Long-term Fiscal Sustainability
in Emerging Asia: Challenges and Strategies
Masahiro Kawai (University of Tokyo) and Peter J. Morgan (ADBI)
Tokyo Fiscal Forum Organized by MoF (PRI)-IMF-ADBI
Tokyo, 10-11 June 2015
Outline
1. Introduction 2. Current fiscal conditions 3. Fiscal expenditures 4. Fiscal sustainability challenges 5. Framework for fiscal and debt management 6. Conclusions
2
1. Introduction • What are LT issues of fiscal sustainability risk
for emerging Asian economies? Subsidies Infrastructure investment Aging and social security spending Contingent liabilities Interest rate repression/banking sector exposure
• What policies should be adopted to reduce sustainability risk Improve balance of revenues and expenditures More explicit fiscal rules Stronger fiscal surveillance at the national/regional level
3
Asian financial crisis experience • Excess private demand, not fiscal profligacy, was
source of current account imbalances in crisis countries (Indonesia, Korea, Malaysia, Thailand)
• Rise in fiscal deficits during crisis period reflected combination of: Higher interest rates Cyclically weak domestic demand Banking sector recapitalization (esp. Indonesia and Thailand)
• Fiscal balances were restored relatively quickly via devaluation-induced economic recoveries and fiscal retrenchment, which contained debt ratios Only Indonesia saw government debt ratio rise to 100% of
GDP 4
2. Current fiscal conditions in emerging Asia
5 Source: IMF World Economic Outlook Database, April 2015
Fiscal balances in Asian crisis-affected countries generally improving
-12-10-8-6-4-202468
10121416
1990 1995 2000 2005 2010
PRC Japan Korea Chinese Taipei IndonesiaMalaysia Philippines Singapore Thailand Vietnam
(Fiscal balance as % of GDP)
6 Source: IMF World Economic Outlook Database, April 2015
South Asian countries, including India, have not improved much
-14
-12
-10
-8
-6
-4
-2
0
2
4
6
1990 1995 2000 2005 2010
Afghanistan Bangladesh Bhutan IndiaNepal Pakistan Sri Lanka
(Fiscal balance as % of GDP)
7 Source: IMF World Economic Outlook Database, April 2015
Government debt ratios in Asian crisis-affected countries generally well-behaved
0
20
40
60
80
100
1990 1995 2000 2005 2010
China Korea Chinese TaipeiIndonesia Malaysia PhilippinesSingapore Thailand Vietnam
(Government debt as % of GDP)
8 Source: IMF World Economic Outlook Database, April 2015
South Asian countries, including India, have generally high government debt ratios
20
40
60
80
100
1990 1995 2000 2005 2010
Bangladesh Bhutan IndiaNepal Pakistan Sri Lanka
(Government debt as % of GDP)
Global financial crisis experience • A number of Asian countries implemented
expansionary fiscal policy to offset sharp drop in import demand from developed economies
• Prudent fiscal management after the Asian financial crisis meant most economies had plenty of fiscal space
• Absence of domestic financial crises meant lesser needs for fiscal resources than elsewhere
• Fiscal balances improved rapidly, with relatively modest accumulation of government debt South Asian countries’ debt levels remain above 60% of GDP Less positively, interest rate repression has contributed
significantly to debt improvement
9
10 Source: IMF World Economic Outlook database, IMF Article IV reports
(Average %, 2011-2012)
Interest rate repression a major contributor to debt stability in Asia
Revenues and expenditures of East and Southeast Asian economies
11
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010
PRC Japan KoreaChinese Taipei Indonesia MalaysiaPhilippines Singapore ThailandVietnam
5
10
15
20
25
30
35
40
1990 1995 2000 2005 2010
PRC Japan KoreaChinese Taipei Indonesia MalaysiaPhilippines Singapore ThailandVietnam
(Revenues, % of GDP) (Expenditures, % of GDP)
Source: IMF World Economic Outlook Database, April 2015
Revenues and expenditures of South Asian countries
12 Source: IMF World Economic Outlook Database, April 2015
5
10
15
20
25
30
35
40
45
50
55
1990 1995 2000 2005 2010
Afghanistan Bangladesh BhutanIndia Nepal PakistanSri Lanka
5
10
15
20
25
30
35
40
45
50
55
1990 1995 2000 2005 2010
Afghanistan Bangladesh BhutanIndia Nepal PakistanSri Lanka
(Revenues, % of GDP) (Expenditures% of GDP)
Composition of revenues and expenditures
• Revenues As expenditures tend to rise more than proportionately
with income, adequate revenue sources must be generated to cover this
Many low income countries have narrow revenue bases Greater reliance on indirect taxes (VAT or GST) could
increase revenues in a relatively non-distorting way • Expenditures
Many low income economies have low investment rates in infrastructure
Social sector-related expenditures tend to grow rapidly with income
13
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Tax revenue Non-tax current revenue Capital receipts Grants
Size and composition of fiscal revenue by country
(annual average % of GDP, 2005-11)
Source: ADB Statistical Database and World Bank, World Development Indicators. Adapted from Das-Gupta (2014).
