VXVWDLQDELOLWneeds to be evaluated at the country (rather than subregional) level, the chart refers toSDUWLFXODU FRXQWULHV IURP WKH ¿YH VXEUHJLRQV DQG LGHQWL¿HV WKH ORFDWLRQ RI WKH DYHUDJHIRU HDFK VXEUHJLRQ 7KH YHUWLFDO D[LV RI WKH FKDUW PHDVXUHV WKH SULPDU ¿VFDO EDODQFHVUHTXLUHG WR VWDELOL]H GHEW UDWLRV EDVHG RQ DYHUDJH QRPLQDO *3 JURZWK DQG LQWHUHVW UDWHVover the period 2000 through 2008 for each of the displayed countries.44 7KH KRUL]RQWDOaxis displays the average primary balance over the same period with a positive numberLPSOLQJ D SULPDU VXUSOXV DQG D QHJDWLYH LPSOLQJ D SULPDU GH¿FLW $FFRUGLQJO WKHREVHUYDWLRQ IRU HDFK FRXQWU LV D SDLU RI DFWXDO DQG GHEWVWDELOL]LQJ SULPDU EDODQFHVDQG WKH FKDUW LV GLYLGHG LQWR WZR ]RQHV ,Q WKH WRS FKDUW SRLQWV DERYH WKH GHJUHHOLQH GHQRWH SRLQWV ZKHUH WKH GHEW VWDELOL]LQJ SULPDU VXUSOXV LV DERYH WKH DFWXDO SULPDUsurplus and the debt ratio is increasing. Points below the 45-degree line denote situationsZKHQ WKH DFWXDO SULPDU VXUSOXV LV ODUJHU WKDQ WKH GHEWVWDELOL]LQJ VXUSOXV DQG WKH GHEWratio is on average decreasing.45 Conversely, points along the 45-degree line denoteHTXDOLW EHWZHHQ WKH DFWXDO DQG GHEWVWDELOL]LQJ SULPDU EDODQFHV DQG VWDELOLW LQ WKH GHEWto-GDP ratio.43 The calculation of debt-stabilizing primary balances was discussed in the preceding section. Note that debt- stabilizing primary balances can be negative (i.e., primary deficits) if nominal interest rates are below the nominal growth rate of the economy. Such a condition is unlikely to hold over very long time periods and very long-run assessments of fiscal sustainability are typically based on the assumption that the interest rate exceeds the growth rate.44 The calculation is based on equations (8) through (9) in the preceding section.45 As the scale of the axes is different in the lower chart, a comparable 45 degree line cannot be drawn. The indicated line plays a comparable role to the 45 degree line in the top chart.
  • 100. 22 | ADB Economics Working Paper Series No. 205Figure 5: Actual and Debt-Stabilizing Primary Balances 15 10 5 P 0 E P PA A PP P P A C C E E S S S S A AC S C C −5 A S A −10 S Bold letters represent subregional averages CStabilizing Balance (% GDP) C −15 −15 −10 −5 0 5 10 15 Note: GDP growth rates and interest rates: 2000-2008 average. Debt and primary balance: 2005-2008 average. 1.5 S S S 1.0 A C P S S S A P A A PA A 0.5 C E A C E EPC S C P P C C 0 −15 −10 −5 0 5 10 15 Actual Primary Balance (% GDP, 2005-2008 average) C: Central Asia E: East Asia P: The Pacific S: South Asia A: Southeast Asia Note: Interest rate assumed 150bp above 2000-2008 average GDP growth rate. Debt and primary balance: 2005-2008 averages.Based on the top part of Figure 5, it is apparent that over the period 2000–2008 mostFRXQWULHV LQ WKH UHJLRQ IDOO ZHOO ZLWKLQ WKH ]RQH RI VXVWDLQDELOLW HYHQ WKRXJK D QXPEHUare close to the 45-degree line. Most notably, several countries in the region have onaverage been running primary surpluses between 0–5% of GDP, with a small numberrunning even larger surpluses. Findings of this kind are consistent with those of severalRWKHU VWXGLHV RI ¿VFDO VXVWDLQDELOLW ZLWKLQ WKH UHJLRQ DQG WKRVH RI EURDGHU VWXGLHV WKDWKDYH DVVHVVHG ¿VFDO VXVWDLQDELOLW DFURVV D QXPEHU RI UHJLRQV +RUQH ,0) 0HQGR]D DQG 2VWU
  • 101. (YHQ WKRXJK WKHVH UHVXOWV DUH HQFRXUDJLQJ WKH VKRXOG QRWEH VHHQ DV JURXQGV IRU FRPSODFHQF 1RW RQO LV LW QHFHVVDU WR UHFRJQL]H WKH VOLSSDJHVLQ ¿VFDO SROLF WKDW KDYH RFFXUUHG GXULQJ WKH JOREDO FULVLV D FORVH LQVSHFWLRQ RI )LJXUH
  • 102. Fiscal Sustainability in Developing Asia | 23 UHYHDOV WKDW WKH GHEWVWDELOL]LQJ SULPDU VXUSOXVHV IRU VHYHUDO FRXQWULHV LQ WKH UHJLRQKDYH LQ WKH SDVW EHHQ QHJDWLYH LH SULPDU GH¿FLWV
  • 103. 7KLV UHÀHFWV WKH IDFW WKDW HFRQRPLFconditions in several countries have been such that the interest rate on debt has beenbelow the growth rate of the economy. Under such circumstances, as illustrated in)LJXUH GHEW UDWLRV FRXOG EH VWDELOL]HG HYHQ ZKHQ UXQQLQJ SULPDU GH¿FLWV WKDW KDYHin some cases been larger than 5% of GDP.46 Either because this condition is unlikelyWR KROG LQGH¿QLWHO RU RQ DFFRXQW RI WKH SRVVLELOLW WKDW WKH DFWXDO LQWHUHVW UDWH PD QRWUHÀHFW WKH WUXH VKDGRZ SULFH RI GHEW WKH UHVXOWV QHHG WR EH WUHDWHG ZLWK FDUH 8OWLPDWHOUREXVW GHEWVWDELOL]LQJ ¿VFDO SROLFLHV QHHG WR EH VXFK DV WR VWDELOL]H WKH GHEW UDWLR LQcircumstances when the interest rate is above the growth rate.$JDLQVW WKLV EDFNJURXQG LW LV DOVR XVHIXO WR FRQVLGHU WKH SRVVLEOH LPSOLFDWLRQV IRU ¿VFDOsustainability of interest rates exceeding the growth rate of nominal GDP. Typically,interest rates on the external public debt of many countries exceed the nominal growthrate so that these rates can, in principle, be used in place of (relatively) low domesticinterest rates. Unfortunately, however, it is not possible to obtain such data for many ofthe countries included in Figure 5. Purely for illustrative purposes, the approach takenLQ WKH ORZHU SDUW RI )LJXUH ZDV WR UHGR WKH GHEW VWDELOL]LQJ FDOFXODWLRQV XQGHU WKHDVVXPSWLRQ WKDW WKH ³XQGHUOLQJ´ JDS EHWZHHQ WKH QRPLQDO LQWHUHVW UDWH DQG WKH JURZWKrate of nominal GDP for all regions was equal to 150 basis points.47 As can be seenfrom the chart, this positive interest rate gap has the effect of reducing the number ofFRXQWULHV ZLWK ¿VFDO SRVLWLRQV WKDW DUH XQDPELJXRXVO VXVWDLQDEOH DQG SXVKLQJ VRPH LQWRthe unsustainable quadrant. The reason for this is straightforward: A positive interest rateJDS LPSOLHV WKDW DOO FRXQWULHV DUH UHTXLUHG WR UXQ SULPDU VXUSOXVHV WR VWDELOL]H RU EULQJGRZQ WKH GHEW UDWLR 7R WKH H[WHQW WKDW ¿VFDO VXVWDLQDELOLW LQ VRPH FRXQWULHV GHSHQGVRQ D IDYRUDEOH²EXW XQOLNHO WR SHUVLVW²DELOLW WR ¿QDQFH GHEW DW LQWHUHVW UDWHV EHORZthe growth rate, the results in this lower chart may give a more realistic long-term senseRI ¿VFDO VXVWDLQDELOLW $W WKH OHDVW WKH FKDUW LQGLFDWHV WKDW ¿VFDO VXVWDLQDELOLW LQ VRPHcountries in the past has been facilitated by very favorable growth and interest rateconditions. Were these conditions to be less favorable in the future, the maintenance of¿VFDO VXVWDLQDELOLW ZRXOG EH PRUH FKDOOHQJLQJ7KH ODVW IHZ FKDUWV DQG WDEOHV SURYLGH NH VWUXFWXUDO LQIRUPDWLRQ IRU WKH ¿VFDO VLWXDWLRQLQ WKH UHJLRQ IRU ± 7KH ¿UVW WZR FKDUWV )LJXUHV DQG
  • 104. VXPPDUL]H WKHrelationship between public debt and GDP in both absolute and per capita terms acrossthe region. As shown, there is a strong positive relationship between GDP and debt,and a modest negative relationship between per capita GDP and the debt ratio, albeit46 Equations (8) and (9) above describe the relationship between the debt stabilizing primary balance and the debt ratio. Effectively, the primary surplus required to stabilize the debt ratio is equal to the gap between the nominal interest rate and the nominal growth rate of GDP multiplied by the debt ratio. When the gap term is negative, the debt ratio can be stabilized with a primary deficit.47 This is based on the average interest rate growth differential in the 2003 IMF study on fiscal sustainability (IMF 2002). Obviously, in practice, the actual differential will differ across countries and may be higher in countries where there are concerns about fiscal sustainability. To the extent that this is the case, some high-debt countries may be even closer to unsustainable fiscal positions.
