Budget Crunch SOUTH ASIA ECONOMIC FOCUS FALL 2018 Dr. Robert C. M. Beyer South Asia Office of the Chief Economist 1
Recent economic developments 2
South Asia is consolidating its position as the fastest-growing region. Source: World Bank and staff calculations. 3
Except for Afghanistan, growth rates are relatively strong and stable. Note: (f) = forecast, CY = calendar year, FY = fiscal year. Afghanistan, Maldives and Sri Lanka are in calendar years. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. Source: World Bank. 4
Stock markets are performing relatively well. Source: Haver Analytics. 5
Strong growth, but not driven by exports Source: World Bank and staff calculations. 6
and industrial production is generally lagging aggregate growth. Source: World Bank and staff calculations. 7
Headline inflation is generally close to target Note: Sri Lanka has not yet moved to explicit inflation targeting; the target used is the center point of the Monetary Policy Consultation Clause (MPCC) of 4.7 percent. For Bangladesh inflation is from August 2018. Sources: Inflation target data is from Haver Analytics (National Authorities). Current inflation data is from Trading Economics. Distance to inflation is based on staff calculations. 8
but headline inflation has picked up in the largest countries in the region. Source: World Bank and staff calculations. 9
South Asian currencies are depreciating Source: Haver Analytics and staff calculations. 10
but the growth of exports remains lower than the growth of imports. Note: The figures refer to merchandise exports and imports only. Source: World Bank and staff calculations. 11
Current account deficits are sizeable Note: Quarterly GDP for Bangladesh, Pakistan, Nepal, Afghanistan is derived from annual GDP and assumed to be constant for all four quarters. Sources: Quarterly current account data is from Trading Economics. Quarterly GDP data for India and Sri Lanka is from Haver Analytics. 12
but the level of international reserves is comfortable in most cases. Source: World Bank. 13
Monetary policy is adjusting to rising inflation and external pressure Sources: Haver Analytics and Reuters. 14
but fiscal policy is not being equally responsive. Note: (f) = forecast, CY = calendar year, FY = fiscal year. Afghanistan, Maldives and Sri Lanka are in calendar years. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. Source: World Bank. 15
South Asia economic outlook 16
Growth in South Asia is projected to accelerate slightly... Note: (f) = forecast. Source: World Bank. 17
and changes in growth rate across countries will be minor. Note: (f) = forecast, CY = calendar year, FY = fiscal year. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. The numbers for 2018 are either estimates or forecasts. Source: World Bank. 18
Private consumption will remain the main contributor to growth. Source: World Bank. 19
Budget crunch 20
Tax revenue is generally low... Note: Values are averages from 2000 to 2017 (2016, 2015, or 2014 for some countries). The red line is a linear trend line between tax revenues and the logarithm of the per capita GDP (PPP adjusted). Source: World Bank. 21
and fiscal deficits remain uncomfortably large. Source: IMF and staff calculations. 22
Fiscal deficits increase with adverse economic shocks. Note: The bars show the average fiscal deficit computed from 104 cycles in world GDP growth, world trade, oil prices, countries received remittances, and terms of trade. The cycle is defined as follows: the value of the respective variable is smaller than mean - one standard deviation in trough, the value which precedes is smaller than the respective mean and the value which follows is bigger than the value in the trough period. The figure shows average five-year periods for all South Asian countries. Sources: Federal Reserve Bank of St. Louis, World Bank, and staff calculations. 23
Fiscal deficits increase in times of national elections. Note: The bars show the average fiscal deficit computed from 39 national elections between 1990 and 2015 in Bangladesh, India, Pakistan, and Sri Lanka. Of these, 19 were presidential and 20 were parliamentary elections. Sources: World Bank, National Election Commissions, and staff calculations. 24
Tax revenue responds positively to economic growth... Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations. 25
but so does the level of public expenditures. Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations. 26
Tax buoyancy is around one, but spending is strongly procyclical. Note: Panel regression models with fixed effects are estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Three stars mean significant at the 1 percent level, two starts at the five percent level. Sources: ADB, IMF, World Bank, and staff calculations. 27
The tax multiplier is negative but insignificant Note: Unbalanced panel VAR model with four lags and fixed effects is estimated using the annual data from 1987 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. 28
while the expenditure multiplier is positive and significant. Note: Unbalanced panel VAR model with four lags and fixed effects is estimated using the annual data from 1987 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. 29
The expenditure multiplier is driven by public investment. Note: Both models are balanced panel VAR models with variables current and capital expenditure respectively, instead of the total expenditure. The model with 3 lags is estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. 30
Public debt is reaching high levels in some countries. Source: World Bank. 31
Three fiscal patterns that affect the region s countries differently. Three fiscal patterns in South Asia: 1. Limited room for maneuver a) Low revenue generation b) Inadequate spending 2. Amplification of boom-and-bust cycles 3. A build-up of liabilities 32
Appendix 33
Remittances are holding well or are even increasing. Source: Haver Analytics and staff calculations. 34
International oil prices are increasing again. Sources: Haver Analytics. 35
Emerging markets have become more vulnerable. Note: ARG=Argentina, BR=Brazil, CHN=China, IND=India, MEX=Mexico, TUR=Turkey, ZAF=South Africa. Sources: Haver Analytics, national central banks, World Bank, and staff calculations. 36
Economic shocks abroad increase bond spreads in South Asia Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes only India, Pakistan and Sri Lanka. Source: JP Morgan and staff calculations. 37
lead to considerable capital outflows in India... Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. Source: International Institute of Finance and staff calculations. 38
and to weaker currencies in the region. Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes Bangladesh, India, Pakistan and Sri Lanka. Sources: Bloomberg, Haver Analytics, and staff calculations. 39
Trade forecasts tend to become more pessimistic. Source: World Bank. 40
Proposed and imposed tariffs restrictive trade measures do not target the region. Source: United States Census Bureau, National Bureau of Statistics of China, Peterson Institute of International Economics, and staff calculations. 41
Import demand by advanced economies will remain strong. Note: (f) = forecast. Euro Area values do not include Malta and Cyprus due to data unavailability. Source: OECD. 42
In Afghanistan, the level of aid-dependence is unsustainable in the long run. Source: Islamic Republic of Afghanistan National Statistics and Information Authority. 43
In Bangladesh, the cost of energy is increasing while electricity demand is surging. Source: International Energy Agency. 44
In Bhutan, revenue from hydropower exports is lumpy and creates instability. Note: Vertical line refers to the Tala hydropower plant getting commissioned. Source: Ministry of Finance of Bhutan. 45
In India, competitive federalism requires strong discipline in the states. Source: Reserve Bank of India. 46
In Maldives, service delivery is costly but bringing it down is expensive too. Note: All data is for 2016. Sources: IMF and World Bank, and staff calculations. 47
In Nepal, decentralization may make budget execution even more challenging. Sources: Ministry of Finance of Nepal, Finance General and Comptroller Office, and staff calculations. 48
In Pakistan, a procyclical budget deficit reinforces the boom-and-bust. Note: Grey shaded areas indicate years when the fiscal deficit widens as GDP growth accelerates, or narrows down as GDP growth decelerates. Source: World Bank. 49
In Sri Lanka, population aging will put pressure on public spending. Sources: UN Population Database and World Bank. 50