fiscal sustainability in developing asia

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 Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org/economics

©2010 by Asian Development BankJune 2010ISSN 1655-5252Publication Stock No.

The views expressed in this paperare those of the author(s) and do not!"#"$$%&'()*&"+"#,*,-"*.'"/$*0&*10('#'"$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 ,-0$"*2%#'!3*,-"*4$'%*%!5*6%#'7#*&"3'0!8*%$*/"((*%$*#0!#"1,9%(:*%!%(),'#%(:*0&*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 v

I. Introduction 1

II. Conceptual Review of Fiscal Sustainability 4

III. Fiscal Diagnostics: Evolution of Key Fiscal Indicators across Asia over Time 13

IV. Econometric Tests of Primary Fiscal Balance Response Functions 26

V. Fiscal Stimulus Scenarios 30

VI. Medium-Term Fiscal Policy Frameworks 32

VII. Concluding Observations 35

Selected References 38

Abstract

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

I. IntroductionH!*&"$10!$"*,0*,-"*1&0!09!#"5*'>1%#,*02*,-"*3(0<%(*7!%!#'%(*%!5*"#0!0>'#*#&'$'$*0!*,&%5"*%!5*3&0/,-:*/-'#-*&"%#-"5*',$*#('>%?*'!*,-"*$"#0!5*-%(2*02*IJJK*%!5*,-"*7&$,*-%(2*02*IJJL:*5"."(01'!3*4$'%*M-"!#"20&,-*4$'%N*-%$*<0(5():*5"#'$'."():*%!5*O9'#C()*9!("%$-"5*$'B%<("*7$#%(*$,'>9(9$*1%#C%3"$@1 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$586 or Yuan 4 trillion stimulus is the most -'3-()*19<('#'B"5*"?%>1("*02*4$'%A$*!"/G209!5*1"!#-%!,*20&*7$#%(*%#,'.'$>:*30."&!>"!,$*across the region have aggressively boosted expenditures and slashed taxes to support 3&0/,-*'!*,-"*/%C"*02*,-"*3(0<%(*#&'$'$@*4$'%A$*7$#%(*%#,'.'$>*&"1&"$"!,$*%!*9!1&"#"5"!,"5*response to an unprecedented crisis. Unprecedented because never before has there <""!*$9#-*%*$)$,">%,'#:*$)!#-&0!'B"5:*%!5*%#&0$$G,-"G<0%&5*7$#%(*"?1%!$'0!*"."!*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 #09!,"&#)#('#%(*7$#%(*10('#'"$*-%."*P/0&C"5Q*%!5*-"(1"5*,-"*&"3'0!*/"%,-"&*,-"*#&'$'$@*H,*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 '!*,-"*RS@*;-"*#0><'!%,'0!*02*,/0*$,&'C'!3*$,)('B"5*2%#,$*02*4$'%A$*10$,#&'$'$*"#0!0>'#*(%!5$#%1":*'@"@:*9!"?1"#,"5()*&0<9$,*&"#0."&)*%!5*&"3'0!/'5"*7$#%(*"?1%!$'0!:*-%."*("5*>%!)*,0*%,,&'<9,"*,-"*&"#0."&)*,0*,-"*7$#%(*"?1%!$'0!:*%(>0$,*<)*5"2%9(,@*H,*'$*,&9"*,-%,*governments across the region have also pursued monetary expansion, but the impact 02*>0!",%&)*10('#)*'$*("$$*'>>"5'%,"*%!5*5'&"#,*,-%!*,-%,*02*7$#%(*10('#):*"$1"#'%(()*30."&!>"!,*$1"!5'!3@*T9&,-"&>0&":*',*'$*9!#"&,%'!*-0/*7&>$*%!5*#0!$9>"&$*&"$10!5*,0*(0/"&*'!,"&"$,*&%,"$*'!*%*$,%,"*02*5"1&"$$"5*#0!75"!#":*/-'#-*#-%&%#,"&'B"$*#&'$'$*1"&'05$@*H,*'$*1&">%,9&"*,0*3%93"*,-"*"?%#,*#0!,&'<9,'0!*02*,-"*7$#%(*$,'>9(9$*,0*4$'%A$*&"#0."&):*and there were clearly a number of other contributory factors, including the relatively -"%(,-)*$,%,"*02*,-"*&"3'0!A$*7!%!#'%(*$)$,">$@*F"."&,-"("$$:*,-"&"*'$*%*1019(%&*1"&#"1,'0!*,-%,*,-"*&"3'0!A$*7$#%(*$,'>9(9$*>%5"*%*.',%(*#0!,&'<9,'0!*,0*,-"*&"3'0!A$*&"#0."&)@

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 Paci!c, Southeast Asia, and South Asia.

U"3%&5("$$*02*,-"*%#,9%(*#0!,&'<9,'0!*02*,-"*7$#%(*$,'>9(9$*,0*4$'%A$*&"#0."&):*,-"*&"3'0!/'5"*9$"*02*#09!,"&#)#('#%(*7$#%(*10('#'"$*<&'!3$*,0*,-"*20&"*,-"*'$$9"*02*4$'%A$*7$#%(*sustainability.2 There are both backward and forward looking reasons for why taking stock 02*,-"*&"3'0!A$*7$#%(*$9$,%'!%<'(',)*'$*%*,'>"()*%!5*0110&,9!"*"?"&#'$"*%,*,-'$*10'!,*'!*,'>"@*4##0&5'!3*,0*#0!."!,'0!%(*/'$50>:*/-%,*"!%<("5*4$'%*,0*&0((*09,*(%&3"*7$#%(*$,'>9(9$*1&03&%>$*$0*O9'#C()*%!5*5"#'$'."()*/%$*,-%,*',$*19<('#*7!%!#"$*/"&"*3"!"&%(()*'!*3005*shape when the global crisis erupted. In particular, its strong initial public debt positions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oing so would give us a better idea of the extent to which the conventional wisdom of %*7$#%(()*&"$10!$'<("*&"3'0!*'$*=9$,'7"5@*Y9#-*%!*%!%()$'$*/09(5*%($0*%((0/*9$*,0*'5"!,'2)*differences across subregions and countries. An analysis of how countries have adjusted ,-"'&*7$#%(*<%(%!#"$*'!*&"$10!$"*,0*&'$'!3*5"<,*("."($*'!*,-"*1%$,*/'((*1&0.'5"*29&,-"&*".'5"!#"*0!*,-"*P7$#%(()*&"$10!$'<("*4$'%Q*-)10,-"$'$@*;0*,-"*"?,"!,*,-%,*/"*7!5*">1'&'#%(*$9110&,*20&*,-"*-)10,-"$'$:*/"*/'((*-%."*3&"%,"&*#0!75"!#"*,-%,*4$'%*/'((*,%C"*"22"#,'."*>"%$9&"$*,0*!0&>%('B"*19<('#*7!%!#"$*%$*,-"*/0&(5*"#0!0>)*&",9&!$*,0*!0&>%(*>05"@

R0'!3*20&/%&5:*4$'%A$*7$#%(*$9$,%'!%<'(',)*>%,,"&$*20&*%*!9><"&*02*&"%$0!$@*T0&*0!":*&"3%&5("$$*02*,-"*.%('5',)*02*,-"*1019(%&*<"('"2*,-%,*,-"*&"3'0!A$*7$#%(*$,'>9(9$*>%5"*%*<'3*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 >0&"*/0&&)'!3():*,-"&"*'$*%*&'$C*,-%,*,-"*$'B%<("*5","&'0&%,'0!*02*,-"*7$#%(*<%(%!#"*%$*%*&"$9(,*02*,-"*%!,'#&'$'$*7$#%(*$,'>9(9$*1%#C%3"$*/'((*!0,*<"*29(()*&"."&$"5*"."!*%2,"&*,-"*global crisis recedes and normalcy returns. From a broader perspective, the biggest risk '$*,-%,*,-"*&"3'0!A$*%!,'#&'$'$*7$#%(*$,'>9(9$*>'3-,*,9&!*09,*,0*<"*%*P3%>"*#-%!3"&Q*,-%,*29!5%>"!,%(()*%(,"&$*,-"*&"3'0!A$*#0!$"&.%,'."*7$#%(*1-'(0$01-)*%!5*09,(00C@*T0&*,-"*>0$,*1%&,:*,-"*&"3'0!A$*7$#%(*10('#)*-%$*<""!*3"%&"5*,0/%&5*1&0.'5'!3*3&0/,-G#0!59#'."*public goods such as infrastructure and education within the government’s budget #0!$,&%'!,@*;-"*3"!"&%(*%."&$'0!*,0*(%&3"*%!5*1"&$'$,"!,*<953",*5"7#',$*/%$*&00,"5*'!*the region’s high premium on macroeconomic stability. The only persistent exception to 4$'%A$*3"!"&%(()*<"!'3!*7$#%(*$',9%,'0!*/%$*Y09,-*4$'%@*4*29&,-"&*2%#,0&*,-%,*('>',"5*<953",*5"7#',$*-%$*<""!*,-"*&"3'0!A$*3"!"&%(*&"(9#,%!#"*,0*19&$9"*#09!,"&#)#('#%(*7$#%(*10('#)*,0*$,%<'('B"*09,19,@*T0&*"?%>1(":*%9,0>%,'#*7$#%(*$,%<'('B"&$*$9#-*%$*9!">1(0)>"!,*<"!"7,$*remain underdeveloped in the region.

2 As discussed below, !scal sustainability refers to whether government budgets can be smoothly !nanced without generating explosive increases in public debt. A sustainable !scal policy is not necessarily an optimal !scal policy but optimal !scal policies will need to be sustainable (Horne 1991).

2 | ADB Economics Working Paper Series No. 205

H!,"&!%,'0!%(*"?1"&'"!#"*'!20&>$*9$*,-%,*10(','#%(*"#0!0>)*2%#,0&$*>%C"*',*5'27#9(,*,0*&"."&$"*7$#%(*"?1%!$'0!*9!5"&,%C"!*59&'!3*<9$'!"$$*#)#("*50/!,9&!$*/-"!*,-"*#)#("*moves up again. This can lead to a ratcheting up of public spending and debt over time. For example, political opposition may stymie the reversal of tax cuts implemented during a recession even though the economy may have come out of the recession. Similarly, the "?1%!$'0!*02*$0#'%(*/"(2%&"*<"!"7,$*59&'!3*50/!$/'!3$*>%)*<"*5'27#9(,*,0*&0((*<%#C*/-"!*the economy recovers. At a broader level, intuitively, it is politically easier for governments to increase spending and cut taxes during recessions than to cut spending and increase ,%?"$*59&'!3*<00>$@*;-'$*3'."$*#09!,"&#)#('#%(*7$#%(*10('#)*%!*'!-"&"!,*$,&9#,9&%(*<'%$*toward higher public spending and debt over time. From Asia’s viewpoint, the popular 1"&#"1,'0!*,-%,*7$#%(*$,'>9(9$*1%#C%3"$*%&"*"22"#,'."*'!*1&0>0,'!3*&"#0."&)*>%)*("%5*,0*7$#%(*%#,'.'$>*'!*3"!"&%(*%2,"&*!0&>%(#)*&",9&!$@*;-%,*'$:*"."!*,-093-*,-"*7$#%(*stimulus packages were an exceptional response to an exceptional crisis, their perceived "22"#,'."!"$$*>%)*1&0.0C"*1019(%&*#%(($*20&*#09!,"&#)#('#%(*7$#%(*%#,'.'$>*59&'!3*!0!#&'$'$*periods.

H!*%55','0!*,0*,-"*5'&"#,*"22"#,*02*,-"*%!,'#&'$'$*7$#%(*$,'>9(9$*%!5*%*P3%>"G#-%!3'!3Q*$-'2,*'!*,-"*&"3'0!A$*7$#%(*1-'(0$01-):*,-"&"*%&"*%*!9><"&*02*0,-"&*$,&9#,9&%(*2%#,0&$*,-%,*'>1()*%*10,"!,'%(()*(%&3"*'!#&"%$"*'!*,-"*&"3'0!A$*5">%!5*20&*7$#%(*&"$09&#"$*'!*,-"*>"5'9>*term. One is population aging, a seismic demographic transition fundamentally reshaping 4$'%A$*5">03&%1-'#*1&07("@*D-'("*,-"&"*%&"*5'22"&"!#"$*%#&0$$*$9<&"3'0!$Z,-"*,&%!$','0!*toward older populations is much more advanced in East and Southeast Asia than in Y09,-*4$'%Z%((*5">03&%1-'#*'!5'#%,0&$*10'!,*,0*%*2%$,G%3'!3*4$'%@*[9'(5'!3*91*>%,9&":*/"((G29!#,'0!'!3*1"!$'0!*$)$,">$*/'((*&"O9'&"*%*$9<$,%!,'%(*%>09!,*02*7$#%(*&"$09&#"$@*Another structural force is rebalancing the region’s growth toward domestic demand, %!*'$$9"*"?1(0&"5*'!*3&"%,*5",%'(*'!*4\[*MIJJL<N@*;-"*'>1%#,*02*7$#%(*10('#)*0!*,-"*&"<%(%!#'!3*1&0#"$$*/'((*<"*5","&>'!"5*<)*,-"*"22"#,'."!"$$*02*$1"#'7#*>'#&0"#0!0>'#*7$#%(*>"%$9&"$*$9#-*%$*$,&"!3,-"!'!3*-"%(,-:*"59#%,'0!:*1"!$'0!:*%!5*$0#'%(*1&0,"#,'0!@*Such measures can promote domestic consumption and hence domestic demand by 5'(9,'!3*,-"*1&"#%9,'0!%&)*>0,'."*20&*$%.'!3@*4*$911()G$'5"*"?%>1("*'$*&">0.'!3*7$#%(*incentives that favor export production (e.g., manufacturing), over production for the 50>"$,'#*>%&C",*M"@3@:*$"&.'#"$N@*H!*1&'!#'1(":*$9#-*1&0G<%(%!#'!3*7$#%(*>"%$9&"$*!""5*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, small-30."&!>"!,*10('#)*"!.'&0!>"!,*,-%,*#-%&%#,"&'B"$*,-"*&"3'0!:*',*'$*('C"()*,-%,*'>1(">"!,'!3*such measures will require moderate expansion.

