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Fiscal Sustainability in Developing Asia

Fiscal Sustainability in Developing Asia

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The central objective of this paper is to empirically examine the issue of fiscal sustainability in developing Asia.
The central objective of this paper is to empirically examine the issue of fiscal sustainability in developing Asia.

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ADB Economics Working Paper Series

Fiscal Sustainability in Developing Asia
Charles Adams, Benno Ferrarini, and Donghyun Park No. 205 | June 2010

ADB Economics Working Paper Series No. 205

Fiscal Sustainability in Developing Asia

Charles Adams, Benno Ferrarini, and Donghyun Park June 2010

Charles 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 the excellent assistance of Cynthia Petalcorin and Christian Mina in constructing our database, and the equally excellent editorial support provided by Lagrimas E. Cuevas.

Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org/economics ©2010 by Asian Development Bank June 2010 ISSN 1655-5252 Publication Stock No. The views expressed in this paper are those of the author(s) and do not QHFHVVDULO\ UHÀHFW WKH YLHZV RU SROLFLHV of the Asian Development Bank.

The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly WKRVH IDFLQJ WKH $VLD DQG 3DFL¿F UHJLRQ DV ZHOO DV FRQFHSWXDO DQDO\WLFDO RU methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness. The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The series is maintained by the Economics and Research Department.

Contents
Abstract I. II. III. IV. V. VI. VII. Introduction Conceptual Review of Fiscal Sustainability v 1 4

Fiscal Diagnostics: Evolution of Key Fiscal Indicators across Asia over Time 13 Econometric Tests of Primary Fiscal Balance Response Functions Fiscal Stimulus Scenarios Medium-Term Fiscal Policy Frameworks Concluding Observations 26 30 32 35 38

Selected References

Abstract
7KH FHQWUDO REMHFWLYH RI WKLV SDSHU LV WR HPSLULFDOO\ H[DPLQH WKH LVVXH RI ¿VFDO VXVWDLQDELOLW\ 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 DFURVV VXEUHJLRQV :H WKHQ HVWLPDWH ¿VFDO SROLF\ UHVSRQVH IXQFWLRQV WKDW PHDVXUH WKH DGMXVWPHQW RI WKH SULPDU\ ¿VFDO EDODQFH WR SXEOLF GHEW SRVLWLRQV 2YHUDOO RXU UHVXOWV LQGLFDWH WKDW WKH UHJLRQ¶V SXEOLF ¿QDQFHV DUH LQ JRRG VKDSH DV D UHVXOW RI UHVSRQVLEOH ¿VFDO EHKDYLRU 1HYHUWKHOHVV IDLOXUH WR ZLWKGUDZ WKH UHJLRQ¶V DQWLFULVLV ¿VFDO VWLPXOXV LQ D WLPHO\ PDQQHU PD\ MHRSDUGL]H ¿VFDO VXVWDLQDELOLW\ EROVWHULQJ WKH FDVH IRU VWURQJ PHGLXPWHUP ¿VFDO SROLF\ IUDPHZRUNV

I. Introduction
,Q UHVSRQVH WR WKH SURQRXQFHG LPSDFW RI WKH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV RQ WUDGH DQG JURZWK ZKLFK UHDFKHG LWV FOLPD[ LQ WKH VHFRQG KDOI RI  DQG WKH ¿UVW KDOI RI  GHYHORSLQJ $VLD KHQFHIRUWK $VLD KDV EROGO\ GHFLVLYHO\ DQG TXLFNO\ XQOHDVKHG VL]DEOH ¿VFDO VWLPXOXV SDFNDJHV1 For the most part, those packages have been skewed toward additional spending, in particular on infrastructure investments, rather than tax cuts. While the People’s Republic of China’s (PRC) US$586 or Yuan 4 trillion stimulus is the most KLJKO\ SXEOLFL]HG H[DPSOH RI $VLD¶V QHZIRXQG SHQFKDQW IRU ¿VFDO DFWLYLVP JRYHUQPHQWV across the region have aggressively boosted expenditures and slashed taxes to support JURZWK LQ WKH ZDNH RI WKH JOREDO FULVLV $VLD¶V ¿VFDO DFWLYLVP UHSUHVHQWV DQ XQSUHFHGHQWHG response to an unprecedented crisis. Unprecedented because never before has there EHHQ VXFK D V\VWHPDWLF V\QFKURQL]HG DQG DFURVVWKHERDUG ¿VFDO H[SDQVLRQ HYHQ though the relative magnitude and composition of the stimulus packages varies widely across the region. The regionwide activist countercyclical response was borne out of sheer necessity in a situation in which plunging exports combined with limp private domestic demand to create a gaping vacuum in aggregate demand. There is fairly widespread but unsubstantiated belief that the region’s anticrisis FRXQWHUF\FOLFDO ¿VFDO SROLFLHV KDYH ³ZRUNHG´ DQG KHOSHG WKH UHJLRQ ZHDWKHU WKH FULVLV ,W is 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 exceeded all expectations. What makes the region’s spectacular V-shaped recovery all the more remarkable is that it is taking place against the backdrop of a modest and fragile recovery LQ WKH * 7KH FRPELQDWLRQ RI WZR VWULNLQJ VW\OL]HG IDFWV RI $VLD¶V SRVWFULVLV HFRQRPLF ODQGVFDSH LH XQH[SHFWHGO\ UREXVW UHFRYHU\ DQG UHJLRQZLGH ¿VFDO H[SDQVLRQ KDYH OHG PDQ\ WR DWWULEXWH WKH UHFRYHU\ WR WKH ¿VFDO H[SDQVLRQ DOPRVW E\ GHIDXOW ,W LV WUXH WKDW governments across the region have also pursued monetary expansion, but the impact RI PRQHWDU\ SROLF\ LV OHVV LPPHGLDWH DQG GLUHFW WKDQ WKDW RI ¿VFDO SROLF\ HVSHFLDOO\ JRYHUQPHQW VSHQGLQJ )XUWKHUPRUH LW LV XQFHUWDLQ KRZ ¿UPV DQG FRQVXPHUV UHVSRQG WR ORZHU 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 UHFRYHU\ and there were clearly a number of other contributory factors, including the relatively KHDOWK\ VWDWH RI WKH UHJLRQ¶V ¿QDQFLDO V\VWHPV 1HYHUWKHOHVV WKHUH LV D SRSXODU SHUFHSWLRQ WKDW WKH UHJLRQ¶V ¿VFDO VWLPXOXV PDGH D YLWDO FRQWULEXWLRQ WR WKH UHJLRQ¶V UHFRYHU\
1

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.

2 | ADB Economics Working Paper Series No. 205

5HJDUGOHVV RI WKH DFWXDO FRQWULEXWLRQ RI WKH ¿VFDO VWLPXOXV WR $VLD¶V UHFRYHU\ WKH UHJLRQZLGH XVH RI FRXQWHUF\FOLFDO ¿VFDO SROLFLHV EULQJV WR WKH IRUH WKH LVVXH RI $VLD¶V ¿VFDO sustainability.2 There are both backward and forward looking reasons for why taking stock RI 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 VWLPXOXV SURJUDPV VR TXLFNO\ DQG GHFLVLYHO\ ZDV WKDW LWV SXEOLF ¿QDQFHV ZHUH JHQHUDOO\ LQ JRRG shape when the global crisis erupted. In particular, its strong initial public debt positions UHODWLYH WR LQGXVWULDOL]HG FRXQWULHV DQG PDQ\ RWKHU SDUWV RI WKH ZRUOG PHDQW WKDW WKH UHJLRQ ZDV DEOH WR DIIRUG FRVWO\ ¿VFDO H[SDQVLRQV VHH (XURSHDQ &RPPLVVLRQ D DQG ,0)   7KHUH DUH DOVR D QXPEHU RI DUJXPHQWV IRU ZK\ FRXQWHUF\FOLFDO ¿VFDO SROLF\ ZRUNV EHVW IURP DQ LQLWLDO SRVLWLRQ RI ¿VFDO VWUHQJWK )RU H[DPSOH ¿VFDO H[SDQVLRQ LQ D FRXQWU\ ZLWK D KLJK GHEW OHYHO FRXOG WULJJHU DGYHUVH UHDFWLRQV LQ WKH ¿QDQFLDO PDUNHWV ZKLFK ZRXOG VHULRXVO\ KDUP EXVLQHVV FRQ¿GHQFH 7KHUHIRUH LW LV ZRUWKZKLOH WR WDNH D EDFNZDUG ORRN DW WKH FXUUHQW DQG SDVW VWDWH RI ¿VFDO KHDOWK DQG VXVWDLQDELOLW\ DFURVV $VLD Doing so would give us a better idea of the extent to which the conventional wisdom of D ¿VFDOO\ UHVSRQVLEOH UHJLRQ LV MXVWL¿HG 6XFK DQ DQDO\VLV ZRXOG DOVR DOORZ XV WR LGHQWLI\ differences across subregions and countries. An analysis of how countries have adjusted WKHLU ¿VFDO EDODQFHV LQ UHVSRQVH WR ULVLQJ GHEW OHYHOV LQ WKH SDVW ZLOO SURYLGH IXUWKHU HYLGHQFH RQ WKH ³¿VFDOO\ UHVSRQVLEOH $VLD´ K\SRWKHVLV 7R WKH H[WHQW WKDW ZH ¿QG HPSLULFDO VXSSRUW IRU WKH K\SRWKHVLV ZH ZLOO KDYH JUHDWHU FRQ¿GHQFH WKDW $VLD ZLOO WDNH HIIHFWLYH PHDVXUHV 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 RQH UHJDUGOHVV RI WKH YDOLGLW\ RI WKH SRSXODU EHOLHI WKDW WKH UHJLRQ¶V ¿VFDO VWLPXOXV PDGH D ELJ contribution to its recovery, the stimulus will raise public debt levels and debt servicing costs in the short term, relative to the counterfactual of no stimulus. For another, and PRUH ZRUU\LQJO\ WKHUH LV D ULVN WKDW WKH VL]DEOH GHWHULRUDWLRQ RI WKH ¿VFDO EDODQFH DV D UHVXOW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV ZLOO QRW EH IXOO\ UHYHUVHG HYHQ DIWHU WKH global crisis recedes and normalcy returns. From a broader perspective, the biggest risk LV WKDW WKH UHJLRQ¶V DQWLFULVLV ¿VFDO VWLPXOXV PLJKW WXUQ RXW WR EH D ³JDPH FKDQJHU´ WKDW IXQGDPHQWDOO\ DOWHUV WKH UHJLRQ¶V FRQVHUYDWLYH ¿VFDO SKLORVRSK\ DQG RXWORRN )RU WKH PRVW SDUW WKH UHJLRQ¶V ¿VFDO SROLF\ KDV EHHQ JHDUHG WRZDUG SURYLGLQJ JURZWKFRQGXFLYH public goods such as infrastructure and education within the government’s budget FRQVWUDLQW 7KH JHQHUDO DYHUVLRQ WR ODUJH DQG SHUVLVWHQW EXGJHW GH¿FLWV ZDV URRWHG LQ the 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 EXGJHW GH¿FLWV KDV EHHQ WKH UHJLRQ¶V JHQHUDO UHOXFWDQFH WR SXUVXH FRXQWHUF\FOLFDO ¿VFDO SROLF\ WR VWDELOL]H RXWSXW )RU H[DPSOH DXWRPDWLF ¿VFDO VWDELOL]HUV VXFK DV XQHPSOR\PHQW EHQH¿WV remain 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).

Fiscal Sustainability in Developing Asia | 3

,QWHUQDWLRQDO H[SHULHQFH LQIRUPV XV WKDW SROLWLFDO HFRQRP\ IDFWRUV PDNH LW GLI¿FXOW WR UHYHUVH ¿VFDO H[SDQVLRQ XQGHUWDNHQ GXULQJ EXVLQHVV F\FOH GRZQWXUQV ZKHQ WKH F\FOH moves 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 during a recession even though the economy may have come out of the recession. Similarly, the H[SDQVLRQ RI VRFLDO ZHOIDUH EHQH¿WV GXULQJ GRZQVZLQJV PD\ EH GLI¿FXOW WR UROO EDFN ZKHQ the economy recovers. At a broader level, intuitively, it is politically easier for governments to increase spending and cut taxes during recessions than to cut spending and increase WD[HV GXULQJ ERRPV 7KLV JLYHV FRXQWHUF\FOLFDO ¿VFDO SROLF\ DQ LQKHUHQW VWUXFWXUDO ELDV toward higher public spending and debt over time. From Asia’s viewpoint, the popular SHUFHSWLRQ WKDW ¿VFDO VWLPXOXV SDFNDJHV DUH HIIHFWLYH LQ SURPRWLQJ UHFRYHU\ PD\ OHDG WR ¿VFDO DFWLYLVP LQ JHQHUDO DIWHU QRUPDOF\ UHWXUQV 7KDW LV HYHQ WKRXJK WKH ¿VFDO stimulus packages were an exceptional response to an exceptional crisis, their perceived HIIHFWLYHQHVV PD\ SURYRNH SRSXODU FDOOV IRU FRXQWHUF\FOLFDO ¿VFDO DFWLYLVP GXULQJ QRQFULVLV periods. ,Q DGGLWLRQ WR WKH GLUHFW HIIHFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV DQG D ³JDPHFKDQJLQJ´ VKLIW LQ WKH UHJLRQ¶V ¿VFDO SKLORVRSK\ WKHUH DUH D QXPEHU RI RWKHU VWUXFWXUDO IDFWRUV WKDW LPSO\ D SRWHQWLDOO\ ODUJH LQFUHDVH LQ WKH UHJLRQ¶V GHPDQG IRU ¿VFDO UHVRXUFHV LQ WKH PHGLXP term. One is population aging, a seismic demographic transition fundamentally reshaping $VLD¶V GHPRJUDSKLF SUR¿OH :KLOH WKHUH DUH GLIIHUHQFHV DFURVV VXEUHJLRQV²WKH WUDQVLWLRQ toward older populations is much more advanced in East and Southeast Asia than in 6RXWK $VLD²DOO GHPRJUDSKLF LQGLFDWRUV SRLQW WR D IDVWDJLQJ $VLD %XLOGLQJ XS PDWXUH ZHOOIXQFWLRQLQJ SHQVLRQ V\VWHPV ZLOO UHTXLUH D VXEVWDQWLDO DPRXQW RI ¿VFDO UHVRXUFHV Another structural force is rebalancing the region’s growth toward domestic demand, DQ LVVXH H[SORUHG LQ JUHDW GHWDLO LQ $'% E  7KH LPSDFW RI ¿VFDO SROLF\ RQ WKH UHEDODQFLQJ SURFHVV ZLOO EH GHWHUPLQHG E\ WKH HIIHFWLYHQHVV RI VSHFL¿F PLFURHFRQRPLF ¿VFDO PHDVXUHV VXFK DV VWUHQJWKHQLQJ KHDOWK HGXFDWLRQ SHQVLRQ DQG VRFLDO SURWHFWLRQ Such measures can promote domestic consumption and hence domestic demand by GLOXWLQJ WKH SUHFDXWLRQDU\ PRWLYH IRU VDYLQJ $ VXSSO\VLGH H[DPSOH LV UHPRYLQJ ¿VFDO incentives that favor export production (e.g., manufacturing), over production for the GRPHVWLF PDUNHW HJ VHUYLFHV  ,Q SULQFLSOH VXFK SUREDODQFLQJ ¿VFDO PHDVXUHV QHHG not involve a quantitative expansion of the government and can be achieved by shifting the composition of government expenditures. In practice, given the low-tax, smallJRYHUQPHQW SROLF\ HQYLURQPHQW WKDW FKDUDFWHUL]HV WKH UHJLRQ LW LV OLNHO\ WKDW LPSOHPHQWLQJ such measures will require moderate expansion. 7KHUH DUH DOVR WZR SROLF\UHODWHG UHDVRQV ZK\ $VLD¶V ¿VFDO VXVWDLQDELOLW\ PDWWHUV DQG matters 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 SDFNDJHV 7KHUH LV D GHOLFDWH EDODQFH EHWZHHQ H[LWLQJ ³WRR VRRQ WRR TXLFNO\´ DQG ³WRR ODWH WRR VORZO\´ ZLWK ERWK HQWDLOLQJ VXEVWDQWLDO FRVWV ,Q WKH FDVH RI $VLD WKHUH LV D ULVN WKDW WKH UHJLRQ¶V UHODWLYHO\ KHDOWK\ SXEOLF ¿QDQFHV PD\ OXOO SROLF\PDNHUV LQWR GRZQSOD\LQJ WKH YHU\