  • 105. 24 | ADB Economics Working Paper Series No. 205with both Singapore and Hong Kong, China being outliers.48 Effectively, rich countriesin the region do not have higher public debt ratios than poorer countries. Within theregion, there is some indication that the highest public debt ratios are among the poorercountries, but the relationship is relatively weak.Figure 6: Public Debt and GDP 8 CHN KOR IND 6 HKG IDN THA MYS SGP PHL PAKGDP (log) 4 BGD VNM KAZUZB LKA AZE 2 NPL PNG ARM KHM GEO LAO FJI TJKKGZ MNG 0 MDV SLB BTN VUT WSM −2 PLW MHL −4 −2 0 2 4 6 Debt (log) Note: 1990-2008 averages in log scale. Specific country averages depend on data availability.Figure 7: Public Debt and Per Capita GDP 4 HKG SGP KORGDP per Capita (log) 2 PLW MYS MDV MHL THA FJI KAZ AZE VUT WSM CHN ARM SLB PHL 0 IDN GEO LKA PNG UZB BTN VNM PAK MNG IND BGD KGZ LAO KHM NPL TJK −2 0 1 2 3 4 5 Debt/GDP ratio (log) Note: 1990-2008 averages in log scale. Specific country averages depend on data availability.7UDGLWLRQDOO SXEOLF GHEW UDWLRV KDYH EHHQ DVVHVVHG LQ WHUPV RI WKHLU VL]H LQ UHODWLRQ WRGDP, with the assumption that the level of GDP provides a useful measure of capacityto service the debt. In practice, however, GDP may not be a very good measure of³FDSDFLW´ LQ VR IDU DV LW GRHV QRW PHDVXUH WKH UHVRXUFHV DYDLODEOH WR WKH JRYHUQPHQW IRUdebt service. Under quite general conditions, the debt-to-revenue ratio might be a morerelevant measure of capacity in so far as it measures how much of GDP the government48 In the case of Singapore, the high public debt ratio is matched by an even larger stock of government assets.
  • 106. Fiscal Sustainability in Developing Asia | 25has at its command to meet debt service payments. To this end, Figure 8 displays therelationship between conventional debt ratios (as a share of GDP) and ratios to revenueLQ WKH UHJLRQ RYHU WKH SHULRG ±Figure 8: Public Debt and Revenue RatiosTotal Government Revenue/GDP Ratio (log) 4.0 MHL PLW COO WSM 3.5 MDVBTNSLB AZE UZB MNG PNG FJI KGZ SGP KAZ ARMVNM VUT MYS 3.0 HKG KOR IDN IND GEO THA PHLTJK LKA CHN LAO TWN AFG 2.5 NPL AK P KHM BGD 2.0 0 1 2 3 4 5 Debt/GDP ratio (log) Note: 1990-2008 averages in log scale. Specific country averages depend on data availability.As implied by Figure 8, debt-to-revenue ratios are generally much higher than debt-to-GDP ratios. The reason for this is that revenue-to-GDP ratios generally lie in the 20–40%GDP range. The chart indicates, however, that there is no clear systematic relationshipbetween revenue and debt ratios across countries in the region. Countries with high debtratios do not generally have high revenue ratios or vice versa. On the other hand, andless positively, there is no indication that countries with higher debt ratios have higherrevenue ratios and hence greater debt service capacity.)LQDOO WKH ODVW WZR FKDUWV )LJXUHV DQG
  • 107. GLVSOD WKH UHODWLRQVKLS EHWZHHQ SXEOLFdebt ratios and uncertainty as measured either by the variability of (nominal) economicgrowth or the variability of interest rates. From a macro prudential perspective, the¿VFDO SRVLWLRQV RI FRXQWULHV ZLWK KLJK DQG XQFRUUHODWHG
  • 108. YDULDELOLW LQ WKHVH YDULDEOHVwould tend to be more vulnerable to macroeconomic shocks than other countries. Inparticular, shocks that reduced output growth and raised interest rates would be themost worrisome, as they could widen the interest rate gap that is an important factorLQ GHWHUPLQLQJ WKH SULPDU ¿VFDO VXUSOXV UHTXLUHG IRU VXVWDLQDELOLW DV GLVFXVVHG HDUOLHUBased on the two charts, however, it appears that subregions with the highest debt ratiostend also to be those with the lowest variability as measured by the standard deviation ofgrowth or interest rates.49 In both cases, variability is measured by the standard deviation either of annual log changes (in the case of nominal GDP) or of levels (in the case of nominal interest rates).
  • 109. 26 | ADB Economics Working Paper Series No. 205Figure 9: Public Debt and Macroeconomic Uncertainty, 1990–2008 70 soaAverage Debt (% GDP) 60 sea 50 paa cea 40 eaa 30 6 7 8 9 10 11 Standard Deviation of GDP Growth (%) Note: The dashed line represents a linear regression across subregions.Figure 10: Public Debt and Financial Uncertainty 70 soa 60Average Debt (% GDP) sea 50 40 paa cea 30 eaa 2 4 6 8 10 12 Standard Deviation of Interest Rate (%) Note: The dashed line represents a linear regression across subregions.IV. Econometric Tests of Primary Fiscal BalanceResponse Functions7KLV VHFWLRQ SUHVHQWV WKH PDLQ UHVXOWV IURP SDQHOUHJUHVVLRQ HVWLPDWHV RI WKH ¿VFDO SROLFresponse functions discussed in Section II (equation 7). Most of the estimations areEDVHG RQ WKH DSSOLFDWLRQ RI IHDVLEOH JHQHUDOL]HG OHDVW VTXDUHV )*/6
  • 110. WR DQ XQEDODQFHG50SDQHO RI WLPH VHULHV DQG FRXQWU GDWD RYHU WKH SHULRG WKURXJK DQG YDULRXVVXESHULRGV
  • 111. ZLWK DOORZDQFH IRU ³¿[HG HIIHFWV´ DOWKRXJK DQ DOWHUQDWLYH 6VWHP *HQHUDO50 The unbalanced panel is the result of missing time series observations for a number of countries in the panel. The use of unbalanced panels is common in the estimation of fiscal response functions (see Mendoza and Ostry 2008).
  • 112. Fiscal Sustainability in Developing Asia | 27Method of Moments (SGMM) approach was also tried. Allowance was made in theHVWLPDWLRQV IRU FRXQWUVSHFL¿F DXWRFRUUHODWLRQ DQG KHWHURVNHGDVWLFLW IRU WKH UHVSRQVHVRI SULPDU ¿VFDO EDODQFHV WR GHEW UDWLRV WR EH QRQOLQHDU DQGRU YDU ZLWK GHEW OHYHOV IRUthe presence of lagged adjustment; and for the interaction between country dummiesand debt. In all the estimated equations, the dependent variable is the primary surplusDV D VKDUH RI *3
  • 113. ZKLOH WKH LQGHSHQGHQW YDULDEOHV DFURVV WKH GLIIHUHQW VSHFL¿FDWLRQVincluded current and lagged values of the debt ratio, and control variables such as(primary) government spending relative to trend and the output gap,51 which are includedWR FDSWXUH WHPSRUDU LQÀXHQFHV RQ ¿VFDO SROLF ,Q VRPH VSHFL¿FDWLRQV WKHUH DUH UHJLRQDORU FRXQWU GXPP WHUPV 7KH NH FRHI¿FLHQW LQ WKH HTXDWLRQV U) is the one attachedto the debt term, which measures the response of the primary balance to debt. AsGLVFXVVHG LQ 6HFWLRQ ,, D YDOXH RI WKLV FRHI¿FLHQW EHWZHHQ ]HUR DQG XQLW LV FRQVLVWHQWZLWK D VWDELOL]LQJ RU VXVWDLQDEOH ¿VFDO SROLF UHVSRQVH WR ULVLQJ GHEW $ QHJDWLYH FRHI¿FLHQWLPSOLHV SRWHQWLDOO GHVWDELOL]LQJ UHVSRQVHVGiven serious data limitations and the considerable heterogeneity within the region, thepresented econometric results should be treated with care. Based on the estimations,WKH ¿VFDO SROLF UHVSRQVHV WR ULVLQJ GHEW OHYHOV DUH QRW HDVLO FDSWXUHG E VLPSOH OLQHDUdecision rules in several countries and regions, and some of the equations may not bestable over time. Moreover, several important endogeneity issues52 in the data maynot be fully resolved and their resolution could affect the parameter estimates. Be thatDV LW PD WKH HVWLPDWHG UHVXOWV VXJJHVW WKDW SULPDU ¿VFDO EDODQFHV LQ VRPH FRXQWULHVDQG UHJLRQV
  • 114. GR UHVSRQG LQ D VWDELOL]LQJ PDQQHU WR LQFUHDVHV LQ GHEW UDWLRV LH ¿VFDOsurpluses are increased in response to rising debt ratios). At the same time, primarybalance responds in a relatively systematic way to the business cycle, as proxied byoutput gaps, and to swings in primary government spending relative to trend.Various estimation results are presented in Table 2 below. The table includes FGLS,ordinary least squares (OLS), and SGMM estimates for all countries for the sample period± EDVHG RQ D QXPEHU RI DOWHUQDWLYH VSHFL¿FDWLRQV RI WKH ODJ VWUXFWXUH RQ GHEWWKH VSHFL¿FDWLRQ RI WKH FRQWURO YDULDEOHV LQ WKH HTXDWLRQV WLPH WUHQGV DQG LQWHUDFWLRQeffects, and assumed properties of the error terms.51 Measured as the deviation of output from trend as measured by a Hodrick Prescott filter.52 These are related to factors such as common shocks to primary surpluses and the control variables.