;-"&"*%&"*%($0*,/0*10('#)G&"(%,"5*&"%$0!$*/-)*4$'%A$*7$#%(*$9$,%'!%<'(',)*>%,,"&$:*%!5*matters a whole lot, at this point in time. One is immediate and concerns an exit strategy, 0&*,-"*'$$9"*02*/-"!*%!5*-0/*,0*9!/'!5*,-"*&"3'0!A$*%!,'#&'$'$*7$#%(*$,'>9(9$*1%#C%3"$@*;-"&"*'$*%*5"('#%,"*<%(%!#"*<",/""!*"?','!3*P,00*$00!:*,00*O9'#C()Q*%!5*P,00*(%,":*,00*$(0/()Q:*/',-*<0,-*"!,%'('!3*$9<$,%!,'%(*#0$,$@*H!*,-"*#%$"*02*4$'%:*,-"&"*'$*%*&'$C*,-%,*,-"*&"3'0!A$*&"(%,'."()*-"%(,-)*19<('#*7!%!#"$*>%)*(9((*10('#)>%C"&$*'!,0*50/!1(%)'!3*,-"*."&)*

Fiscal Sustainability in Developing Asia | 3

&"%(*#0$,$*02*"?','!3*P,00*(%,":*,00*$(0/()Q@*4,*%*>'!'>9>:*09&*"?%>'!%,'0!*02*,-"*&"3'0!A$*7$#%(*$9$,%'!%<'(',)*/'((*&">'!5*10('#)>%C"&$*%<09,*,-0$"*#0$,$*%!5*"!#09&%3"*,-">*,0*factor them in more explicitly into their policymaking calculus. The second policy-related >0,'."*20&*09&*%!%()$'$*'$*&"(%,"5*,0*,-"*7&$,:*%!5*',*'$*,0*%("&,*,-"*&"3'0!A$*10('#)>%C"&$*,0*,-"*!""5*20&*$,&0!3*>"5'9>G,"&>*7$#%(*10('#)*2&%>"/0&C$*,-%,*1&0>0,"*7$#%(*$9$,%'!%<'(',)*'!*,-"*>"5'9>*%!5*(0!3*&9!@*;-"*>"5'9>G,"&>*'>1%#,*02*,-"*%!,'#&'$'$*7$#%(*$,'>9(9$*1%#C%3"$:*%(0!3*/',-*!"/*7$#%(*5">%!5$*,-%,*%&"*"?1"#,"5*,0*%&'$"*'!*,-"*>"5'9>*,"&>:*make it imperative for regional policymakers to actively explore effective and credible medium-term policy frameworks. Regardless of the exact timing and nature of exit from ,-"*#9&&"!,*7$#%(*$,'>9(9$:*$9#-*2&%>"/0&C$*/'((*%($0*%$$9%3"*,-"*19<('#A$*#0!#"&!$*%<09,*,-"*,-&"%,*,0*(0!3G,"&>*7$#%(*$9$,%'!%<'(',)*10$"5*<)*,-"*$,'>9(9$@

;-"*&"$,*02*09&*1%1"&*'$*0&3%!'B"5*%$*20((0/$@*Y"#,'0!*HH*&".'"/$*,-"*#0!#"1,$*02*$,%,'#*%!5*5)!%>'#*7$#%(*$9$,%'!%<'(',)*%!5*$0>"*%(,"&!%,'."*%11&0%#-"$*,0*,-"'&*%$$"$$>"!,@*Y"#,'0!*HHH*#0!$'5"&$*,-"*C")*5'>"!$'0!$*02*,-"*19<('#*7!%!#"$*%#&0$$*5"."(01'!3*4$'%:*20#9$'!3*'!*1%&,'#9(%&*0!*7$#%(*<%(%!#"$:*30."&!>"!,*$1"!5'!3:*%!5*&"."!9"$:*%$*/"((*%$*levels of public debt. Section IV discusses the results from a number of econometric tests 02*7$#%(*$9$,%'!%<'(',)*<%$"5*0!*1%!"(*&"3&"$$'0!*,"#-!'O9"$:*%!5*1&"$"!,$*"$,'>%,"$*02*7$#%(*10('#)*&"$10!$"*29!#,'0!$*,0*'!."$,'3%,"*,-"*&"$10!$"$*02*1&'>%&)*7$#%(*<%(%!#"$*,0*changes in debt ratios. Section V presents three alternative scenarios or stress tests of ,-"*10,"!,'%(()*%5."&$"*'>1('#%,'0!$*20&*7$#%(*$9$,%'!%<'(',)*'2*#09!,&'"$*/"&"*,0*10$,10!"*for too long the reversal of recent stimulus packages or adjust in too timid a manner. Y"#,'0!*]H*5'$#9$$"$*,-"*&0("*&0<9$,*>"5'9>G,"&>*7$#%(*10('#)*2&%>"/0&C$*>'3-,*1(%)*'!*-"(1'!3*4$'%*%,,%'!*%!5*>%'!,%'!*7$#%(*$9$,%'!%<'(',)*'!*,-"*10$,#&'$'$*1"&'05@*T'!%(():*Y"#,'0!*]HH*#0!#(95"$*/',-*%!*0."&.'"/*02*,-"*>%'!*7!5'!3$*02*09&*1%1"&:*%(0!3*/',-*,-"*10('#)*'>1('#%,'0!$*02*,-0$"*7!5'!3$@

II. Conceptual Review of Fiscal SustainabilityT'$#%(*$9$,%'!%<'(',)*'$*,-"*$,%,"*/-"&"'!*,-"*30."&!>"!,*<953",*#%!*<"*$>00,-()*7!%!#"5*without generating explosive increases in public debt (or money supply3) over time. When this condition is met, the budget is said to be sustainable and, conversely, when the condition is not met.4 In some contexts, it is useful to draw an explicit distinction <",/""!*$,%,'#*7$#%(*$9$,%'!%<'(',)*M/-"!*,-"*<953",*#%!*<"*7!%!#"5*$>00,-()*1"&'05*<)*1"&'05N*%!5*5)!%>'#*7$#%(*$9$,%'!%<'(',)*M/-"!*,-"*<953",*50"$*!0,*("%5*0."&*,'>"*3 In what follows, we abstract from monetary !nancing, 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 !nance !scal de!cits and have adopted in"ation targeting frameworks, implying that low and stable in"ation are the key objective of monetary policy. See BIS (2006).

4 Note that !scal sustainability is di#erent from external sustainability. Whereas !scal sustainability covers the government budget, external sustainability deals with whether the balance of payments can be smoothly !nanced without explosive increases in external debt. See Chalk and Hemming (2000) and IMF (2003) for further discussion.


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 5)!%>'#*$9$,%'!%<'(',)*'$*#0!#"&!"5*/',-*."&)*(0!3G,"&>*7$#%(*$0(."!#)@5 Both static %!5*5)!%>'#*7$#%(*$9$,%'!%<'(',)*%&"*'>10&,%!,:*%!5*,-&"%,$*,0*"',-"&*0&*<0,-*#%!*-%."*'>1('#%,'0!$*20&*>%#&0"#0!0>'#*%!5*7!%!#'%(*$,%<'(',)@6

V."!*,-093-*7$#%(*$9$,%'!%<'(',)*'$*3"!"&%(()*&"3%&5"5*%$*."&)*'>10&,%!,:*,-"&"*'$*!0*universal agreement about how it should best be assessed. Various approaches to %$$"$$'!3*7$#%(*$9$,%'!%<'(',)*-%."*<""!*9$"5:*%!5*',*'$*9$"29(*,0*#0!$'5"&*$0>"*02*the key approaches. For illustrative purposes, equation (1) describes the (ex ante) government7 budget constraint under the assumption that all government spending (including gross interest payments) is included in government expenditure (G); and that all government receipts8 are included in revenues (Z). Abstracting from central <%!C*7!%!#'!3:L equation (1) implies that differences between government revenues %!5*"?1"!5',9&"$*'!*%!)*1"&'05*M,-"*<953",*$9&1(9$N*/'((*<"*&"+"#,"5*'!*#-%!3"$*'!*,-"*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 0!*19<('#*5"<,*2&0>*%((*0,-"&*30."&!>"!,*"?1"!5',9&"*%!5*5"7!"*Y*%$*,-"*1&'>%&)*M0&*nondebt-interest-related) budget surplus.11 With R as the one-period nominal interest rate factor,12*"O9%,'0!*M^N*#%!*<"*/&',,"!*%$*20((0/$*/-"&"*YM,N:*,-"*1&'>%&)*7$#%(*$9&1(9$:*'$*5"7!"5*%$*_M,N*`*RaM,N*/',-*RaM,N*5"!0,'!3*1&'>%&)*30."&!>"!,*$1"!5'!3@

B(t+1) = R B(t) – S(t) t= 1,2, 3,………..N (2)

5 At a fundamental level, the distinction has to do with the di#erence between illiquidity and insolvency (see Horne 1991, Blanchard et al. 1990, Bohn 1995).

6 Financial stability can be threatened directly in circumstances, such as in much of Asia, where local banking systems hold substantial amounts of public debt. Asian bond markets and bank exposure to public debt are regularly assessed in the Asia Bond Monitor of the ADB.

7 As argued in the next section, !scal policy can be assessed for various levels of government or for the public sector as a whole. In the case of countries with signi!cant state-owned enterprises or government linked companies, the lines between the “private” and “public” sectors can be di$cult to draw and may be changing over time under reform programs.

8 These would include tax and nontax revenues and, in the case of governments with asset holdings, the income on those assets.

9 In any period, some part of government spending may be !nanced by the central bank acquiring public debt on the primary or secondary market. Such implicit monetization is netted out of equation (1) and is generally small in the region.

10 Public debt refers, in general, to outstanding government borrowing, which is assumed for illustrative purposes to take the form of bonds rather than bank loans.

11 Here, and in what follows, we abstract from any assets held by the government, and we do not distinguish between gross and net debt.

12 That is to say, R is 1 plus the nominal interest rate.


According to equation (2), the dynamics of public debt are linked to the interest rate on 19<('#*5"<,*%!5*,-"*$'B"*02*,-"*1&'>%&)*$9&1(9$*MYN@*H!*#'&#9>$,%!#"$*/-"!*,-"*1&'>%&)*<%(%!#"*'$*B"&0:*,-"*"O9%,'0!*'>1('"$*,-%,*,-"*19<('#*5"<,*/'((*3&0/*%,*,-"*M!0>'!%(N*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 5"<,*'!*&"(%,'0!*,0*3&0$$*50>"$,'#*1&059#,*MR\6N*/'((*%($0*<"*'!+9"!#"5*<)*/-",-"&*,-"*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

B t R t t j S t j R t t T B t Tj T( ) ( , ) ( ) lim ( , ) ( , )= + + + + +=

! "

#!

"$ 01 1 1 (3)

Here, B (t, T+1) is the terminal or very long-term debt stock and R(t, t+j) is the discount

2%#,0&*<",/""!*1"&'05*,*%!5*1"&'05*,b*=:*/-'#-*'$*5"7!"5*%$* k

j

t kR=

+0

% . Generally, dynamic 7$#%(*$9$,%'!%<'(',)*'$*,%C"!*,0*&"O9'&"*,-%,*,-" terminal debt stock (discounted at a 10$','."*'!,"&"$,*&%,"N*%11&0%#-*B"&0*%$*;*%11&0%#-"$*'!7!',):*/-'#-*#%!*<"*&"3%&5"5*%$*&9('!3*09,*P60!B'GX%5022Q*$#-">"$*'!*/-'#-*!"/*5"<,*"?1(05"$*0&*'$*&0(("5*0."&*'!5"7!',"()@14 With this condition imposed, the interpretation of equation (3) is that the 7$#%(*$',9%,'0!*'$*"?*%!,"*M5)!%>'#%(()N*$9$,%'!%<("*'2*,-"*1&"$"!,*.%(9"*02*%((*1&'>%&)*surpluses matches the value of the current debt stock. Alternatively, if the current debt $,0#C*'$*B"&0:*,-"*&"O9'&">"!,*20&*7$#%(*$9$,%'!%<'(',)*'$*,-%,*,-"*1&"$"!,*.%(9"*02*%((*(noninterest or primary) government expenditures should match the present value of all government revenues as given by equation (4).

R t t j G t j R t t j Z t jj j

( , ) ( ) ( , ) ( )+ + = + +"

=

!"

=

!

& &1

0

1

0 (4)

[)*.'&,9"*02*',$*5"1"!5"!#"*0!*,-"*<"-%.'0&*02*19<('#*5"<,*0."&*%!*'!7!',"*,'>"*1"&'05:*7$#%(*$9$,%'!%<'(',)*'$*%*$0>"/-%,*%<$,&%#,*#0!5','0!@*4$*!0,"5*<"(0/:*10('#)G<%$"5*%$$"$$>"!,$*02*7$#%(*$9$,%'!%<'(',)*'!.%&'%<()*5"%(*/',-*,-"*<"-%.'0&*02*5"<,*0."&*$-0&,G*to medium-term time periods and are guided, in varying degrees, by the very long-term considerations underpinning the abovementioned terminal condition. Notwithstanding these considerations, however, budget constraint equations such as given by equations MSN*%!5*McN*>%C"*#("%&*,-%,*,-"*7$#%(*$,'>9(9$*'!,&059#"5*59&'!3*,-"*3(0<%(*$(0/50/!*/'((*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 !nite horizon of 3–5 years (see below).


"?1"!5',9&"$@*;-'$*'$*%*#0!$"O9"!#"*02*,-"*P!0*2&""*(9!#-Q*#0!5','0!*'>1('"5*<)*5)!%>'#*7$#%(*$9$,%'!%<'(',)*%!5*,-"*10$','."*5'$#09!,*2%#,0&*MUN*9!5"&()'!3*,-"*%!%()$'$@15

;"$,'!3*/-",-"&*,-"*7$#%(*$9$,%'!%<'(',)*#0!5','0!*,-%,*,-"*M"?*%!,"N*30."&!>"!,*<953",*-0(5$*0."&*,'>"*'$*!0,*"%$)*,0*%11()*'!*1&%#,'#"@*F0,*0!()*'$*,-"&"*,-"*5'27#9(,)*,-%,*,-"*#0!$,&%'!,*-0(5$*0."&*%!*'!7!',"*M9!0<$"&.%<("N*,'>"*-0&'B0!:*<9,*,-"&"*%&"*%($0*5'27#9(,'"$*&"(%,"5*,0*,-"*2%#,*,-%,*,-"&"*%&"*2"/*,-"0&",'#%(*&"$,&'#,'0!$*0!*,-"*.%(9"$*of government spending and revenues. With the possible exception of some extreme boundary conditions, such as revenue should not exceed GDP, or that there be a certain minimum level of noninterest-related government spending, there are, in principle, an '!7!',"*!9><"&*02*/%)$*'!*/-'#-*,-"*$9$,%'!%<'(',)*#0!5','0!*>'3-,*<"*$%,'$7"5@16 Hence, 20&*"?%>1(":*'2*%*30."&!>"!,*/%$*#9&&"!,()*&9!!'!3*%*(%&3"*7$#%(*5"7#',*/',-*19<('#*5"<,*&'$'!3*$-%&1():*',*/09(5*<"*5'27#9(,*,0*#0!#(95"*,-%,*$9$,%'!%<'(',)*/%$*!"#"$$%&'()*.'0(%,"5@*;-'$*'$*<"#%9$"*,-"*30."&!>"!,*>%)*<"*1(%!!'!3*,0*#9,*$1"!5'!3*%!5*&9!*(%&3"*7$#%(*surpluses in the very distant future so as to satisfy the sustainability condition over time. 4!5:*%&39%<():*"."!*'!*,-"*>0$,*"?,&">"*#%$"$*02*7$#%(*"?,&%.%3%!#":*,-"&"*#09(5*%(/%)$*be some future level of government spending and taxes to ensure that conditions such as "O9%,'0!*MSN*%&"*$%,'$7"5@*

Based, inter alia, on these types of considerations, it is therefore frequently argued that 7$#%(*$9$,%'!%<'(',)*%!%()$'$*'$*>0&"*02*%!*P%&,Q*,-%!*%*P$#'"!#"Q@*Y9#-*%!%()$'$*5"%($*!0,*$0*>9#-*/',-*/-%,*#09(5*-%11"!*M'!#(95'!3*/-",-"&*,-"&"*>%)*<"*%*7$#%(*#&'$'$*'!*the event policy is not sustainable),17 as with what will happen based on factors such %$*1%$,*"?1"&'"!#"$*/',-*7$#%(*%5=9$,>"!,@*H!*,-"$"*#'&#9>$,%!#"$:*"$,'>%,"$*02*7$#%(*10('#)*&"%#,'0!$Z/-'#-*>"%$9&"*-0/*30."&!>"!,$*-%."*,&%5','0!%(()*&"$10!5"5*,0*&'$'!3*5"<,*("."($Z#%!*<"*'>10&,%!,*,00($*'!*%$$"$$'!3*,-"*1&0$1"#,$*20&*7$#%(*$9$,%'!%<'(',):*%$*discussed below.