4 | ADB Economics Working Paper Series No. 205

UHDO FRVWV RI H[LWLQJ ³WRR ODWH WRR VORZO\´ $W D PLQLPXP RXU H[DPLQDWLRQ RI WKH UHJLRQ¶V ¿VFDO VXVWDLQDELOLW\ ZLOO UHPLQG SROLF\PDNHUV DERXW WKRVH FRVWV DQG HQFRXUDJH WKHP WR factor them in more explicitly into their policymaking calculus. The second policy-related PRWLYH IRU RXU DQDO\VLV LV UHODWHG WR WKH ¿UVW DQG LW LV WR DOHUW WKH UHJLRQ¶V SROLF\PDNHUV WR WKH QHHG IRU VWURQJ PHGLXPWHUP ¿VFDO SROLF\ IUDPHZRUNV WKDW SURPRWH ¿VFDO VXVWDLQDELOLW\ LQ WKH PHGLXP DQG ORQJ UXQ 7KH PHGLXPWHUP LPSDFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV DORQJ ZLWK QHZ ¿VFDO GHPDQGV WKDW DUH H[SHFWHG WR DULVH LQ WKH PHGLXP WHUP make it imperative for regional policymakers to actively explore effective and credible medium-term policy frameworks. Regardless of the exact timing and nature of exit from WKH FXUUHQW ¿VFDO VWLPXOXV VXFK IUDPHZRUNV ZLOO DOVR DVVXDJH WKH SXEOLF¶V FRQFHUQV DERXW WKH WKUHDW WR ORQJWHUP ¿VFDO VXVWDLQDELOLW\ SRVHG E\ WKH VWLPXOXV 7KH UHVW RI RXU SDSHU LV RUJDQL]HG DV IROORZV 6HFWLRQ ,, UHYLHZV WKH FRQFHSWV RI VWDWLF DQG G\QDPLF ¿VFDO VXVWDLQDELOLW\ DQG VRPH DOWHUQDWLYH DSSURDFKHV WR WKHLU DVVHVVPHQW 6HFWLRQ ,,, FRQVLGHUV WKH NH\ GLPHQVLRQV RI WKH SXEOLF ¿QDQFHV DFURVV GHYHORSLQJ $VLD IRFXVLQJ LQ SDUWLFXODU RQ ¿VFDO EDODQFHV JRYHUQPHQW VSHQGLQJ DQG UHYHQXHV DV ZHOO DV levels of public debt. Section IV discusses the results from a number of econometric tests RI ¿VFDO VXVWDLQDELOLW\ EDVHG RQ SDQHO UHJUHVVLRQ WHFKQLTXHV DQG SUHVHQWV HVWLPDWHV RI ¿VFDO SROLF\ UHVSRQVH IXQFWLRQV WR LQYHVWLJDWH WKH UHVSRQVHV RI SULPDU\ ¿VFDO EDODQFHV WR changes in debt ratios. Section V presents three alternative scenarios or stress tests of WKH SRWHQWLDOO\ DGYHUVH LPSOLFDWLRQV IRU ¿VFDO VXVWDLQDELOLW\ LI FRXQWULHV ZHUH WR SRVWSRQH for 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 SOD\ LQ KHOSLQJ $VLD DWWDLQ DQG PDLQWDLQ ¿VFDO VXVWDLQDELOLW\ LQ WKH SRVWFULVLV SHULRG )LQDOO\ 6HFWLRQ 9,, FRQFOXGHV ZLWK DQ RYHUYLHZ RI WKH PDLQ ¿QGLQJV RI RXU SDSHU DORQJ ZLWK WKH SROLF\ LPSOLFDWLRQV RI WKRVH ¿QGLQJV

II. Conceptual Review of Fiscal Sustainability
)LVFDO VXVWDLQDELOLW\ LV WKH VWDWH ZKHUHLQ WKH JRYHUQPHQW EXGJHW FDQ EH VPRRWKO\ ¿QDQFHG without 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, when the condition is not met.4 In some contexts, it is useful to draw an explicit distinction EHWZHHQ VWDWLF ¿VFDO VXVWDLQDELOLW\ ZKHQ WKH EXGJHW FDQ EH ¿QDQFHG VPRRWKO\ SHULRG E\ SHULRG DQG G\QDPLF ¿VFDO VXVWDLQDELOLW\ ZKHQ WKH EXGJHW GRHV QRW OHDG RYHU WLPH
3

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.

Fiscal Sustainability in Developing Asia | 5

to explosive increases in public debt). Loosely, static sustainability refers to the ability of the government to fund its budget on a period-by-period basis (funding liquidity) while G\QDPLF VXVWDLQDELOLW\ LV FRQFHUQHG ZLWK YHU\ ORQJWHUP ¿VFDO VROYHQF\5 Both static DQG G\QDPLF ¿VFDO VXVWDLQDELOLW\ DUH LPSRUWDQW DQG WKUHDWV WR HLWKHU RU ERWK FDQ KDYH LPSOLFDWLRQV IRU PDFURHFRQRPLF DQG ¿QDQFLDO VWDELOLW\6 (YHQ WKRXJK ¿VFDO VXVWDLQDELOLW\ LV JHQHUDOO\ UHJDUGHG DV YHU\ LPSRUWDQW WKHUH LV QR universal agreement about how it should best be assessed. Various approaches to DVVHVVLQJ ¿VFDO VXVWDLQDELOLW\ KDYH EHHQ XVHG DQG LW LV XVHIXO WR FRQVLGHU VRPH RI the 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); and that all government receipts8 are included in revenues (Z). Abstracting from central EDQN ¿QDQFLQJ equation (1) implies that differences between government revenues DQG H[SHQGLWXUHV LQ DQ\ SHULRG WKH EXGJHW VXUSOXV ZLOO EH UHÀHFWHG LQ FKDQJHV LQ WKH outstanding 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 payments RQ SXEOLF GHEW IURP DOO RWKHU JRYHUQPHQW H[SHQGLWXUH DQG GH¿QH 6 DV WKH SULPDU\ RU nondebt-interest-related) budget surplus.11 With R as the one-period nominal interest rate factor,12 HTXDWLRQ  FDQ EH ZULWWHQ DV IROORZV ZKHUH 6 W  WKH SULPDU\ ¿VFDO VXUSOXV LV GH¿QHG DV = W ± * W ZLWK * W GHQRWLQJ SULPDU\ JRYHUQPHQW VSHQGLQJ B(t+1) = R B(t) – S(t) t= 1,2, 3,………..N (2)

5 6

7

8 9

10 11 12

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). 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. 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. These would include tax and nontax revenues and, in the case of governments with asset holdings, the income on those assets. 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. 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. Here, and in what follows, we abstract from any assets held by the government, and we do not distinguish between gross and net debt. That is to say, R is 1 plus the nominal interest rate.

6 | ADB Economics Working Paper Series No. 205

According to equation (2), the dynamics of public debt are linked to the interest rate on SXEOLF GHEW DQG WKH VL]H RI WKH SULPDU\ VXUSOXV 6  ,Q FLUFXPVWDQFHV ZKHQ WKH SULPDU\ EDODQFH LV ]HUR WKH HTXDWLRQ LPSOLHV WKDW WKH SXEOLF GHEW ZLOO JURZ DW WKH QRPLQDO interest rate. Conversely, the growth of the public debt will be less than the nominal interest rate when the primary balance is in surplus. In all cases, the behavior of public GHEW LQ UHODWLRQ WR JURVV GRPHVWLF SURGXFW *'3 ZLOO DOVR EH LQÀXHQFHG E\ ZKHWKHU WKH nominal interest rate is above or below the growth rate of nominal GDP (as discussed below). By solving equation (2) forward over time, the public debt in period t can be written as follows:13
−1 B( t ) = Σ ∞ j = 0 R (t , t + j ) S (t + j ) + lim T →∞

R(t , t + T )−1B(t ,T + 1)

(3)

Here, B (t, T+1) is the terminal or very long-term debt stock and R(t, t+j) is the discount Rt + k . Generally, dynamic Π IDFWRU EHWZHHQ SHULRG W DQG SHULRG W M ZKLFK LV GH¿QHG DV k =0 ¿VFDO VXVWDLQDELOLW\ LV WDNHQ WR UHTXLUH WKDW WKH terminal debt stock (discounted at a SRVLWLYH LQWHUHVW UDWH DSSURDFK ]HUR DV 7 DSSURDFKHV LQ¿QLW\ ZKLFK FDQ EH UHJDUGHG DV UXOLQJ RXW ³3RQ]L0DGRII´ VFKHPHV LQ ZKLFK QHZ GHEW H[SORGHV RU LV UROOHG RYHU LQGH¿QLWHO\14 With this condition imposed, the interpretation of equation (3) is that the ¿VFDO VLWXDWLRQ LV H[ DQWH G\QDPLFDOO\ VXVWDLQDEOH LI WKH SUHVHQW YDOXH RI DOO SULPDU\ surpluses matches the value of the current debt stock. Alternatively, if the current debt VWRFN 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 all government revenues as given by equation (4).
j

∑ R(t, t + j )−1G(t + j ) = ∑ R(t, t + j )−1Z (t + j )
j =0 j =0

(4)

%\ 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 SROLF\EDVHG DVVHVVPHQWV RI ¿VFDO VXVWDLQDELOLW\ LQYDULDEO\ GHDO ZLWK WKH EHKDYLRU RI GHEW RYHU VKRUW to medium-term time periods and are guided, in varying degrees, by the very long-term considerations underpinning the abovementioned terminal condition. Notwithstanding these considerations, however, budget constraint equations such as given by equations  DQG  PDNH FOHDU WKDW WKH ¿VFDO VWLPXOXV LQWURGXFHG GXULQJ WKH JOREDO VORZGRZQ ZLOO need eventually to be paid back through either higher government revenues or lower
13

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).

Fiscal Sustainability in Developing Asia | 7

H[SHQGLWXUHV 7KLV LV D FRQVHTXHQFH RI WKH ³QR IUHH OXQFK´ FRQGLWLRQ LPSOLHG E\ G\QDPLF ¿VFDO VXVWDLQDELOLW\ DQG WKH SRVLWLYH GLVFRXQW IDFWRU 5 XQGHUO\LQJ WKH DQDO\VLV15 7HVWLQJ ZKHWKHU WKH ¿VFDO VXVWDLQDELOLW\ FRQGLWLRQ WKDW WKH H[ DQWH JRYHUQPHQW EXGJHW KROGV RYHU WLPH LV QRW HDV\ WR DSSO\ LQ SUDFWLFH 1RW RQO\ LV WKHUH WKH GLI¿FXOW\ WKDW WKH FRQVWUDLQW KROGV RYHU DQ LQ¿QLWH XQREVHUYDEOH WLPH KRUL]RQ EXW WKHUH DUH DOVR GLI¿FXOWLHV UHODWHG WR WKH IDFW WKDW WKHUH DUH IHZ WKHRUHWLFDO UHVWULFWLRQV RQ WKH YDOXHV of government spending and revenues. With the possible exception of some extreme boundary conditions, such as revenue should not exceed GDP, or that there be a certain minimum level of noninterest-related government spending, there are, in principle, an LQ¿QLWH QXPEHU RI ZD\V 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 GHEW ULVLQJ VKDUSO\ LW ZRXOG EH GLI¿FXOW WR FRQFOXGH WKDW VXVWDLQDELOLW\ ZDV QHFHVVDULO\ YLRODWHG 7KLV LV EHFDXVH WKH JRYHUQPHQW PD\ EH SODQQLQJ WR FXW VSHQGLQJ DQG UXQ ODUJH ¿VFDO surpluses 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 DOZD\V be some future level of government spending and taxes to ensure that conditions such as HTXDWLRQ  DUH VDWLV¿HG Based, inter alia, on these types of considerations, it is therefore frequently argued that ¿VFDO VXVWDLQDELOLW\ DQDO\VLV LV PRUH RI DQ ³DUW´ WKDQ D ³VFLHQFH´ 6XFK DQDO\VLV GHDOV QRW VR PXFK ZLWK ZKDW FRXOG KDSSHQ LQFOXGLQJ ZKHWKHU WKHUH PD\ EH D ¿VFDO FULVLV LQ the event policy is not sustainable),17 as with what will happen based on factors such DV SDVW H[SHULHQFHV ZLWK ¿VFDO DGMXVWPHQW ,Q WKHVH FLUFXPVWDQFHV HVWLPDWHV RI ¿VFDO SROLF\ UHDFWLRQV²ZKLFK PHDVXUH KRZ JRYHUQPHQWV KDYH WUDGLWLRQDOO\ UHVSRQGHG WR ULVLQJ GHEW OHYHOV²FDQ EH LPSRUWDQW WRROV LQ DVVHVVLQJ WKH SURVSHFWV IRU ¿VFDO VXVWDLQDELOLW\ DV discussed below. $VVHVVPHQWV RI ¿VFDO VXVWDLQDELOLW\ KDYH WHQGHG WR DGRSW RQH RU PRUH RI D QXPEHU RI interrelated approaches. For the most part, the assessments have focused on dynamic rather than static sustainability, although there was some discussion of the latter in last year’s Asia Economic Monitor $'% D  7KH Asia Economic Monitor noted that WKHUH 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 WKH
15

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.