  • 115. 28 | ADB Economics Working Paper Series No. 205Table 2: Econometric Estimation Results, 1990-2008 Regressant: All Countries Selected Countries (1) (2) (3) (4) (5) (6) (7) (8) Primary surplus FGLS OLS FE SGMM FGLS FGLS OLS FE SGMM FGLS (linear) (linear) (linear) (quadratic) (linear) (linear) (linear) (quadratic) L.debt /1 0.0578*** 0.12445*** 0.1279 0.1651*** .04973*** 0.06253*** 0.0733*** −0.0637* L.debt^2 /2 −0.0009*** 0.0011*** GDP Gap /3 0.0987*** 0.1503 0.1733* 0.1096*** .08141*** 0.05428* 0.1408*** 0.08147*** GEXP Gap /4 −0.1333*** −0.1263*** −0.1575*** −0.1421*** −0.1648*** −0.16143*** −0.1843*** −0.1614*** Time trend −0.1154 −0.1520** 1.9863 Constant −0.4666*** −6.2689*** 2.3646*** 0.4789 −2.5824*** No. obs. 417 384 384 417 126 119 119 126 No. countries 33 33 33 33 7 7 7 7 Wald Chi2 441.37 51.2582 378.23 468.5228 298.2808 453.26 DW Statistic 1.712 0.4145 LBI Statistic 1.817 0.5666 AB AR1 −1.0505 −.50461 AB AR2 −.97226 −.41912* significant at 10%; ** significant at 5%; *** significant at 1% using Two-tailed Wald tests of zero coefficients.FGLS = feasible generalized least squares, OLS = ordinary least squares, SGMM = System General Method of Moments.Regression methods:(1)(4)(5)(8): Feasible Generalized Least Squares (FGLS) estimation, allowing for country-specific autocorrelation (AR1) and heteroskedasticity. Regressors include country dummies, also interacted with debt, to allow for panel-level fixed effects (coefficients not reported here.) For the case of regressions involving the sample of all countries, debt enters at two- year averages.(2) and (6): OLS within-estimator, allowing for fixed (country) effects and AR1.(3) and (7): Blundell-Bond type system-GMM estimator, instrumenting lagged primary balance and debt as regressors both in levels and differences and including a time trend. Windmeijer-robust standard errors. Note that both models are likely to suffer from misspecification, as second-order autocorrelation in the residuals from first-differenced errors is not rejected.Note that Figure 11 is based on the coefficients estimated by model (4) and Figure 12 is based on model (8).Notes on regressors:/1 Debt/GDP ratio, lagged 1 year (this ratio enters regressions at 2-year averages for the case of regressions involving the sample of all countries.)/2 Squared Debt/GDP ratio, lagged 1 year (this ratio enters regressions at 2-year averages for the case of regressions involving the sample of all countries.)/3 GDP deviation from Hodrick-Prescott trend, percent./4 Total government expenditure deviation from Hodrick-Prescott trend, percent.Across the estimated equations for all countries in Table 2, there is evidence consistentwith an average response of the primary balance to current and lagged debt ratiosWKDW OLHV EHWZHHQ DQG DOWKRXJK WKH FRHI¿FLHQW LQ VRPH VSHFL¿FDWLRQV LVLQVLJQL¿FDQW VWDWLVWLFDOO 7KHVH HVWLPDWHV DUH EURDGO LQ OLQH ZLWK D QXPEHU RI RWKHUVWXGLHV ,0)
  • 116. ,Q QR FDVHV DUH SULPDU ¿VFDO EDODQFHV IRXQG WR UHVSRQG SHUYHUVHOWR ULVLQJ GHEW LQ WKH VHQVH RI D VWDWLVWLFDOO VLJQL¿FDQW QHJDWLYH FRHI¿FLHQW EHLQJ DWWDFKHGto the debt ratio variable. Finally, the last few columns of Table 2 present the results fora particular subset of larger countries in the region and allows for the possibility that¿VFDO UHVSRQVHV WR GHEW PD YDU DW GLIIHUHQW GHEW OHYHOV 7ZR EURDG DSSURDFKHV ZHUHtaken to allow for such effects: In the spline approach (not reported in Table 2), debt wasdivided into above or below median debt ranges, and the estimates sought to determinewhether the response of the primary balance differed across the ranges. In the nonlinearequation approach, allowance was made for the possibility that the response of the
  • 117. Fiscal Sustainability in Developing Asia | 29primary balance to debt was described by a simple quadratic function rather than a linearUHVSRQVH IXQFWLRQ 2YHUDOO WKH UHVXOWV VXJJHVWHG VRPH HYLGHQFH RI ³GLIIHUHQWLDO´ HIIHFWVwhereby the primary balance function either has a u shape (implying that the adjustmentSDUDPHWHU ¿UVW IDOOV DQG WKHQ ULVHV
  • 118. RU DQ Q VKDSH LPSOLQJ WKDW WKH DGMXVWPHQWSDUDPHWHU ¿UVW ULVHV DQG WKHQ IDOOV
  • 119. 7KH ¿QGLQJ RI D ³XVKDSHG´ ¿VFDO UHVSRQVH IXQFWLRQV GLIIHUV IURP VRPH RWKHU VWXGLHV0HQGR]D DQG 2VWU ,0) ZKLFK ¿QG QVKDSHG HIIHFWV
  • 120. DQG LV SRWHQWLDOOTXLWH VLJQL¿FDQW LQ HFRQRPLF WHUPV VHH )LJXUHV DQG
  • 121. 8QGHU D XVKDSHG IXQFWLRQWKH ¿VFDO DGMXVWPHQW HIIRUW ¿UVW PRGHUDWHV DV GHEW UDWLRV LQFUHDVH EXW WKHQ VWUHQJWKHQVwhen a certain critical debt ratio is reached as part, perhaps, of a wake-up call effect.Unfortunately, however, there are also countries in the region that appear to displayDGMXVWPHQW ³IDWLJXH´ RU DQ ³QVKDSHG´ HIIHFW LQ ZKLFK WKH ¿VFDO SROLF UHVSRQVHV WHQG WRweaken as debt levels climb to very high levels in relation to GDP. In the u-shaped case,the turning point for debt is found to lie below the median debt ratio. In the n-shapedcase, the turning point is found to lie above the median debt ratio.Figure 11: An n-Shaped Primary Balance Response Function 10Primary Fiscal Slurplus (% GDP) 8 6 4 Sample median 2 0 43.4 88.9 120 Debt (% GDP) Note: Based on FGLS regression on the whole sample. Debt in 2-year averages, 1 year lag.Based on these preliminary estimation results, three broad conclusions can be drawn:L
  • 122. 5HÀHFWLQJ FRQVLGHUDEOH KHWHURJHQHLW DFURVV FRXQWULHV DQG RYHU WLPH DYHUDJH ¿VFDO EHKDYLRU LQ WKH UHJLRQ LV QRW HDVLO FDSWXUHG E D VLQJOH RQHVL]H¿WVDOO VSHFL¿FDWLRQ RI WKH OLQNDJH EHWZHHQ SULPDU ¿VFDO EDODQFHV DQG GHEW UDWLRV Across the region, however, some evidence is found consistent with a statistically VLJQL¿FDQW SRVLWLYH UHVSRQVH RI WKH SULPDU VXUSOXV WR GHEW UDWLRV FRQVLVWHQW ZLWK VWDELOL]LQJ EHKDYLRU
  • 123. 30 | ADB Economics Working Paper Series No. 205(ii) Reponses of primary balances to debt ratios appear to display quite complex lag structures that differ across subregions.(iii) In some countries, there is evidence consistent with nonlinear responses of the primary balance to debt ratios and of the existence of debt tipping points. These may be either of the u-shape or n-shape kind with different implications for the HIIHFWV RI ¿VFDO VOLSSDJHV RQ WKH DGMXVWPHQW HIIRUWFigure 12: A u-Shapred Primary Balance Response Function 10Primary Fiscal Slurplus (% GDP) 8 6 4 Sample median 2 0 28.8 39.8 120 Debt (% GDP) Note: FGLS regression on the small sample of seven countries. Debt lagged 1 year.V. Fiscal Stimulus Scenarios7KLV VHFWLRQ GLVFXVVHV WKH LPSOLFDWLRQ IRU GHEW VXVWDLQDELOLW RI WKH UHFHQW ¿VFDO VWLPXOXVSDFNDJHV DGRSWHG LQ WKH UHJLRQ 7KUHH EURDG ³ZKDW LI´ RU VWUHVV WSH VFHQDULRV DUHdeveloped and applied to a selected group of countries for whom detailed projection dataDUH DYDLODEOH 7KH ¿UVW VFHQDULR LV EDVHG RQ KROGLQJ ¿VFDO VWLPXOL FRQVWDQW DW WKHLU ±2010 levels and projecting the implications for debt ratios on the basis of the forecastsfor nominal GDP in the Asian Development Outlook $% E
  • 124. DQG WKH WHFKQLFDOassumption that interest rates will rise gradually from their current relatively low levels inWKH FRQWH[W RI PRQHWDU SROLF QRUPDOL]DWLRQ 7KH VHFRQG DQG WKLUG VFHQDULRV DUH EDVHGRQ WKH ¿VFDO SROLF UHDFWLRQ IXQFWLRQV HVWLPDWHG LQ WKH SUHYLRXV VHFWLRQ DQG DOORZ IRU WKH¿VFDO VWLPXOXV WR EH XQZRXQG RQ WKH EDVLV RI KLVWRULFDO DGMXVWPHQW SDWWHUQV 7R PDNH WKLVscenario relevant to the heterogeneity in the region, the upper and lower bounds for the FRQ¿GHQFH LQWHUYDOVV
  • 125. IRU WKH DYHUDJH YDOXH RI WKH UHVSRQVH RI ¿VFDO SROLF WR GHEWratios in the region were used.53 An upper bound of 0.08 is used to capture very forceful¿VFDO DGMXVWPHQW ZKLOH WKH ORZHU ERXQG RI LV XVHG WR FDSWXUH PXFK VORZHU ¿VFDOadjustment.53 For simplicity, the control variables in these equations are held constant.