4$$"$$>"!,$*02*7$#%(*$9$,%'!%<'(',)*-%."*,"!5"5*,0*%501,*0!"*0&*>0&"*02*%*!9><"&*02*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*M4\[*IJJL%N@*;-"*Asia Economic Monitor noted that ,-"&"*-%5*<""!*%*!9><"&*02*P2%'("5Q*19<('#*5"<,*%9#,'0!$*'!*,-"*#0!,"?,*02*$""C'!3*,0*7!%!#"*$0>"*02*,-"*7$#%(*$,'>9(9$*1%#C%3"$*'!*,-"*&"3'0!*'!*IJJL:*%!5*',*&".'"/"5*,-"*15 A little re"ection also makes clear why !scal 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 satis!ed 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 !scal 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 !scal 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 !scal sustainability need not necessarily lead to !scal crises as conventionally de!ned. Instead,

they might lead to debt monetization and in"ation, or to (formal or informal) debt restructuring. Moreover, the implications of unsustainable !scal policy would be expected to depend as well on whether there is an accompanying problem of external debt sustainability.


circumstances and implications of these failures. If the government is not able to sell (or &0((*0."&N*',$*19<('#*5"<,*%$*%*&"$9(,*02*P2%'("5Q*%9#,'0!$:*$,%,'#*7$#%(*$9$,%'!%<'(',)*/'((*<"*violated. The Asia Economic Monitor, however, did not judge this to be a major issue in the region during the global crisis.18

[&0%5():*,-&""*5'22"&"!,*$",$*02*%11&0%#-"$*,0*%$$"$$'!3*5)!%>'#*7$#%(*$9$,%'!%<'(',)*#%!*<"*'5"!,'7"5*M$""*[(%!#-%&5*",*%(@*^LLJ:*W"(9$9!*",*%(@*IJJdN@*E!"*%11&0%#-*'!.0(."$*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 $,0#C$*%&"*%$$"$$"5*M$"":*20&*"?%>1(":*;&"-%!*%!5*D%($-*^LKK*%!5*^LL^:*e%93*^LL^:*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.^L In line with some of the oldest approaches to assessing 7$#%(*$9$,%'!%<'(',)*M\0>%&*^LccN:*,-"$"*,"$,$*"22"#,'."()*#0!$'5"&*/-",-"&*19<('#*5"<,*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 "?1(0$'."*<"-%.'0&*,-%,*>'3-,*<"*"?1"#,"5*'!*,-"*"."!,*,-%,*7$#%(*10('#)*'$*9!$9$,%'!%<("@**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 >'3-,*<"*209!5*'!*,-"*#%$"*02*7$#%(*10('#)*<"'!3*9!$9$,%'!%<("*Me%>'(,0!*%!5*T(%.'!*^LKd:*e0&!"*^LL^:*W-%(C*%!5*e">>'!3*IJJJN@*H!*%55','0!:*,-"&"*%&"*,"$,$*02*,-"*#0'!,"3&%,'!3*relationships that would be expected to hold among various variables in the event that 7$#%(*10('#)*'$*$9$,%'!%<("*%$*3'."!*'!*"O9%,'0!*MSN@*;-"$"*,"$,$*'!.0(."*#0!$'5"&'!3*/-",-"&*#"&,%'!*7$#%(*.%&'%<("$*$9#-*%$*30."&!>"!,*$1"!5'!3*%!5*,%?"$*$-%&"*#0>>0!*$,0#-%$,'#*,&"!5$*#0!$'$,"!,*/',-*,-"*5)!%>'#*30."&!>"!,*<953",*#0!$,&%'!,*%!5*7$#%(*sustainability.

By their nature, time series tests are backward looking (in so far as they use historical 5%,%N*%!5*0!()*>"%$9&"*'!5'&"#,()*,-"*"?,"!,*,0*/-'#-*,-"*#0!5','0!$*20&*7$#%(*$9$,%'!%<'(',)*%&"*$%,'$7"5@*V?1('#',()*0&*'>1('#',():*,-"*%11&0%#-"$*%($0*%$$9>"*,-%,*,-"*5'$,%!,*29,9&"*/'((*P(00C*('C"Q*,-"*1%$,*%!5*,-%,*10('#'"$*,-%,*/"&"*$9$,%'!%<("*'!*,-"*1%$,*will continue to be sustainable in the future. In practice, the time series approaches to 7$#%(*$9$,%'!%<'(',)*-%."*!0,*<""!*."&)*#0>>0!*20&:*%,*("%$,:*,-&""*&"%$0!$@*T'&$,:*,-"$"*approaches typically require relatively long time series of data that are frequently not %.%'(%<("*'!*,-"*7$#%(*%&"%:*"$1"#'%(()*%$*&"3%&5$*19<('#*5"<,@20 Secondly, the power of unit root tests tends to be relatively low (especially in small samples) in distinguishing, '!*1%&,'#9(%&:*<",/""!*$',9%,'0!$*'!*/-'#-*7$#%(*10('#)*>%)*<"*#(0$"*,0*<"'!3*$9$,%'!%<("*%!5*/-"!*',*'$*9!$9$,%'!%<("@*4!5:*7!%(():*%$*%&39"5*<)*[0-!*M^LLf*%!5*^LLKN:*,-"*('!C$*18 Viet Nam, in particular, experienced some failed debt auctions but these were judged to have re"ected 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).


<",/""!*,-"$"*,"$,$*%!5*7$#%(*$9$,%'!%<'(',)*'$*!0,*!"#"$$%&'()*."&)*#(0$"*%!5*$0>"*<%$'#*time series tests do not fully exploit the implications of uncertainty in deriving appropriate ,"$,$*02*7$#%(*$9$,%'!%<'(',)@21

More fundamentally, a shortcoming of the time series approaches is that they do not "?1('#',()*'5"!,'2)*,-"*7$#%(*10('#)*&"%#,'0!*29!#,'0!$*,-%,*9!5"&('"*,-"*5%,%@*4$*%*&"$9(,:*,-")*50*!0,*$-"5*>9#-*('3-,*0!*,-"*C'!5$*02*7$#%(*10('#'"$*,-%,*>'3-,*5"('."&*$9$,%'!%<'(',):*or identify why sustainability may not have held in the past. The next two approaches 20#9$*5'&"#,()*0!*7$#%(*10('#)*<"-%.'0&*%$*&"+"#,"5*'!*,-"*1&'>%&)*7$#%(*<%(%!#"@

Another set of tests can be referred to primary balance tests as they involve estimating P5"#'$'0!*&9("$Q*20&*1&'>%&)*7$#%(*<%(%!#"$*%!5:*'!*1%&,'#9(%&:*20&*-0/*1&'>%&)*<%(%!#"$*&"$10!5*,0*#-%!3"$*'!*19<('#*5"<,*%!5*0,-"&*.%&'%<("$*M[0-!*^LLK:*W-%(C*%!5*e">>'!3*IJJJN@*;-"$"*,"$,$*%&"*%($0*<%#C/%&5*(00C'!3*'!*$0*2%&*%$*,-")*>05"(*7$#%(*5"#'$'0!*&9("$*based on past behavior. They have the desirable feature, however, in that they focus on 7$#%(*&"$10!$"$*%!5:*'!*1%&,'#9(%&:*0!*-0/*,-"*1&'>%&)*7$#%(*<%(%!#"*M%$*%*>"%$9&"*02*,-"*7$#%(*%5=9$,>"!,*"220&,N*'$*%5=9$,"5*%$*19<('#*5"<,*'!#&"%$"$@*H!,9','."():*,-"*<%$'$*20&*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 [0-!*M^LLKN*%!5*[%&,0('!'*%!5*W0,,%&"(('*M^LLcN*'!*/-'#-*"O9%,'0!*MSN*%<0."*'$*"22"#,'."()*replaced by equation (5):

B t E u c t j u c t S t E u c tj

j

T tT( ) ’( ( )) / ’( ( )) ( ) lim ’( (= + + + +

=

!

#!

+&0

11! ! jj U c t B t t+ + +1 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 $9<$,',9,'0!*'!*#0!$9>1,'0!*%11&0%#-"$*B"&0*%$*T # ! , which implies that equation (6) holds.

B t E u c t j u c t S tj

j( ) ’( ( )) / ’( ( )) ( )= + +=

!

&0

1! (6)

H,*'$*10$$'<(":*20((0/'!3*[0-!*M^LLfN:*,0*/&',"*,-"*&"(%,'0!$-'1*<",/""!*,-"*1&'>%&)*surplus and public debt in a simple linear based decision rule as in equation (7) below. In equation (7), lower case letters are used to denote the public debt (b) and primary surplus (s) as proportions of GDP, "*5"!0,"$*,">10&%&)*M$,%,'0!%&)N*'!+9"!#"$*0!*,-"*21 Bohn (1998), in particular, has argued that some of the time series tests may reject sustainability in circumstances

where !scal policy is sustainable.22 All expectations are conditional on information through the current period.


primary balance to GDP ratio,23 and #*'$*%*/-',"*!0'$"*"&&0&*,"&>@*;-"*#0"27#'"!,*$ measures the response of the primary balance to changes in the debt ratio while ! measures the response of the primary balance to the temporary factors included in ".24

s t b t t t( ) ( ) ( ) ( )= " + +% &µ '1 ' (' ( , )0 2 (7)

[0-!*M^LLKN*%&39"$*,-%,*%*$927#'"!,*#0!5','0!25*20&*7$#%(*10('#)*,0*<"*$9$,%'!%<("Z%!5*20&*"O9%,'0!*MdN*,0*-0(5Z'$*,-%,*$ 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 %11&0%#-"$*!"3%,'."*'!7!',)N:*$ should also be less than unity. Based on the estimation of "O9%,'0!$*$9#-*%$*MgN:*-)10,-"$"$*%<09,*,-"*$'3!*%!5*$'B"*02*$ can be tested statistically MW-%(C*%!5*e">>'!3*IJJJ:*[0-!*^LLf:*HXT*IJJS:*%!5*X"!50B%*%!5*E$,&)*IJJKN@*

VO9%,'0!*MgN*'$*,-"*C")*"O9%,'0!*20&*%$$"$$'!3*7$#%(*$9$,%'!%<'(',)*'!*,-'$*2&%>"/0&C*$'!#"*',*5","&>'!"$*/-",-"&*,-"*1&'>%&)*<%(%!#"*&"$10!5$*'!*%*$,%<'('B'!3*>%!!"&*,0*#-%!3"$*in the debt ratio. A value for the response parameter $*<",/""!*B"&0*%!5*9!',)*'>1('"$*,-%,*,-"*1&'>%&)*$9&1(9$*'!#&"%$"$*%$*,-"*5"<,*&%,'0*&'$"$:*/-'#-*'$*$927#'"!,*20&*5)!%>'#*sustainability. And the closer $*'$*,0*9!',):*,-"*(%&3"&:*0&*>0&"*20&#"29(:*'$*,-"*7$#%(*policy response to increases in the debt ratio. Conversely, if $*'$*B"&0*0&*!"3%,'.":*,-"*implication is that higher debt ratios lead either to no response of the primary surplus; or ,0*%*$>%(("&:*1&'>%&)*$9&1(9$@*H!*$9#-*#'&#9>$,%!#"$:*7$#%(*10('#)*>%)*<"*9!$9$,%'!%<("*if it leads to explosive public debt ratios.26 Based on this reasoning, (estimated) values of the $*#0"27#'"!,*%(0!3*/',-*,-"*&"$10!$"*02*1&'>%&)*<%(%!#"$*,0*,">10&%&)*$-0#C$*%$*captured through the "*,"&>*#%!*<"*9$"5*,0*P$#0&"Q*7$#%(*10('#)*&"$10!$"$@*T0&*"?%>1(":*a value of $*,-%,*'$*#(0$"*,0*9!',)*#%!*<"*$#0&"5*%$*%*P20&#"29(Q*10('#)*&"$10!$"*%!5*%*.%(9"*#(0$"*,0*B"&0*%$*%*P5%>1"5Q*&"$10!$"@*;-"*"$,'>%,"5*.%(9"$*02*!, on the other -%!5:*>"%$9&"*,-"*&"$10!$"*02*7$#%(*10('#)*,0*,">10&%&)*2%#,0&$*$9#-*%$*,-"*<9$'!"$$*cycle (as measured, say, by gaps between actual and potential output); or to temporary $/'!3$*'!*M1&'>%&)N*30."&!>"!,*$1"!5'!3*%$*5'$#9$$"5*<)*[%&&0*M^LgLN@

Notwithstanding the role the $*#0"27#'"!,*1(%)$*'!*5","&>'!'!3*,-"*1&0$1"#,$*20&*5)!%>'#*$9$,%'!%<'(',):*',*!""5$*,0*<"*&"#03!'B"5*,-%,*,-"*<"-%.'0&*02*5"<,*&%,'0$*0."&*,-"*$-0&,*,0*>"5'9>*,"&>*-0&'B0!$*%($0*5"1"!5$*'>10&,%!,()*0!*,-"*<"-%.'0&*02*,-"*3%1*<",/""!*the interest rate on public debt and the growth rate of the economy. In circumstances /-"&"*,-"*3&0/,-*&%,"*'$*%<0."*,-"*'!,"&"$,*&%,":*$-0&,G,"&>*5"<,*,0*R\6*$,%<'('B%,'0!*#%!*0##9&*"."!*/-"!*,-"*1&'>%&)*<%(%!#"*'$*'!*5"7#',@*H!*$9#-*#'&#9>$,%!#"$:*%*2%'(9&"*02*,-"*1&'>%&)*<%(%!#"*,0*'!#&"%$"*%$*5"<,*'!#&"%$"$Z/-'#-*'$*$927#'"!,*20&*."&)*(0!3*23 As discussed below, these temporary in"uences include temporary government spending shocks and the

deviation of output from trend.24 Note that ! and " can be appropriately dimensioned vectors.25 The reason why this is a su$cient (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 de!cit.

26 Sustainability will also be in"uenced by whether the nominal interest rate is above or below the growth rate of nominal GDP.


$9$,%'!%<'(',)*/-"!*,-"*'!,"&"$,*&%,"*'$*%<0."*,-"*3&0/,-*&%,"Z/'((*!0,*!"#"$$%&)*1&"#(95"*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 -%$*<""!*'!*5"7#',@*E."&*(0!3*,'>"*1"&'05$:*-0/"."&:*7$#%(*$9$,%'!%<'(',)*/'((*<"*$9110&,"5*by the primary balance increasing as the debt ratio rises.

H2*,-"*7$#%(*$',9%,'0!*'$*$9$,%'!%<("*M %' ( , )0 1 ), the long-run expected value of the debt ratio can be written as in equation (8) below.

E b t b t( ( )) ( ( )cov( , ( )) / ( )_

= " + " + " + "µ % ) % ) )1 1 1 1 (8)

Here * 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 $ but also on the gap between the nominal interest rate and the nominal growth rate of the economy.

X0&"*3"!"&%(():*,-"*1&'>%&)*<%(%!#"*2&%>"/0&C*20&*7$#%(*$9$,%'!%<'(',)*#%!*<"*"?,"!5"5*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 ($) to vary over time. As regards nonlinearity issues, a particular interesting possibility is that there are threshold effects whereby the response of the primary balance to the debt stock >'3-,*'!#&"%$"*0&*5'>'!'$-*%$*5"<,*("."($*&'$"*%$*1%&,:*1"&-%1$:*"',-"&*02*P/%C"*91*#%(($Q*0&*02*P%5=9$,>"!,*2%,'39"@Q28 The presence of such effects would raise the possibility that ,-"*'>1('#%,'0!$*02*7$#%(*$('11%3"$*5"1"!5*0!*,-"*5"<,*("."($*%,*/-'#-*,-")*0##9&:*%!5*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 ,"$,$*%&"*<%$"5*0!*P/-%,*'2Q*0&*P$,&"$$*,"$,Q*,)1"*>05"('!3*"',-"&*/',-*&"$1"#,*,0*,-"*'>1('#%,'0!$*20&*7$#%(*$9$,%'!%<'(',)*02*#0!,'!9'!3*/',-*#9&&"!,*7$#%(*10('#'"$*M%$*5"7!"5*<)*the primary balance) or of identifying the gap between the primary balance required to 1&059#"*7$#%(*$9$,%'!%<'(',)*%!5*,-"*#9&&"!,*7$#%(*10('#)*$",,'!3$@*

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 (*N:*,03",-"&*/',-*,-"*1&'>%&)*7$#%(*$9&1(9$*%!5*,-"*5"<,*&%,'0@*;-'$*'$*3'."!*

27 See discussion in Section II.28 An extreme example of this would be the Debt La#er curve e#ect in which there is a tipping point beyond which

higher debt produces a reduction in the primary surplus ( $<0). This case would be a !scal policy analogy to the original Bulow-Rogo# model of sovereign debt problems and the Debt La#er curve (Blanchard and Fischer 1989).


by equation (8) where + denotes a proportional change and * denotes the difference between the nominal interest rate and the growth rate of nominal GDP.IL

(b t t s t b t( ) ( ) ( ) / ( )= "* (8)

h!5"&*,-"*7&$,*,)1"*02*"?"&#'$":*,-"*,'>"*1%,-*20&*,-"*5"<,*&%,'0*'$*1&0="#,"5*0!*,-"*<%$'$*of a given set of assumptions about the primary surplus (for example, which is constant in relation to GDP) and the gap between the nominal interest rate and the nominal growth rate (*N@*H!*,-"*"."!,*,-%,*,-'$*1&059#"$*%!*P"?1(0$'."Q*'!#&"%$"*'!*,-"*5"<,*&%,'0*0."&*%*3'."!*,'>"*-0&'B0!:*,-"*%$$9>"5:*0&*#9&&"!,:*7$#%(*10('#)*$,%!#"*/09(5*<"*=953"5*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 &%,'0*<"*#0!$,%!,N@*4!)*3%1*<",/""!*,-'$*$9&1(9$*M,-"*5"<,G$,%<'('B'!3*$9&1(9$N*%!5*,-"*%#,9%(*1&'>%&)*$9&1(9$*/09(5*,-"!*<"*$""!*%$*'>1()'!3*,-"*%>09!,*02*7$#%(*%5=9$,>"!,*&"O9'&"5*,0*5"('."&*7$#%(*$9$,%'!%<'(',)@*

;-"$"*%11&0%#-"$*%&"*'((9$,&%,"5*'!*"O9%,'0!*MLN*/-"&"*,-"*7$#%(*3%1*M,N*'$*5"7!"5*%$*,-"*difference between the sustainable primary balance (ss) and the actual balance (sa), /',-*,-"*20&>"&*5"7!"5*%$*,-"*<%(%!#"*&"O9'&"5*,0*-0(5*,-"*5"<,*&%,'0*#0!$,%!,*%,*',$*current level.30

- .( ) [( ( ) ( )) ( )]t R t t b s ta= " " * MLN

[0,-*,-"$"*,)1"$*02*$#"!%&'0*0&*$,&"$$*,"$,$*%&"*9$"29(*20&*$-"55'!3*('3-,*0!*7$#%(*sustainability. As in the case of the primary-balance approach to sustainability discussed above, the gap between the nominal interest rate and the nominal growth rate of the economy (*) plays a key role. A common assumption is that this gap term will be positive but, as noted in subsequent sections, there are several Asian economies that have grown faster than the nominal interest rate over several years and in which * has been negative. 4$*5'$#9$$"5*'!*Y"#,'0!*HHH:*%*#0>>0!*%$$9>1,'0!*'!*>%!)*7$#%(*$#"!%&'0*"?"&#'$"$*'$*that the nominal interest rate exceeds the nominal growth rate of the economy. In the %<$"!#"*02*$9#-*%*#0!5','0!Z/-'#-*#09(5*'>1()*%*5"1%&,9&"*2&0>*5)!%>'#*"27#'"!#)Zvery long-run terminal conditions on debt may no longer be binding and public debt can become unbounded.31 Accordingly, because a positive interest rate gap is necessary 20&*>"%!'!329(*'!7!',"*-0&'B0!*$#"!%&'0$:*',*'$*$0>",'>"$*%$$9>"5*,0*-0(5*"."!*0."&*29 If the economy is dynamically e$cient, the modi!ed 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 * 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 e$ciency and the modi!ed golden rule. When an economy satis!es the modi!ed golden rule, the nominal interest rate will exceed the nominal growth rate of the economy.