8 | ADB Economics Working Paper Series No. 205

circumstances and implications of these failures. If the government is not able to sell (or UROO RYHU LWV SXEOLF GHEW DV D UHVXOW RI ³IDLOHG´ DXFWLRQV VWDWLF ¿VFDO VXVWDLQDELOLW\ ZLOO EH violated. The Asia Economic Monitor, however, did not judge this to be a major issue in the region during the global crisis.18 %URDGO\ WKUHH GLIIHUHQW VHWV RI DSSURDFKHV WR DVVHVVLQJ G\QDPLF ¿VFDO VXVWDLQDELOLW\ FDQ EH LGHQWL¿HG VHH %ODQFKDUG HW DO  &HOXVXQ HW DO   2QH DSSURDFK LQYROYHV time series tests in which the (formal) time series properties of variables such as primary and nonprimary government spending and revenues, interest payments, and public debt VWRFNV 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 application of standard unit root tests. In line with some of the oldest approaches to assessing ¿VFDO VXVWDLQDELOLW\ 'RPDU   WKHVH WHVWV HIIHFWLYHO\ FRQVLGHU ZKHWKHU SXEOLF GHEW or the ratio of public debt to GDP is stationary (in a statistical sense) and exhibits mean reverting tendencies. Effectively, these types of tests involve determining whether the time series for a variable such as the debt stock (or the debt ratio) exhibits the kind of H[SORVLYH EHKDYLRU WKDW PLJKW EH H[SHFWHG LQ WKH HYHQW WKDW ¿VFDO SROLF\ LV XQVXVWDLQDEOH In another time series approach, the literature on asset price bubbles is applied to test whether the time series for debt stocks include a bubble term (or unstable root) such as PLJKW EH IRXQG LQ WKH FDVH RI ¿VFDO SROLF\ EHLQJ XQVXVWDLQDEOH +DPLOWRQ DQG )ODYLQ  +RUQH  &KDON DQG +HPPLQJ   ,Q DGGLWLRQ WKHUH DUH WHVWV RI WKH FRLQWHJUDWLQJ relationships that would be expected to hold among various variables in the event that ¿VFDO SROLF\ LV VXVWDLQDEOH DV JLYHQ LQ HTXDWLRQ   7KHVH WHVWV LQYROYH FRQVLGHULQJ ZKHWKHU FHUWDLQ ¿VFDO YDULDEOHV VXFK DV JRYHUQPHQW VSHQGLQJ DQG WD[HV VKDUH FRPPRQ VWRFKDVWLF WUHQGV FRQVLVWHQW ZLWK WKH G\QDPLF JRYHUQPHQW EXGJHW FRQVWUDLQW DQG ¿VFDO sustainability. By their nature, time series tests are backward looking (in so far as they use historical GDWD DQG RQO\ PHDVXUH LQGLUHFWO\ WKH H[WHQW WR ZKLFK WKH FRQGLWLRQV IRU ¿VFDO VXVWDLQDELOLW\ DUH VDWLV¿HG ([SOLFLWO\ RU LPSOLFLWO\ WKH DSSURDFKHV DOVR DVVXPH WKDW WKH GLVWDQW IXWXUH ZLOO ³ORRN OLNH´ WKH SDVW DQG WKDW SROLFLHV WKDW ZHUH VXVWDLQDEOH LQ WKH SDVW will 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 WKHVH approaches typically require relatively long time series of data that are frequently not DYDLODEOH LQ WKH ¿VFDO DUHD HVSHFLDOO\ DV UHJDUGV SXEOLF GHEW20 Secondly, the power of unit 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 VXVWDLQDEOH DQG ZKHQ LW LV XQVXVWDLQDEOH $QG ¿QDOO\ DV DUJXHG E\ %RKQ  DQG   WKH OLQNV
18

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).

Fiscal Sustainability in Developing Asia | 9

EHWZHHQ WKHVH WHVWV DQG ¿VFDO VXVWDLQDELOLW\ LV QRW QHFHVVDULO\ YHU\ FORVH DQG VRPH EDVLF time series tests do not fully exploit the implications of uncertainty in deriving appropriate WHVWV RI ¿VFDO VXVWDLQDELOLW\21 More fundamentally, a shortcoming of the time series approaches is that they do not H[SOLFLWO\ LGHQWLI\ WKH ¿VFDO SROLF\ UHDFWLRQ IXQFWLRQV WKDW XQGHUOLH WKH GDWD $V D UHVXOW WKH\ GR QRW VKHG PXFK OLJKW RQ WKH NLQGV RI ¿VFDO SROLFLHV WKDW PLJKW GHOLYHU VXVWDLQDELOLW\ or identify why sustainability may not have held in the past. The next two approaches IRFXV GLUHFWO\ RQ ¿VFDO SROLF\ EHKDYLRU DV UHÀHFWHG LQ WKH SULPDU\ ¿VFDO EDODQFH Another set of tests can be referred to primary balance tests as they involve estimating ³GHFLVLRQ UXOHV´ IRU SULPDU\ ¿VFDO EDODQFHV DQG LQ SDUWLFXODU IRU KRZ SULPDU\ EDODQFHV UHVSRQG WR FKDQJHV LQ SXEOLF GHEW DQG RWKHU YDULDEOHV %RKQ  &KDON DQG +HPPLQJ   7KHVH WHVWV DUH DOVR EDFNZDUG ORRNLQJ LQ VR IDU DV WKH\ PRGHO ¿VFDO GHFLVLRQ UXOHV based 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 RI WKH ¿VFDO DGMXVWPHQW HIIRUW LV DGMXVWHG DV SXEOLF GHEW LQFUHDVHV ,QWXLWLYHO\ WKH EDVLV IRU these tests is that a tendency for primary surpluses to increase as public debt increase over time will tend to support (dynamic) sustainability. The approach can be illustrated using the explicit uncertainty framework adopted by %RKQ  DQG %DUWROLQL DQG &RWWDUHOOL  LQ ZKLFK HTXDWLRQ  DERYH LV HIIHFWLYHO\ replaced by equation (5): B(t ) = E ∑ E j u ’(c (t + j )) / u ’(c (t ))S(t + 1) +
j =0 ∞ T →∞

lim Et E T +1u ’(c (t + j + 1)) / U ’(c (t ))B(t + t + 1) (5)

Here E is the (mathematical) expectations operator22 and u’ (c (t + j))/u’ (c(t)) denotes the marginal rate of substitution between consumption (c) in two adjacent time periods. Equation (5) is analogous to equation (3) but applies when uncertainty is explicitly modeled and the (one period) discount factor is replaced by the potentially time-varying marginal rate of substitution in consumption. Using equation (5) the condition for sustainability is that the terminal debt stock discounted by the expected marginal rate of VXEVWLWXWLRQ 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)
j =0 ∞

(6)

,W LV SRVVLEOH IROORZLQJ %RKQ   WR ZULWH WKH UHODWLRQVKLS EHWZHHQ WKH SULPDU\ surplus 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 primary surplus (s) as proportions of GDP, P GHQRWHV WHPSRUDU\ VWDWLRQDU\ LQÀXHQFHV RQ WKH
21

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.

10 | ADB Economics Working Paper Series No. 205

primary balance to GDP ratio,23 and H LV D ZKLWH QRLVH HUURU WHUP 7KH FRHI¿FLHQW U measures the response of the primary balance to changes in the debt ratio while E measures the response of the primary balance to the temporary factors included in P.24 s(t ) = ρ b(t − 1) + βμ (t ) + ε (t )

ε ⋅ (0,σ 2 )

(7)

%RKQ  DUJXHV WKDW D VXI¿FLHQW FRQGLWLRQ25 IRU ¿VFDO SROLF\ WR EH VXVWDLQDEOH²DQG IRU HTXDWLRQ  WR KROG²LV WKDW U be positive in value. And, to avoid explosive increases in public sector assets over time (i.e., situations in which gross debt is unbounded and DSSURDFKHV QHJDWLYH LQ¿QLW\  U should also be less than unity. Based on the estimation of HTXDWLRQV VXFK DV   K\SRWKHVHV DERXW WKH VLJQ DQG VL]H RI U can be tested statistically &KDON DQG +HPPLQJ  %RKQ  ,0)  DQG 0HQGR]D DQG 2VWU\   (TXDWLRQ  LV WKH NH\ HTXDWLRQ IRU DVVHVVLQJ ¿VFDO VXVWDLQDELOLW\ LQ WKLV IUDPHZRUN VLQFH LW GHWHUPLQHV ZKHWKHU WKH SULPDU\ EDODQFH UHVSRQGV LQ D VWDELOL]LQJ PDQQHU WR FKDQJHV in the debt ratio. A value for the response parameter U EHWZHHQ ]HUR DQG XQLW\ LPSOLHV WKDW WKH SULPDU\ VXUSOXV LQFUHDVHV DV WKH GHEW UDWLR ULVHV ZKLFK LV VXI¿FLHQW IRU G\QDPLF sustainability. And the closer U LV WR XQLW\ WKH ODUJHU RU PRUH IRUFHIXO LV WKH ¿VFDO policy response to increases in the debt ratio. Conversely, if U LV ]HUR RU QHJDWLYH WKH implication is that higher debt ratios lead either to no response of the primary surplus; or WR D VPDOOHU SULPDU\ VXUSOXV ,Q VXFK FLUFXPVWDQFHV ¿VFDO SROLF\ PD\ EH XQVXVWDLQDEOH if it leads to explosive public debt ratios.26 Based on this reasoning, (estimated) values of the U FRHI¿FLHQW DORQJ ZLWK WKH UHVSRQVH RI SULPDU\ EDODQFHV WR WHPSRUDU\ VKRFNV DV captured through the P WHUP FDQ EH XVHG WR ³VFRUH´ ¿VFDO SROLF\ UHVSRQVHV )RU H[DPSOH a value of U WKDW LV FORVH WR XQLW\ FDQ EH VFRUHG DV D ³IRUFHIXO´ SROLF\ UHVSRQVH DQG D YDOXH FORVH WR ]HUR DV D ³GDPSHG´ UHVSRQVH 7KH HVWLPDWHG YDOXHV RI E, on the other KDQG PHDVXUH WKH UHVSRQVH RI ¿VFDO SROLF\ WR WHPSRUDU\ IDFWRUV VXFK DV WKH EXVLQHVV cycle (as measured, say, by gaps between actual and potential output); or to temporary VZLQJV LQ SULPDU\ JRYHUQPHQW VSHQGLQJ DV GLVFXVVHG E\ %DUUR   Notwithstanding the role the U FRHI¿FLHQW SOD\V LQ GHWHUPLQLQJ WKH SURVSHFWV IRU G\QDPLF VXVWDLQDELOLW\ LW QHHGV WR EH UHFRJQL]HG WKDW WKH EHKDYLRU RI GHEW UDWLRV RYHU WKH VKRUW WR PHGLXP WHUP KRUL]RQV DOVR GHSHQGV LPSRUWDQWO\ RQ WKH EHKDYLRU RI WKH JDS EHWZHHQ the interest rate on public debt and the growth rate of the economy. In circumstances ZKHUH WKH JURZWK UDWH LV DERYH WKH LQWHUHVW UDWH VKRUWWHUP GHEW WR *'3 VWDELOL]DWLRQ FDQ RFFXU HYHQ ZKHQ WKH SULPDU\ EDODQFH LV LQ GH¿FLW ,Q VXFK FLUFXPVWDQFHV D IDLOXUH RI WKH SULPDU\ EDODQFH WR LQFUHDVH DV GHEW LQFUHDVHV²ZKLFK LV VXI¿FLHQW IRU YHU\ ORQJ
23

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.

Fiscal Sustainability in Developing Asia | 11

VXVWDLQDELOLW\ ZKHQ WKH LQWHUHVW UDWH LV DERYH WKH JURZWK UDWH²ZLOO QRW QHFHVVDU\ SUHFOXGH a stable debt-to-GDP ratio in the near term. As we note below,27 in some subregions and countries, the debt ratio has been stable even in circumstances when the primary balance KDV EHHQ LQ GH¿FLW 2YHU ORQJ WLPH SHULRGV KRZHYHU ¿VFDO VXVWDLQDELOLW\ ZLOO EH VXSSRUWHG by 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 ratio can 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 of the economy (assumed to be positive in the very long run), the term cov (..) represents a covariance term, and a bar is used to denote a long-run value of a variable. This equation determines the expected value of the long-run debt ratio, which depends critically not only on the value of U but also on the gap between the nominal interest rate and the nominal growth rate of the economy. 0RUH JHQHUDOO\ WKH SULPDU\ EDODQFH IUDPHZRUN IRU ¿VFDO VXVWDLQDELOLW\ FDQ EH H[WHQGHG in a number of directions including allowing for nonlinear or lagged relationships between the primary surplus and public debt, or by allowing for the response parameter (U) to vary over time. As regards nonlinearity issues, a particular interesting possibility is that there are threshold effects whereby the response of the primary balance to the debt stock PLJKW 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 that WKH LPSOLFDWLRQV RI ¿VFDO VOLSSDJHV GHSHQG RQ WKH GHEW OHYHOV DW ZKLFK WKH\ RFFXU DQG that 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 used by the International Monetary Fund, World Bank, and Asian Development Bank. These WHVWV DUH EDVHG RQ ³ZKDW LI´ RU ³VWUHVV WHVW´ W\SH PRGHOLQJ HLWKHU ZLWK UHVSHFW WR WKH LPSOLFDWLRQV IRU ¿VFDO VXVWDLQDELOLW\ RI FRQWLQXLQJ ZLWK FXUUHQW ¿VFDO SROLFLHV DV GH¿QHG E\ the primary balance) or of identifying the gap between the primary balance required to SURGXFH ¿VFDO VXVWDLQDELOLW\ DQG WKH FXUUHQW ¿VFDO SROLF\ VHWWLQJV The application of these scenario approaches can be illustrated by noting that the proportional change in the public debt ratio will (approximately) depend on the difference gap between (one plus) the nominal interest rate and (one plus) the growth rate of nominal GDP (I  WRJHWKHU ZLWK WKH SULPDU\ ¿VFDO VXUSOXV DQG WKH GHEW UDWLR 7KLV LV JLYHQ
27 28

See discussion in Section II. 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 ( U<0). 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).

12 | ADB Economics Working Paper Series No. 205

by equation (8) where ' denotes a proportional change and I denotes the difference between the nominal interest rate and the growth rate of nominal GDP. Δb(t ) = I (t ) − s(t ) / b(t ) (8)

8QGHU WKH ¿UVW W\SH RI H[HUFLVH WKH WLPH SDWK IRU WKH GHEW UDWLR LV SURMHFWHG RQ WKH EDVLV of a given set of assumptions about the primary surplus (for example, which is constant in relation to GDP) and the gap between the nominal interest rate and the nominal growth rate (I  ,Q WKH HYHQW WKDW WKLV SURGXFHV DQ ³H[SORVLYH´ LQFUHDVH LQ WKH GHEW UDWLR RYHU D JLYHQ WLPH KRUL]RQ WKH DVVXPHG RU FXUUHQW ¿VFDO SROLF\ VWDQFH ZRXOG EH MXGJHG unsustainable. This is because it might violate the terminal condition on debt and lead to the debt-to-GDP ratio increasing beyond bounds. Conversely, in the second type of exercise, the approach would be to compute the primary surplus required to deliver a given sustainable path for the debt ratio over the medium term (for example, that the debt UDWLR EH FRQVWDQW  $Q\ JDS EHWZHHQ WKLV VXUSOXV WKH GHEWVWDELOL]LQJ VXUSOXV DQG WKH DFWXDO SULPDU\ VXUSOXV ZRXOG WKHQ EH VHHQ DV LPSO\LQJ WKH DPRXQW RI ¿VFDO DGMXVWPHQW UHTXLUHG WR GHOLYHU ¿VFDO VXVWDLQDELOLW\ 7KHVH DSSURDFKHV DUH LOOXVWUDWHG LQ HTXDWLRQ  ZKHUH WKH ¿VFDO JDS Z LV GH¿QHG DV WKH difference 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 LWV current level.30

ω (t ) = [(R(t ) − η (t ))b − s a (t )] 

%RWK WKHVH W\SHV RI VFHQDULR RU VWUHVV WHVWV DUH XVHIXO IRU VKHGGLQJ OLJKW RQ ¿VFDO sustainability. As in the case of the primary-balance approach to sustainability discussed above, the gap between the nominal interest rate and the nominal growth rate of the economy (I) plays a key role. A common assumption is that this gap term will be positive but, as noted in subsequent sections, there are several Asian economies that have grown faster 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 LV that the nominal interest rate exceeds the nominal growth rate of the economy. In the DEVHQFH RI VXFK D FRQGLWLRQ²ZKLFK FRXOG LPSO\ D GHSDUWXUH IURP G\QDPLF HI¿FLHQF\² very long-run terminal conditions on debt may no longer be binding and public debt can become unbounded.31 Accordingly, because a positive interest rate gap is necessary IRU PHDQLQJIXO LQ¿QLWH KRUL]RQ VFHQDULRV LW LV VRPHWLPHV DVVXPHG WR KROG HYHQ RYHU
29

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.