  • 126. Fiscal Sustainability in Developing Asia | 31Figure 13: Fiscal Stimulus Unwinding Scenarios Central Asia East Asia 70 70 60 60Debt (% GDP) Debt (% GDP) 50 50 40 40 30 30 20 20 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 Year Year Southeast Asia South Asia 70 70 60 60Debt (% GDP) Debt (% GDP) 50 50 40 40 30 30 20 20 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 Year Year Asia7 Scenario I: Fiscal stimuli constant at 2009/10 level 70 60 Scenario II: Modest adjustment of the primary balance (rho=0.04)Debt (% GDP) 50 40 Scenario II: Forceful adjustment of the primary balance (rho=0.08) 30 20 2008 2009 2010 2011 2012 2013 2014 2015 Year Note: See the text body for a description of the assumptions underlying this scenario. Asia7 comprises India, Indonesia, Korea Rep., Malaysia, Thailand, Philippines, PRC.
  • 127. 32 | ADB Economics Working Paper Series No. 2057KH EDVHOLQHV IRU ERWK VFHQDULRV LQFRUSRUDWH HVWLPDWHV RI WKH ¿VFDO EDODQFHV IRU WKHVHOHFWHG JURXS RI FRXQWULHV LQ DQG GUDZLQJ RQ DQQRXQFHG ¿VFDO VWLPXOXVprograms and budgetary data.54 As indicated in the Fiscal Unwinding Scenarios includedLQ )LJXUH D IDLOXUH WR XQZLQG ¿VFDO VWLPXOXV DIWHU ZRXOG JHQHUDOO OHDG WRpublic-debt ratios remaining high and, in some instances, rising sharply above currenthigh levels. The key exception to this pattern is South Asia where rapid GDP growthin relation to interest rates contributes to a steady decline in the debt ratio over theSURMHFWLRQ SHULRG *HQHUDOO WKHUHIRUH GHODLQJ WKH UHPRYDO RI ¿VFDO VWLPXOXV EHRQG2010 does not present a desirable approach, especially in the case of countries withERUGHUOLQH ¿VFDO VXVWDLQDELOLW WKDW FDQQRW HDVLO ³DIIRUG´ VKDUS ULVHV LQ GHEW UDWLRV $VH[SHFWHG VHH )LJXUH
  • 128. IRUFHIXO ¿VFDO DGMXVWPHQW JHQHUDOO OHDGV WR VKDUSHU GHFOLQHVLQ GHEW UDWLRV WKDQ PRUH PRGHUDWH ¿VFDO DGMXVWPHQW EXW WKH GQDPLFV RI WKH PRGHOalong with the narrowing of the gap between growth rates and interest rates over theprojection period, imply that the difference between these adjustment paths is not alwaysvery large. Intuitively, the reason for this result is that, in the near term, rapid cyclicalUHFRYHULHV UHODWLYH WR TXLWH ORZ LQWHUHVW UDWHV LPSO WKDW FRQWLQXHG ODUJH ¿VFDO GH¿FLWV GRnot necessarily lead to large increases in debt ratios. Over time, however, as the gapbetween growth rates and interest rates tends to narrow, pressure on public debt ratiosVWDUW WR LQFUHDVH LI ¿VFDO GH¿FLWV UHPDLQ ODUJHBased on the scenario result, it is apparent most countries will need to start unwindingWKHLU ¿VFDO VWLPXOXV SDFNDJHV UHODWLYHO VRRQ LI WKH DUH WR VWDELOL]H VKRUWWHUP GHEW DQGin some cases, avoid quite sharp increases in debt ratios. Especially in countries withalready high debt, the unwinding might need to go at a somewhat faster pace than in thepast and, especially, in circumstances where the gap between growth rates and interestrates may be narrowing.VI. Medium-Term Fiscal Policy Frameworks7KLV VHFWLRQ DGGUHVVHV LVVXHV UHODWHG WR WKH ³QHZ´ ¿VFDO SROLF IUDPHZRUNV WKDW ZLOObe adopted in the region in the post global crisis environment. As noted earlier, theVXFFHVVIXO FRQWULEXWLRQ RI ¿VFDO SROLF WR KHOSLQJ WKH UHJLRQ ZHDWKHU WKH JOREDO VORZGRZQPD OHDG WR D ODUJHU UROH IRU FRXQWHUFFOLFDO ¿VFDO SROLF LQ WKH IXWXUH DQG WR D UDQJH RI³GHPDQGV´ RQ EXGJHWV E JURXSV DGYHUVHO DIIHFWHG E HFRQRPLF GRZQWXUQV $QG RQ WRSof current and prospective demands on budgets related to pensions and population aging,¿VFDO SROLF LQ D QXPEHU RI FRXQWULHV LQ WKH UHJLRQ PD EH FDOOHG XSRQ WR DVVLVW LQ WKHglobal rebalancing effort over the medium term. A key challenge governments are likelyWR IDFH ZLOO EH WR UHFRQFLOH D SRVVLEO PRUH DFWLYLVW UROH IRU ¿VFDO SROLF LQ WKH IXWXUH ZKLOHHQVXULQJ WKDW WKH UHJLRQ¶V JHQHUDOO VWURQJ UHFRUG RI ¿VFDO VXVWDLQDELOLW LV QRW SXW DW ULVN54 Effectively, in those cases where fiscal data is not available for 2009, the 2008 estimates are updated to reflect announced stimulus packages.