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 ,-"*('!C*<",/""!*,-"*7$#%(*%5=9$,>"!,*"220&,*M>"%$9&"5*,-&093-*,-"*1&'>%&)*<%(%!#"N*and the debt ratio. In the primary balance approach, the policy response parameter for the primary balance ($) is estimated from the data, whereas in the scenario approaches, ,-"*1%&%>","&*>%)*<"*'>10$"5*2&0>*P09,$'5"Q*%##0&5'!3*,0*/-%,*'$*=953"5*!"#"$$%&)*,0*1&059#"*7$#%(*$9$,%'!%<'(',)@*H!*1&'!#'1(":*,-"*"$,'>%,"5*%5=9$,>"!,*1%&%>","&$*2&0>*the model-based approaches to sustainability can be used to enrich the scenario-based %11&0%#-"$*,0*7$#%(*$9$,%'!%<'(',):*%!5*%##09!,*#%!*%($0*<"*,%C"!*02*5"<,*,'11'!3*10'!,$*in which the parameter may be different at various debt levels. These are the approaches ,%C"!*'!*,-"*7!%(*$"#,'0!*02*,-"*1%1"&@

III. Fiscal Diagnostics: Evolution of Key Fiscal Indicators across Asia over Time ;-'$*$"#,'0!*&".'"/$*7$#%(*<%(%!#"$:*19<('#*$1"!5'!3*%!5*&"."!9"$:*%!5*19<('#*5"<,*(in relation to GDP) across the region and over time, with particular attention to the <&"%C50/!*02*7$#%(*10$','0!$*'!,0*1&'>%&)*%!5*!0!1&'>%&)*#0>10!"!,$:*,-"*&"(%,'0!$-'1*<",/""!*1&'>%&)*7$#%(*<%(%!#"$*%!5*19<('#*5"<,*&%,'0$:*%!5*,-"*('!C$*<",/""!*%#,9%(*%!5*5"<,*$,%<'('B'!3*1&'>%&)*7$#%(*<%(%!#"$@*H!*%55','0!:*,-"*$"#,'0!*&".'"/$*C")*2"%,9&"$*02*#09!,&'"$A*7$#%(*10$','0!$:*'!#(95'!3*,-"*&"(%,'0!$-'1*<",/""!*19<('#*5"<,*&%,'0$*%!5*.%&'09$*>"%$9&"$*02*"#0!0>'#*$'B":*.0(%,'(',):*%!5*&"."!9"*&%,'0$@*

;-"*%$$"$$>"!,*02*19<('#*7!%!#"$*'!*,-"*&"3'0!*'$*%*5%9!,'!3*#-%(("!3"*%!5*,-"&"*%&"*-93"*5'27#9(,'"$*%$$"><('!3*%*#0>1&"-"!$'."*$",*02*7$#%(*%!5*19<('#*5"<,*5%,%*20&*%((*the developing country members of the ADB. Not only are there familiar problems of occasional missing observations over time and across countries, there are also a number 02*$"&'09$*$-0&,#0>'!3$*%$*&"3%&5$*,-"*%.%'(%<'(',)*02*#0!$'$,"!,*%!5*#0>1&"-"!$'."*7$#%(*data in some countries and, in particular, as regards public debt obligations. In addition, only a very limited number of countries publish public sector asset positions (as well as 19<('#*5"<,*5%,%N:*>"%!'!3*,-%,*7$#%(*$9$,%'!%<'(',)*%!%()$'$*!""5$:*20&*,-"*>0$,*1%&,:*,0*<"*<%$"5*0!()*0!*0!"*1%&,*02*,-"*7$#%(*1'#,9&"*M('%<'(','"$*&%,-"&*,-%!*%$$",$32). 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.


,0*/-'#-*$0>"*#09!,&'"$*'$$9"*19<('#*5"<,*,0*P#%1,'."Q*(0#%(*<9)"&$*M$9#-*%$*(0#%(*<%!C$:*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 $-"",N*%!5*1&0$1"#,'."*7$#%(*('%<'(','"$@*[%$"5*0!*"?1"&'"!#":*MV9&01"%!*W0>>'$$'0!*IJJL%:*4\[*^LLKN:*,-"$"*%&"*02,"!*,-"*C")*2%#,0&$*'!*'!+9"!#'!3*7$#%(*$9$,%'!%<'(',)*0."&*,'>":*%!5*%&"*/-"&"*,-"*P7$#%(*$9&1&'$"$Q*02,"!*0##9&@33 The omission of contingent 7$#%(*('%<'(','"$*'>1('"$*,-%,*,-"*%11&0%#-*%501,"5*'!*,-"*1%1"&*%&39%<()*&"1&"$"!,$*,-"*P<"$,*#%$"Q*'!*$0*2%&*%$*,-"*%##09!,'!3*20&*#0!,'!3"!,*('%<'(','"$*/09(5*('C"()*("%5*,0*,-"*possibility of higher rather than lower future debt ratios, and potentially larger threats to 7$#%(*$9$,%'!%<'(',)@

At the most fundamental level, there is also the issue of how broadly or narrowly the 19<('#*$"#,0&*$-09(5*<"*5"7!"5@*H5"%(():*7$#%(*$9$,%'!%<'(',)*%!%()$'$*$-09(5*#0."&*%((*%$1"#,$*02*19<('#*$"#,0&*01"&%,'0!$*%!5*%#,'.','"$*,-%,*-%."*7$#%(*'>1('#%,'0!$:*$933"$,'!3*a very broad and comprehensive approach. Such comprehensiveness is probably best %#-'"."5*<)*20#9$'!3*0!*,-"*0."&%((*19<('#*$"#,0&Z'!#(95'!3*%((*%#,9%(*%!5*O9%$'*$,%,"G0/!"5*"!,"&1&'$"$*%!5*30."&!>"!,G('!C"5*#0>1%!'"$Z<9,*',*'$*2&"O9"!,()*5'27#9(,*,0*5&%/*,-"*('!"*'!*5"7!'!3*,-"*19<('#*$"#,0&:34 and comprehensive data for the entire public $"#,0&*'$*2&"O9"!,()*5'27#9(,*,0*0<,%'!@*4!5:*"."!*'!*,-0$"*#%$"$*/-"&"*',*'$*0!()*2"%$'<("*,0*cover the (formal) government sector, there are often issues related to the availability of data for different levels of government (central, state, and local) and its consistency over ,'>"@*;-"&"*%&"*!0*$'>1("*$0(9,'0!$*,0*,-"$"*%!5*&"(%,"5*P<09!5%&)Q*1&0<(">$*'!*5"7!'!3*,-"*19<('#*$"#,0&@*4!5:*2&"O9"!,():*',*'$*!"#"$$%&)*,0*<%$"*,-"*%!%()$'$*0!*%*P!%&&0/Q*5"7!','0!*02*30."&!>"!,*59"*,0*(%#C*02*5%,%*20&*<&0%5"&*5"7!','0!$*02*,-"*19<('#*$"#,0&@

T0&*19&10$"$*02*,-"*1%1"&:*%!!9%(*5%,%*/%$*%$$"><("5*0!*30."&!>"!,*7$#%(*10$','0!$*and debt (and other variables) for over 30 developing member countries of ADB from ,-"*"%&()*^LLJ$*,-&093-*IJJK@*D-"&"*10$$'<(":*5%,%*20&*,-"*3"!"&%(*30."&!>"!,*/%$*9$"5*<9,:*'!*$"."&%(*'!$,%!#"$:*#"!,&%(*30."&!>"!,*5%,%*-%5*,0*$927#"@*H!*$0>"*#%$"$:*$"&'"$*-%5*<&"%C$*0&*3%1$*%!5*.%&'09$*%11&0%#-"$*/"&"*9$"5*,0*P3%1*7((Q*,-"$"*$"&'"$@*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 !scal positions during the Asian !nancial crisis was associated with bailouts of distressed banks and other !nancial 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 e#ect on the results.


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*M4\[*IJJL<N*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 %33&"3%,'!3*.%&'%<("$*$9#-*%$*R\6:*',*'$*!0,*#("%&*/-",-"&*',*$-09(5*<"*9$"5*20&*7$#%(*.%&'%<("$*/-"&"*,-"&"*'$*!0*>"%!'!329(*#0!#"1,*02*%*&"3'0!/'5"*7$#%(*10$','0!@*[%$"5*0!*,-"$"*,)1"$*02*#0!$'5"&%,'0!$Z%!5*%($0*<"#%9$"*,-"*">1'&'#%(*%!%()$'$*'!*,-"*!"?,*$"#,'0!*'$*<%$"5*0!*'!5'.'59%(*#09!,&)*"?1"&'"!#"Z,-"*7$#%(*%33&"3%,"$*20&*,-"*&"3'0!*presented in this section are all unweighted (rather than weighted) averages of data for individual countries and subregions.36

H!*%55','0!*,0*#0!$'5"&'!3*7$#%(*<"-%.'0&*'!*5'22"&"!,*#09!,&'"$*M,-"*#&0$$*$"#,'0!%(*5'>"!$'0!N:*,-"*1%1"&*#0!$'5"&$*%($0*-0/*7$#%(*"?1"&'"!#"*-%$*".0(."5*0."&*,'>"*M,-"*,'>"*$"&'"$*5'>"!$'0!N@*;0*,-'$*"!5:*,-"*$"#,'0!*#0!$'5"&$*%."&%3"*7$#%(*5%,%*<0,-*20&*,-"*1"&'05*^LLJÌJJK*%$*%*/-0("*%!5*20&*,-"*$9<1"&'05$*^LLJ`^LLg*M1&"G4$'%!*7!%!#'%(*#&'$'$N8*^LLK`^LLL*M4$'%!*7!%!#'%(*#&'$'$N8*%!5*IJJJÌJJK*M1&"3(0<%(*7!%!#'%(*#&'$'$N@37 The reason for these particular decompositions is that the Asian crisis represented %*/%,"&$-"5*20&*7$#%(*10('#)*20&*>%!)*#09!,&'"$*'!*,-"*&"3'0!:*%$*>%!)*#09!,&'"$*"?1"&'"!#"5*(%&3"*#&'$'$G&"(%,"5*7$#%(*$('11%3"$@*;-"*9!/'!5'!3*02*,-"$"*7$#%(*$('11%3"$*/%$*%*1&'>%&)*20#9$*02*>%!)*#09!,&'"$A*7$#%(*10('#'"$*'!*,-"*("%5G91*,0*,-"*3(0<%(*#&'$'$*'!*IJJL@**F""5("$$*,0*$%):*-0/"."&:*5'22"&"!,*&"3'0!$*'!*4$'%*-%."*5'22"&"5*$-%&1()*/',-*&"$1"#,*,0*,-"'&*9!5"&()'!3*M0&*$,&9#,9&%(N*7$#%(*10$','0!$*%!5*,-"'&*".0(9,'0!*0."&*,'>"@

;%<("*H*M%!5*%($0*[0?*^N*5'$1(%)*C")*7$#%(*'!5'#%,0&$*20&*,-"*&"3'0!*0."&*,-"*,-&""*$9<1"&'05$*&"2"&&"5*,0*%<0."*%!5*20&*^LLJÌJJK*%$*%*/-0("@*H!*('!"*/',-*4\[A$*#(%$$'7#%,'0!:*,-"*&"3'0!*'$*<&0C"!*50/!*'!,0*7."*$9<&"3'0!$i*W"!,&%(*4$'%:*V%$,*4$'%:*,-"*6%#'7#:*Y09,-"%$,*4$'%:*%!5*Y09,-*4$'%@38*[0,-*0."&%((*%!5*1&'>%&)*7$#%(*<%(%!#"$*'!*Table I are measured as the difference between receipts and spending so that a positive $'3!*'>1('"$*%*7$#%(*$9&1(9$*/-'("*%*!"3%,'."*$'3!*'>1('"$*%*5"7#',@*

Y"."&%(*0<$"&.%,'0!$*#%!*<"*>%5"*0!*,-"*<%$'$*02*,-"*7$#%(*'!5'#%,0&$*'!*;%<("*H@

M'N* T0&*,-"*1"&'05*%$*/-0(":*,-"&"*'$*%*&"(%,'."()*!%&&0/*5'$1"&$'0!*02*7$#%(*<%(%!#"$*across the region.SL*4#&0$$*,-"*&"3'0!:*7$#%(*<%(%!#"$*%&"*'!*$>%((*5"7#',*0."&*,-"*"!,'&"*^LLJÌJJK*1"&'05*<9,*,-"*5"7#',$*%&"*$0>"/-%,*-'3-"&*'!*,-"*6%#'7#:*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 di#erence.

37 Preliminary estimates and forecasts of !scal positions (including recent !scal stimulus packages) for 2009 and 2010 are presented and discussed in the !nal 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 di#erence between revenues and expenditures with the implication that a

positive sign denotes a surplus while a negative sign denotes a de!cit.


and South Asia, which were not very badly affected by the Asian crisis,40 other $9<&"3'0!$*$%/*,-"'&*7$#%(*5"7#',$*'!#&"%$"*'!*,-"*(%,"*^LLJ$:*<9,*,-"*5"7#',$*/"&"*then generally pared back.