Fiscal Sustainability in Developing Asia | 13

the short to medium run (IMF 2003). Over a few years, however, the possibility that economies may grow more rapidly than the interest rate on public debt must be considered, even if this raises issues about very long-run terminal conditions. Even though the model-based and scenario approaches are different, there are a number of connections between them that can be usefully exploited. Both approaches address WKH OLQN EHWZHHQ WKH ¿VFDO DGMXVWPHQW HIIRUW PHDVXUHG WKURXJK WKH SULPDU\ EDODQFH and the debt ratio. In the primary balance approach, the policy response parameter for the 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 QHFHVVDU\ WR SURGXFH ¿VFDO VXVWDLQDELOLW\ ,Q SULQFLSOH WKH HVWLPDWHG DGMXVWPHQW SDUDPHWHUV IURP the model-based approaches to sustainability can be used to enrich the scenario-based DSSURDFKHV WR ¿VFDO VXVWDLQDELOLW\ DQG DFFRXQW FDQ DOVR EH WDNHQ RI GHEW WLSSLQJ SRLQWV in which the parameter may be different at various debt levels. These are the approaches WDNHQ LQ WKH ¿QDO VHFWLRQ RI WKH SDSHU

III. Fiscal Diagnostics: Evolution of Key Fiscal Indicators across Asia over Time
7KLV 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 the EUHDNGRZQ RI ¿VFDO SRVLWLRQV LQWR SULPDU\ DQG QRQSULPDU\ FRPSRQHQWV WKH UHODWLRQVKLS EHWZHHQ SULPDU\ ¿VFDO EDODQFHV DQG SXEOLF GHEW UDWLRV DQG WKH OLQNV EHWZHHQ DFWXDO DQG GHEW VWDELOL]LQJ SULPDU\ ¿VFDO EDODQFHV ,Q DGGLWLRQ WKH VHFWLRQ UHYLHZV NH\ IHDWXUHV RI FRXQWULHV¶ ¿VFDO SRVLWLRQV LQFOXGLQJ WKH UHODWLRQVKLS EHWZHHQ SXEOLF GHEW UDWLRV DQG YDULRXV PHDVXUHV RI HFRQRPLF VL]H YRODWLOLW\ DQG UHYHQXH UDWLRV 7KH DVVHVVPHQW RI SXEOLF ¿QDQFHV LQ WKH UHJLRQ LV D GDXQWLQJ FKDOOHQJH DQG WKHUH DUH KXJH GLI¿FXOWLHV DVVHPEOLQJ D FRPSUHKHQVLYH VHW RI ¿VFDO DQG SXEOLF GHEW GDWD IRU DOO the developing country members of the ADB. Not only are there familiar problems of occasional missing observations over time and across countries, there are also a number RI VHULRXV VKRUWFRPLQJV DV UHJDUGV WKH DYDLODELOLW\ RI FRQVLVWHQW DQG FRPSUHKHQVLYH ¿VFDO data 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 as SXEOLF GHEW GDWD  PHDQLQJ WKDW ¿VFDO VXVWDLQDELOLW\ DQDO\VLV QHHGV IRU WKH PRVW SDUW WR EH 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 are not generally available for the actual interest rates on public debt and the extent to which debt may be serviced at concessional or market interest rates. Moreover, to the extent
32

Income on (any) public asset is implicitly recorded under government revenue.

14 | ADB Economics Working Paper Series No. 205

WR ZKLFK VRPH FRXQWULHV LVVXH SXEOLF GHEW WR ³FDSWLYH´ ORFDO EX\HUV VXFK DV ORFDO EDQNV pension funds etc.), the true economic costs of servicing that debt may be different from the recorded costs. There is also the problem that countries do not generally report contingent (off-balance VKHHW DQG SURVSHFWLYH ¿VFDO OLDELOLWLHV %DVHG RQ H[SHULHQFH (XURSHDQ &RPPLVVLRQ D $'%   WKHVH DUH RIWHQ WKH NH\ IDFWRUV LQ LQÀXHQFLQJ ¿VFDO VXVWDLQDELOLW\ RYHU 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 WKH ³EHVW FDVH´ LQ VR IDU DV WKH DFFRXQWLQJ IRU FRQWLQJHQW OLDELOLWLHV ZRXOG OLNHO\ OHDG WR WKH possibility of higher rather than lower future debt ratios, and potentially larger threats to ¿VFDO VXVWDLQDELOLW\ At the most fundamental level, there is also the issue of how broadly or narrowly the SXEOLF VHFWRU VKRXOG EH GH¿QHG ,GHDOO\ ¿VFDO VXVWDLQDELOLW\ DQDO\VLV VKRXOG FRYHU DOO DVSHFWV RI SXEOLF VHFWRU RSHUDWLRQV DQG DFWLYLWLHV WKDW KDYH ¿VFDO LPSOLFDWLRQV VXJJHVWLQJ a very broad and comprehensive approach. Such comprehensiveness is probably best DFKLHYHG E\ IRFXVLQJ RQ WKH RYHUDOO SXEOLF VHFWRU²LQFOXGLQJ DOO DFWXDO DQG TXDVL VWDWH RZQHG HQWHUSULVHV DQG JRYHUQPHQWOLQNHG FRPSDQLHV²EXW LW LV IUHTXHQWO\ GLI¿FXOW WR GUDZ WKH OLQH LQ GH¿QLQJ WKH SXEOLF VHFWRU34 and comprehensive data for the entire public VHFWRU LV IUHTXHQWO\ GLI¿FXOW WR REWDLQ $QG HYHQ LQ WKRVH FDVHV ZKHUH LW LV RQO\ IHDVLEOH WR cover the (formal) government sector, there are often issues related to the availability of data for different levels of government (central, state, and local) and its consistency over WLPH 7KHUH DUH QR VLPSOH VROXWLRQV WR WKHVH DQG UHODWHG ³ERXQGDU\´ SUREOHPV LQ GH¿QLQJ WKH SXEOLF VHFWRU $QG IUHTXHQWO\ LW LV QHFHVVDU\ WR EDVH WKH DQDO\VLV 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 SRVLWLRQV and debt (and other variables) for over 30 developing member countries of ADB from WKH HDUO\ V WKURXJK  :KHUH SRVVLEOH GDWD IRU WKH JHQHUDO JRYHUQPHQW ZDV XVHG EXW LQ VHYHUDO LQVWDQFHV FHQWUDO JRYHUQPHQW GDWD KDG WR VXI¿FH ,Q VRPH FDVHV VHULHV KDG EUHDNV RU JDSV DQG YDULRXV DSSURDFKHV ZHUH XVHG WR ³JDS ¿OO´ WKHVH VHULHV Even with these approaches, however, the panel data that was collected is somewhat unbalanced, with the most comprehensive time series coverage generally occurring in the more developed countries in the region.35

33

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.

Fiscal Sustainability in Developing Asia | 15

One key question that arises in presenting (and interpreting) large amounts of country data concerns the way in which the data are aggregated to produce subregional aggregates. Generally, the aggregates in the Asian Development Outlook $'% E are based on gross national income weighting in which large countries implicitly receive a larger weight than small countries. Even though such an approach is appropriate for DJJUHJDWLQJ YDULDEOHV VXFK DV *'3 LW LV QRW FOHDU ZKHWKHU LW VKRXOG EH XVHG IRU ¿VFDO YDULDEOHV ZKHUH WKHUH LV QR PHDQLQJIXO FRQFHSW RI D UHJLRQZLGH ¿VFDO SRVLWLRQ %DVHG RQ WKHVH W\SHV RI FRQVLGHUDWLRQV²DQG DOVR EHFDXVH WKH HPSLULFDO DQDO\VLV LQ WKH QH[W VHFWLRQ LV EDVHG RQ LQGLYLGXDO FRXQWU\ H[SHULHQFH²WKH ¿VFDO DJJUHJDWHV IRU WKH UHJLRQ presented in this section are all unweighted (rather than weighted) averages of data for individual countries and subregions.36 ,Q DGGLWLRQ WR FRQVLGHULQJ ¿VFDO EHKDYLRU LQ GLIIHUHQW FRXQWULHV WKH FURVV VHFWLRQDO GLPHQVLRQ  WKH SDSHU FRQVLGHUV DOVR KRZ ¿VFDO H[SHULHQFH KDV HYROYHG RYHU WLPH WKH WLPH VHULHV GLPHQVLRQ  7R WKLV HQG WKH VHFWLRQ FRQVLGHUV DYHUDJH ¿VFDO GDWD ERWK IRU WKH SHULRG ± DV D ZKROH DQG IRU WKH VXESHULRGV ± SUH$VLDQ ¿QDQFLDO FULVLV  ± $VLDQ ¿QDQFLDO FULVLV  DQG ± SUHJOREDO ¿QDQFLDO FULVLV 37 The reason for these particular decompositions is that the Asian crisis represented D ZDWHUVKHG IRU ¿VFDO SROLF\ IRU PDQ\ FRXQWULHV LQ WKH UHJLRQ DV PDQ\ FRXQWULHV H[SHULHQFHG ODUJH FULVLVUHODWHG ¿VFDO VOLSSDJHV 7KH XQZLQGLQJ RI WKHVH ¿VFDO VOLSSDJHV ZDV D SULPDU\ IRFXV RI PDQ\ FRXQWULHV¶ ¿VFDO SROLFLHV LQ WKH OHDGXS WR WKH JOREDO FULVLV LQ  1HHGOHVV WR VD\ KRZHYHU GLIIHUHQW UHJLRQV LQ $VLD KDYH GLIIHUHG VKDUSO\ ZLWK UHVSHFW WR WKHLU XQGHUO\LQJ RU VWUXFWXUDO ¿VFDO SRVLWLRQV DQG WKHLU HYROXWLRQ RYHU WLPH 7DEOH , DQG DOVR %R[  GLVSOD\ NH\ ¿VFDO LQGLFDWRUV IRU WKH UHJLRQ RYHU WKH WKUHH VXESHULRGV UHIHUUHG WR DERYH DQG IRU ± DV D ZKROH ,Q OLQH ZLWK $'%¶V FODVVL¿FDWLRQ WKH UHJLRQ LV EURNHQ GRZQ LQWR ¿YH VXEUHJLRQV &HQWUDO $VLD (DVW $VLD WKH 3DFL¿F 6RXWKHDVW $VLD DQG 6RXWK $VLD38 %RWK RYHUDOO DQG SULPDU\ ¿VFDO EDODQFHV LQ Table I are measured as the difference between receipts and spending so that a positive VLJQ LPSOLHV D ¿VFDO VXUSOXV ZKLOH D QHJDWLYH VLJQ LPSOLHV D GH¿FLW 6HYHUDO REVHUYDWLRQV FDQ EH PDGH RQ WKH EDVLV RI WKH ¿VFDO LQGLFDWRUV LQ 7DEOH , L )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 Central

36

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.

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¿FLWV :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 

LLL

Table 1: Fiscal Indicators, Ratio to GDP, 1990–2008 (percent )
Subregion Central Asia Period 1 2 3 All periods 1 2 3 All periods 1 2 3 All periods 1 2 3 All periods 1 2 3 All periods Public Debt 35.10 68.70 34.50 38.00 17.30 35.20 32.20 27.00 39.00 36.70 40.20 39.50 48.30 57.60 56.70 53.90 63.60 62.00 65.10 64.20 Primary Surplus −4.70 −3.50 1.00 0.30 −0.80 −3.50 0.90 −0.20 1.90 −0.50 −1.70 −0.40 4.80 −1.00 0.30 1.70 −2.60 −1.90 −2.10 −2.30 Fiscal Surplus −7.00 −5.50 0.20 −0.70 −1.40 −3.70 0.20 −0.80 −0.20 −2.10 −2.40 −1.70 2.40 −2.40 −1.70 −0.40 −6.00 −5.00 −5.10 −5.40 Government Goverment Expenditure Revenue 21.00 14.00 20.20 14.70 25.00 25.20 24.30 23.60 18.20 16.70 23.80 19.00 21.80 22.00 20.70 19.70 38.70 38.50 36.40 34.30 42.70 40.10 40.70 38.90 19.40 21.80 21.40 18.70 20.70 19.10 20.30 20.00 27.50 21.60 24.00 19.10 25.50 20.50 26.10 20.80 Interest Payments 1.30 1.40 0.80 0.90 1.00 1.70 1.00 1.10 2.40 2.20 1.50 1.80 2.80 2.10 2.20 2.40 3.30 3.10 2.90 3.10

East Asia

The Pacific

Southeast Asia

South Asia

40

Fiscal developments in Central Asia during the 1990s were influenced importantly by the international treatment of the debts of the former Soviet Union.

Fiscal Sustainability in Developing Asia | 17

Box 1: Various Fiscal Indicators
Debt/GDP Ratio by Subregions and Periods (mean values, percent)
Central Asia East Asia The Pacific Southeast Asia South Asia Central Asia East Asia The Pacific Southeast Asia South Asia Central Asia East Asia The Pacific Southeast Asia South Asia Central Asia East Asia The Pacific 1990−1997 Southeast Asia South Asia Central Asia East Asia The Pacific Southeast Asia South Asia

Debt/GDP Ratio by Subregions and Periods (median values, percent)

1990−1997

1998−1999

1998−1999

2000−2008

Central Asia East Asia The Pacific 2000−2008 Southeast Asia South Asia

0

20

40

60

80

0

20

40

60

80

Debt/GDP Ratio by Subregions and Years (mean values, percent) 80 80

Debt/GDP Ratio by Subregions and Years (median values, percent)

60

60

40

40

20

20

0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Central Asia East Asia The Pacific Southeast Asia South Asia
Debt/Revenue Ratio by Subregions and Periods (mean values, percent)
Central Asia East Asia 1990−1997 The Pacific Southeast Asia South Asia Central Asia East Asia 1998−1999 The Pacific Southeast Asia South Asia Central Asia East Asia 2000−2008 The Pacific Southeast Asia South Asia 0 100 200 300 400 500

0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Central Asia East Asia The Pacific Southeast Asia South Asia
Debt/Revenue Ratio by Subregions and Periods (median values, percent)
Central Asia East Asia The Pacific Southeast Asia South Asia

1990−1997

1998−1999

Central Asia East Asia The Pacific Southeast Asia South Asia

2000−2008

Central Asia East Asia The Pacific Southeast Asia South Asia 0 100 200 300 400 500

Debt/Revenue Ratio by Subregions and Years (mean values, percent)
600 600

Debt/Revenue Ratio by Subregions and Years (median values, percent)

400

400

200

200

0

0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Central Asia East Asia The Pacific Southeast Asia South Asia

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year Central Asia East Asia The Pacific Southeast Asia South Asia

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 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 SD\PHQWV 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.