  • 129. Fiscal Sustainability in Developing Asia | 33,Q DGGLWLRQ WKH SRVVLELOLW VKRXOG EH FRQVLGHUHG WKDW PDLQWDLQLQJ ¿VFDO VXVWDLQDELOLW PDbe more challenging looking forward if some of the favorable economic conditions thatKHOG LQ WKH SDVW²LQFOXGLQJ LQWHUHVW UDWHV WKDW DUH RIWHQ ZHOO EHORZ WKH JURZWK UDWH RI WKHHFRQRP²DUH QR ORQJHU DVVXUHG ,Q VXFK FLUFXPVWDQFHV PDLQWDLQLQJ ¿VFDO VXVWDLQDELOLWFRXOG UHTXLUH PRUH IRUFHIXO SROLF UHVSRQVHV WR ¿VFDO VOLSSDJHV WKDQ LQ WKH SDVWHVSHFLDOO LQ WKRVH FDVHV ZKHUH ¿VFDO VXVWDLQDELOLW LV DW ULVN DQG PLJKW EHQH¿W IURP WKHDGRSWLRQ RI VWURQJ PHGLXPWHUP ¿VFDO SROLF IUDPHZRUNV WKDW DUH UHJXODUO VWUHVV WHVWHGfor a number of unfavorable contingencies.%DVHG RQ D ZLGH UDQJH RI H[SHULHQFHV VWURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV²LQ ZKLFKgovernment spending, revenues, debt service and debt levels are projected over thePHGLXP WHUP LQ D UHDOLVWLF DQG FRQVLVWHQW ZD DQG VWUHVV WHVWHG IRU GLIIHUHQW VKRFNV²KDYH SURYHG XVHIXO IRU KHOSLQJ DVVXUH WKDW EXGJHWV FRQIRUP WR ¿VFDO VXVWDLQDELOLW .RSLWVDQG 6PDQVN
  • 130. 7KH UHDVRQ IRU WKLV LV WKDW VXFK IUDPHZRUNV FDQ KHOS LGHQWLIin a timely manner whether debt ratios may be tending to rise too rapidly, and assistLQ IUDPLQJ WKH DSSURSULDWH ¿VFDO SROLF UHVSRQVHV ,Q DGGLWLRQ PDQ FRXQWULHV KDYHIRXQG LW XVHIXO WR XQGHUSLQ VXFK SROLF IUDPHZRUNV ZLWK ³UXOHV RU OLPLWV´ RQ ¿VFDO SROLFLQVWUXPHQWV VXFK DV UHYHQXHV RU SULPDU H[SHQGLWXUHV RU RQ RXWFRPHV VXFK DV ¿VFDOGH¿FLWV RU SXEOLF GHEW UDWLRV 1RW RQO FDQ VXFK PHGLXPWHUP ¿VFDO IUDPHZRUNV EH XVHIXOLQ ¿VFDO SROLF IRUPXODWLRQ DQG LPSOHPHQWDWLRQ WKH FDQ DOVR EH LPSRUWDQW LQ KHOSLQJEX ¿VFDO FUHGLELOLW DQG PD SD GLYLGHQGV LQ WHUPV RI ORZHU ¿QDQFLQJ DQG RWKHU FRVWV(XURSHDQ RPPLVVLRQ E
  • 131. 1HHGOHVV WR VD ¿VFDO SROLF UXOHV FRPH LQ PDQ GLIIHUHQW ³VKDSHV DQG VL]HV´ DQG WKHUHLV XQOLNHO WR EH D VLQJOH RQHVL]H¿WVDOO DSSURDFK DSSOLFDEOH WR DOO FRXQWULHV LQ WKH UHJLRQ(Buiter 2003). In addition, different countries may have different budgetary and legislativeIUDPHZRUNV DQG GLIIHUHQW UROHV IRU WKH YDULRXV EUDQFKHV RI JRYHUQPHQW LQ ¿VFDO SROLFformulation and implementation; these will need to be taken into account in designingsuch frameworks. Even though directed primarily toward the medium term, suchframeworks might also be of relevance in the context of the exit strategies from recentVWLPXOXV SURJUDPV 6WURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV PD KHOS IDFLOLWDWH WKH JURZWKIULHQGO ZLWKGUDZDO RI ¿VFDO VWLPXOXV SDFNDJHV LI WKH IDYRUDEOH HIIHFWV RQ FUHGLELOLW DQGinterest rates implied by such frameworks help crowd in private spending (Cottarelli and9LQDOV
  • 132. 7KH ¿VFDO SROLF IUDPHZRUNV DQG UXOHV WKDW KDYH EHHQ DGRSWHG LQ YDULRXV FRXQWULHVaround the world have differed in a number of important dimensions. Such rules canEH ULJLG RU ÀH[LEOH DSSO WR GLIIHUHQW FRPSRQHQWV RI WKH EXGJHW RU WR WKH RYHUDOO EXGJHWGH¿FLW DSSO WR GHEW VWRFNV RU GHEW LVVXDQFH DSSO HDU E HDU RU RYHU WKH PHGLXPWHUP WDNH WKH IRUP RI UDQJHV RU SRLQW OLPLWV RQ ¿VFDO YDULDEOHV DQG PD RU PD QRWinclude escape clauses to deal with exceptional circumstances. In addition, suchUXOHV PD H[SOLFLWO DOORZ IRU ¿VFDO SROLF WR SOD D FRXQWHUFFOLFDO UROH E WDUJHWLQJWKH VWUXFWXUDO RU KLJK HPSORPHQW EXGJHW GH¿FLW RU WKH PD GLUHFWO RU LQGLUHFWO OLPLW
  • 133. 34 | ADB Economics Working Paper Series No. 205FRXQWHUFFOLFDO ¿VFDO SROLF UHVSRQVHV E EHLQJ IUDPHG LQ DFWXDO UDWKHU WKDQ VWUXFWXUDOterms.7KH EHVWNQRZQ ¿VFDO SROLF UXOHV DUH WKRVH DVVRFLDWHG ZLWK WKH (XURSHDQ 8QLRQenshrined in the Growth and Stability Pact. The key elements of the Pact are relativelyULJLG XSSHU ERXQGV RQ ¿VFDO GH¿FLWV DQG SXEOLF GHEW UDWLRV LQ UHODWLRQ WR *3
  • 134. VXSSRUWHGby a set of formal penalties to be imposed on countries that do not adhere to the rules.Fiscal policy rules, however, have been adopted in many other countries and parts of theworld, and by both developed and emerging market countries. In the case of the United6WDWHV PHGLXPWHUP ¿VFDO SROLF WDUJHWV DQG UXOHV SODHG DQ LPSRUWDQW UROH LQ SODFLQJ¿VFDO SROLF RQ D D PRUH VROLG IRRWLQJ LQ WKH ODWH V DQG HDUO V +RULJXFKL
  • 135. )LVFDO SROLF UXOHV SODHG DQ LPSRUWDQW UROH LQ DQDGD¶V HIIRUWV WR WDPH H[SORGLQJSXEOLF GHEW GXULQJ WKH V DQG HDUO V 7KH 8QLWHG .LQJGRP DGRSWHG D ¿VFDOUHVSRQVLELOLW IUDPHZRUN LQ WKH HDUO SDUW RI WKH V WKDW VRXJKW WR OLPLW WKH VL]H RI¿VFDO GH¿FLWV ([DPSOHV RI UXOHVEDVHG PHGLXPWHUP ¿VFDO IUDPHZRUNV LQ $VLD LQFOXGHWKH ¿VFDO SROLF IUDPHZRUNV RI ,QGLD DQG 3DNLVWDQ LQ WKH FRQWH[W RI WKH QHHG WR DGGUHVVGHHSVHDWHG ¿VFDO ZHDNQHVV WKH ¿VFDO IUDPHZRUN DGRSWHG E ,QGRQHVLD LQ WKH DIWHUPDWKRI ¿VFDO VOLSSDJHV UHODWHG WR WKH $VLDQ FULVLV DQG 6LQJDSRUH¶V IUDPHZRUN IRU OLPLWLQJ ¿VFDOVOLSSDJHV DQG SURWHFWLQJ ¿VFDO UHVHUYHV ,0) D
  • 136. %RWK $XVWUDOLD DQG 1HZ =HDODQGKDYH DOVR DGRSWHG UXOHVEDVHG PHGLXP WHUP ¿VFDO IUDPHZRUNV DQG DFURVV WKH UHJLRQmany countries have adopted key elements of such frameworks as part of an effort toDVVXUH ¿VFDO VXVWDLQDELOLWLooking forward, countries in the region might usefully consider strengthening andDGDSWLQJ WKHLU ¿VFDO IUDPHZRUNV WR WKH SRVWFULVLV ZRUOG .H HOHPHQWV RI VXFK SRVWFULVLVIUDPHZRUNV ZRXOG EH UHDOLVWLF DQG FRQVLVWHQW PHGLXPWHUP SURMHFWLRQV IRU ¿VFDO YDULDEOHVDQG GHEW VWRFNV DOORZDQFH IRU IXWXUH DQG SURVSHFWLYH ¿VFDO OLDELOLWLHV VWUHVV WHVWLQJagainst a number of unfavorable developments; formal or informal rules that lead toprimary surpluses increasing in response to rising debt stocks as discussed in Section IIDQG ZKLFK JLYH ULVH WR VWDELOL]LQJ SULPDU EDODQFH UHVSRQVH IXQFWLRQV
  • 137. DQG IUDPHZRUNVVHHNLQJ WR DGGUHVV WKH IDFWRUV WKDW FRQWULEXWH WR GHEW WLSSLQJ SRLQWV ZKHUH WKH ¿VFDODGMXVWPHQW HIIRUW WDSHUV RII 6XFK IUDPHZRUNV FDQ DOVR EH GHVLJQHG WR FUHDWH WKH ¿VFDOspace necessary to deal with unforeseen contingencies and cyclical downturns. PoliciesWKDW VHHN WR EXLOG XS ¿VFDO VSDFH GXULQJ WKH XSVZLQJ RI WKH EXVLQHVV FFOH ZLOO KDYH WKHEHQH¿W RI DOORZLQJ ¿VFDO SROLF WR SOD D SRWHQWLDOO LPSRUWDQW FRXQWHUFFOLFDO UROH LQ ERWK³JRRG´ DQG ³EDG´ WLPHV ,Q DGGLWLRQ WKH ZRXOG FRPSOHPHQW HIIRUWV LQ WKH UHJLRQ WR OLPLWWKH SURFFOLFDOLW RI ¿QDQFLDO VVWHPV WKURXJK PDFUR SUXGHQWLDO SROLFLHV DQG FRXOG KHOSreduce the amplitude of regional business cycles.