(ii) Across the entire period, there is a wide range of experience as regards primary 7$#%(*<%(%!#"$:*/',-*$0>"*$9<&"3'0!$*%."&%3'!3*$9&1(9$"$*%!5*0,-"&$*%."&%3'!3*5"7#',$@*Y09,-"%$,*4$'%:*-0/"."&:*'$*,-"*0!()*$9<&"3'0!*&9!!'!3*%*(%&3"*1&'>%&)*surplus, while subregions such as South Asia have on average been running &"(%,'."()*(%&3"*%!5*1"&$'$,"!,*1&'>%&)*5"7#',$@

M'''N* D',-*,-"*"?#"1,'0!*02*,-"*6%#'7#*/-"&"*30."&!>"!,*$1"!5'!3*%!5*&"."!9"$*-%."*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, V9&01"%!*W0>>'$$'0!*IJJL%N@

Table 1: Fiscal Indicators, Ratio to GDP, 1990!2008 (percent )Subregion Period Public

DebtPrimary Surplus

Fiscal Surplus

Government Expenditure

Goverment Revenue

Interest Payments

Central Asia 1 35.10 %4.70 %7.00 21.00 14.00 1.302 68.70 %3.50 %5.50 20.20 14.70 1.403 34.50 1.00 0.20 25.00 25.20 0.80

All periods 38.00 0.30 %0.70 24.30 23.60 0.90East Asia 1 17.30 %0.80 %1.40 18.20 16.70 1.00

2 35.20 %3.50 %3.70 23.80 19.00 1.703 32.20 0.90 0.20 21.80 22.00 1.00

All periods 27.00 %0.20 %0.80 20.70 19.70 1.10The Paci!c 1 39.00 1.90 %0.20 38.70 38.50 2.40

2 36.70 %0.50 %2.10 36.40 34.30 2.203 40.20 %1.70 %2.40 42.70 40.10 1.50

All periods 39.50 %0.40 %1.70 40.70 38.90 1.80Southeast Asia 1 48.30 4.80 2.40 19.40 21.80 2.80

2 57.60 %1.00 %2.40 21.40 18.70 2.103 56.70 0.30 %1.70 20.70 19.10 2.20

All periods 53.90 1.70 %0.40 20.30 20.00 2.40South Asia 1 63.60 %2.60 %6.00 27.50 21.60 3.30

2 62.00 %1.90 %5.00 24.00 19.10 3.103 65.10 %2.10 %5.10 25.50 20.50 2.90

All periods 64.20 %2.30 %5.40 26.10 20.80 3.10

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


Box 1: Various Fiscal Indicators

0 20 40 60 80

1990%1997

2000%2008

South AsiaSoutheast Asia

The Paci!cEast Asia

Central Asia

1998%1999


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia

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

0 20 40 60 80

2000%2008

1998%1999

1990%1997


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia

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

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008Year

Central Asia East Asia The Paci!cSoutheast Asia South Asia

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008Year


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

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

80

60

40

20

0

80

60

40

20

0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008Year


1990 1992 1994 1996 1998 2000 2002 2004 2006 2008Year


0 100 200 300 400 500

2000%2008

1998%1999

1990%1997


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia

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

0 100 200 300 400 500

2000%2008

1998%1999

1990%1997


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia


The Paci!cEast Asia

Central Asia

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

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

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

600

400

200

0

600

400

200

0


(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 W"!,&%(*4$'%*'!*,-"*(%,"*^LLJ$*<9,*,-"!*2"((*$-%&1()*'!*,-"*#0!,"?,*02*%*!9><"&*02*7$#%(*%5=9$,>"!,*%!5*5"<,*&"$,&9#,9&'!3*1&03&%>$@

(v) Across the region, interest payments on the public debt have been around 1-3% of GDP and show no clear tendency to increase over time. Generally, subregions with the highest debt to GDP ratios also have the highest levels of interest 1%)>"!,$*,0*R\6@*U"+"#,'!3*5'22"&"!,*29!5'!3*#0$,$:*-0/"."&:*&"(%,"5*'!,"&*%('%*,0*the access to concessional funding, the relationship between interest payment and debt is not always very close.

T'39&"*^*1&0.'5"$*%!0,-"&*1"&$1"#,'."*0!*7$#%(*10$','0!$*'!*,-"*&"3'0!@*;-"*#-%&,*5'$1(%)$*%."&%3"*M0."&%((N*7$#%(*<%(%!#"$*%!5*5"<,*M<0,-*%$*%*&%,'0*,0*R\6N*%#&0$$*"%#-*02*,-"*7."*$9<&"3'0!$*0."&*,-"*"!,'&"*,'>"*1"&'05*^LLJ`IJJK@*H!*1&'!#'1(":*,-"*0<$"&."5*&"(%,'0!$-'1*<",/""!*,-"*0."&%((*7$#%(*<%(%!#"*%!5*,-"*5"<,*&%,'0*%#&0$$*,-"*subregions could be either positive or negative. The relationship would be negative if ,-"*$9<&"3'0!$*/',-*-'3-*19<('#*5"<,*&%,'0$*/"&"*&9!!'!3*$>%(("&*7$#%(*$9&1(9$"$*0."&*the period. Conversely, if subregions with higher public debt ratios were running larger 7$#%(*$9&1(9$"$*,-"!*,-"*&"(%,'0!$-'1*/09(5*<"*%*10$','."*0!"@*4##0&5'!3():*,-"*!%,9&"*02*,-"*&"(%,'0!$-'1*<",/""!*7$#%(*<%(%!#"$*%!5*5"<,*1&0.'5"$*'!20&>%,'0!*%<09,*/-",-"&*7$#%(*%5=9$,>"!,*%#&0$$*,-"*$9<&"3'0!$*'$*#0!$'$,"!,*/',-*$,%<'('B'!3*&"$10!$"$*02*7$#%(*balances to debt.41

Figure 1: Fiscal Balances and Debt (1990!2008 averages)

ceaeaa

paa

sea

soa

Linear regression line (excluding South Asia)

Fisc

al S

urpl

us (%

GD

P)

Debt (% GDP)

0

%2

%4

%630 40 50 60 70

41 Note that the causation between the !scal balance and the debt ratio runs in both directions. Larger !scal de!cits can lead to larger increases in debt ratios and, conversely, countries can seek to reduce !scal de!cits in order to stabilize or reduce public debt ratios.


Inspection of Figure 1 reveals that there is a slight positive relationship between overall 7$#%(*$9&1(9$"$*%!5*19<('#*5"<,*%#&0$$*,-"*&"3'0!*/-"!*Y09,-*4$'%*'$*"?#(95"5@*;-'$*implies that, over the entire period, most subregions with higher public debt ratios ,"!5"5*,0*&9!*(%&3"&*7$#%(*$9&1(9$"$*0&*$>%(("&*7$#%(*5"7#',$@*W0!."&$"():*'!*Y09,-*4$'%:*in particular, a high debt ratio over the entire period is accompanied by relatively large 7$#%(*5"7#',$*%!5*,-"&"*'$*(',,("*".'5"!#"*'!*,-'$*$9<&"3'0!*02*(0!3G&9!*7$#%(*%5=9$,>"!,*being under way. The time snapshots for the subregions included in the following charts MT'39&"*IN*<&0%5()*#0!7&>*,-"$"*1%,,"&!$*,-&093-*,-"*!%,9&"*02*,-"*&"(%,'0!$-'1*<",/""!*7$#%(*<%(%!#"$*%!5*5"<,*&%,'0$*.%&'"$*%#&0$$*,-"*7."*$9<&"3'0!$*20&*,-"*,-&""*$9<1"&'05$*^LLJ`^LLg:*^LLK`^LLL:*%!5*IJJJ`IJJK@*V$$"!,'%(():*,-"*5'22"&"!,*&"(%,'0!$-'1$*%#&0$$*,-"*,-&""*$9<1"&'05$*&"+"#,*,-"*2%#,*,-%,*1"&'05$*$9#-*%$*^LLK`^LLL*/"&"*1"&'05$*/-"!*5"<,*increased sharply during the Asian crisis. On the other hand, periods such as after 2000 -%."*<""!*1"&'05$*02*7$#%(*%5=9$,>"!,:*"$1"#'%(()*'!*V%$,*%!5*Y09,-"%$,*4$'%@

Figure 2: Fiscal Balances and Debt (averages by periods and subregions)

1990-1997 1998-1999 2000-2008

Fisc

al S

urpl

us (%

GD

P)

Debt (% GDP)

2

0

%2

%4

%6

%83020 40 50 60 70

cea

eaa

paa

sea

soacea

eaa

paasea

soa

ceaeaa

paasea

soa

4!0,-"&*1"&$1"#,'."*0!*,-"*!"?9$*<",/""!*7$#%(*10('#)*%!5*19<('#*5"<,*'$*1&0.'5"5*<)*considering the behavior of primary balances across subregions and over time. Figures S*%!5*c*5'$1(%)*,-"*&"(%,'0!$-'1*<",/""!*,-"*1&'>%&)*7$#%(*$9&1(9$*%!5*19<('#*5"<,*M<0,-*%$*%*1"&#"!,%3"*02*R\6N*20&*,-"*7."*$9<&"3'0!$*02*5"."(01'!3*4$'%*0."&*,-"*"!,'&"*^LLJ`2008 time period. The behavior over the three subperiods is displayed in Figure 4.


Figure 3: Primary Fiscal Balances and Debt (1990!2008 averages)

soa

cea

eaapaa

sea

Linear regression line (excluding South Asia)

Prim

ary

Fisc

al S

urpl

us (%

GD

P)

Debt (% GDP)

1

0

%1

%2

30 40 50 60 70

Figure 4: Primary Fiscal Balances and Debt (averages by periods and subregions)

cea

eaa

paa

sea

soa

ceaeaa

paa

sea soa

ceaeaa

paasea

soa

Prim

ary

Fisc

al S

urpl

us (%

GD

P)

Debt (% GDP)

4

2

0

%2

%4

1990-1997 1998-1999 2000-2008

3020 40 50 60 70

In interpreting the two charts, it is useful to note that a positive relationship between 1&'>%&)*$9&1(9$"$*%!5*5"<,*'>1('"$*,-%,*7$#%(*10('#)*-%$*<""!*$9110&,'!3*$9$,%'!%<'(',)@*This is because a positive relationship can be interpreted as implying that the primary $9&1(9$*'!#&"%$"$*M0&*,-"*1&'>%&)*5"7#',*'$*&"59#"5N*%$*,-"*5"<,*&%,'0*'!#&"%$"$@*Conversely, a negative (or no) relationship between these variables may not be consistent /',-*7$#%(*$9$,%'!%<'(',)*0."&*."&)*(0!3*,'>"*1"&'05$@42 As shown in Figures 3 and 4, there is a relatively strong positive relationship between primary surpluses and debt across the region when South Asia is excluded. This conforms to the pattern for the regions 5'$#9$$"5*%<0."*/',-*&"3%&5*,0*,-"*&"(%,'0!$-'1*<",/""!*,-"*M0."&%((N*7$#%(*<%(%!#"$*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 !scal

positions may “appear” sustainable and the debt ratio may be falling.


$9<1"&'05$*$'!#"*^LLJ*0!#"*%((0/%!#"*'$*>%5"*20&*,-"*4$'%!*#&'$'$G&"(%,"5*<(0/G09,*02*7$#%(*10$','0!$*'!*,-"*(%,"*^LLJ$@*

;-"*&"(%,'0!$-'1*<",/""!*%#,9%(*%!5*5"<,G$,%<'('B'!3*1&'>%&)*<%(%!#"$:*%$*5'$1(%)"5*'!*Figure 5,43*1&0.'5"$*%!0,-"&*1"&$1"#,'."*0!*7$#%(*$9$,%'!%<'(',)@*Y'!#"*7$#%(*$9$,%'!%<'(',)*needs to be evaluated at the country (rather than subregional) level, the chart refers to 1%&,'#9(%&*#09!,&'"$*2&0>*,-"*7."*$9<&"3'0!$*%!5*'5"!,'7"$*,-"*(0#%,'0!*02*,-"*%."&%3"*20&*"%#-*$9<&"3'0!@*;-"*."&,'#%(*%?'$*02*,-"*#-%&,*>"%$9&"$*,-"*1&'>%&)*7$#%(*<%(%!#"$*&"O9'&"5*,0*$,%<'('B"*5"<,*&%,'0$*<%$"5*0!*%."&%3"*!0>'!%(*R\6*3&0/,-*%!5*'!,"&"$,*&%,"$*over the period 2000 through 2008 for each of the displayed countries.44*;-"*-0&'B0!,%(*axis displays the average primary balance over the same period with a positive number '>1()'!3*%*1&'>%&)*$9&1(9$*%!5*%*!"3%,'.":*'>1()'!3*%*1&'>%&)*5"7#',@*4##0&5'!3():*,-"*0<$"&.%,'0!*20&*"%#-*#09!,&)*'$*%*1%'&*02*%#,9%(*%!5*5"<,G$,%<'('B'!3*1&'>%&)*<%(%!#"$*%!5*,-"*#-%&,*'$*5'.'5"5*'!,0*,/0*B0!"$@*H!*,-"*,01*#-%&,:*10'!,$*%<0."*,-"*cfG5"3&""*('!"*5"!0,"*10'!,$*/-"&"*,-"*5"<,*$,%<'('B'!3*1&'>%&)*$9&1(9$*'$*%<0."*,-"*%#,9%(*1&'>%&)*surplus and the debt ratio is increasing. Points below the 45-degree line denote situations /-"!*,-"*%#,9%(*1&'>%&)*$9&1(9$*'$*(%&3"&*,-%!*,-"*5"<,G$,%<'('B'!3*$9&1(9$*%!5*,-"*5"<,*ratio is on average decreasing.45 Conversely, points along the 45-degree line denote "O9%(',)*<",/""!*,-"*%#,9%(*%!5*5"<,G$,%<'('B'!3*1&'>%&)*<%(%!#"$*%!5*$,%<'(',)*'!*,-"*5"<,Gto-GDP ratio.

43 The calculation of debt-stabilizing primary balances was discussed in the preceding section. Note that debt-stabilizing primary balances can be negative (i.e., primary de!cits) 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 !scal 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 di#erent 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.


Figure 5: Actual and Debt-Stabilizing Primary Balances

C EPAS CC

C

CC

CE

EPPP

PP P

A

A

A AA

AS

S

S

S

S S

%15 %10 %5 0 5 10 15

%15 %10 %5 0 5 10 15

Bold letters represent subregional averages

Stab

ilizi

ng B

alan

ce (%

GD

P)

Note: GDP growth rates and interest rates: 2000-2008 average. Debt and primary balance: 2005-2008 average.

CE

AS

CC

CE

E

P

P

PA

PPA

S

C

C

C

P

A

A

A

A

SS

S

S S

C: Central Asia E: East Asia P: The Paci!c S: South Asia A: Southeast Asia

Actual Primary Balance (% GDP, 2005-2008 average)

15

10

5

0

%5

%10

%15

1.5

1.0

0.5

0

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 #09!,&'"$*'!*,-"*&"3'0!*2%((*/"((*/',-'!*,-"*B0!"*02*$9$,%'!%<'(',)*"."!*,-093-*%*!9><"&*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 0,-"&*$,95'"$*02*7$#%(*$9$,%'!%<'(',)*/',-'!*,-"*&"3'0!:*%!5*,-0$"*02*<&0%5"&*$,95'"$*,-%,*-%."*%$$"$$"5*7$#%(*$9$,%'!%<'(',)*%#&0$$*%*!9><"&*02*&"3'0!$*Me0&!"*^LL^:*HXT*IJJS:*X"!50B%*%!5*E$,&)*IJJKN@*V."!*,-093-*,-"$"*&"$9(,$*%&"*"!#09&%3'!3:*,-")*$-09(5*!0,*<"*$""!*%$*3&09!5$*20&*#0>1(%#"!#)@*F0,*0!()*'$*',*!"#"$$%&)*,0*&"#03!'B"*,-"*$('11%3"$*'!*7$#%(*10('#)*,-%,*-%."*0##9&&"5*59&'!3*,-"*3(0<%(*#&'$'$:*%*#(0$"*'!$1"#,'0!*02*T'39&"*


f*&"."%($*,-%,*,-"*5"<,G$,%<'('B'!3*1&'>%&)*$9&1(9$"$*20&*$"."&%(*#09!,&'"$*'!*,-"*&"3'0!*-%."*'!*,-"*1%$,*<""!*!"3%,'."*M'@"@:*1&'>%&)*5"7#',$N@*;-'$*&"+"#,$*,-"*2%#,*,-%,*"#0!0>'#*conditions in several countries have been such that the interest rate on debt has been below the growth rate of the economy. Under such circumstances, as illustrated in T'39&"*f:*5"<,*&%,'0$*#09(5*<"*$,%<'('B"5*"."!*/-"!*&9!!'!3*1&'>%&)*5"7#',$*,-%,*-%."*in some cases been larger than 5% of GDP.46 Either because this condition is unlikely ,0*-0(5*'!5"7!',"():*0&*0!*%##09!,*02*,-"*10$$'<'(',)*,-%,*,-"*%#,9%(*'!,"&"$,*&%,"*>%)*!0,*&"+"#,*,-"*,&9"*$-%50/*1&'#"*02*5"<,:*,-"*&"$9(,$*!""5*,0*<"*,&"%,"5*/',-*#%&"@*h(,'>%,"():*&0<9$,*5"<,G$,%<'('B'!3*7$#%(*10('#'"$*!""5*,0*<"*$9#-*%$*,0*$,%<'('B"*,-"*5"<,*&%,'0*'!*circumstances when the interest rate is above the growth rate.