(v)

)LJXUH  SURYLGHV DQRWKHU SHUVSHFWLYH RQ ¿VFDO SRVLWLRQV LQ WKH UHJLRQ 7KH FKDUW GLVSOD\V DYHUDJH RYHUDOO ¿VFDO EDODQFHV DQG GHEW ERWK DV D UDWLR WR *'3 DFURVV HDFK RI WKH ¿YH VXEUHJLRQV RYHU WKH HQWLUH WLPH SHULRG ± ,Q SULQFLSOH WKH REVHUYHG UHODWLRQVKLS EHWZHHQ WKH RYHUDOO ¿VFDO EDODQFH DQG WKH GHEW UDWLR DFURVV WKH subregions could be either positive or negative. The relationship would be negative if WKH VXEUHJLRQV ZLWK KLJK SXEOLF GHEW UDWLRV ZHUH UXQQLQJ VPDOOHU ¿VFDO VXUSOXVHV RYHU the 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 RI WKH UHODWLRQVKLS EHWZHHQ ¿VFDO EDODQFHV DQG GHEW SURYLGHV LQIRUPDWLRQ DERXW ZKHWKHU ¿VFDO DGMXVWPHQW DFURVV WKH VXEUHJLRQV LV FRQVLVWHQW ZLWK VWDELOL]LQJ UHVSRQVHV RI ¿VFDO balances to debt.41 Figure 1: Fiscal Balances and Debt (1990–2008 averages)
0
sea eaa cea paa

Fiscal Surplus (% GDP)

−2

Linear regression line (excluding South Asia)

−4

soa

−6 30 40 50 Debt (% GDP)
41

60

70

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.

Fiscal Sustainability in Developing Asia | 19

Inspection 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 7KLV implies that, over the entire period, most subregions with higher public debt ratios WHQGHG WR UXQ ODUJHU ¿VFDO VXUSOXVHV RU VPDOOHU ¿VFDO GH¿FLWV &RQYHUVHO\ LQ 6RXWK $VLD in 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 DGMXVWPHQW being under way. The time snapshots for the subregions included in the following charts )LJXUH  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 WKH WKUHH VXESHULRGV UHÀHFW WKH IDFW WKDW SHULRGV VXFK DV ± ZHUH SHULRGV ZKHQ GHEW increased sharply during the Asian crisis. On the other hand, periods such as after 2000 KDYH EHHQ SHULRGV RI ¿VFDO DGMXVWPHQW HVSHFLDOO\ LQ (DVW DQG 6RXWKHDVW $VLD Figure 2: Fiscal Balances and Debt (averages by periods and subregions)
2 0
eaa eaacea paa paa eaa soa soa cea soa cea sea paa sea sea

Fiscal Surplus (% GDP)

−2 −4 −6 −8 20 30 1990-1997

40 Debt (% GDP) 1998-1999

50

60 2000-2008

70

$QRWKHU SHUVSHFWLYH RQ WKH QH[XV EHWZHHQ ¿VFDO SROLF\ DQG SXEOLF GHEW LV SURYLGHG E\ considering the behavior of primary balances across subregions and over time. Figures  DQG  GLVSOD\ WKH UHODWLRQVKLS EHWZHHQ WKH SULPDU\ ¿VFDO VXUSOXV DQG SXEOLF GHEW ERWK DV D SHUFHQWDJH RI *'3 IRU WKH ¿YH VXEUHJLRQV RI GHYHORSLQJ $VLD RYHU WKH HQWLUH ± 2008 time period. The behavior over the three subperiods is displayed in Figure 4.

20 | ADB Economics Working Paper Series No. 205

Figure 3: Primary Fiscal Balances and Debt (1990–2008 averages)
1
sea cea

Primary Fiscal Surplus (% GDP)

0
eaa paa

Linear regression line (excluding South Asia)

−1

−2
soa

30

40

50 Debt (% GDP)

60

70

Figure 4: Primary Fiscal Balances and Debt (averages by periods and subregions)
4 Primary Fiscal Surplus (% GDP)
sea

2
cea eaa

paa

0
eaa

paa paa

sea sea soa soa soa cea

−2
eaa

−4
cea

20

30 1990-1997

40 Debt (% GDP) 1998-1999

50

60 2000-2008

70

In interpreting the two charts, it is useful to note that a positive relationship between SULPDU\ VXUSOXVHV DQG GHEW LPSOLHV WKDW ¿VFDO SROLF\ KDV EHHQ VXSSRUWLQJ VXVWDLQDELOLW\ This is because a positive relationship can be interpreted as implying that the primary VXUSOXV LQFUHDVHV RU WKH SULPDU\ GH¿FLW LV UHGXFHG DV WKH GHEW UDWLR LQFUHDVHV Conversely, a negative (or no) relationship between these variables may not be consistent ZLWK ¿VFDO VXVWDLQDELOLW\ RYHU YHU\ ORQJ WLPH SHULRGV42 As shown in Figures 3 and 4, there is a relatively strong positive relationship between primary surpluses and debt across the region when South Asia is excluded. This conforms to the pattern for the regions GLVFXVVHG DERYH ZLWK UHJDUG WR WKH UHODWLRQVKLS EHWZHHQ WKH RYHUDOO ¿VFDO EDODQFHV and debt. As evident from Figure 4, this pattern holds for the most part across the three
42

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.

Fiscal Sustainability in Developing Asia | 21

VXESHULRGV VLQFH  RQFH DOORZDQFH LV PDGH IRU WKH $VLDQ FULVLVUHODWHG EORZRXW RI ¿VFDO SRVLWLRQV LQ WKH ODWH V 7KH UHODWLRQVKLS EHWZHHQ DFWXDO DQG GHEWVWDELOL]LQJ SULPDU\ EDODQFHV DV GLVSOD\HG LQ Figure 5,43 SURYLGHV DQRWKHU SHUVSHFWLYH RQ ¿VFDO VXVWDLQDELOLW\ 6LQFH ¿VFDO VXVWDLQDELOLW\ needs to be evaluated at the country (rather than subregional) level, the chart refers to SDUWLFXODU FRXQWULHV IURP WKH ¿YH VXEUHJLRQV DQG LGHQWL¿HV WKH ORFDWLRQ RI WKH DYHUDJH IRU HDFK VXEUHJLRQ 7KH YHUWLFDO D[LV RI WKH FKDUW PHDVXUHV WKH SULPDU\ ¿VFDO EDODQFHV UHTXLUHG WR VWDELOL]H GHEW UDWLRV EDVHG RQ DYHUDJH QRPLQDO *'3 JURZWK DQG LQWHUHVW UDWHV over the period 2000 through 2008 for each of the displayed countries.44 7KH KRUL]RQWDO axis displays the average primary balance over the same period with a positive number LPSO\LQJ D SULPDU\ VXUSOXV DQG D QHJDWLYH LPSO\LQJ D SULPDU\ GH¿FLW $FFRUGLQJO\ WKH REVHUYDWLRQ IRU HDFK FRXQWU\ LV D SDLU RI DFWXDO DQG GHEWVWDELOL]LQJ SULPDU\ EDODQFHV DQG WKH FKDUW LV GLYLGHG LQWR WZR ]RQHV ,Q WKH WRS FKDUW SRLQWV DERYH WKH GHJUHH OLQH GHQRWH SRLQWV ZKHUH WKH GHEW VWDELOL]LQJ SULPDU\ VXUSOXV LV DERYH WKH DFWXDO SULPDU\ surplus and the debt ratio is increasing. Points below the 45-degree line denote situations ZKHQ WKH DFWXDO SULPDU\ VXUSOXV LV ODUJHU WKDQ WKH GHEWVWDELOL]LQJ VXUSOXV DQG WKH GHEW ratio is on average decreasing.45 Conversely, points along the 45-degree line denote HTXDOLW\ EHWZHHQ WKH DFWXDO DQG GHEWVWDELOL]LQJ SULPDU\ EDODQFHV DQG VWDELOLW\ LQ WKH GHEW to-GDP ratio.

43

The calculation of debt-stabilizing primary balances was discussed in the preceding section. Note that debtstabilizing 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.

22 | ADB Economics Working Paper Series No. 205

Figure 5: Actual and Debt-Stabilizing Primary Balances
15 10 5 0 −5 −10 Stabilizing Balance (% GDP) −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. P S E A P A P P C P A P E S E C C A S S S A C A S A C S C P C

Bold letters represent subregional averages

1.5
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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 most FRXQWULHV LQ WKH UHJLRQ IDOO ZHOO ZLWKLQ WKH ]RQH RI VXVWDLQDELOLW\ HYHQ WKRXJK D QXPEHU are close to the 45-degree line. Most notably, several countries in the region have on average been running primary surpluses between 0–5% of GDP, with a small number running even larger surpluses. Findings of this kind are consistent with those of several RWKHU VWXGLHV RI ¿VFDO VXVWDLQDELOLW\ ZLWKLQ WKH UHJLRQ DQG WKRVH RI EURDGHU VWXGLHV WKDW KDYH DVVHVVHG ¿VFDO VXVWDLQDELOLW\ DFURVV D QXPEHU RI UHJLRQV +RUQH  ,0)  0HQGR]D DQG 2VWU\   (YHQ WKRXJK WKHVH UHVXOWV DUH HQFRXUDJLQJ WKH\ VKRXOG QRW EH VHHQ DV JURXQGV IRU FRPSODFHQF\ 1RW RQO\ LV LW QHFHVVDU\ WR UHFRJQL]H WKH VOLSSDJHV LQ ¿VFDO SROLF\ WKDW KDYH RFFXUUHG GXULQJ WKH JOREDO FULVLV D FORVH LQVSHFWLRQ RI )LJXUH

Fiscal Sustainability in Developing Asia | 23 

UHYHDOV WKDW WKH GHEWVWDELOL]LQJ SULPDU\ VXUSOXVHV IRU VHYHUDO FRXQWULHV LQ WKH UHJLRQ KDYH LQ WKH SDVW EHHQ QHJDWLYH LH SULPDU\ GH¿FLWV  7KLV UHÀHFWV WKH IDFW WKDW HFRQRPLF conditions in several countries have been such that the interest rate on debt has been below 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 KDYH in some cases been larger than 5% of GDP.46 Either because this condition is unlikely WR KROG LQGH¿QLWHO\ RU RQ DFFRXQW RI WKH SRVVLELOLW\ WKDW WKH DFWXDO LQWHUHVW UDWH PD\ QRW UHÀHFW WKH WUXH VKDGRZ SULFH RI GHEW WKH UHVXOWV QHHG WR EH WUHDWHG ZLWK FDUH 8OWLPDWHO\ UREXVW GHEWVWDELOL]LQJ ¿VFDO SROLFLHV QHHG WR EH VXFK DV WR VWDELOL]H WKH GHEW UDWLR LQ circumstances when the interest rate is above the growth rate. $JDLQVW WKLV EDFNJURXQG LW LV DOVR XVHIXO WR FRQVLGHU WKH SRVVLEOH LPSOLFDWLRQV IRU ¿VFDO sustainability of interest rates exceeding the growth rate of nominal GDP. Typically, interest rates on the external public debt of many countries exceed the nominal growth rate so that these rates can, in principle, be used in place of (relatively) low domestic interest rates. Unfortunately, however, it is not possible to obtain such data for many of the countries included in Figure 5. Purely for illustrative purposes, the approach taken LQ WKH ORZHU SDUW RI )LJXUH  ZDV WR UHGR WKH GHEW VWDELOL]LQJ FDOFXODWLRQV XQGHU WKH DVVXPSWLRQ WKDW WKH ³XQGHUO\LQJ´ JDS EHWZHHQ WKH QRPLQDO LQWHUHVW UDWH DQG WKH JURZWK rate of nominal GDP for all regions was equal to 150 basis points.47 As can be seen from the chart, this positive interest rate gap has the effect of reducing the number of FRXQWULHV ZLWK ¿VFDO SRVLWLRQV WKDW DUH XQDPELJXRXVO\ VXVWDLQDEOH DQG SXVKLQJ VRPH LQWR the unsustainable quadrant. The reason for this is straightforward: A positive interest rate JDS LPSOLHV WKDW DOO FRXQWULHV DUH UHTXLUHG WR UXQ SULPDU\ VXUSOXVHV WR VWDELOL]H RU EULQJ GRZQ WKH GHEW UDWLR 7R WKH H[WHQW WKDW ¿VFDO VXVWDLQDELOLW\ LQ VRPH FRXQWULHV GHSHQGV RQ D IDYRUDEOH²EXW XQOLNHO\ WR SHUVLVW²DELOLW\ WR ¿QDQFH GHEW DW LQWHUHVW UDWHV EHORZ the growth rate, the results in this lower chart may give a more realistic long-term sense RI ¿VFDO VXVWDLQDELOLW\ $W WKH OHDVW WKH FKDUW LQGLFDWHV WKDW ¿VFDO VXVWDLQDELOLW\ LQ VRPH countries in the past has been facilitated by very favorable growth and interest rate conditions. Were these conditions to be less favorable in the future, the maintenance of ¿VFDO VXVWDLQDELOLW\ ZRXOG EH PRUH FKDOOHQJLQJ 7KH ODVW IHZ FKDUWV DQG WDEOHV SURYLGH NH\ VWUXFWXUDO LQIRUPDWLRQ IRU WKH ¿VFDO VLWXDWLRQ LQ WKH UHJLRQ IRU ± 7KH ¿UVW WZR FKDUWV )LJXUHV  DQG  VXPPDUL]H WKH relationship between public debt and GDP in both absolute and per capita terms across the 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, albeit
46

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.

24 | ADB Economics Working Paper Series No. 205

with both Singapore and Hong Kong, China being outliers.48 Effectively, rich countries in the region do not have higher public debt ratios than poorer countries. Within the region, there is some indication that the highest public debt ratios are among the poorer countries, but the relationship is relatively weak. Figure 6: Public Debt and GDP
8
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Note: 1990-2008 averages in log scale. Specific country averages depend on data availability.

Figure 7: Public Debt and Per Capita GDP
4
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−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 WR GDP, with the assumption that the level of GDP provides a useful measure of capacity to service the debt. In practice, however, GDP may not be a very good measure of ³FDSDFLW\´ LQ VR IDU DV LW GRHV QRW PHDVXUH WKH UHVRXUFHV DYDLODEOH WR WKH JRYHUQPHQW IRU debt service. Under quite general conditions, the debt-to-revenue ratio might be a more relevant measure of capacity in so far as it measures how much of GDP the government
48

In the case of Singapore, the high public debt ratio is matched by an even larger stock of government assets.

Fiscal Sustainability in Developing Asia | 25

has at its command to meet debt service payments. To this end, Figure 8 displays the relationship between conventional debt ratios (as a share of GDP) and ratios to revenue LQ WKH UHJLRQ RYHU WKH SHULRG ± Figure 8: Public Debt and Revenue Ratios
Total Government Revenue/GDP Ratio (log) 4.0
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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-toGDP 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 relationship between revenue and debt ratios across countries in the region. Countries with high debt ratios do not generally have high revenue ratios or vice versa. On the other hand, and less positively, there is no indication that countries with higher debt ratios have higher revenue ratios and hence greater debt service capacity. )LQDOO\ WKH ODVW WZR FKDUWV )LJXUHV  DQG  GLVSOD\ WKH UHODWLRQVKLS EHWZHHQ SXEOLF debt ratios and uncertainty as measured either by the variability of (nominal) economic growth or the variability of interest rates. From a macro prudential perspective, the ¿VFDO SRVLWLRQV RI FRXQWULHV ZLWK KLJK DQG XQFRUUHODWHG YDULDELOLW\ LQ WKHVH YDULDEOHV would tend to be more vulnerable to macroeconomic shocks than other countries. In particular, shocks that reduced output growth and raised interest rates would be the most worrisome, as they could widen the interest rate gap that is an important factor LQ GHWHUPLQLQJ WKH SULPDU\ ¿VFDO VXUSOXV UHTXLUHG IRU VXVWDLQDELOLW\ DV GLVFXVVHG HDUOLHU Based on the two charts, however, it appears that subregions with the highest debt ratios tend also to be those with the lowest variability as measured by the standard deviation of growth 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).