  • 138. Fiscal Sustainability in Developing Asia | 35VII. Concluding Observations7KH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV KDV IXQGDPHQWDOO DOWHUHG $VLD¶V ¿VFDO SROLFHQYLURQPHQW 3ULRU WR WKH FULVLV WKH UHJLRQ¶V WUDGLWLRQDO ¿VFDO SKLORVRSK ZDV RQH RIproviding growth-conducive public goods such as infrastructure and education withoutMHRSDUGL]LQJ ¿VFDO VXVWDLQDELOLW DQG KHQFH PDFURHFRQRPLF VWDELOLW )RU WKH PRVW SDUWwith few exceptions such as South Asia, the outcome of this philosophy has beenJHQHUDOO VPDOO JRYHUQPHQW EXGJHW GH¿FLWV DQG ORZ SXEOLF GHEW OHYHOV :KHUH WKHUH ZHUHWHPSRUDU ¿VFDO VOLSSDJHV KHDOWK RI SXEOLF ¿QDQFHV KDG EHHQ UHVWRUHG TXLFNO WKURXJKVSHHG DQG GHFLVLYH ¿VFDO DGMXVWPHQWV 2QH NH IDFWRU XQGHUOLQJ VXFK JHQHUDOO EHQLJQSUHFULVLV ¿VFDO DQG GHEW SRVLWLRQ ZDV WKH UHJLRQ¶V UHOXFWDQFH WR SXUVXH FRXQWHUFFOLFDOSROLFLHV 7KLV UHOXFWDQFH VWHPPHG IURP WKH UHJLRQ¶V SULRULW RQ PD[LPL]LQJ RXWSXW JURZWKUDWKHU WKDQ PLQLPL]LQJ RXWSXW YRODWLOLW )XUWKHUPRUH VWURQJ JURZWK RQ D VXVWDLQHG EDVLVin much of the region obviated the need for countercyclical polices that, in practice, referWR DQWLUHFHVVLRQ SROLFLHV 7KH JOREDO FULVLV KDV EURXJKW FRXQWHUFFOLFDO ¿VFDO DFWLYLVPEDFN LQWR $VLD ZLWK D WKXQGHURXV EDQJ 7KH XQSUHFHGHQWHG ¿VFDO VWLPXOXV SXW LQWReffect by governments across the region was borne out of sheer necessity rather thanDQ IXQGDPHQWDO VKLIW LQ ¿VFDO SKLORVRSK (YHQ VR WKH DQWLFULVLV VWLPXOXV PD KDYHUHSHUFXVVLRQV IRU ERWK ¿VFDO SROLF DQG ¿VFDO RXWFRPHV IDU EHRQG WKH FULVLV7KH UHYLYDO RI FRXQWHUFFOLFDO ¿VFDO SROLFLHV LQ WKH UHJLRQ EULQJV EDFN WKH LVVXH RI ¿VFDOsustainability back to center stage. Precisely because the region’s governments haveODUJHO UHIUDLQHG IURP ¿VFDO DFWLYLVP LQ WKH SDVW ¿VFDO VXVWDLQDELOLW KDV QRW EHHQ D PDMRUSROLF FRQFHUQ LQ WKH UHJLRQ +RZHYHU WKH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV ZLOO OHDGWR GHWHULRUDWLRQ RI WKH ¿VFDO DQG SXEOLF GHEW SRVLWLRQV LQ WKH VKRUW UXQ DQG PD DOVREULQJ DERXW D ³JDPHFKDQJLQJ´ VKLIW LQ WKH UHJLRQ¶V ¿VFDO SKLORVRSK WRZDUG KHLJKWHQHGcountercyclical activism beyond the crisis. In light of the renewed importance of Asia’s¿VFDO VXVWDLQDELOLW LQ WKH SRVWFULVLV SHULRG ZH FDUU RXW WKUHH WSHV RI HPSLULFDO DQDOVLVL
  • 139. DQDOVLV RI WKH DFWXDO VWDWH RI SXEOLF ¿QDQFHV ORRNLQJ DW NH ¿VFDO LQGLFDWRUV DFURVVWKH UHJLRQ LL
  • 140. HFRQRPHWULF WHVWV RI ¿VFDO VXVWDLQDELOLW LQ SDUWLFXODU HVWLPDWLRQV RI ¿VFDOSROLF UHDFWLRQ IXQFWLRQV WKDW PHDVXUH WKH UHVSRQVH RI SULPDU ¿VFDO EDODQFHV WR FKDQJHVLQ GHEW UDWLRV DFURVV FRXQWULHV DQG RYHU WLPH DQG LLL
  • 141. ¿VFDO VLPXODWLRQV WKDW DVVHVV WKHLPSDFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV RQ GHEW VXVWDLQDELOLW LQ WKH UHJLRQ 7KH RYHUDOOEDODQFH RI HYLGHQFH IURP WKH ¿UVW WZR WSHV RI DQDOVLV LQGLFDWHV WKDW DOWKRXJK WKHUHis considerable heterogeneity across countries and subregions, by and large Asia’sSXEOLF ¿QDQFHV DUH LQ UHODWLYHO JRRG VKDSH DQG $VLD¶V JRYHUQPHQWV KDYH SXUVXHG ¿VFDOVXVWDLQDELOLW 7KDW LV WKH HYLGHQFH FRQ¿UPV WKH FRQYHQWLRQDO ZLVGRP WKDW $VLD KDV EHHQ¿VFDOO UHVSRQVLEOH LQ WKH SDVW 7KH WKLUG WSH RI DQDOVLV ¿QGV WKDW IDLOXUH WR XQZLQG WKHDQWLFULVLV ¿VFDO VWLPXOXV ZLOO VHULRXVO HURGH WKH UHJLRQ¶V ¿VFDO VXVWDLQDELOLWA number of important policy implications emerge from our empirical analysis. The mostimmediate policy message is that regional policymakers should continue to give highSULRULW WR SURPRWLQJ DQG VXVWDLQLQJ ¿VFDO VXVWDLQDELOLW DV WKH KDYH GRQH LQ WKH SDVW
  • 142. 36 | ADB Economics Working Paper Series No. 2052XU ¿QGLQJV LPSO WKDW ¿VFDO VXVWDLQDELOLW PDWWHUV DQG PDWWHUV D ORW DQG WKLV ZLOO FRQWLQXHWR EH WKH FDVH LQ WKH IXWXUH *LYHQ WKH SRSXODU SHUFHSWLRQ WKDW FRXQWHUFFOLFDO ¿VFDOpolicies played a key role in Asia’s spectacular V-shaped recovery, it may be tempting toEHOLHYH WKDW $VLDQ JRYHUQPHQWV VKRXOG QRZ WKLQN PRUH DERXW XVLQJ ¿VFDO UHVRXUFHV DQGOHVV DERXW VXVWDLQLQJ ¿VFDO VXVWDLQDELOLW +RZHYHU LW LV SUHFLVHO EHFDXVH $VLD KDV UXQVPDOO EXGJHW GH¿FLWV DQG DFFXPXODWHG PDQDJHDEOH GHEW OHYHOV WKDW LW ZDV DEOH WR DIIRUGVXFK ODUJH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV 5HJDUGOHVV RI WKH DFWXDO FRQWULEXWLRQ RIWKH VWLPXOXV WR $VLD¶V UHFRYHU²DQG WKLV LVVXH ZLOO QRW EH VHWWOHG IRU VRPH WLPH²WKH IDFWUHPDLQV WKDW $VLD GLG KDYH DPSOH ¿VFDO VSDFH DV LW HQWHUHG WKH FULVLV DQG WKLV VSDFH ZDVWKH FRQVHTXHQFH RI D KLVWRU RI ¿VFDOO UHVSRQVLEOH EHKDYLRU ,Q SDUWLFXODU RXU HYLGHQFHVXJJHVWV WKDW LQ WKH SDVW $VLDQ JRYHUQPHQWV KDYH PDGH ¿VFDO DGMXVWPHQWV LQ UHVSRQVHto deterioration of public debt positions. The primary forward-looking implication for AsianSROLFPDNHUV LV WKH FRQWLQXHG QHHG IRU ¿VFDO UHVSRQVLELOLW LI WKH DUH WR VHFXUH DGHTXDWH¿VFDO VSDFH WR FRSH ZLWK H[WUHPH VKRFNV LQ WKH IXWXUH :KLOH WKH JOREDO FULVLV ZDVXQGRXEWHGO XQLTXH DQG H[FHSWLRQDO LQ WHUPV RI WKH VQFKURQL]HG DQG JOREDO QDWXUH RI LWVimpact, we cannot rule out the recurrence of severe regional or global crises.7KH VHFRQG SROLF PHVVDJH LV WKDW $VLD ZLOO EHQH¿W IURP WKH DGRSWLRQ RI VWURQJ PHGLXPWHUP ¿VFDO SROLF IUDPHZRUNV WKDW DUH UHJXODUO WHVWHG IRU D QXPEHU RI XQIDYRUDEOHcontingencies. A key challenge governments are likely to face will be to reconcile aSRVVLEO PRUH DFWLYLVW UROH IRU ¿VFDO SROLF LQ WKH IXWXUH ZKLOH HQVXULQJ WKDW WKH UHJLRQ¶VJHQHUDOO VWURQJ UHFRUG RI ¿VFDO VXVWDLQDELOLW LV QRW SXW DW ULVN $ VWURQJ PHGLXPWHUP¿VFDO SROLF IUDPHZRUN ZLOO EH FULWLFDO IRU PHHWLQJ WKDW FKDOOHQJH 5HJDUGOHVV RI WKHDFWXDO FRQWULEXWLRQ RI WKH ¿VFDO VWLPXOXV WR WKH UHJLRQ¶V UHFRYHU WKH SRSXODU SHUFHSWLRQWKDW LW SODHG D FHQWUDO UROH PD EULQJ DERXW D JDPHFKDQJLQJ VKLIW LQ WKH UHJLRQ¶V ¿VFDOphilosophy from its traditional conservatism toward countercyclical activism. Such aVKLIW PD MHRSDUGL]H ¿VFDO VXVWDLQDELOLW EHFDXVH RI DQ LQKHUHQW DVPPHWULF ELDV LQFRXQWHUFFOLFDO ¿VFDO SROLF LH LW LV SROLWLFDOO HDVLHU WR LQFUHDVH VSHQGLQJ DQG FXWtaxes during recessions than to go the other way during booms. Even in the