43%'!$,*,-'$*<%#C3&09!5:*',*'$*%($0*9$"29(*,0*#0!$'5"&*,-"*10$$'<("*'>1('#%,'0!$*20&*7$#%(*sustainability of interest rates exceeding the growth rate of nominal GDP. Typically, interest rates on the external public debt of many countries exceed the nominal growth rate so that these rates can, in principle, be used in place of (relatively) low domestic interest rates. Unfortunately, however, it is not possible to obtain such data for many of the countries included in Figure 5. Purely for illustrative purposes, the approach taken '!*,-"*(0/"&*1%&,*02*T'39&"*f*/%$*,0*&"50*,-"*5"<,*$,%<'('B'!3*#%(#9(%,'0!$*9!5"&*,-"*%$$9>1,'0!*,-%,*,-"*P9!5"&()'!3Q*3%1*<",/""!*,-"*!0>'!%(*'!,"&"$,*&%,"*%!5*,-"*3&0/,-*rate of nominal GDP for all regions was equal to 150 basis points.47 As can be seen from the chart, this positive interest rate gap has the effect of reducing the number of #09!,&'"$*/',-*7$#%(*10$','0!$*,-%,*%&"*9!%><'3909$()*$9$,%'!%<(":*%!5*19$-'!3*$0>"*'!,0*the unsustainable quadrant. The reason for this is straightforward: A positive interest rate 3%1*'>1('"$*,-%,*%((*#09!,&'"$*%&"*&"O9'&"5*,0*&9!*1&'>%&)*$9&1(9$"$*,0*$,%<'('B"*0&*<&'!3*50/!*,-"*5"<,*&%,'0@*;0*,-"*"?,"!,*,-%,*7$#%(*$9$,%'!%<'(',)*'!*$0>"*#09!,&'"$*5"1"!5$*0!*%*2%.0&%<("Z<9,*9!('C"()*,0*1"&$'$,Z%<'(',)*,0*7!%!#"*5"<,*%,*'!,"&"$,*&%,"$*<"(0/*the growth rate, the results in this lower chart may give a more realistic long-term sense 02*7$#%(*$9$,%'!%<'(',)@*4,*,-"*("%$,:*,-"*#-%&,*'!5'#%,"$*,-%,*7$#%(*$9$,%'!%<'(',)*'!*$0>"*countries in the past has been facilitated by very favorable growth and interest rate conditions. Were these conditions to be less favorable in the future, the maintenance of 7$#%(*$9$,%'!%<'(',)*/09(5*<"*>0&"*#-%(("!3'!3@

;-"*(%$,*2"/*#-%&,$*%!5*,%<("$*1&0.'5"*C")*$,&9#,9&%(*'!20&>%,'0!*20&*,-"*7$#%(*$',9%,'0!*'!*,-"*&"3'0!*20&*^LLJ`IJJK@*;-"*7&$,*,/0*#-%&,$*MT'39&"$*d*%!5*gN*$9>>%&'B"*,-"*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. E#ectively, 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 de!cit.

47 This is based on the average interest rate growth di#erential in the 2003 IMF study on !scal sustainability (IMF 2002). Obviously, in practice, the actual di#erential will di#er across countries and may be higher in countries where there are concerns about !scal sustainability. To the extent that this is the case, some high-debt countries may be even closer to unsustainable !scal positions.


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

ARM

AZE

BGD

BTN

CHN

FJIGEO

HKG IDN

IND

KAZ

KGZKHM

KOR

LAO

LKA

MDV

MHL

MNG

MYS

NPL

PAKPHL

PLW

PNG

SGP

SLB

THA

TJK

UZBVNM

VUT WSM

Note: 1990-2008 averages in log scale. Speci!c country averages depend on data availability.

GD

P (lo

g)

Debt (log)

8

6

4

2

0

%2

%2%4 0 2 4 6

Figure 7: Public Debt and Per Capita GDP

ARMAZE

BGD

BTNCHN

FJI

GEO

HKG

IDN

IND

KAZ

KGZKHM

KOR

LAO

LKA

MDVMHL

MNG

MYS

NPL

PAK

PHL

PLW

PNG

SGP

SLB

THA

TJK

UZBVNM

VUT WSM


GD

P pe

r Cap

ita (l

og)

Debt/GDP ratio (log)

4

2

0

%210 2 3 4 5

;&%5','0!%(():*19<('#*5"<,*&%,'0$*-%."*<""!*%$$"$$"5*'!*,"&>$*02*,-"'&*$'B"*'!*&"(%,'0!*,0*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 P#%1%#',)Q*'!*$0*2%&*%$*',*50"$*!0,*>"%$9&"*,-"*&"$09&#"$*%.%'(%<("*,0*,-"*30."&!>"!,*20&*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.


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 '!*,-"*&"3'0!*0."&*,-"*1"&'05*^LLJ`IJJK@*

Figure 8: Public Debt and Revenue Ratios

AFG

ARM

AZE

BGD

BTN

CHN

COO

FJI

GEOHKG IDN INDKAZ

KGZ

KHM

KOR

LAO

LKA

MDV

MHL

MNG

MYS

NPLPAK

PHL

PLW

PNG SGPSLB

THA TJK

TWN

UZB

VNMVUT

WSM


Tota

l Gov

ernm

ent R

even

ue/G

DP

Ratio

(log

)

Debt/GDP ratio (log)

4.0

3.5

3.0

2.5

2.010 2 3 4 5

As implied by Figure 8, debt-to-revenue ratios are generally much higher than debt-to-GDP ratios. The reason for this is that revenue-to-GDP ratios generally lie in the 20–40% GDP range. The chart indicates, however, that there is no clear systematic 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.

T'!%(():*,-"*(%$,*,/0*#-%&,$*MT'39&"$*L*%!5*^JN*5'$1(%)*,-"*&"(%,'0!$-'1*<",/""!*19<('#*debt ratios and uncertainty as measured either by the variability of (nominal) economic growth or the variability of interest rates.cL From a macro prudential perspective, the 7$#%(*10$','0!$*02*#09!,&'"$*/',-*-'3-*M%!5*9!#0&&"(%,"5N*.%&'%<'(',)*'!*,-"$"*.%&'%<("$*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 '!*5","&>'!'!3*,-"*1&'>%&)*7$#%(*$9&1(9$*&"O9'&"5*20&*$9$,%'!%<'(',)*%$*5'$#9$$"5*"%&('"&@*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).


Figure 9: Public Debt and Macroeconomic Uncertainty, 1990–2008

cea

eaa

paa

sea

soa

Note: The dashed line represents a linear regression across subregions.

Aver

age

Deb

t (%

GD

P)

Standard Deviation of GDP Growth (%)

70

60

50

40

3076 8 9 10 11

Figure 10: Public Debt and Financial Uncertainty

cea

eaa

paa

sea

soa

Note: The dashed line represents a linear regression across subregions.

Aver

age

Deb

t (%

GD

P)

Standard Deviation of Interest Rate (%)

70

60

50

40

30

42 6 8 10 12

IV. Econometric Tests of Primary Fiscal Balance Response Functions;-'$*$"#,'0!*1&"$"!,$*,-"*>%'!*&"$9(,$*2&0>*1%!"(G&"3&"$$'0!*"$,'>%,"$*02*,-"*7$#%(*10('#)*response functions discussed in Section II (equation 7). Most of the estimations are <%$"5*0!*,-"*%11('#%,'0!*02*2"%$'<("*3"!"&%('B"5*("%$,*$O9%&"$*MTRjYN*,0*%!*9!<%(%!#"550 1%!"(*02*,'>"*$"&'"$*%!5*#09!,&)*5%,%*0."&*,-"*1"&'05*^LLJ*,-&093-*IJJK*M%!5*.%&'09$*$9<1"&'05$N*/',-*%((0/%!#"*20&*P7?"5*"22"#,$Q:*%(,-093-*%!*%(,"&!%,'."*Y)$,">*R"!"&%(*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 !scal response functions (see Mendoza and Ostry 2008).


Method of Moments (SGMM) approach was also tried. Allowance was made in the "$,'>%,'0!$i*20&*#09!,&)G$1"#'7#*%9,0#0&&"(%,'0!*%!5*-","&0$C"5%$,'#',)8*20&*,-"*&"$10!$"$*02*1&'>%&)*7$#%(*<%(%!#"$*,0*5"<,*&%,'0$*,0*<"*!0!('!"%&*%!5k0&*.%&)*/',-*5"<,*("."($8*20&*the presence of lagged adjustment; and for the interaction between country dummies and debt. In all the estimated equations, the dependent variable is the primary surplus M%$*%*$-%&"*02*R\6N*/-'("*,-"*'!5"1"!5"!,*.%&'%<("$*%#&0$$*,-"*5'22"&"!,*$1"#'7#%,'0!$*included current and lagged values of the debt ratio, and control variables such as (primary) government spending relative to trend and the output gap,51 which are included ,0*#%1,9&"*,">10&%&)*'!+9"!#"$*0!*7$#%(*10('#)@*H!*$0>"*$1"#'7#%,'0!$:*,-"&"*%&"*&"3'0!%(*0&*#09!,&)*59>>)*,"&>$@*;-"*C")*#0"27#'"!,*'!*,-"*"O9%,'0!$*M$) is the one attached to the debt term, which measures the response of the primary balance to debt. As 5'$#9$$"5*'!*Y"#,'0!*HH:*%*.%(9"*02*,-'$*#0"27#'"!,*<",/""!*B"&0*%!5*9!',)*'$*#0!$'$,"!,*/',-*%*$,%<'('B'!3*0&*$9$,%'!%<("*7$#%(*10('#)*&"$10!$"*,0*&'$'!3*5"<,@*4*!"3%,'."*#0"27#'"!,*'>1('"$*10,"!,'%(()*5"$,%<'('B'!3*&"$10!$"$@

Given serious data limitations and the considerable heterogeneity within the region, the presented econometric results should be treated with care. Based on the estimations, ,-"*7$#%(*10('#)*&"$10!$"$*,0*&'$'!3*5"<,*("."($*%&"*!0,*"%$'()*#%1,9&"5*<)*$'>1("*('!"%&*decision rules in several countries and regions, and some of the equations may not be stable over time. Moreover, several important endogeneity issues52 in the data may not be fully resolved and their resolution could affect the parameter estimates. Be that %$*',*>%):*,-"*"$,'>%,"5*&"$9(,$*$933"$,*,-%,*1&'>%&)*7$#%(*<%(%!#"$*'!*$0>"*#09!,&'"$*M%!5*&"3'0!$N*50*&"$10!5*'!*%*$,%<'('B'!3*>%!!"&*,0*'!#&"%$"$*'!*5"<,*&%,'0$*M'@"@:*7$#%(*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 ^LLJ`IJJK*<%$"5*0!*%*!9><"&*02*%(,"&!%,'."*$1"#'7#%,'0!$*02*,-"*(%3*$,&9#,9&"*0!*5"<,:*,-"*$1"#'7#%,'0!*02*,-"*#0!,&0(*.%&'%<("$*'!*,-"*"O9%,'0!$:*,'>"*,&"!5$*%!5*'!,"&%#,'0!*effects, and assumed properties of the error terms.

51 Measured as the deviation of output from trend as measured by a Hodrick Prescott !lter.52 These are related to factors such as common shocks to primary surpluses and the control variables.


Table 2: Econometric Estimation Results, 1990-2008Regressant:

Primary surplus

All Countries Selected Countries

(1) (2) (3) (4) (5) (6) (7) (8)

FGLS(linear)

OLS FE(linear)

SGMM(linear)

FGLS(quadratic)

FGLS(linear)

OLS FE(linear)

SGMM(linear)

FGLS(quadratic)

L.debt /1 0.0578*** 0.12445*** 0.1279 0.1651*** .04973*** 0.06253*** 0.0733*** %0.0637*L.debt^2 /2 %0.0009*** 0.0011***GDP Gap /3 0.0987*** 0.1503 0.1733* 0.1096*** .08141*** 0.05428* 0.1408*** 0.08147***GEXP Gap /4 %0.1333*** %0.1263*** %0.1575*** %0.1421*** %0.1648*** %0.16143*** %0.1843*** %0.1614***Time trend %0.1154 %0.1520** 1.9863Constant %0.4666*** %6.2689*** 2.3646*** 0.4789 %2.5824***

No. obs. 417 384 384 417 126 119 119 126No. countries 33 33 33 33 7 7 7 7Wald Chi2 441.37 51.2582 378.23 468.5228 298.2808 453.26DW Statistic 1.712 0.4145LBI Statistic 1.817 0.5666AB AR1 %1.0505 %.50461AB AR2 %.97226 %.41912

* signi!cant at 10%; ** signi!cant at 5%; *** signi!cant at 1% using Two-tailed Wald tests of zero coe$cients.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-speci!c autocorrelation (AR1) and

heteroskedasticity. Regressors include country dummies, also interacted with debt, to allow for panel-level !xed e#ects (coe$cients not reported here.) For the case of regressions involving the sample of all countries, debt enters at two-year averages.

(2) and (6): OLS within-estimator, allowing for !xed (country) e#ects and AR1. (3) and (7): Blundell-Bond type system-GMM estimator, instrumenting lagged primary balance and debt as regressors both in levels

and di#erences and including a time trend. Windmeijer-robust standard errors. Note that both models are likely to su#er from misspeci!cation, as second-order autocorrelation in the residuals from !rst-di#erenced errors is not rejected.

Note that Figure 11 is based on the coe$cients 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 ,-%,*('"$*<",/""!*J@J^*%!5*J@Jdc:*%(,-093-*,-"*#0"27#'"!,*'!*$0>"*$1"#'7#%,'0!$*'$*'!$'3!'7#%!,*$,%,'$,'#%(()@*;-"$"*"$,'>%,"$*%&"*<&0%5()*'!*('!"*/',-*%*!9><"&*02*0,-"&*$,95'"$*MHXT*IJJSN@*H!*!0*#%$"$*%&"*1&'>%&)*7$#%(*<%(%!#"$*209!5*,0*&"$10!5*1"&."&$"()*,0*&'$'!3*5"<,*'!*,-"*$"!$"*02*%*$,%,'$,'#%(()*$'3!'7#%!,*!"3%,'."*#0"27#'"!,*<"'!3*%,,%#-"5*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 7$#%(*&"$10!$"$*,0*5"<,*>%)*.%&)*%,*5'22"&"!,*5"<,*("."($@*;/0*<&0%5*%11&0%#-"$*/"&"*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


primary balance to debt was described by a simple quadratic function rather than a linear &"$10!$"*29!#,'0!@*E."&%((:*,-"*&"$9(,$*$933"$,"5*$0>"*".'5"!#"*02*P5'22"&"!,'%(Q*"22"#,$*whereby the primary balance function either has a u shape (implying that the adjustment 1%&%>","&*7&$,*2%(($*%!5*,-"!*&'$"$N*0&*%!*!*$-%1"*M'>1()'!3*,-%,*,-"*%5=9$,>"!,*1%&%>","&*7&$,*&'$"$*%!5*,-"!*2%(($N@*

;-"*7!5'!3*02*%*P9G$-%1"5Q*7$#%(*&"$10!$"*29!#,'0!$*5'22"&$*2&0>*$0>"*0,-"&*$,95'"$*MX"!50B%*%!5*E$,&)*IJJK:*HXT*IJJS:*/-'#-*7!5*!G$-%1"5*"22"#,$N*%!5*'$*10,"!,'%(()*O9',"*$'3!'7#%!,*'!*"#0!0>'#*,"&>$*M$""*T'39&"$*^^*%!5*^IN@*h!5"&*%*9G$-%1"5*29!#,'0!:*,-"*7$#%(*%5=9$,>"!,*"220&,*7&$,*>05"&%,"$*%$*5"<,*&%,'0$*'!#&"%$":*<9,*,-"!*$,&"!3,-"!$*when a certain critical debt ratio is reached as part, perhaps, of a wake-up call effect. Unfortunately, however, there are also countries in the region that appear to display %5=9$,>"!,*P2%,'39"Q*0&*%!*P!G$-%1"5Q*"22"#,*'!*/-'#-*,-"*7$#%(*10('#)*&"$10!$"$*,"!5*,0*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

Sample median

Debt (% GDP)Note: Based on FGLS regression on the whole sample. Debt in 2-year averages, 1 year lag.