15 Note: Japan social protection is general government basis Source: ADB Statistical Database System
Composition of expenditures by country
-5 0 5 10 15 20 25 30 35 40
MongoliaJapan
GeorgiaSingapore
MalaysiaArmenia
Lao PDR.Nepal
ThailandPRC
Hong KongKorea
CambodiaSri LankaIndonesia
PhilippinesIndia
Chinese TaipeiBangladesh
Social protection Defense EducationEconomic services Other current Capital
Subsidies
16
Asian Food and Fuel Subsidy Programs
% of GDP Total Subsidy% of Total
Expenditure Fuel FoodPRC 1.9 9.5 1.5 0.4India 4.1 - 1.6 2.5Indonesia 2.9 13.7 2.7 0.2Korea 0.4 1.5 0.4 0.0Malaysia 3.3 13.0 2.6 0.7Philippines 3.6 4.3 0.2 3.4Taipei,China 1.3 6.8 1.3 0.0Thailand 0.9 2.5 0.8 0.1Source: CEIC Database Co., UOB.
3. Fiscal expenditure issues
17
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Transport Electricity ICT Water and sanitation
Estimated infrastructure investment needs in emerging Asia
(annual average during 2010-20, % of GDP)
Source: Bhattacharyay (2012).
Actual infrastructure investment levels diverge widely within Asia
18
Infrastructure investment, % of GDP0–4% 4–7% More than 7%Cambodia Lao PDR PRCIndonesia Mongolia ThailandPhilippines India Viet NamSources: ADB, JBIC, World Bank (2005), FICCI (2012)Note: GDP means gross domestic product.
Dependency ratios (age 65+/age 15-64)—highest in the NIEs, Thailand, PRC
19
Sources: World Population Prospects: The 2010 Revision of the United Nations Population Division, available at: http://data.un.org/Data.aspx?q=dependency+ratio&d=PopDiv&f=variableID%3a44 and Council for economic planning and development (Chinese Taipei), available at: http://www.cepd.gov.tw/encontent/m1.aspx?sNo=0001457, accessed 28.12.2012
0
10
20
30
40
50
60
70
1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
PRC
Hong Kong
India
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Chinese Taipei
Viet Nam
20 Source: ADB (2011) and World Population Prospects: The 2012 Revision of the United Nations Population Division. CEIC data.
Spending on social protection (% of GDP) rises with income & old-age dependency
Social insurance benefits (% of GDP) rise with per capita income and old-age
dependency
21
Coefficient t-statistics p-valueConstant -7.85*** -3.28 0.003Old-age dependency 0.36** 2.72 0.011GDP per Capita (Log) 1.83** 2.13 0.042Socialist Dummy 1.76 1.62 0.116Number of obsF( 2, 29)Prob > FR-squaredSource: Authors' estimates.