absenceRI JDPHFKDQJLQJ VKLIWV LQ ¿VFDO SKLORVRSK WKH GHWHULRUDWLRQ RI ¿VFDO SRVLWLRQV DFURVVthe region due to the anticrisis stimulus packages may have adverse implications for¿VFDO VXVWDLQDELOLW DQG KDV WKXV UHQGHUHG WKH QHHG IRU VWURQJ PHGLXPWHUP ¿VFDO SROLFframeworks all the more urgent. The adoption of such frameworks may also provide aPRUH LPPHGLDWH EHQH¿W LQ VR IDU DV WKH FDQ KHOS VLJQDO WKDW WKH UHFHQW ¿VFDO VWLPXOXVSURJUDPV DUH WHPSRUDU DQG ZLOO QRW UHSUHVHQW D WKUHDW WR ORQJHUWHUP ¿VFDO VXVWDLQDELOLWAnd, any positive impact of frameworks on credibility about sustainability could helpFURZG LQ SULYDWH VSHQGLQJ DQG UHGXFH ¿QDQFLQJ FRVWV DV ¿VFDO SROLF LV SXW EDFN RQ WUDFN6WURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV FDQ WKXV IDFLOLWDWH JURZWKIULHQGO H[LW VWUDWHJLHVfrom recent stimulus packages.The third policy message emerging from our analysis is that Asian countries need toWDNH D ORQJ DQG EURDG YLHZ RI ¿VFDO VXVWDLQDELOLW ZKLFK WDNHV LQWR DFFRXQW WKH UHJLRQ¶VPHGLXPWHUP ¿VFDO QHHGV RYHU D VXI¿FLHQWO ORQJ WLPH KRUL]RQ 6XFK D YLHZ RI ¿VFDO
  • 143. Fiscal Sustainability in Developing Asia | 37VXVWDLQDELOLW LV FORVHO UHODWHG WR DQG FRQVLVWHQW ZLWK WKH QHHG IRU VWURQJ ¿VFDO SROLFIUDPHZRUNV EXW DW WKH VDPH WLPH SRLQWV WR WKH QHHG WR DGDSW WKH QRWLRQ RI ¿VFDOVXVWDLQDELOLW WR SRWHQWLDOO ODUJH FKDQJHV LQ $VLD¶V SRVWFULVLV ¿VFDO HQYLURQPHQW 7KHUHJLRQ KDV VRPH ORQJVWDQGLQJ PHGLXPWHUP ¿VFDO QHHGV VXFK DV SKVLFDO LQIUDVWUXFWXUH$ PRUH UHFHQW PHGLXPWHUP ¿VFDO FKDOOHQJH LV WR SURYLGH DGHTXDWH SHQVLRQ DQG KHDOWKcare as the region rapidly shifts to an older population. A medium-term need that hasarisen as a direct result of the global crisis is more spending on social protection andother areas that can facilitate Asia’s growth rebalancing. Finally, given Asia’s growingZHLJKW LQ WKH ZRUOG HFRQRP DQG LQÀXHQFH LQ WKH LQWHUQDWLRQDO FRPPXQLW $VLD ZLOO EHH[SHFWHG WR FRQWULEXWH PRUH WR JOREDO SXEOLF JRRGV VXFK DV ¿JKWLQJ FOLPDWH FKDQJHand poverty in Africa. For all of these reasons, even if there were no shift towardFRXQWHUFFOLFDO ¿VFDO SROLFLHV $VLD PD H[SHULHQFH DQ LQFUHDVH LQ WKH UROH RI WKHJRYHUQPHQW ,Q DGGLWLRQ LQ LWV ¿VFDO VXVWDLQDELOLW DVVHVVPHQWV WKH UHJLRQ VKRXOGH[SOLFLWO WDNH LQWR DFFRXQW VLJQL¿FDQW RIIEXGJHW LWHPV DQG FRQWLQJHQW OLDELOLWLHV LQFOXGLQJthose incurred during the crisis. For example, much of the PRC’s recent bank lendingsurge is implicitly guaranteed by the government, which means that nonperformingloans will end up on the government’s balance sheets. The broader point here is thatD SURVSHFWLYH PHGLXPWHUP LQFUHDVH LQ ¿VFDO GHPDQGV LQ WKH SRVWFULVLV SHULRG UHQGHUVSUHFULVLV QRWLRQV RI ¿VFDO VXVWDLQDELOLW REVROHWH LQ WKH VHQVH WKDW ODUJHU UHYHQXHV ZLOO EHrequired to achieve sustainability.,Q D IXQGDPHQWDO VHQVH HYHQ LI $VLD UHYHUWV WR LWV WUDGLWLRQDO SUHFULVLV ¿VFDO FRQVHUYDWLVPDIWHU LW XQZLQGV LWV DQWLFULVLV ¿VFDO VWLPXOXV WKH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV KDVDOUHDG EHHQ D JDPHFKDQJHU IRU ¿VFDO SROLF DQG ¿VFDO VXVWDLQDELOLW LQ WKH UHJLRQ1HYHU EHIRUH KDV WKH UHJLRQ H[SHULHQFHG VXFK D IRUFHIXO VQFKURQL]HG DQG XQLIRUP¿VFDO UHVSRQVH WR DQ HFRQRPLF GRZQWXUQ ,Q FRQWUDVW WR WKH LQGXVWULDOL]HG FRXQWULHV WKHUHJLRQ LV QRW DFFXVWRPHG WR VXFK XVH RI ¿VFDO SROLF IRU FRXQWHUFFOLFDO SXUSRVHV )LVFDOVXVWDLQDELOLW ZDV D NH FRQVHTXHQFH RI WKH UHJLRQ¶V FRPPLWPHQW WR ¿VFDO GLVFLSOLQH DQGmacroeconomic stability. The global crisis has highlighted a fact that has hitherto beenXQGHUDSSUHFLDWHG LQ WKH UHJLRQ²WKDW ¿VFDO VXVWDLQDELOLW LV DV PXFK D YDOXDEOH WRRO DV LW LVD FRQVHTXHQFH $ YDOXDEOH WRRO EHFDXVH LW KDV DOORZHG WKH UHJLRQ WR XQOHDVK ODUJH ¿VFDOVWLPXOXV SURJUDPV 6RPHZKDW SDUDGR[LFDOO FXUUHQW ¿VFDO SURÀLJDF ZKLFK ZDV WKH ULJKWPHGLFLQH IRU WKH FULVLV ZDV PDGH SRVVLEOH E SDVW ¿VFDO IUXJDOLW *LYHQ WKH SRVVLELOLW RIsubstantial medium-term increases in government spending, Asian policymakers shouldalso explore ways to substantially increase revenues in nondistortionary ways that do notharm growth. To some extent, the region’s rapid growth will generate higher revenues buta well-designed revenue effort may still be required.)LQDOO WKH JDPHFKDQJLQJ VKLIW LQ WKH UHJLRQ¶V ¿VFDO ODQGVFDSH VLQFH WKH JOREDO FULVLVis not without some serious risks. In particular, higher government expenditures and,PRUH JHQHUDOO DQ H[SDQVLRQ LQ WKH HFRQRPLF UROH RI WKH JRYHUQPHQW LV RIWHQ GLI¿FXOW WRUHYHUVH RU DGMXVW HYHQ ZKHQ WKH DUH QR ORQJHU MXVWL¿HG 3ROLWLFDO FRQVLGHUDWLRQV PDNHLW HDVLHU IRU JRYHUQPHQWV WR SXUVXH ¿VFDO H[SDQVLRQ UDWKHU WKDQ ¿VFDO FRQWUDFWLRQ GXULQJ
  • 144. 38 | ADB Economics Working Paper Series No. 205GRZQWXUQV 7KLV KDV EHHQ HYLGHQW LQ WKH H[SHULHQFH RI LQGXVWULDOL]HG FRXQWULHV 7KHVFRSH IRU ¿VFDO UHYHUVDO RU DGMXVWPHQW LV HYHQ PRUH OLPLWHG LQ GHYHORSLQJ FRXQWULHV ZLWKweaker institutions and policy environments. However, the need for caution does notmean that the government should refrain from rethinking and expanding its role whereDSSURSULDWH DQG MXVWL¿HG 7KH FULVLV KDV VKRZQ WKDW WKH JRYHUQPHQW FDQ DQG VKRXOG VHUYHas a consumer of last resort when all the other components of demand are stalling. At aPLQLPXP DQG DVLGH IURP DQ GLUHFW LPSDFW RQ JURZWK LW LV OLNHO WKDW WKH UHJLRQ¶V ¿VFDOVWLPXOXV KDV KHOSHG WR LPSURYH EXVLQHVV DQG FRQVXPHU FRQ¿GHQFH ZKLFK KDG FUDWHUHGDV WKH FULVLV LQWHQVL¿HG *RLQJ IRUZDUG WKH NH FKDOOHQJH IRU $VLD LV WR UHGH¿QH WKH UROHRI WKH JRYHUQPHQW DQG DGDSW LW WR WKH SRVWFULVLV ZRUOG ZLWKRXW FRPSURPLVLQJ WKH ¿VFDOsustainability that has served the region so well.Selected References$% Asian Development Outlook 1998. Asian Development Bank, Manila.BBBBB D Asia Economic Monitor. Asian Development Bank, Manila.BBBBB E Asian Development Outlook 2009. Asian Development Bank, Manila.$GHGHML 2 DQG - 7KRUQWRQ ³)LVFDO 6XVWDLQDELOLW LQ D 3DQHO RI $VLDQ RXQWULHV´ Applied Economics Letters. September.%DUUR 5 - ³2Q WKH HWHUPLQDWLRQ RI 3XEOLF HEW´ Journal of Political Economy