Prim

ary

Fisc

al S

lurp

lus (

% G

DP)

10

8

6

4

243.40 88.9 120

Based on these preliminary estimation results, three broad conclusions can be drawn:

M'N* U"+"#,'!3*#0!$'5"&%<("*-","&03"!"',)*%#&0$$*#09!,&'"$*%!5*0."&*,'>":*%."&%3"*7$#%(*<"-%.'0&*'!*,-"*&"3'0!*'$*!0,*"%$'()*#%1,9&"5*<)*%*$'!3("*0!"G$'B"G7,$G%((*$1"#'7#%,'0!*02*,-"*('!C%3"*<",/""!*1&'>%&)*7$#%(*<%(%!#"$*%!5*5"<,*&%,'0$@*Across the region, however, some evidence is found consistent with a statistically $'3!'7#%!,*10$','."*&"$10!$"*02*,-"*1&'>%&)*$9&1(9$*,0*5"<,*&%,'0$:*#0!$'$,"!,*/',-*$,%<'('B'!3*<"-%.'0&@*


(ii) Reponses of primary balances to debt ratios appear to display quite complex lag structures that differ across subregions.

(iii) In some countries, there is evidence consistent with nonlinear responses of the primary balance to debt ratios and of the existence of debt tipping points. These may be either of the u-shape or n-shape kind with different implications for the "22"#,$*02*7$#%(*$('11%3"$*0!*,-"*%5=9$,>"!,*"220&,@

Figure 12: A u-Shapred Primary Balance Response Function

Sample median

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

Prim

ary

Fisc

al S

lurp

lus (

% G

DP)

10

8

6

4

228.80 39.8 120

V. Fiscal Stimulus Scenarios;-'$*$"#,'0!*5'$#9$$"$*,-"*'>1('#%,'0!*20&*5"<,*$9$,%'!%<'(',)*02*,-"*&"#"!,*7$#%(*$,'>9(9$*1%#C%3"$*%501,"5*'!*,-"*&"3'0!@*;-&""*<&0%5*P/-%,*'2Q*0&*$,&"$$*,)1"*$#"!%&'0$*%&"*developed and applied to a selected group of countries for whom detailed projection data %&"*%.%'(%<("@*;-"*7&$,*$#"!%&'0*'$*<%$"5*0!*-0(5'!3*7$#%(*$,'>9('*#0!$,%!,*%,*,-"'&*IJJL`2010 levels and projecting the implications for debt ratios on the basis of the forecasts for nominal GDP in the Asian Development Outlook*M4\[*IJJL<N*%!5*,-"*,"#-!'#%(*assumption that interest rates will rise gradually from their current relatively low levels in ,-"*#0!,"?,*02*>0!",%&)*10('#)*!0&>%('B%,'0!@*;-"*$"#0!5*%!5*,-'&5*$#"!%&'0$*%&"*<%$"5*0!*,-"*7$#%(*10('#)*&"%#,'0!*29!#,'0!$*"$,'>%,"5*'!*,-"*1&".'09$*$"#,'0!*%!5*%((0/*20&*,-"*7$#%(*$,'>9(9$*,0*<"*9!/09!5*0!*,-"*<%$'$*02*-'$,0&'#%(*%5=9$,>"!,*1%,,"&!$@*;0*>%C"*,-'$*scenario relevant to the heterogeneity in the region, the upper and lower bounds for the Lfl*#0!75"!#"*'!,"&.%($M$N*20&*,-"*%."&%3"*.%(9"*02*,-"*&"$10!$"*02*7$#%(*10('#)*,0*5"<,*ratios in the region were used.53 An upper bound of 0.08 is used to capture very forceful 7$#%(*%5=9$,>"!,*/-'("*,-"*(0/"&*<09!5*02*J@Jc*'$*9$"5*,0*#%1,9&"*>9#-*$(0/"&*7$#%(*adjustment.

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


Deb

t (%

GD

P)

2008 2009 2010 2011 2012 2013 2014 2015Year

2008 2009 2010 2011 2012 2013 2014 2015Year

2008 2009 2010 2011 2012 2013 2014 2015Year

2008 2009 2010 2011 2012 2013 2014 2015Year

2008 2009 2010 2011 2012 2013Year

Central Asia East Asia

Southeast Asia South Asia

Asia7Scenario I: Fiscal stimuli constant at 2009/10 level

Scenario II: Modest adjustment of the primary balance (rho=0.04)

Scenario II: Forceful adjustment of the primary balance (rho=0.08)

Note: See the text body for a description of the assumptions underlying this scenario.

Asia7 comprises India, Indonesia, Korea Rep., Malaysia, Thailand, Philippines, PRC.

70

60

50

40

30

20

Deb

t (%

GD

P)

70

60

50

40

30

20

Deb

t (%

GD

P)

70

60

50

40

30

20

Deb

t (%

GD

P)

70

60

50

40

30

20

Deb

t (%

GD

P)

70

60

50

40

30

20

Figure 13: Fiscal Stimulus Unwinding Scenarios


;-"*<%$"('!"$*20&*<0,-*$#"!%&'0$*'!#0&10&%,"*"$,'>%,"$*02*,-"*7$#%(*<%(%!#"$*20&*,-"*$"("#,"5*3&091*02*#09!,&'"$*'!*IJJL*%!5*IJ^J*5&%/'!3*0!*%!!09!#"5*7$#%(*$,'>9(9$*programs and budgetary data.54 As indicated in the Fiscal Unwinding Scenarios included '!*T'39&"*^S:*%*2%'(9&"*,0*9!/'!5*7$#%(*$,'>9(9$*%2,"&*IJ^J*/09(5*3"!"&%(()*("%5*,0*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 1&0="#,'0!*1"&'05@*R"!"&%(():*,-"&"20&":*5"(%)'!3*,-"*&">0.%(*02*7$#%(*$,'>9(9$*<")0!5*2010 does not present a desirable approach, especially in the case of countries with <0&5"&('!"*7$#%(*$9$,%'!%<'(',)*,-%,*#%!!0,*"%$'()*P%220&5Q*$-%&1*&'$"$*'!*5"<,*&%,'0$@*4$*"?1"#,"5*M$""*T'39&"*^SN:*20&#"29(*7$#%(*%5=9$,>"!,*3"!"&%(()*("%5$*,0*$-%&1"&*5"#('!"$*'!*5"<,*&%,'0$*,-%!*>0&"*>05"&%,"*7$#%(*%5=9$,>"!,:*<9,*,-"*5)!%>'#$*02*,-"*>05"(:*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 &"#0."&'"$*&"(%,'."*,0*O9',"*(0/*'!,"&"$,*&%,"$*'>1()*,-%,*#0!,'!9"5*(%&3"*7$#%(*5"7#',$*50*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 $,%&,*,0*'!#&"%$"*'2*7$#%(*5"7#',$*&">%'!*(%&3"@

Based on the scenario result, it is apparent most countries will need to start unwinding ,-"'&*7$#%(*$,'>9(9$*1%#C%3"$*&"(%,'."()*$00!*'2*,-")*%&"*,0*$,%<'('B"*$-0&,G,"&>*5"<,*%!5:*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 ;-'$*$"#,'0!*%55&"$$"$*'$$9"$*&"(%,"5*,0*,-"*P!"/Q*7$#%(*10('#)*2&%>"/0&C$*,-%,*/'((*be adopted in the region in the post global crisis environment. As noted earlier, the $9##"$$29(*#0!,&'<9,'0!*02*7$#%(*10('#)*,0*-"(1'!3*,-"*&"3'0!*/"%,-"&*,-"*3(0<%(*$(0/50/!*>%)*("%5*,0*%*(%&3"&*&0("*20&*#09!,"&#)#('#%(*7$#%(*10('#)*'!*,-"*29,9&"*%!5*,0*%*&%!3"*02*P5">%!5$Q*0!*<953",$*<)*3&091$*%5."&$"()*%22"#,"5*<)*"#0!0>'#*50/!,9&!$@*4!5*0!*,01*of current and prospective demands on budgets related to pensions and population aging, 7$#%(*10('#)*'!*%*!9><"&*02*#09!,&'"$*'!*,-"*&"3'0!*>%)*<"*#%(("5*910!*,0*%$$'$,*'!*,-"*global rebalancing effort over the medium term. A key challenge governments are likely ,0*2%#"*/'((*<"*,0*&"#0!#'("*%*10$$'<()*>0&"*%#,'.'$,*&0("*20&*7$#%(*10('#)*'!*,-"*29,9&"*/-'("*"!$9&'!3*,-%,*,-"*&"3'0!A$*3"!"&%(()*$,&0!3*&"#0&5*02*7$#%(*$9$,%'!%<'(',)*'$*!0,*19,*%,*&'$C@*54 E#ectively, in those cases where !scal data is not available for 2009, the 2008 estimates are updated to re"ect

announced stimulus packages.


H!*%55','0!:*,-"*10$$'<'(',)*$-09(5*<"*#0!$'5"&"5*,-%,*>%'!,%'!'!3*7$#%(*$9$,%'!%<'(',)*>%)*be more challenging looking forward if some of the favorable economic conditions that -"(5*'!*,-"*1%$,Z'!#(95'!3*'!,"&"$,*&%,"$*,-%,*%&"*02,"!*/"((*<"(0/*,-"*3&0/,-*&%,"*02*,-"*"#0!0>)Z%&"*!0*(0!3"&*%$$9&"5@*H!*$9#-*#'&#9>$,%!#"$:*>%'!,%'!'!3*7$#%(*$9$,%'!%<'(',)*#09(5*&"O9'&"*>0&"*20&#"29(*10('#)*&"$10!$"$*,0*7$#%(*$('11%3"$*,-%!*'!*,-"*1%$,:*"$1"#'%(()*'!*,-0$"*#%$"$*/-"&"*7$#%(*$9$,%'!%<'(',)*'$*%,*&'$C:*%!5*>'3-,*<"!"7,*2&0>*,-"*%501,'0!*02*$,&0!3*>"5'9>G,"&>*7$#%(*10('#)*2&%>"/0&C$*,-%,*%&"*&"39(%&()*$,&"$$*,"$,"5*for a number of unfavorable contingencies.

[%$"5*0!*%*/'5"*&%!3"*02*"?1"&'"!#"$:*$,&0!3*>"5'9>G,"&>*7$#%(*2&%>"/0&C$Z'!*/-'#-*government spending, revenues, debt service and debt levels are projected over the >"5'9>*,"&>*'!*%*&"%('$,'#*%!5*#0!$'$,"!,*/%):*%!5*$,&"$$*,"$,"5*20&*5'22"&"!,*$-0#C$Z-%."*1&0."5*9$"29(*20&*-"(1'!3*%$$9&"*,-%,*<953",$*#0!20&>*,0*7$#%(*$9$,%'!%<'(',)*Mm01',$*%!5*Y)>%!$C)*^LLKN@*;-"*&"%$0!*20&*,-'$*'$*,-%,*$9#-*2&%>"/0&C$*#%!*-"(1*'5"!,'2)*in a timely manner whether debt ratios may be tending to rise too rapidly, and assist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

F""5("$$*,0*$%):*7$#%(*10('#)*&9("$*#0>"*'!*>%!)*5'22"&"!,*P$-%1"$*%!5*$'B"$Q*%!5*,-"&"*'$*9!('C"()*,0*<"*%*$'!3("*0!"G$'B"G7,$G%((*%11&0%#-*%11('#%<("*,0*%((*#09!,&'"$*'!*,-"*&"3'0!*(Buiter 2003). In addition, different countries may have different budgetary and legislative 2&%>"/0&C$*%!5*5'22"&"!,*&0("$*20&*,-"*.%&'09$*<&%!#-"$*02*30."&!>"!,*'!*7$#%(*10('#)*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 $,'>9(9$*1&03&%>$@*Y,&0!3*>"5'9>G,"&>*7$#%(*2&%>"/0&C$*>%)*-"(1*2%#'(',%,"*,-"*3&0/,-*2&'"!5()*/',-5&%/%(*02*7$#%(*$,'>9(9$*1%#C%3"$*'2*,-"*2%.0&%<("*"22"#,$*0!*#&"5'<'(',)*%!5*interest rates implied by such frameworks help crowd in private spending (Cottarelli and ]'!%($*IJJLN@

;-"*7$#%(*10('#)*2&%>"/0&C$*%!5*&9("$*,-%,*-%."*<""!*%501,"5*'!*.%&'09$*#09!,&'"$*around the world have differed in a number of important dimensions. Such rules can <"*&'3'5*0&*+"?'<("8*%11()*,0*5'22"&"!,*#0>10!"!,$*02*,-"*<953",*0&*,0*,-"*0."&%((*<953",*5"7#',8*%11()*,0*5"<,*$,0#C$*0&*5"<,*'$$9%!#"8*%11()*)"%&*<)*)"%&*0&*0."&*,-"*>"5'9>*,"&>8*,%C"*,-"*20&>*02*&%!3"$*0&*10'!,*('>',$*0!*7$#%(*.%&'%<("$8*%!5*>%)*0&*>%)*!0,*include escape clauses to deal with exceptional circumstances. In addition, such &9("$*>%)*"?1('#',()*%((0/*20&*7$#%(*10('#)*,0*1(%)*%*#09!,"&#)#('#%(*&0("*<)*,%&3",'!3*,-"*$,&9#,9&%(*0&*-'3-*">1(0)>"!,*<953",*5"7#',8*0&*,-")*>%)*5'&"#,()*0&*'!5'&"#,()*('>',*


#09!,"&#)#('#%(*7$#%(*10('#)*&"$10!$"$*<)*<"'!3*2&%>"5*'!*%#,9%(*&%,-"&*,-%!*$,&9#,9&%(*terms.

;-"*<"$,GC!0/!*7$#%(*10('#)*&9("$*%&"*,-0$"*%$$0#'%,"5*/',-*,-"*V9&01"%!*h!'0!:*enshrined in the Growth and Stability Pact. The key elements of the Pact are relatively &'3'5*911"&*<09!5$*0!*7$#%(*5"7#',$*%!5*19<('#*5"<,*&%,'0$*M'!*&"(%,'0!*,0*R\6N*$9110&,"5*by a set of formal penalties to be imposed on countries that do not adhere to the rules. Fiscal policy rules, however, have been adopted in many other countries and parts of the world, and by both developed and emerging market countries. In the case of the United Y,%,"$:*>"5'9>G,"&>*7$#%(*10('#)*,%&3",$*%!5*&9("$*1(%)"5*%!*'>10&,%!,*&0("*'!*1(%#'!3*7$#%(*10('#)*0!*%*%*>0&"*$0('5*200,'!3*'!*,-"*(%,"*^LKJ$*%!5*"%&()*^LLJ$*Me0&'39#-'*^LLIN@*T'$#%(*10('#)*&9("$*1(%)"5*%!*'>10&,%!,*&0("*'!*W%!%5%A$*"220&,$*,0*,%>"*"?1(05'!3*19<('#*5"<,*59&'!3*,-"*^LKJ$*%!5*"%&()*^LLJ$@*;-"*h!',"5*m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many countries have adopted key elements of such frameworks as part of an effort to %$$9&"*7$#%(*$9$,%'!%<'(',)@

Looking forward, countries in the region might usefully consider strengthening and %5%1,'!3*,-"'&*7$#%(*2&%>"/0&C$*,0*,-"*10$,#&'$'$*/0&(5@*m")*"(">"!,$*02*$9#-*10$,#&'$'$*2&%>"/0&C$*/09(5*<"*&"%('$,'#*%!5*#0!$'$,"!,*>"5'9>G,"&>*1&0="#,'0!$*20&*7$#%(*.%&'%<("$*%!5*5"<,*$,0#C$8*%((0/%!#"*20&*29,9&"*%!5*1&0$1"#,'."*7$#%(*('%<'(','"$8*$,&"$$*,"$,'!3*against a number of unfavorable developments; formal or informal rules that lead to primary surpluses increasing in response to rising debt stocks as discussed in Section II M%!5*/-'#-*3'."*&'$"*,0*$,%<'('B'!3*1&'>%&)*<%(%!#"*&"$10!$"*29!#,'0!$N8*%!5*2&%>"/0&C$*$""C'!3*,0*%55&"$$*,-"*2%#,0&$*,-%,*#0!,&'<9,"*,0*5"<,*,'11'!3*10'!,$*/-"&"*,-"*7$#%(*%5=9$,>"!,*"220&,*,%1"&$*022@*Y9#-*2&%>"/0&C$*#%!*%($0*<"*5"$'3!"5*,0*#&"%,"*,-"*7$#%(*space necessary to deal with unforeseen contingencies and cyclical downturns. Policies ,-%,*$""C*,0*<9'(5*91*7$#%(*$1%#"*59&'!3*,-"*91$/'!3*02*,-"*<9$'!"$$*#)#("*/'((*-%."*,-"*<"!"7,*02*%((0/'!3*7$#%(*10('#)*,0*1(%)*%*10,"!,'%(()*'>10&,%!,*#09!,"&#)#('#%(*&0("*'!*<0,-*P3005Q*%!5*P<%5Q*,'>"$@*H!*%55','0!:*,-")*/09(5*#0>1(">"!,*"220&,$*'!*,-"*&"3'0!*,0*('>',*,-"*1&0G#)#('#%(',)*02*7!%!#'%(*$)$,">$*,-&093-*>%#&0*1&95"!,'%(*10('#'"$:*%!5*#09(5*-"(1*reduce the amplitude of regional business cycles.