26 | ADB Economics Working Paper Series No. 205

Figure 9: Public Debt and Macroeconomic Uncertainty, 1990–2008
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Figure 10: Public Debt and Financial Uncertainty
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IV. Econometric Tests of Primary Fiscal Balance Response Functions
7KLV VHFWLRQ SUHVHQWV WKH PDLQ UHVXOWV IURP SDQHOUHJUHVVLRQ HVWLPDWHV RI WKH ¿VFDO SROLF\ response functions discussed in Section II (equation 7). Most of the estimations are EDVHG RQ WKH DSSOLFDWLRQ RI IHDVLEOH JHQHUDOL]HG OHDVW VTXDUHV )*/6 WR DQ XQEDODQFHG50 SDQHO RI WLPH VHULHV DQG FRXQWU\ GDWD RYHU WKH SHULRG  WKURXJK  DQG YDULRXV VXESHULRGV ZLWK DOORZDQFH IRU ³¿[HG HIIHFWV´ DOWKRXJK DQ DOWHUQDWLYH 6\VWHP *HQHUDO
50

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).

Fiscal Sustainability in Developing Asia | 27

Method of Moments (SGMM) approach was also tried. Allowance was made in the HVWLPDWLRQV IRU FRXQWU\VSHFL¿F DXWRFRUUHODWLRQ DQG KHWHURVNHGDVWLFLW\ IRU WKH UHVSRQVHV RI SULPDU\ ¿VFDO EDODQFHV WR GHEW UDWLRV WR EH QRQOLQHDU DQGRU YDU\ ZLWK GHEW OHYHOV IRU the presence of lagged adjustment; and for the interaction between country dummies and debt. In all the estimated equations, the dependent variable is the primary surplus DV D VKDUH RI *'3 ZKLOH WKH LQGHSHQGHQW YDULDEOHV DFURVV WKH GLIIHUHQW VSHFL¿FDWLRQV included 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 included WR FDSWXUH WHPSRUDU\ LQÀXHQFHV RQ ¿VFDO SROLF\ ,Q VRPH VSHFL¿FDWLRQV WKHUH DUH UHJLRQDO RU FRXQWU\ GXPP\ WHUPV 7KH NH\ FRHI¿FLHQW LQ WKH HTXDWLRQV U) is the one attached to the debt term, which measures the response of the primary balance to debt. As GLVFXVVHG LQ 6HFWLRQ ,, D YDOXH RI WKLV FRHI¿FLHQW EHWZHHQ ]HUR DQG XQLW\ LV FRQVLVWHQW ZLWK D VWDELOL]LQJ RU VXVWDLQDEOH ¿VFDO SROLF\ UHVSRQVH WR ULVLQJ GHEW $ QHJDWLYH FRHI¿FLHQW LPSOLHV SRWHQWLDOO\ GHVWDELOL]LQJ UHVSRQVHV Given serious data limitations and the considerable heterogeneity within the region, the presented 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 OLQHDU decision rules in several countries and regions, and some of the equations may not be stable over time. Moreover, several important endogeneity issues52 in the data may not be fully resolved and their resolution could affect the parameter estimates. Be that DV LW PD\ WKH HVWLPDWHG UHVXOWV VXJJHVW WKDW SULPDU\ ¿VFDO EDODQFHV LQ VRPH FRXQWULHV DQG UHJLRQV GR UHVSRQG LQ D VWDELOL]LQJ PDQQHU WR LQFUHDVHV LQ GHEW UDWLRV LH ¿VFDO surpluses are increased in response to rising debt ratios). At the same time, primary balance responds in a relatively systematic way to the business cycle, as proxied by output 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 GHEW WKH VSHFL¿FDWLRQ RI WKH FRQWURO YDULDEOHV LQ WKH HTXDWLRQV WLPH WUHQGV DQG LQWHUDFWLRQ effects, and assumed properties of the error terms.

51 52

Measured as the deviation of output from trend as measured by a Hodrick Prescott filter. These are related to factors such as common shocks to primary surpluses and the control variables.

28 | ADB Economics Working Paper Series No. 205

Table 2: Econometric Estimation Results, 1990-2008
Regressant: Primary surplus L.debt L.debt^2 GDP Gap GEXP Gap Time trend Constant /1 /2 /3 /4 (1) FGLS (linear) 0.0578*** All Countries (2) OLS FE (linear) 0.12445*** (3) SGMM (linear) 0.1279 0.1733* −0.1575*** −0.1154 (4) FGLS (quadratic) 0.1651*** −0.0009*** 0.1096*** −0.1421*** 2.3646*** 384 33 51.2582 417 33 378.23 (5) FGLS (linear) .04973*** Selected Countries (6) OLS FE (linear) 0.06253*** (7) SGMM (linear) 0.0733*** (8) FGLS (quadratic) −0.0637* 0.0011*** 0.08147*** −0.1614*** 1.9863

0.0987*** 0.1503 −0.1333*** −0.1263*** −0.4666*** −6.2689*** 417 33 441.37 384 33 1.712 1.817

.08141*** 0.05428* 0.1408*** −0.1648*** −0.16143*** −0.1843*** −0.1520** 0.4789 −2.5824*** 126 7 468.5228 119 7 0.4145 0.5666 119 7 298.2808

No. obs. No. countries Wald Chi2 DW Statistic LBI Statistic AB AR1 AB AR2

126 7 453.26

−1.0505 −.97226

−.50461 −.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 twoyear 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 consistent with an average response of the primary balance to current and lagged debt ratios WKDW OLHV EHWZHHQ  DQG  DOWKRXJK WKH FRHI¿FLHQW LQ VRPH VSHFL¿FDWLRQV LV LQVLJQL¿FDQW VWDWLVWLFDOO\ 7KHVH HVWLPDWHV DUH EURDGO\ LQ OLQH ZLWK D QXPEHU RI RWKHU VWXGLHV ,0)   ,Q QR FDVHV DUH SULPDU\ ¿VFDO EDODQFHV IRXQG WR UHVSRQG SHUYHUVHO\ WR ULVLQJ GHEW LQ WKH VHQVH RI D VWDWLVWLFDOO\ VLJQL¿FDQW QHJDWLYH FRHI¿FLHQW EHLQJ DWWDFKHG to the debt ratio variable. Finally, the last few columns of Table 2 present the results for a 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 ZHUH taken to allow for such effects: In the spline approach (not reported in Table 2), debt was divided into above or below median debt ranges, and the estimates sought to determine whether the response of the primary balance differed across the ranges. In the nonlinear equation approach, allowance was made for the possibility that the response of the

Fiscal Sustainability in Developing Asia | 29

primary balance to debt was described by a simple quadratic function rather than a linear UHVSRQVH IXQFWLRQ 2YHUDOO WKH UHVXOWV VXJJHVWHG VRPH HYLGHQFH RI ³GLIIHUHQWLDO´ HIIHFWV whereby the primary balance function either has a u shape (implying that the adjustment SDUDPHWHU ¿UVW IDOOV DQG WKHQ ULVHV RU DQ Q VKDSH LPSO\LQJ WKDW WKH DGMXVWPHQW SDUDPHWHU ¿UVW ULVHV DQG WKHQ IDOOV  7KH ¿QGLQJ RI D ³XVKDSHG´ ¿VFDO UHVSRQVH IXQFWLRQV GLIIHUV IURP VRPH RWKHU VWXGLHV 0HQGR]D DQG 2VWU\  ,0)  ZKLFK ¿QG QVKDSHG HIIHFWV DQG LV SRWHQWLDOO\ TXLWH VLJQL¿FDQW LQ HFRQRPLF WHUPV VHH )LJXUHV  DQG   8QGHU D XVKDSHG IXQFWLRQ WKH ¿VFDO DGMXVWPHQW HIIRUW ¿UVW PRGHUDWHV DV GHEW UDWLRV LQFUHDVH EXW WKHQ VWUHQJWKHQV when 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 display DGMXVWPHQW ³IDWLJXH´ RU DQ ³QVKDSHG´ HIIHFW LQ ZKLFK WKH ¿VFDO SROLF\ UHVSRQVHV WHQG WR weaken 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-shaped case, the turning point is found to lie above the median debt ratio. Figure 11: An n-Shaped Primary Balance Response Function
10 Primary 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 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

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. 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 HIIRUW

(iii)

Figure 12: A u-Shapred Primary Balance Response Function
10 Primary Fiscal Slurplus (% GDP)

8

6

4 Sample median 0 28.8 39.8 120

2

Debt (% GDP) Note: FGLS regression on the small sample of seven countries. Debt lagged 1 year.

V. Fiscal Stimulus Scenarios
7KLV VHFWLRQ GLVFXVVHV WKH LPSOLFDWLRQ IRU GHEW VXVWDLQDELOLW\ RI WKH UHFHQW ¿VFDO VWLPXOXV SDFNDJHV DGRSWHG LQ WKH UHJLRQ 7KUHH EURDG ³ZKDW LI´ RU VWUHVV W\SH VFHQDULRV DUH developed and applied to a selected group of countries for whom detailed projection data DUH 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 forecasts for nominal GDP in the Asian Development Outlook $'% E DQG WKH WHFKQLFDO assumption that interest rates will rise gradually from their current relatively low levels in WKH FRQWH[W RI PRQHWDU\ SROLF\ QRUPDOL]DWLRQ 7KH VHFRQG DQG WKLUG VFHQDULRV DUH EDVHG RQ 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 WKLV scenario relevant to the heterogeneity in the region, the upper and lower bounds for the  FRQ¿GHQFH LQWHUYDOV V IRU WKH DYHUDJH YDOXH RI WKH UHVSRQVH RI ¿VFDO SROLF\ WR GHEW ratios 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 ¿VFDO adjustment.
53

For simplicity, the control variables in these equations are held constant.

Fiscal Sustainability in Developing Asia | 31

Figure 13: Fiscal Stimulus Unwinding Scenarios
Central Asia 70 60 Debt (% GDP) 50 40 30 20 2008 2009 2010 2011 2012 2013 2014 2015 Year Southeast Asia 70 60 Debt (% GDP) 50 40 30 20 2008 2009 2010 2011 2012 2013 2014 2015 Year Asia7 70 60 Debt (% GDP) Scenario II: Modest adjustment of the primary balance (rho=0.04) 50 40 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. Scenario II: Forceful adjustment of the primary balance (rho=0.08) Scenario I: Fiscal stimuli constant at 2009/10 level Debt (% GDP) 70 60 50 40 30 20 2008 2009 2010 2011 2012 2013 Year Debt (% GDP) 70 60 50 40 30 20 2008 2009 2010 2011 2012 2013 2014 2015 Year South Asia East Asia

32 | ADB Economics Working Paper Series No. 205

7KH EDVHOLQHV IRU ERWK VFHQDULRV LQFRUSRUDWH HVWLPDWHV RI WKH ¿VFDO EDODQFHV IRU WKH VHOHFWHG JURXS RI FRXQWULHV LQ  DQG  GUDZLQJ RQ DQQRXQFHG ¿VFDO VWLPXOXV programs and budgetary data.54 As indicated in the Fiscal Unwinding Scenarios included LQ )LJXUH  D IDLOXUH WR XQZLQG ¿VFDO VWLPXOXV DIWHU  ZRXOG JHQHUDOO\ OHDG WR public-debt ratios remaining high and, in some instances, rising sharply above current high levels. The key exception to this pattern is South Asia where rapid GDP growth in relation to interest rates contributes to a steady decline in the debt ratio over the SURMHFWLRQ SHULRG *HQHUDOO\ WKHUHIRUH GHOD\LQJ WKH UHPRYDO RI ¿VFDO VWLPXOXV EH\RQG 2010 does not present a desirable approach, especially in the case of countries with ERUGHUOLQH ¿VFDO VXVWDLQDELOLW\ WKDW FDQQRW HDVLO\ ³DIIRUG´ VKDUS ULVHV LQ GHEW UDWLRV $V H[SHFWHG VHH )LJXUH   IRUFHIXO ¿VFDO DGMXVWPHQW JHQHUDOO\ OHDGV WR VKDUSHU GHFOLQHV LQ GHEW UDWLRV WKDQ PRUH PRGHUDWH ¿VFDO DGMXVWPHQW EXW WKH G\QDPLFV RI WKH PRGHO along with the narrowing of the gap between growth rates and interest rates over the projection period, imply that the difference between these adjustment paths is not always very large. Intuitively, the reason for this result is that, in the near term, rapid cyclical UHFRYHULHV UHODWLYH WR TXLWH ORZ LQWHUHVW UDWHV LPSO\ WKDW FRQWLQXHG ODUJH ¿VFDO GH¿FLWV GR not necessarily lead to large increases in debt ratios. Over time, however, as the gap between growth rates and interest rates tends to narrow, pressure on public debt ratios VWDUW WR LQFUHDVH LI ¿VFDO GH¿FLWV UHPDLQ ODUJH Based on the scenario result, it is apparent most countries will need to start unwinding WKHLU ¿VFDO VWLPXOXV SDFNDJHV UHODWLYHO\ VRRQ LI WKH\ DUH WR VWDELOL]H VKRUWWHUP GHEW DQG in some cases, avoid quite sharp increases in debt ratios. Especially in countries with already high debt, the unwinding might need to go at a somewhat faster pace than in the past and, especially, in circumstances where the gap between growth rates and interest rates may be narrowing.

VI. Medium-Term Fiscal Policy Frameworks
7KLV VHFWLRQ DGGUHVVHV LVVXHV UHODWHG WR WKH ³QHZ´ ¿VFDO SROLF\ IUDPHZRUNV WKDW ZLOO be adopted in the region in the post global crisis environment. As noted earlier, the VXFFHVVIXO FRQWULEXWLRQ RI ¿VFDO SROLF\ WR KHOSLQJ WKH UHJLRQ ZHDWKHU WKH JOREDO VORZGRZQ PD\ OHDG WR D ODUJHU UROH IRU FRXQWHUF\FOLFDO ¿VFDO SROLF\ LQ WKH IXWXUH DQG WR D UDQJH RI ³GHPDQGV´ RQ EXGJHWV E\ JURXSV DGYHUVHO\ DIIHFWHG E\ HFRQRPLF GRZQWXUQV $QG RQ WRS of 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 WKH global rebalancing effort over the medium term. A key challenge governments are likely WR IDFH ZLOO EH WR UHFRQFLOH D SRVVLEO\ PRUH DFWLYLVW UROH IRU ¿VFDO SROLF\ LQ WKH IXWXUH ZKLOH HQVXULQJ WKDW WKH UHJLRQ¶V JHQHUDOO\ VWURQJ UHFRUG RI ¿VFDO VXVWDLQDELOLW\ LV QRW SXW DW ULVN
54

Effectively, in those cases where fiscal data is not available for 2009, the 2008 estimates are updated to reflect announced stimulus packages.