  • 145. ± 71.BBBBB ³86 H¿FLWV VLQFH :RUOG :DU ,´ Scandinavian Journal of Economics
  • 146. ±%DUWROLQL / DQG RWWDUHOOL ³*RYHUQPHQW 3RQ]L *DPHV DQG WKH 6XVWDLQDELOLW RI 3XEOLF H¿FLWV 8QGHU 8QFHUWDLQW´ Ricerche Economiche 48(1):1–22.BIS. 2006. Monetary Policy in Asia: Approaches and Implementation. Proceedings of a Bank for International Settlements/HKIMR Conference held at the Monetary and Economic Department, November 2005, Hong Kong, China.%ODQFKDUG 2 DQG 6 )LVFKHU Lectures on Macroeconomics. Cambridge, Massachusetts: MIT Press.%ODQFKDUG 2 - KRXUDTXL 5 3 +DJHPDQQ DQG 1 6DUWRU ³7KH 6XVWDLQDELOLW RI )LVFDO 3ROLF 1HZ $QVZHUV WR DQ 2OG 4XHVWLRQ´ OECD Economic Studies 15:7–36.%RKQ + ³7KH 6XVWDLQDELOLW RI %XGJHW H¿FLWV ZLWK /XPS6XP DQG ZLWK ,QFRPH%DVHG 7D[DWLRQ´ Journal of Money, Credit, and Banking 23(3):580–604.BBBBB ³7KH 6XVWDLQDELOLW RI %XGJHW H¿FLWV LQ D 6WRFKDVWLF (FRQRP´ Journal of Money, Credit, and Banking 27(1):257–271.BBBBB ³7KH %HKDYLRU RI 86 3XEOLF HEW DQG H¿FLWV´ Quarterly Journal of Economics
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  • 150. ±HODVXQ 2 ; HEUXQ DQG - 2VWU ³3ULPDU 6XUSOXV %HKDYLRU DQG 5LVNV WR )LVFDO 6XVWDLQDELOLW LQ (PHUJLQJ 0DUNHW RXQWULHV $ C)DQKDUW¶ $SSURDFK´ IMF Staff Papers 53(3):401–25.Chalk, N. A., and R. Hemming. 2000. Assessing Fiscal Sustainability in Theory and Practice. IMF Working Paper No. 00/81, International Monetary Fund, Washington, DC.
  • 151. Fiscal Sustainability in Developing Asia | 39RWWDUHOOL DQG - 9LQDOV $ 6WUDWHJ IRU 5HQRUPDOL]LQJ )LVFDO DQG 0RQHWDU 3ROLFLHV LQ $GYDQFHG (FRQRPLHV ,0) 6WDII 3RVLWLRQ 1RWH 631 ,QWHUQDWLRQDO 0RQHWDU )XQG Washington, DC.Croce, E., and V. H. Juan-Ramon. 2003. Assessing Fiscal Sustainability: A Cross- Country Comparison. IMF Working Paper No. 03/145, International Monetary Fund, Washington, DC.RPDU ( ³7KH µ%XUGHQ RI WKH HEW¶ DQG WKH 1DWLRQDO ,QFRPH´ American Economic Review
  • 152. ±(XURSHDQ RPPLVVLRQ ³3XEOLF )LQDQFHV LQ (08² 3DUW ,,, 1DWLRQDO 1XPHULFDO )LVFDO 5XOHV DQG ,QVWLWXWLRQV IRU 6RXQG 3XEOLF )LQDQFHV´ European Economy No. 3 (2006). Brussels.BBBBB ³3XEOLF )LQDQFHV LQ (08² 3DUW ,9 /HVVRQ )URP 6XFFHVVIXO )LVFDO RQVROLGDWLRQV´ European Economy No. 3 (2007). Brussels.BBBBB D Sustainability Report. Brussels.BBBBB E ³3XEOLF )LQDQFHV LQ (08²´ European Economy 1R
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  • 154. ±+DXJ $ $ ³RLQWHJUDWLRQ DQG *RYHUQPHQW %RUURZLQJ RQVWUDLQWV (YLGHQFH IRU WKH 8QLWHG 6WDWHV´ Journal of Business and Economic Statistics
  • 155. ±+RULJXFKL The US Economy, Performance and Issues. International Monetary Fund, Washington, DC.Hostland, D., and P. Karam. 2006. Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods. World Bank Policy Research Working Paper WPS3821, World Bank, Washington, DC.+RUQH - ,QGLFDWRUV RI )LVFDO 6XVWDLQDELOLW ,0) :RUNLQJ 3DSHU 1R ,QWHUQDWLRQDO Monetary Fund, Washington, DC.IMF. 2002. Assessing Sustainability. International Monetary Fund, Washington, DC. Available: www. imf.org/external/np/pdr/sus/2002/eng/052802.pdf._____. 2003. World Economic Outlook. International Monetary Fund, Washington, DC.BBBBB D )LVFDO ,PSOLFDWLRQV RI WKH *OREDO (FRQRPLF DQG )LQDQFLDO ULVLV ,0) 2FFDVLRQDO 3DSHU ,QWHUQDWLRQDO 0RQHWDU )XQG :DVKLQJWRQ BBBBB E ³HEW %LDV DQG 2WKHU LVWRUWLRQV ULVLV5HODWHG ,VVXHV LQ 7D[ 3ROLF´ International Monetary Fund, Washington, DC. Available: http://www.imf.org/external/np/pp/ HQJSGI.RSLWV * DQG 6 $ 6PDQVN )LVFDO 5XOHV ,0) 2FFDVLRQDO 3DSHU ,QWHUQDWLRQDO Monetary Fund, Washington, DC.Kumar, M., and T. Ter-Minassian, eds., 2007. Promoting Fiscal Discipline. International Monetary Fund, Washington, DC.0HQGR]D ( * DQG - 2VWU ³,QWHUQDWLRQDO (YLGHQFH RQ )LVFDO 6ROYHQF ,V )LVFDO 3ROLF µ5HVSRQVLEOH¶´ Journal of Monetary Economics ±0HQGR]D ( * DQG 3 0 2YLHGR )LVFDO 3ROLF DQG 0DFURHFRQRPLF 8QFHUWDLQW LQ Developing Countries: The Tale of the Tormented Insurer. NBER Working Paper No. 12586, National Bureau of Economic Research, Cambridge, MA.7UHKDQ % DQG ( :DOVK ³RPPRQ 7UHQGV WKH *RYHUQPHQW %XGJHW RQVWUDLQW DQG 5HYHQXH 6PRRWKLQJ´ Journal of Economic Dynamics and Control 12(2–3):425–44.BBBBB ³7HVWLQJ ,QWHUWHPSRUDO %XGJHW RQVWUDLQWV 7KHRU DQG $SSOLFDWLRQV WR 86 )HGHUDO %XGJHW DQG XUUHQW $FFRXQW H¿FLWV´ Journal of Money, Credit, and Banking 23(2):206–23.:LOFR[ : ³7KH 6XVWDLQDELOLW RI *RYHUQPHQW H¿FLWV ,PSOLFDWLRQV RI 3UHVHQWYDOXH %RUURZLQJ RQVWUDLQW´ Journal of Money, Credit, and Banking
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  • 157. About the PaperCharles Adams, Benno Ferrarini, and Donghyun Park empirically examine the conventionalwisdom that developing Asia has been fiscally responsible in the past. Their evidenceconfirms that the region’s public finances are generally healthy as a result of historicalfiscal discipline. Nevertheless, their forward-looking scenario analysis indicates that failureto withdraw the region’s anticrisis fiscal stimulus in a timely manner may jeopardize fiscalsustainability in the future.About the Asian Development BankADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developingmember countries substantially reduce poverty and improve the quality of life of theirpeople. Despite the region’s many successes, it remains home to two-thirds of the world’spoor: 1.8 billion people who live on less than $2 a day, with 903 million struggling onless than $1.25 a day. ADB is committed to reducing poverty through inclusive economicgrowth, environmentally sustainable growth, and regional integration.Based in Manila, ADB is owned by 67 members, including 48 from the region. Its maininstruments for helping its developing member countries are policy dialogue, loans, equityinvestments, guarantees, grants, and technical assistance.Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org/economicsISSN: 1655-5252Publication Stock No. Printed in the Philippines

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