VII. Concluding Observations;-"*3(0<%(*7!%!#'%(*%!5*"#0!0>'#*#&'$'$*-%$*29!5%>"!,%(()*%(,"&"5*4$'%A$*7$#%(*10('#)*"!.'&0!>"!,@*6&'0&*,0*,-"*#&'$'$:*,-"*&"3'0!A$*,&%5','0!%(*7$#%(*1-'(0$01-)*/%$*0!"*02*providing growth-conducive public goods such as infrastructure and education without ="01%&5'B'!3*7$#%(*$9$,%'!%<'(',)*%!5*-"!#"*>%#&0"#0!0>'#*$,%<'(',)@*T0&*,-"*>0$,*1%&,:*with few exceptions such as South Asia, the outcome of this philosophy has been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in much of the region obviated the need for countercyclical polices that, in practice, refer ,0*%!,'&"#"$$'0!*10('#'"$@*;-"*3(0<%(*#&'$'$*-%$*<&093-,*#09!,"&#)#('#%(*7$#%(*%#,'.'$>*<%#C*'!,0*4$'%*/',-*%*,-9!5"&09$*<%!3@*;-"*9!1&"#"5"!,"5*7$#%(*$,'>9(9$*19,*'!,0*effect by governments across the region was borne out of sheer necessity rather than %!)*29!5%>"!,%(*$-'2,*'!*7$#%(*1-'(0$01-)@*V."!*$0:*,-"*%!,'#&'$'$*$,'>9(9$*>%)*-%."*&"1"&#9$$'0!$*20&*<0,-*7$#%(*10('#)*%!5*7$#%(*09,#0>"$*2%&*<")0!5*,-"*#&'$'$@

;-"*&".'.%(*02*#09!,"&#)#('#%(*7$#%(*10('#'"$*'!*,-"*&"3'0!*<&'!3$*<%#C*,-"*'$$9"*02*7$#%(*sustainability back to center stage. Precisely because the region’s governments have (%&3"()*&"2&%'!"5*2&0>*7$#%(*%#,'.'$>*'!*,-"*1%$,:*7$#%(*$9$,%'!%<'(',)*-%$*!0,*<""!*%*>%=0&*10('#)*#0!#"&!*'!*,-"*&"3'0!@*e0/"."&:*,-"*%!,'#&'$'$*7$#%(*$,'>9(9$*1%#C%3"$*/'((*("%5*,0*5","&'0&%,'0!*02*,-"*7$#%(*%!5*19<('#*5"<,*10$','0!$*'!*,-"*$-0&,*&9!:*%!5*>%)*%($0*<&'!3*%<09,*%*P3%>"G#-%!3'!3Q*$-'2,*'!*,-"*&"3'0!A$*7$#%(*1-'(0$01-)*,0/%&5*-"'3-,"!"5*countercyclical activism beyond the crisis. In light of the renewed importance of Asia’s 7$#%(*$9$,%'!%<'(',)*'!*,-"*10$,#&'$'$*1"&'05:*/"*#%&&)*09,*,-&""*,)1"$*02*">1'&'#%(*%!%()$'$i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is considerable heterogeneity across countries and subregions, by and large Asia’s 19<('#*7!%!#"$*%&"*'!*&"(%,'."()*3005*$-%1"*%!5*4$'%A$*30."&!>"!,$*-%."*19&$9"5*7$#%(*$9$,%'!%<'(',)@*;-%,*'$:*,-"*".'5"!#"*#0!7&>$*,-"*#0!."!,'0!%(*/'$50>*,-%,*4$'%*-%$*<""!*7$#%(()*&"$10!$'<("*'!*,-"*1%$,@**;-"*,-'&5*,)1"*02*%!%()$'$*7!5$*,-%,*2%'(9&"*,0*9!/'!5*,-"*%!,'#&'$'$*7$#%(*$,'>9(9$*/'((*$"&'09$()*"&05"*,-"*&"3'0!A$*7$#%(*$9$,%'!%<'(',)@

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 1&'0&',)*,0*1&0>0,'!3*%!5*$9$,%'!'!3*7$#%(*$9$,%'!%<'(',)*%$*,-")*-%."*50!"*'!*,-"*1%$,@*


E9&*7!5'!3$*'>1()*,-%,*7$#%(*$9$,%'!%<'(',)*>%,,"&$*%!5*>%,,"&$*%*(0,:*%!5*,-'$*/'((*#0!,'!9"*,0*<"*,-"*#%$"*'!*,-"*29,9&"@*R'."!*,-"*1019(%&*1"&#"1,'0!*,-%,*#09!,"&#)#('#%(*7$#%(*policies played a key role in Asia’s spectacular V-shaped recovery, it may be tempting to <"('"."*,-%,*4$'%!*30."&!>"!,$*$-09(5*!0/*,-'!C*>0&"*%<09,*9$'!3*7$#%(*&"$09&#"$*%!5*("$$*%<09,*$9$,%'!'!3*7$#%(*$9$,%'!%<'(',)@*e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to deterioration of public debt positions. The primary forward-looking implication for Asian 10('#)>%C"&$*'$*,-"*#0!,'!9"5*!""5*20&*7$#%(*&"$10!$'<'(',)*'2*,-")*%&"*,0*$"#9&"*%5"O9%,"*7$#%(*$1%#"*,0*#01"*/',-*"?,&">"*$-0#C$*'!*,-"*29,9&"@*D-'("*,-"*3(0<%(*#&'$'$*/%$*9!509<,"5()*9!'O9"*%!5*"?#"1,'0!%(*'!*,"&>$*02*,-"*$)!#-&0!'B"5*%!5*3(0<%(*!%,9&"*02*',$*impact, we cannot rule out the recurrence of severe regional or global crises.

;-"*$"#0!5*10('#)*>"$$%3"*'$*,-%,*4$'%*/'((*<"!"7,*2&0>*,-"*%501,'0!*02*$,&0!3*>"5'9>G,"&>*7$#%(*10('#)*2&%>"/0&C$*,-%,*%&"*&"39(%&()*,"$,"5*20&*%*!9><"&*02*9!2%.0&%<("*contingencies. A key challenge governments are likely to face will be to reconcile a 10$$'<()*>0&"*%#,'.'$,*&0("*20&*7$#%(*10('#)*'!*,-"*29,9&"*/-'("*"!$9&'!3*,-%,*,-"*&"3'0!A$*3"!"&%(()*$,&0!3*&"#0&5*02*7$#%(*$9$,%'!%<'(',)*'$*!0,*19,*%,*&'$C@*4*$,&0!3*>"5'9>G,"&>*7$#%(*10('#)*2&%>"/0&C*/'((*<"*#&','#%(*20&*>"",'!3*,-%,*#-%(("!3"@*U"3%&5("$$*02*,-"*%#,9%(*#0!,&'<9,'0!*02*,-"*7$#%(*$,'>9(9$*,0*,-"*&"3'0!A$*&"#0."&):*,-"*1019(%&*1"&#"1,'0!*,-%,*',*1(%)"5*%*#"!,&%(*&0("*>%)*<&'!3*%<09,*%*3%>"G#-%!3'!3*$-'2,*'!*,-"*&"3'0!A$*7$#%(*philosophy from its traditional conservatism toward countercyclical activism. Such a $-'2,*>%)*="01%&5'B"*7$#%(*$9$,%'!%<'(',)*<"#%9$"*02*%!*'!-"&"!,*%$)>>",&'#*<'%$*'!*#09!,"&#)#('#%(*7$#%(*10('#):*'@"@:*',*'$*10(','#%(()*"%$'"&*,0*'!#&"%$"*$1"!5'!3*%!5*#9,*taxes during recessions than to go the other way during booms. Even in the absence 02*3%>"G#-%!3'!3*$-'2,$*'!*7$#%(*1-'(0$01-):*,-"*5","&'0&%,'0!*02*7$#%(*10$','0!$*%#&0$$*the region due to the anticrisis stimulus packages may have adverse implications for 7$#%(*$9$,%'!%<'(',):*%!5*-%$*,-9$*&"!5"&"5*,-"*!""5*20&*$,&0!3*>"5'9>G,"&>*7$#%(*10('#)*frameworks all the more urgent. The adoption of such frameworks may also provide a >0&"*'>>"5'%,"*<"!"7,*'!*$0*2%&*%$*,-")*#%!*-"(1*$'3!%(*,-%,*,-"*&"#"!,*7$#%(*$,'>9(9$*1&03&%>$*%&"*,">10&%&)*%!5*/'((*!0,*&"1&"$"!,*%*,-&"%,*,0*(0!3"&G,"&>*7$#%(*$9$,%'!%<'(',)@*And, any positive impact of frameworks on credibility about sustainability could help #&0/5*'!*1&'.%,"*$1"!5'!3*%!5*&"59#"*7!%!#'!3*#0$,$*%$*7$#%(*10('#)*'$*19,*<%#C*0!*,&%#C@*Y,&0!3*>"5'9>G,"&>*7$#%(*2&%>"/0&C$*#%!*,-9$*2%#'(',%,"*3&0/,-G2&'"!5()*"?',*$,&%,"3'"$*from recent stimulus packages.

The third policy message emerging from our analysis is that Asian countries need to ,%C"*%*(0!3*%!5*<&0%5*.'"/*02*7$#%(*$9$,%'!%<'(',):*/-'#-*,%C"$*'!,0*%##09!,*,-"*&"3'0!A$*>"5'9>G,"&>*7$#%(*!""5$*0."&*%*$927#'"!,()*(0!3*,'>"*-0&'B0!@**Y9#-*%*.'"/*02*7$#%(*


$9$,%'!%<'(',)*'$*#(0$"()*&"(%,"5*,0*%!5*#0!$'$,"!,*/',-*,-"*!""5*20&*$,&0!3*7$#%(*10('#)*2&%>"/0&C$:*<9,*%,*,-"*$%>"*,'>"*10'!,$*,0*,-"*!""5*,0*%5%1,*,-"*!0,'0!*02*7$#%(*$9$,%'!%<'(',)*,0*10,"!,'%(()*(%&3"*#-%!3"$*'!*4$'%A$*10$,#&'$'$*7$#%(*"!.'&0!>"!,@*;-"*&"3'0!*-%$*$0>"*(0!3G$,%!5'!3*>"5'9>G,"&>*7$#%(*!""5$*$9#-*%$*1-)$'#%(*'!2&%$,&9#,9&"@*4*>0&"*&"#"!,*>"5'9>G,"&>*7$#%(*#-%(("!3"*'$*,0*1&0.'5"*%5"O9%,"*1"!$'0!*%!5*-"%(,-*care as the region rapidly shifts to an older population. A medium-term need that has arisen as a direct result of the global crisis is more spending on social protection and other areas that can facilitate Asia’s growth rebalancing. Finally, given Asia’s growing /"'3-,*'!*,-"*/0&(5*"#0!0>)*%!5*'!+9"!#"*'!*,-"*'!,"&!%,'0!%(*#0>>9!',):*4$'%*/'((*<"*"?1"#,"5*,0*#0!,&'<9,"*>0&"*,0*3(0<%(*19<('#*3005$*$9#-*%$*73-,'!3*#('>%,"*#-%!3"*and poverty in Africa. For all of these reasons, even if there were no shift toward #09!,"&#)#('#%(*7$#%(*10('#'"$:*4$'%*>%)*"?1"&'"!#"*%!*'!#&"%$"*'!*,-"*&0("*02*,-"*30."&!>"!,@*H!*%55','0!:*'!*',$*7$#%(*$9$,%'!%<'(',)*%$$"$$>"!,$:*,-"*&"3'0!*$-09(5*"?1('#',()*,%C"*'!,0*%##09!,*$'3!'7#%!,*022G<953",*',">$*%!5*#0!,'!3"!,*('%<'(','"$:*'!#(95'!3*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 %*1&0$1"#,'."*>"5'9>G,"&>*'!#&"%$"*'!*7$#%(*5">%!5$*'!*,-"*10$,#&'$'$*1"&'05*&"!5"&$*1&"#&'$'$*!0,'0!$*02*7$#%(*$9$,%'!%<'(',)*0<$0(","*'!*,-"*$"!$"*,-%,*(%&3"&*&"."!9"$*/'((*<"*required to achieve sustainability.

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macroeconomic stability. The global crisis has highlighted a fact that has hitherto been 9!5"&%11&"#'%,"5*'!*,-"*&"3'0!Z,-%,*7$#%(*$9$,%'!%<'(',)*'$*%$*>9#-*%*.%(9%<("*,00(*%$*',*'$*%*#0!$"O9"!#"@*4*.%(9%<("*,00(*<"#%9$"*',*-%$*%((0/"5*,-"*&"3'0!*,0*9!("%$-*(%&3"*7$#%(*$,'>9(9$*1&03&%>$@*Y0>"/-%,*1%&%50?'#%(():*#9&&"!,*7$#%(*1&0+'3%#):*/-'#-*/%$*,-"*&'3-,*>"5'#'!"*20&*,-"*#&'$'$:*/%$*>%5"*10$$'<("*<)*1%$,*7$#%(*2&93%(',)@*R'."!*,-"*10$$'<'(',)*02*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.

T'!%(():*,-"*3%>"G#-%!3'!3*$-'2,*'!*,-"*&"3'0!A$*7$#%(*(%!5$#%1"*$'!#"*,-"*3(0<%(*#&'$'$*is not without some serious risks. In particular, higher government expenditures and, >0&"*3"!"&%(():*%!*"?1%!$'0!*'!*,-"*"#0!0>'#*&0("*02*,-"*30."&!>"!,*'$*02,"!*5'27#9(,*,0*&"."&$"*0&*%5=9$,*"."!*/-"!*,-")*%&"*!0*(0!3"&*=9$,'7"5@*60(','#%(*#0!$'5"&%,'0!$*>%C"*',*"%$'"&*20&*30."&!>"!,$*,0*19&$9"*7$#%(*"?1%!$'0!*&%,-"&*,-%!*7$#%(*#0!,&%#,'0!*59&'!3*


50/!,9&!$@*;-'$*-%$*<""!*".'5"!,*'!*,-"*"?1"&'"!#"*02*'!59$,&'%('B"5*#09!,&'"$@*;-"*$#01"*20&*7$#%(*&"."&$%(*0&*%5=9$,>"!,*'$*"."!*>0&"*('>',"5*'!*5"."(01'!3*#09!,&'"$*/',-*weaker institutions and policy environments. However, the need for caution does not mean that the government should refrain from rethinking and expanding its role where %11&01&'%,"*%!5*=9$,'7"5@*;-"*#&'$'$*-%$*$-0/!*,-%,*,-"*30."&!>"!,*#%!*%!5*$-09(5*$"&."*as a consumer of last resort when all the other components of demand are stalling. At a >'!'>9>:*%!5*%$'5"*2&0>*%!)*5'&"#,*'>1%#,*0!*3&0/,-:*',*'$*('C"()*,-%,*,-"*&"3'0!A$*7$#%(*$,'>9(9$*-%$*-"(1"5*,0*'>1&0."*<9$'!"$$*%!5*#0!$9>"&*#0!75"!#":*/-'#-*-%5*#&%,"&"5*%$*,-"*#&'$'$*'!,"!$'7"5@*R0'!3*20&/%&5:*,-"*C")*#-%(("!3"*20&*4$'%*'$*,0*&"5"7!"*,-"*&0("*02*,-"*30."&!>"!,*%!5*%5%1,*',*,0*,-"*10$,#&'$'$*/0&(5*/',-09,*#0>1&0>'$'!3*,-"*7$#%(*sustainability that has served the region so well.

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

About the Asian Development BankADB’s vision is an Asia and Paci!c 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.

Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org/economicsISSN: 1655-5252Publication Stock No. Printed in the Philippines

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