3214.980.00000.6915
4. Fiscal sustainability challenges
Public debt dynamics: dt – dt-1 = – bt + [(r – g)/(1 + g)] dt-1 where dt = public debt as a ratio of GDP bt = primary balance as a ratio of GDP r = nominal interest rate on public debt g = nominal GDP growth rate • To contain (and reduce) debt accumulation, the
primary balance needs to be in surplus and/or r < g Steady-state conditions: b* = [(r – g)/(1 + g)] d* • The primary balance needs to be in surplus if r >g 22
IMF fiscal sustainability analysis shows emerging Asia is generally in good
condition…
23
CAPB needed to stabilize
debt1
CAPB change, 2009–13
Further adjustment
needed
Progress through 2013
PRC -0.3 2.8 -1.1 2.0India 1.8 0.7 6.9 0.1Indonesia 0.2 -0.6 0.8 -3.2Korea -0.4 2.1 -4.4 2.0Malaysia 1.2 2.1 3.0 0.4Philippines -0.2 0.8 -0.8 2.0Thailand 1.4 -1.7 4.2 -0.7
1 The cyclically adjusted primary balance (CAPB) needed to stabilize debt is the CAPB required in 2020 to allow the debt-to-GDP ratio to return to 2011 levels by
Progress in Fiscal Consolidation through 2013 (% of GDP)
Benchmark: Adjustment to Stabilize Debt1
Source: IMF Fiscal Monitor, Oct. 2012.
But they still face long-term sustainability challenges
• Subsidies • Infrastructure investment • Tax revenue and collection • Social protection spending due to aging-
related and other social welfare benefit increases
• Contingent liabilities • Potential ending of interest rate repression
24
Balanced composition of tax revenues desirable
25 Source: World Bank World Development Indicators
Composition of Tax Revenue, % of total revenue, 2010
PRC 58.9 24.6 3.7 1.2 10.5Hong Kong, China 8.5 35.8 0.4 16.1 13.5India 23.3 47.0 12.8 0.1 9.7Indonesia 29.4 36.5 4.8 4.1 10.9Japan 34.4 39.9 1.4 4.1 16.8Korea 26.7 28.1 4.0 8.0 15.1Malaysia 16.7 45.6 4.1 3.9 13.8Philippines 26.8 42.1 19.5 -- 12.3Singapore 25.3 34.4 -- 17.4 14.1Thailand 39.4 38.0 4.4 0.6 17.6
Source: World Bank WDI, available at: http://databank.worldbank.org/ddp/home.do?Step=1&id=4, accessed 15.01.2013, and OECD
Taxes on goods
and services
Taxes on income,
profits and
capital gains
Taxes on international trade Country
Other taxes
Tax revenue
(% of GDP)
Note: PRC, 2009; Philippines, Singapore and Thailand, 2011.
Social insurance spending (% of GDP) expected to rise substantially by 2030
26 Source: ADB (2011), authors’ estimates.
Estimate of PRC contingent liabilities PRC Government Liabilities, 2009 Category % of GDP Official government debt 17.7 Local government debt 25.5 Ministry of Railways liabilities 3.8 Total government debt 47.0 Commercial bank NPLs 4.0 Asset management company bonds 2.9 Policy bank bonds 13.3 PBOC bonds 12.4 Local investment company debt 33.5 Total contingent liabilities 66.1 Total government liabilities 113.1 Source: Based on Hemming (2012)
27
Potential ending of interest rate repression
• The interest rate gap tends to narrow as incomes rise, in line with greater financial liberalization and openness (Hong Kong and Singapore are major exceptions, though)
• A narrowing of the interest rate gap will make it more difficult for countries to “inflate away” their debt burdens, putting a greater burden on adjustment in the primary balance to achieve debt sustainability
• High holdings of government bonds by the banking sector could raise the risk of a “doom loop” of a sovereign debt and banking crisis
• This will require greater reliance on fiscal discipline, supported by fiscal rules
28
29 Source: IMF World Economic Outlook database, IMF Article IV reports
Interest rate repression tends to disappear with economic development
PRC also has very high bank holdings of government debt
30
Country Banks
Other domestic financial
institutionsGovern