Fiscal Sustainability in Developing Asia | 33

,Q DGGLWLRQ WKH SRVVLELOLW\ VKRXOG EH FRQVLGHUHG WKDW PDLQWDLQLQJ ¿VFDO VXVWDLQDELOLW\ PD\ be more challenging looking forward if some of the favorable economic conditions that KHOG LQ WKH SDVW²LQFOXGLQJ LQWHUHVW UDWHV WKDW DUH RIWHQ ZHOO EHORZ WKH JURZWK UDWH RI WKH HFRQRP\²DUH QR ORQJHU DVVXUHG ,Q VXFK FLUFXPVWDQFHV PDLQWDLQLQJ ¿VFDO VXVWDLQDELOLW\ FRXOG UHTXLUH PRUH IRUFHIXO SROLF\ UHVSRQVHV WR ¿VFDO VOLSSDJHV WKDQ LQ WKH SDVW HVSHFLDOO\ LQ WKRVH FDVHV ZKHUH ¿VFDO VXVWDLQDELOLW\ LV DW ULVN DQG PLJKW EHQH¿W IURP WKH DGRSWLRQ RI VWURQJ PHGLXPWHUP ¿VFDO SROLF\ IUDPHZRUNV WKDW DUH UHJXODUO\ VWUHVV WHVWHG for a number of unfavorable contingencies. %DVHG RQ D ZLGH UDQJH RI H[SHULHQFHV VWURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV²LQ ZKLFK government spending, revenues, debt service and debt levels are projected over the PHGLXP WHUP LQ D UHDOLVWLF DQG FRQVLVWHQW ZD\ DQG VWUHVV WHVWHG IRU GLIIHUHQW VKRFNV² KDYH SURYHG XVHIXO IRU KHOSLQJ DVVXUH WKDW EXGJHWV FRQIRUP WR ¿VFDO VXVWDLQDELOLW\ .RSLWV DQG 6\PDQVN\   7KH UHDVRQ IRU WKLV LV WKDW VXFK IUDPHZRUNV FDQ KHOS LGHQWLI\ in a timely manner whether debt ratios may be tending to rise too rapidly, and assist LQ IUDPLQJ WKH DSSURSULDWH ¿VFDO SROLF\ UHVSRQVHV ,Q DGGLWLRQ PDQ\ FRXQWULHV KDYH IRXQG LW XVHIXO WR XQGHUSLQ VXFK SROLF\ IUDPHZRUNV ZLWK ³UXOHV RU OLPLWV´ RQ ¿VFDO SROLF\ LQVWUXPHQWV VXFK DV UHYHQXHV RU SULPDU\ H[SHQGLWXUHV RU RQ RXWFRPHV VXFK DV ¿VFDO GH¿FLWV RU SXEOLF GHEW UDWLRV 1RW RQO\ FDQ VXFK PHGLXPWHUP ¿VFDO IUDPHZRUNV EH XVHIXO LQ ¿VFDO SROLF\ IRUPXODWLRQ DQG LPSOHPHQWDWLRQ WKH\ FDQ DOVR EH LPSRUWDQW LQ KHOSLQJ EX\ ¿VFDO FUHGLELOLW\ DQG PD\ SD\ GLYLGHQGV LQ WHUPV RI ORZHU ¿QDQFLQJ DQG RWKHU FRVWV (XURSHDQ &RPPLVVLRQ E  1HHGOHVV WR VD\ ¿VFDO SROLF\ UXOHV FRPH LQ PDQ\ GLIIHUHQW ³VKDSHV DQG VL]HV´ DQG WKHUH LV 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 legislative IUDPHZRUNV DQG GLIIHUHQW UROHV IRU WKH YDULRXV EUDQFKHV RI JRYHUQPHQW LQ ¿VFDO SROLF\ formulation and implementation; these will need to be taken into account in designing such frameworks. Even though directed primarily toward the medium term, such frameworks might also be of relevance in the context of the exit strategies from recent VWLPXOXV SURJUDPV 6WURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV PD\ KHOS IDFLOLWDWH WKH JURZWK IULHQGO\ ZLWKGUDZDO RI ¿VFDO VWLPXOXV SDFNDJHV LI WKH IDYRUDEOH HIIHFWV RQ FUHGLELOLW\ DQG interest rates implied by such frameworks help crowd in private spending (Cottarelli and 9LQDOV   7KH ¿VFDO SROLF\ IUDPHZRUNV DQG UXOHV WKDW KDYH EHHQ DGRSWHG LQ YDULRXV FRXQWULHV around the world have differed in a number of important dimensions. Such rules can EH ULJLG RU ÀH[LEOH DSSO\ WR GLIIHUHQW FRPSRQHQWV RI WKH EXGJHW RU WR WKH RYHUDOO EXGJHW GH¿FLW DSSO\ WR GHEW VWRFNV RU GHEW LVVXDQFH DSSO\ \HDU E\ \HDU RU RYHU WKH PHGLXP WHUP WDNH WKH IRUP RI UDQJHV RU SRLQW OLPLWV RQ ¿VFDO YDULDEOHV DQG PD\ RU PD\ QRW include escape clauses to deal with exceptional circumstances. In addition, such UXOHV PD\ H[SOLFLWO\ DOORZ IRU ¿VFDO SROLF\ WR SOD\ D FRXQWHUF\FOLFDO UROH E\ WDUJHWLQJ WKH VWUXFWXUDO RU KLJK HPSOR\PHQW EXGJHW GH¿FLW RU WKH\ PD\ GLUHFWO\ RU LQGLUHFWO\ OLPLW

34 | ADB Economics Working Paper Series No. 205

FRXQWHUF\FOLFDO ¿VFDO SROLF\ UHVSRQVHV E\ EHLQJ IUDPHG LQ DFWXDO UDWKHU WKDQ VWUXFWXUDO terms. 7KH EHVWNQRZQ ¿VFDO SROLF\ UXOHV DUH WKRVH DVVRFLDWHG ZLWK WKH (XURSHDQ 8QLRQ enshrined in the Growth and Stability Pact. The key elements of the Pact are relatively ULJLG XSSHU ERXQGV RQ ¿VFDO GH¿FLWV DQG SXEOLF GHEW UDWLRV LQ UHODWLRQ WR *'3 VXSSRUWHG by 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 the world, and by both developed and emerging market countries. In the case of the United 6WDWHV PHGLXPWHUP ¿VFDO SROLF\ WDUJHWV DQG UXOHV SOD\HG DQ LPSRUWDQW UROH LQ SODFLQJ ¿VFDO SROLF\ RQ D D PRUH VROLG IRRWLQJ LQ WKH ODWH V DQG HDUO\ V +RULJXFKL   )LVFDO SROLF\ UXOHV SOD\HG DQ LPSRUWDQW UROH LQ &DQDGD¶V HIIRUWV WR WDPH H[SORGLQJ SXEOLF GHEW GXULQJ WKH V DQG HDUO\ V 7KH 8QLWHG .LQJGRP DGRSWHG D ¿VFDO UHVSRQVLELOLW\ 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 LQFOXGH WKH ¿VFDO SROLF\ IUDPHZRUNV RI ,QGLD DQG 3DNLVWDQ LQ WKH FRQWH[W RI WKH QHHG WR DGGUHVV GHHSVHDWHG ¿VFDO ZHDNQHVV WKH ¿VFDO IUDPHZRUN DGRSWHG E\ ,QGRQHVLD LQ WKH DIWHUPDWK RI ¿VFDO VOLSSDJHV UHODWHG WR WKH $VLDQ FULVLV DQG 6LQJDSRUH¶V IUDPHZRUN IRU OLPLWLQJ ¿VFDO VOLSSDJHV DQG SURWHFWLQJ ¿VFDO UHVHUYHV ,0) D  %RWK $XVWUDOLD DQG 1HZ =HDODQG KDYH DOVR DGRSWHG UXOHVEDVHG PHGLXP WHUP ¿VFDO IUDPHZRUNV DQG DFURVV WKH UHJLRQ many countries have adopted key elements of such frameworks as part of an effort to DVVXUH ¿VFDO VXVWDLQDELOLW\ Looking forward, countries in the region might usefully consider strengthening and DGDSWLQJ WKHLU ¿VFDO IUDPHZRUNV WR WKH SRVWFULVLV ZRUOG .H\ HOHPHQWV RI VXFK SRVWFULVLV IUDPHZRUNV ZRXOG EH UHDOLVWLF DQG FRQVLVWHQW PHGLXPWHUP SURMHFWLRQV IRU ¿VFDO YDULDEOHV DQG GHEW VWRFNV DOORZDQFH IRU IXWXUH DQG SURVSHFWLYH ¿VFDO OLDELOLWLHV VWUHVV WHVWLQJ against a number of unfavorable developments; formal or informal rules that lead to primary surpluses increasing in response to rising debt stocks as discussed in Section II DQG ZKLFK JLYH ULVH WR VWDELOL]LQJ SULPDU\ EDODQFH UHVSRQVH IXQFWLRQV  DQG IUDPHZRUNV VHHNLQJ WR DGGUHVV WKH IDFWRUV WKDW FRQWULEXWH WR GHEW WLSSLQJ SRLQWV ZKHUH WKH ¿VFDO DGMXVWPHQW HIIRUW WDSHUV RII 6XFK IUDPHZRUNV FDQ DOVR EH GHVLJQHG WR FUHDWH WKH ¿VFDO space necessary to deal with unforeseen contingencies and cyclical downturns. Policies WKDW VHHN WR EXLOG XS ¿VFDO VSDFH GXULQJ WKH XSVZLQJ RI WKH EXVLQHVV F\FOH ZLOO KDYH WKH EHQH¿W RI DOORZLQJ ¿VFDO SROLF\ WR SOD\ D SRWHQWLDOO\ LPSRUWDQW FRXQWHUF\FOLFDO UROH LQ ERWK ³JRRG´ DQG ³EDG´ WLPHV ,Q DGGLWLRQ WKH\ ZRXOG FRPSOHPHQW HIIRUWV LQ WKH UHJLRQ WR OLPLW WKH SURF\FOLFDOLW\ RI ¿QDQFLDO V\VWHPV WKURXJK PDFUR SUXGHQWLDO SROLFLHV DQG FRXOG KHOS reduce the amplitude of regional business cycles.

Fiscal Sustainability in Developing Asia | 35

VII. Concluding Observations
7KH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV KDV IXQGDPHQWDOO\ DOWHUHG $VLD¶V ¿VFDO SROLF\ HQYLURQPHQW 3ULRU WR WKH FULVLV WKH UHJLRQ¶V WUDGLWLRQDO ¿VFDO SKLORVRSK\ ZDV RQH RI providing growth-conducive public goods such as infrastructure and education without MHRSDUGL]LQJ ¿VFDO VXVWDLQDELOLW\ DQG KHQFH PDFURHFRQRPLF VWDELOLW\ )RU WKH PRVW SDUW with few exceptions such as South Asia, the outcome of this philosophy has been JHQHUDOO\ VPDOO JRYHUQPHQW EXGJHW GH¿FLWV DQG ORZ SXEOLF GHEW OHYHOV :KHUH WKHUH ZHUH WHPSRUDU\ ¿VFDO VOLSSDJHV KHDOWK RI SXEOLF ¿QDQFHV KDG EHHQ UHVWRUHG TXLFNO\ WKURXJK VSHHG\ DQG GHFLVLYH ¿VFDO DGMXVWPHQWV 2QH NH\ IDFWRU XQGHUO\LQJ VXFK JHQHUDOO\ EHQLJQ SUHFULVLV ¿VFDO DQG GHEW SRVLWLRQ ZDV WKH UHJLRQ¶V UHOXFWDQFH WR SXUVXH FRXQWHUF\FOLFDO SROLFLHV 7KLV UHOXFWDQFH VWHPPHG IURP WKH UHJLRQ¶V SULRULW\ RQ PD[LPL]LQJ RXWSXW JURZWK UDWKHU WKDQ PLQLPL]LQJ RXWSXW YRODWLOLW\ )XUWKHUPRUH VWURQJ JURZWK RQ D VXVWDLQHG EDVLV in much of the region obviated the need for countercyclical polices that, in practice, refer WR DQWLUHFHVVLRQ SROLFLHV 7KH JOREDO FULVLV KDV EURXJKW FRXQWHUF\FOLFDO ¿VFDO DFWLYLVP EDFN LQWR $VLD ZLWK D WKXQGHURXV EDQJ 7KH XQSUHFHGHQWHG ¿VFDO VWLPXOXV SXW LQWR effect by governments across the region was borne out of sheer necessity rather than DQ\ IXQGDPHQWDO VKLIW LQ ¿VFDO SKLORVRSK\ (YHQ VR WKH DQWLFULVLV VWLPXOXV PD\ KDYH UHSHUFXVVLRQV IRU ERWK ¿VFDO SROLF\ DQG ¿VFDO RXWFRPHV IDU EH\RQG WKH FULVLV 7KH UHYLYDO RI FRXQWHUF\FOLFDO ¿VFDO SROLFLHV LQ WKH UHJLRQ EULQJV EDFN WKH LVVXH RI ¿VFDO sustainability back to center stage. Precisely because the region’s governments have ODUJHO\ UHIUDLQHG IURP ¿VFDO DFWLYLVP LQ WKH SDVW ¿VFDO VXVWDLQDELOLW\ KDV QRW EHHQ D PDMRU SROLF\ FRQFHUQ LQ WKH UHJLRQ +RZHYHU WKH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV ZLOO OHDG WR GHWHULRUDWLRQ RI WKH ¿VFDO DQG SXEOLF GHEW SRVLWLRQV LQ WKH VKRUW UXQ DQG PD\ DOVR EULQJ DERXW D ³JDPHFKDQJLQJ´ VKLIW LQ WKH UHJLRQ¶V ¿VFDO SKLORVRSK\ WRZDUG KHLJKWHQHG countercyclical activism beyond the crisis. In light of the renewed importance of Asia’s ¿VFDO VXVWDLQDELOLW\ LQ WKH SRVWFULVLV SHULRG ZH FDUU\ RXW WKUHH W\SHV RI HPSLULFDO DQDO\VLV L DQDO\VLV RI WKH DFWXDO VWDWH RI SXEOLF ¿QDQFHV ORRNLQJ DW NH\ ¿VFDO LQGLFDWRUV DFURVV WKH UHJLRQ LL HFRQRPHWULF WHVWV RI ¿VFDO VXVWDLQDELOLW\ LQ SDUWLFXODU HVWLPDWLRQV RI ¿VFDO SROLF\ UHDFWLRQ IXQFWLRQV WKDW PHDVXUH WKH UHVSRQVH RI SULPDU\ ¿VFDO EDODQFHV WR FKDQJHV LQ GHEW UDWLRV DFURVV FRXQWULHV DQG RYHU WLPH DQG LLL ¿VFDO VLPXODWLRQV WKDW DVVHVV WKH LPSDFW RI WKH DQWLFULVLV ¿VFDO VWLPXOXV RQ GHEW VXVWDLQDELOLW\ LQ WKH UHJLRQ 7KH RYHUDOO EDODQFH RI HYLGHQFH IURP WKH ¿UVW WZR W\SHV RI DQDO\VLV LQGLFDWHV WKDW DOWKRXJK WKHUH is considerable heterogeneity across countries and subregions, by and large Asia’s SXEOLF ¿QDQFHV DUH LQ UHODWLYHO\ JRRG VKDSH DQG $VLD¶V JRYHUQPHQWV KDYH SXUVXHG ¿VFDO VXVWDLQDELOLW\ 7KDW LV WKH HYLGHQFH FRQ¿UPV WKH FRQYHQWLRQDO ZLVGRP WKDW $VLD KDV EHHQ ¿VFDOO\ UHVSRQVLEOH LQ WKH SDVW 7KH WKLUG W\SH RI DQDO\VLV ¿QGV WKDW IDLOXUH WR XQZLQG WKH DQWLFULVLV ¿VFDO VWLPXOXV ZLOO VHULRXVO\ HURGH WKH UHJLRQ¶V ¿VFDO VXVWDLQDELOLW\ A number of important policy implications emerge from our empirical analysis. The most immediate policy message is that regional policymakers should continue to give high SULRULW\ WR SURPRWLQJ DQG VXVWDLQLQJ ¿VFDO VXVWDLQDELOLW\ DV WKH\ KDYH GRQH LQ WKH SDVW