mentCentral Banks
Foreign holdings Others
PRC 77.0 10.5 0.0 0.0 -- 13.3Indonesia 39.1 17.8 -- 0.6 29.6 42.7Japan 38.4 27.6 9.6 10.2 8.7 14.2Korea 18.8 43.3 23.2 2.8 10.0 31.2Malaysia 44.1 71.6 1.0 0.4 27.1 27.1Thailand 15.8 51.6 1.0 6.2 15.0 10.4
Share of Government Bond Holdings, %
Notes: the category "other domestic financial institutions" may also include Contractual Savings Institutions, such as insurance, pension and other funds institutions. Source: Asian Bonds On-line, available at: http://asianbondsonline.adb.org/regional.php, accessed 15.1.2013
Identification of countries with relatively high medium-term fiscal sustainability risk
31 Source: Authors
Subsidies Infrastructure
investment needs
Aging & social
spending
Contingent liabilities
Interest rate repression
PRC ✓ ✓ ✓ Korea ✓ Singapore ✓ Chinese Taipei ✓ Mongolia ✓ Cambodia ✓ Indonesia ✓ ✓ ✓ ✓ Lao PDR ✓ Malaysia ✓ ✓ Myanmar ✓ Philippines ✓ ✓ Thailand ✓ ✓ Viet Nam ✓ ✓ ✓ India ✓ ✓ ✓ ✓ Bangladesh ✓ ✓ Nepal ✓ ✓ Pakistan ✓ ✓ Sri Lanka ✓ ✓
Some policy options to reduce medium-term fiscal risk
• Subsidies Phase out subsidies and replace with targeted cash transfer
programs
• Infrastructure investment Encourage PPP Manage contingent liabilities, e.g., loss-sharing
arrangements
• Aging and social spending increase Raise premiums, and ensure obligatory premium payments Cut benefits to high-income or wealthy individuals Reduce the replacement ratio and raise retirement age Taxation of benefits (if not done already) Shift from defined benefits to defined contributions Make health beneficiaries share more costs
32
5. Framework for fiscal and debt management
• Coordinated, well-defined and distinct roles should be set for central and local governments, state-owned commercial banks and state-owned enterprises Clear rules for funding of infrastructure projects Avoid use of commercial banks for fiscal policy purposes
• Establishment of fiscal rules • Debt management office • Strengthening of fiscal surveillance
National level: Finance ministry, central bank, financial supervisors
Regional level: AMRO, ADB, IMF 33
Role of fiscal rules in Asia
34
Economy Expenditure rule
Revenue rule
Budget balance
rule
Debt rule Key elements of fiscal rules
Armenia ✓ Public debt may not exceed 60 percent of GDP. Hong Kong ✓ The budget should always display an operating surplus, i.e. an
excess recurrent revenue over recurrent expenditure. India ✓ * Originally the target was to reduce the fiscal deficit to 3 percent of
GDP by 2008. The escape clause in the fiscal rule law (FRBMA) allows the government not to comply with the targets in exceptional circumstances "as the central government may specify."
Indonesia ✓ ✓ DR (since 2004): Total central and local government debt should not exceed 60 percent of GDP. BBR: The consolidated national and local government budget deficit is limited to 3 percent of GDP in any given year.
Japan ✓
✓ ER: “Overall Expenditure Limit”: the amount of the General Account Expenditure, excluding debt repayment and interest payment, should not exceed that of the previous fiscal year. BBR: "Pay-as-you go" rule: any measure that involves increases in expenditure or decreases in revenue need to be compensated by permanent reductions in expenditures or permanent revenue-raising measures.
Pakistan ✓ ✓ BBR: Balanced (current) budget by 2008 and surplus thereafter. DR: Debt-to-GDP ratio to be reduced to 60 percent by 2013, by reducing public debt by no less than 2.5 percent of GDP per year.
Sri Lanka ✓ ✓ BBR: Deficit targets over a multiyear horizon. DR: Falling debt ceilings over a multiyear horizon.
Note. *Implemented by Indian Government until 2008. Source: Budina, Kinda, Schaechter and Weber (2012).
Role of debt management offices in emerging Asia
35
CountryIndonesia
Thailand
Objectives
Sources: Ministry of Finance of the Republic of Indonesia. The presentation of Mr. WidjanarkoDirector, Directorate General of Debt Management on 8th UNCTAD Debt Management ConferenceGeneva, 14 - 16 November 2011 and Public Debt Management Office of Thailand, available at: http://www.pdmo.go.th/en/about.php?m=about
1. Manage public debt to achieve low costs subject to acceptable risks (Strategy 1) 2. Develop the domestic bond market to be one of the three main pillars of the financial market (Strategy 2) 3. Evaluate and mobilize feasible funds to finance government’s infrastructure products (Strategy 3) 4. Modernize Technology to support PDMO’s operations (Strategy 4)
1. To establish government debt portfolio management in an effective, transparent and accountable manner 2. To control debt issuance and procurement by maintain a borrowing capacity that supports fiscal sustainability 3. To establish development financing independence by prioritizing domestic financing sources and developing an efficient and stable domestic market 4. To establish international cooperation in obtaining alternative financing sources as well as supporting regional financial market stability
Objectives of the Public Debt Management Offices
Fiscal (compact) indicators for Asia
36
Economy
General government gross debt
General government
fiscal balance
CPI inflation Rate
Interest rate on time deposits,
12 Months
Lending rate
% of GDP % of GDP % change % % Armenia 40.5 1.0 5.8 11.7 16.0 Bangladesh 34.7 -3.3 7.5 11.2 13.0 Cambodia 28.7 -1.8 3.0 1.3 … PRC 39.4 -1.7* 2.6 3.0 6.0 Georgia 32.2 -2.1 -0.5 9.7 13.6 Hong Kong 7.0 0.6 4.3 0.0 5.0 India 65.5 -4.6 10.0 … 10.3 Indonesia 24.9 -2.3 6.4 6.3 11.7 Japan 242.6 -8.0* 0.4 0.1 1.3 Kazakhstan 12.9 -2.1 5.8 3.2 … Korea 33.9 1.0 1.3 2.9 4.6 Kyrgyz Republic 46.1 -0.7 6.6 4.9 16.3 Lao PDR 60.1 -5.6 6.4 … … Malaysia 57.7 -3.9 2.1 4.6 3.0 Mongolia 67.3 -1.7 8.6 12.0 18.5 Myanmar 40.8 -4.9 5.7 8.0 13.0 Nepal 31.2 -1.9 9.9 … … Pakistan 64.3 -4.2 7.4 7.2 … Philippines 39.1 -1.4 2.9 1.7 5.8 Singapore 102.1 8.7* 2.4 0.1 5.4 Sri Lanka 78.3 -5.9 6.9 10.2 12.6 Chinese Taipei 39.1 -2.9* 0.8 15.7 … Tajikistan 29.2 -4.8 5.0 6.6 24.3 Thailand 45.9 -1.8 2.2 2.9 7.0 Viet Nam 52.1 -4.7 6.6 7.1 10.4
Notes: Public sector debt refers to consolidated government debt except for Indonesia and Korea, while the Philippines refers to nonfinancial public sector debt. * figures are from year 2012.
Sources: IMF, WEO and International Financial Statistics; ADB, Key Indicators.
6. Conclusions • Fiscal sustainability conditions in Asia, excluding
Japan, are generally benign—only India among major countries has a debt-to-GDP ratio above 60%
• But, future developments may undermine this rosy picture: Indonesia, India, Malaysia and Philippines have high levels
of subsidy Asian NIEs and (to a lesser extent) Thailand and PRC face
aging populations and rising social spending pressure India, Indonesia, Philippines Mongolia and Lao PDR face
rising pressures on greater infrastructure investment PRC has large contingent liabilities PRC, India, Indonesia, Viet Nam and Thailand have high
levels of interest rate repression that may not continue PRC has very high bank holdings of government debt 37
Conclusions (cont’d) • Ways to reduce medium-term fiscal sustainability risk:
Replace subsidies with targeted cash transfer programs Contain social protection program costs and raising
premiums to provide adequate funding Promote financial development to widen channels of funding
for infrastructure investment, including PPP financing Deal with contingent liabilities in a more transparent way
and avoid use of commercial banks for fiscal stimulus Establish a rational framework for allocating expenditures Secure more balanced sources of direct & indirect revenue,
with stronger tax base and collection Adopt responsible and realistic fiscal rules Establish a debt management office Strengthen fiscal surveillance by national as well as regional
and global bodies 38
Thank you For more information:
Masahiro Kawai, PhD Professor, Graduate School of Public Policy,
University of Tokyo Peter J. Morgan, PhD
Senior Consultant for Research Asian Development Bank Institute