36 | ADB Economics Working Paper Series No. 205

2XU ¿QGLQJV LPSO\ WKDW ¿VFDO VXVWDLQDELOLW\ PDWWHUV DQG PDWWHUV D ORW DQG WKLV ZLOO FRQWLQXH WR EH WKH FDVH LQ WKH IXWXUH *LYHQ WKH SRSXODU SHUFHSWLRQ WKDW FRXQWHUF\FOLFDO ¿VFDO policies played a key role in Asia’s spectacular V-shaped recovery, it may be tempting to EHOLHYH WKDW $VLDQ JRYHUQPHQWV VKRXOG QRZ WKLQN PRUH DERXW XVLQJ ¿VFDO UHVRXUFHV DQG OHVV DERXW VXVWDLQLQJ ¿VFDO VXVWDLQDELOLW\ +RZHYHU LW LV SUHFLVHO\ EHFDXVH $VLD KDV UXQ VPDOO EXGJHW GH¿FLWV DQG DFFXPXODWHG PDQDJHDEOH GHEW OHYHOV WKDW LW ZDV DEOH WR DIIRUG VXFK ODUJH DQWLFULVLV ¿VFDO VWLPXOXV SDFNDJHV 5HJDUGOHVV RI WKH DFWXDO FRQWULEXWLRQ RI WKH VWLPXOXV WR $VLD¶V UHFRYHU\²DQG WKLV LVVXH ZLOO QRW EH VHWWOHG IRU VRPH WLPH²WKH IDFW UHPDLQV WKDW $VLD GLG KDYH DPSOH ¿VFDO VSDFH DV LW HQWHUHG WKH FULVLV DQG WKLV VSDFH ZDV WKH FRQVHTXHQFH RI D KLVWRU\ RI ¿VFDOO\ UHVSRQVLEOH EHKDYLRU ,Q SDUWLFXODU RXU HYLGHQFH VXJJHVWV WKDW LQ WKH SDVW $VLDQ JRYHUQPHQWV KDYH PDGH ¿VFDO DGMXVWPHQWV LQ UHVSRQVH to deterioration of public debt positions. The primary forward-looking implication for Asian SROLF\PDNHUV 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 ZDV XQGRXEWHGO\ XQLTXH DQG H[FHSWLRQDO LQ WHUPV RI WKH V\QFKURQL]HG DQG JOREDO QDWXUH RI LWV impact, 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 PHGLXP WHUP ¿VFDO SROLF\ IUDPHZRUNV WKDW DUH UHJXODUO\ WHVWHG IRU D QXPEHU RI XQIDYRUDEOH contingencies. A key challenge governments are likely to face will be to reconcile a SRVVLEO\ PRUH DFWLYLVW UROH IRU ¿VFDO SROLF\ LQ WKH IXWXUH ZKLOH HQVXULQJ WKDW WKH UHJLRQ¶V JHQHUDOO\ VWURQJ UHFRUG RI ¿VFDO VXVWDLQDELOLW\ LV QRW SXW DW ULVN $ VWURQJ PHGLXPWHUP ¿VFDO SROLF\ IUDPHZRUN ZLOO EH FULWLFDO IRU PHHWLQJ WKDW FKDOOHQJH 5HJDUGOHVV RI WKH DFWXDO FRQWULEXWLRQ RI WKH ¿VFDO VWLPXOXV WR WKH UHJLRQ¶V UHFRYHU\ WKH SRSXODU SHUFHSWLRQ WKDW LW SOD\HG D FHQWUDO UROH PD\ EULQJ DERXW D JDPHFKDQJLQJ VKLIW LQ WKH UHJLRQ¶V ¿VFDO philosophy from its traditional conservatism toward countercyclical activism. Such a VKLIW PD\ MHRSDUGL]H ¿VFDO VXVWDLQDELOLW\ EHFDXVH RI DQ LQKHUHQW DV\PPHWULF ELDV LQ FRXQWHUF\FOLFDO ¿VFDO SROLF\ LH LW LV SROLWLFDOO\ HDVLHU WR LQFUHDVH VSHQGLQJ DQG FXW taxes during recessions than to go the other way during booms. Even in the absence RI JDPHFKDQJLQJ VKLIWV LQ ¿VFDO SKLORVRSK\ WKH GHWHULRUDWLRQ RI ¿VFDO SRVLWLRQV DFURVV the region due to the anticrisis stimulus packages may have adverse implications for ¿VFDO VXVWDLQDELOLW\ DQG KDV WKXV UHQGHUHG WKH QHHG IRU VWURQJ PHGLXPWHUP ¿VFDO SROLF\ frameworks all the more urgent. The adoption of such frameworks may also provide a PRUH LPPHGLDWH EHQH¿W LQ VR IDU DV WKH\ FDQ KHOS VLJQDO WKDW WKH UHFHQW ¿VFDO VWLPXOXV SURJUDPV DUH WHPSRUDU\ DQG ZLOO QRW UHSUHVHQW D WKUHDW WR ORQJHUWHUP ¿VFDO VXVWDLQDELOLW\ And, any positive impact of frameworks on credibility about sustainability could help FURZG LQ SULYDWH VSHQGLQJ DQG UHGXFH ¿QDQFLQJ FRVWV DV ¿VFDO SROLF\ LV SXW EDFN RQ WUDFN 6WURQJ PHGLXPWHUP ¿VFDO IUDPHZRUNV FDQ WKXV IDFLOLWDWH JURZWKIULHQGO\ H[LW VWUDWHJLHV from recent stimulus packages. The third policy message emerging from our analysis is that Asian countries need to WDNH D ORQJ DQG EURDG YLHZ RI ¿VFDO VXVWDLQDELOLW\ ZKLFK WDNHV LQWR DFFRXQW WKH UHJLRQ¶V PHGLXPWHUP ¿VFDO QHHGV RYHU D VXI¿FLHQWO\ ORQJ WLPH KRUL]RQ 6XFK D YLHZ RI ¿VFDO

Fiscal Sustainability in Developing Asia | 37

VXVWDLQDELOLW\ LV FORVHO\ UHODWHG WR DQG FRQVLVWHQW ZLWK WKH QHHG IRU VWURQJ ¿VFDO SROLF\ IUDPHZRUNV EXW DW WKH VDPH WLPH SRLQWV WR WKH QHHG WR DGDSW WKH QRWLRQ RI ¿VFDO VXVWDLQDELOLW\ WR SRWHQWLDOO\ ODUJH FKDQJHV LQ $VLD¶V SRVWFULVLV ¿VFDO HQYLURQPHQW 7KH UHJLRQ KDV VRPH ORQJVWDQGLQJ PHGLXPWHUP ¿VFDO QHHGV VXFK DV SK\VLFDO LQIUDVWUXFWXUH $ PRUH UHFHQW PHGLXPWHUP ¿VFDO FKDOOHQJH LV WR SURYLGH DGHTXDWH SHQVLRQ DQG KHDOWK care as the region rapidly shifts to an older population. A medium-term need that has arisen as a direct result of the global crisis is more spending on social protection and other areas that can facilitate Asia’s growth rebalancing. Finally, given Asia’s growing ZHLJKW LQ WKH ZRUOG HFRQRP\ DQG LQÀXHQFH LQ WKH LQWHUQDWLRQDO FRPPXQLW\ $VLD ZLOO EH H[SHFWHG WR FRQWULEXWH PRUH WR JOREDO SXEOLF JRRGV VXFK DV ¿JKWLQJ FOLPDWH FKDQJH and poverty in Africa. For all of these reasons, even if there were no shift toward FRXQWHUF\FOLFDO ¿VFDO SROLFLHV $VLD PD\ H[SHULHQFH DQ LQFUHDVH LQ WKH UROH RI WKH JRYHUQPHQW ,Q DGGLWLRQ LQ LWV ¿VFDO VXVWDLQDELOLW\ DVVHVVPHQWV WKH UHJLRQ VKRXOG H[SOLFLWO\ WDNH LQWR DFFRXQW VLJQL¿FDQW RIIEXGJHW LWHPV DQG FRQWLQJHQW OLDELOLWLHV LQFOXGLQJ those incurred during the crisis. For example, much of the PRC’s recent bank lending surge is implicitly guaranteed by the government, which means that nonperforming loans will end up on the government’s balance sheets. The broader point here is that D SURVSHFWLYH PHGLXPWHUP LQFUHDVH LQ ¿VFDO GHPDQGV LQ WKH SRVWFULVLV SHULRG UHQGHUV SUHFULVLV QRWLRQV RI ¿VFDO VXVWDLQDELOLW\ REVROHWH LQ WKH VHQVH WKDW ODUJHU UHYHQXHV ZLOO EH required to achieve sustainability. ,Q D IXQGDPHQWDO VHQVH HYHQ LI $VLD UHYHUWV WR LWV WUDGLWLRQDO SUHFULVLV ¿VFDO FRQVHUYDWLVP DIWHU LW XQZLQGV LWV DQWLFULVLV ¿VFDO VWLPXOXV WKH JOREDO ¿QDQFLDO DQG HFRQRPLF FULVLV KDV DOUHDG\ EHHQ D JDPHFKDQJHU IRU ¿VFDO SROLF\ DQG ¿VFDO VXVWDLQDELOLW\ LQ WKH UHJLRQ 1HYHU EHIRUH KDV WKH UHJLRQ H[SHULHQFHG VXFK D IRUFHIXO V\QFKURQL]HG DQG XQLIRUP ¿VFDO UHVSRQVH WR DQ HFRQRPLF GRZQWXUQ ,Q FRQWUDVW WR WKH LQGXVWULDOL]HG FRXQWULHV WKH UHJLRQ LV QRW DFFXVWRPHG WR VXFK XVH RI ¿VFDO SROLF\ IRU FRXQWHUF\FOLFDO SXUSRVHV )LVFDO VXVWDLQDELOLW\ ZDV D NH\ FRQVHTXHQFH RI WKH UHJLRQ¶V FRPPLWPHQW WR ¿VFDO GLVFLSOLQH DQG macroeconomic stability. The global crisis has highlighted a fact that has hitherto been XQGHUDSSUHFLDWHG LQ WKH UHJLRQ²WKDW ¿VFDO VXVWDLQDELOLW\ LV DV PXFK D YDOXDEOH WRRO DV LW LV D FRQVHTXHQFH $ YDOXDEOH WRRO EHFDXVH LW KDV DOORZHG WKH UHJLRQ WR XQOHDVK ODUJH ¿VFDO VWLPXOXV SURJUDPV 6RPHZKDW SDUDGR[LFDOO\ FXUUHQW ¿VFDO SURÀLJDF\ ZKLFK ZDV WKH ULJKW PHGLFLQH IRU WKH FULVLV ZDV PDGH SRVVLEOH E\ SDVW ¿VFDO IUXJDOLW\ *LYHQ WKH SRVVLELOLW\ RI substantial medium-term increases in government spending, Asian policymakers should also explore ways to substantially increase revenues in nondistortionary ways that do not harm growth. To some extent, the region’s rapid growth will generate higher revenues but a well-designed revenue effort may still be required. )LQDOO\ WKH JDPHFKDQJLQJ VKLIW LQ WKH UHJLRQ¶V ¿VFDO ODQGVFDSH VLQFH WKH JOREDO FULVLV is 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 WR UHYHUVH RU DGMXVW HYHQ ZKHQ WKH\ DUH QR ORQJHU MXVWL¿HG 3ROLWLFDO FRQVLGHUDWLRQV PDNH LW HDVLHU IRU JRYHUQPHQWV WR SXUVXH ¿VFDO H[SDQVLRQ UDWKHU WKDQ ¿VFDO FRQWUDFWLRQ GXULQJ

38 | ADB Economics Working Paper Series No. 205

GRZQWXUQV 7KLV KDV EHHQ HYLGHQW LQ WKH H[SHULHQFH RI LQGXVWULDOL]HG FRXQWULHV 7KH VFRSH IRU ¿VFDO UHYHUVDO RU DGMXVWPHQW LV HYHQ PRUH OLPLWHG LQ GHYHORSLQJ FRXQWULHV ZLWK weaker institutions and policy environments. However, the need for caution does not mean that the government should refrain from rethinking and expanding its role where DSSURSULDWH DQG MXVWL¿HG 7KH FULVLV KDV VKRZQ WKDW WKH JRYHUQPHQW FDQ DQG VKRXOG VHUYH as a consumer of last resort when all the other components of demand are stalling. At a PLQLPXP DQG DVLGH IURP DQ\ GLUHFW LPSDFW RQ JURZWK LW LV OLNHO\ WKDW WKH UHJLRQ¶V ¿VFDO VWLPXOXV KDV KHOSHG WR LPSURYH EXVLQHVV DQG FRQVXPHU FRQ¿GHQFH ZKLFK KDG FUDWHUHG DV WKH FULVLV LQWHQVL¿HG *RLQJ IRUZDUG WKH NH\ FKDOOHQJH IRU $VLD LV WR UHGH¿QH WKH UROH RI WKH JRYHUQPHQW DQG DGDSW LW WR WKH SRVWFULVLV ZRUOG ZLWKRXW FRPSURPLVLQJ WKH ¿VFDO sustainability 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   ± 71. BBBBB  ³86 'H¿FLWV VLQFH :RUOG :DU ,´ Scandinavian Journal of Economics   ± %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   ± %XLWHU : +  ³7HQ &RPPDQGPHQWV IRU D )LVFDO 5XOH LQ WKH ( 0 8´ Oxford Review of Economic Policy   ± &DPSEHOO - < DQG 5 - 6KLOOHU  ³&RLQWHJUDWLRQ DQG 7HVWV RI 3UHVHQW 9DOXH 0RGHOV´ Journal of Political Economy   ± &HODVXQ 2 ; 'HEUXQ DQG - ' 2VWU\  ³3ULPDU\ 6XUSOXV %HKDYLRU DQG 5LVNV WR )LVFDO 6XVWDLQDELOLW\ LQ (PHUJLQJ 0DUNHW &RXQWULHV $ C)DQ&KDUW¶ $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.

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&RWWDUHOOL & 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   ± (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    %UXVVHOV )LVFKHU 6 DQG : (DVWHUO\  ³7KH (FRQRPLFV RI WKH *RYHUQPHQW %XGJHW &RQVWUDLQW´ World Bank Research Observer 5(2):127–42. +DPLOWRQ - DQG 0 $ )ODYLQ  ³2Q WKH /LPLWDWLRQV RI *RYHUQPHQW %RUURZLQJ $ )UDPHZRUN IRU (PSLULFDO 7HVWLQJ´ American Economic Review   ± +DXJ $ $  ³&RLQWHJUDWLRQ DQG *RYHUQPHQW %RUURZLQJ &RQVWUDLQWV (YLGHQFH IRU WKH 8QLWHG 6WDWHV´ Journal of Business and Economic Statistics   ± +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 ³'HEW %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 $ 6\PDQVN\  )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  ³&RPPRQ 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   ±

About the Paper Charles Adams, Benno Ferrarini, and Donghyun Park empirically examine the conventional wisdom that developing Asia has been fiscally responsible in the past. Their evidence confirms that the region’s public finances are generally healthy as a result of historical fiscal discipline. Nevertheless, their forward-looking scenario analysis indicates that failure to withdraw the region’s anticrisis fiscal stimulus in a timely manner may jeopardize fiscal sustainability in the future.

About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries substantially reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.8 billion people who live on less than $2 a day, with 903 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.

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