S O U T H AS I A E C O N O MI C F O CUS FAL L 2 018 2 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 21 20 19 18 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. ISBN (electronic): 978-1-4648-1369-6 DOI: 10.1596/978-1-4648-1369-6 Cover photo: World Bank and JohnnyGreig/istock Design: Alejandro Espinosa/sonideas S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 3 Hari Mahidhar / Shutterstock.com 4 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 Hari Mahidhar / Shutterstock.com S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 5 T his report is a joint product of the Office of the Chief Economist for the South Asia Region (SARCE) and the Macroeconomics, Trade and Investment Global Practice (MTI). Its preparation was led by Robert Beyer (Economist) under the oversight of Martin Rama (Chief Economist, South Asia Region) in close collaboration with Manuela Francisco (Practice Manager, MTI). Substantive contributions were made by Milagros Chocce, Ishita Dugar, Lazar Milivojevic and Rucheta Singh (in alphabetical order, all SARCE). The report greatly benefitted from inputs from Temel Taskin and other colleagues in the Development Economics Prospects Group (DECPG) under the supervision of Ayhan Kose (Director DECPG). We are very grateful for comments and suggestions provided by Enrique Blanco Armas, Poonam Gupta, Zahid Hussain, Fernando Gabriel Im, Taehyun Lee, Mona Prasad, Aurelien Kruse, Florian Blum, and Adnan Ashraf Ghumman (all MTI), as well as to Prof. Ila Patnaik (National Institute of Public Finance and Policy, Delhi), Martin Melecky (Finance, Competitiveness and Innovation Global Practice), and to Fan Zhang (SARCE). Colleagues providing information for country briefs include Mona Prasad, Tobias Akhtar Haque, Taehyun Lee, Zahid Hussain, Shegufta Shahriar, Afroza Alam, Nazmus Sadat Khan, Yoichiro Ishihara, Aurelien Kruse, Rangeet Ghosh, Fernando Gabriel Im, Kishan Abeygunawardana, Roshan Darshan Bajracharya, Kene Ezemenari, Enrique Blanco Armas, Adnan Ashraf Ghumman under supervision of Manuela Francisco (Practice Manager, MTI). Alejandro Espinosa at Sonideas signed responsible for the layout, design and typesetting, Alexander Ferguson (Senior Manager, South Asia External Communications) and Yann Doignon coordinated the dissemination, Gonzalo Alberto Villamizar De La Rosa created accompanying videos, and Neelam Chowdhry provided valuable administrative support. South Asia as used in this report includes Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The cutoff date for this report was October 1, 2018. South Asia Chief Economist Office Macroeconomics, Trade and Investment Global Practice 6 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 Dario Diament / Shutterstock.com S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 7 Table of Contents Recent economic developments 8 A generally positive picture 10 Five tensions to watch 12 A turbulent external environment 19 South Asia economic outlook 24 Budget crunch 32 Limited room for maneuver 34 Amplification of boom-and-bust cycles 37 A build-up of liabilities 40 A fiscal “reading” of development challenges 43 Summing up 48 South Asia country briefs 52 South Asia at a glance 72 8 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 Recent economic developments CRS PHOTO / Shutterstock.com 10 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments S outh Asia remains the fastest-growing region in the world and its performance has strengthened further, with growth rates exceeding 7 percent in Bangladesh, India and Maldives. Inflation remains near or below targets, but it has picked up in some countries. The external environment, while remaining conducive, has become more turbulent. Monetary policy is being adjusted accordingly, but fiscal policy is not equally responsive and fiscal deficits remain large. Despite strong demand from advanced economies and considerable depreciation of domestic currencies, imports are still growing stronger than exports in most countries. International reserves remain comfortable in most cases, but they are generally declining. Rising oil prices add further pressure on South Asia’s high current account deficits. growth has been decelerating since the third quarter of A generally positive picture 2017 and was only 2 percent in the second quarter of 2018. Developing countries grew by 5 percent during Global growth has stabilized at a relatively high level the first half of this year. and is particularly strong in the United States, a key export destination for the region. The world has been In a positive development for the region, remittances growing above 3 percent since the second quarter of are holding well or are even increasing. Remittances 2017. Growth in the United States accelerated to 2.6 per- are an important source of foreign reserves and a key cent in the first quarter of this year and further to 2.9 in contributor to domestic demand and poverty reduc- the second quarter, roughly twice the growth rate of two tion in several South Asian countries. With many South years ago. In other OECD countries, on the other hand, Asian migrants working in Gulf countries, remittances are Figure 1: Growth has plateaued at the global level but is accelerating in the US. Real GDP growth Percent change, y-o-y 6 5 4 3 2 1 0 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 Developing countries United States World OECD (excluding United States) Source: World Bank and staff calculations. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 11 Figure 2: Remittances are holding well or are even increasing. Remittance flows Percent change, y-o-y 40 30 20 10 0 -10 -20 -30 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 Bangladesh India Nepal Pakistan Sri Lanka Source: Haver Analytics and staff calculations. sensitive to international oil prices. Their amount had de- Asia increased for five consecutive quarters – from 5.5 creased substantially after oil prices dropped in 2015 and percent in the second quarter of 2017 to 8.1 percent in remained low throughout 2016, but it is now recovering. the second quarter of 2018. Meanwhile, growth in East Over the last year, the flow of remittances has increased Asia and the Pacific – the other leading region – slightly strongly in Bangladesh and India. In the second quarter decreased in the second quarter of 2018, to 6.4 percent. of this year, remittances to these two countries were 18 Elsewhere the moderation is sharper. Growth in Sub-Sa- percent and 28 percent higher than a year earlier, re- haran Africa decreased from 2.6 percent in the last quar- spectively. In Pakistan and Sri Lanka, on the other hand, ter of 2017 to 1.7 percent in the second quarter of 2018. remittances are nearly at the same level as one year ago. Growth in Latin America and the Caribbean decreased to 1.8 percent and 1.6 percent in the last two quarters. In this conducive environment, South Asia remains In the Middle East and North Africa, growth decreased the fastest-growing region in the world, and the gap from 5.1 percent in the third quarter of 2017 to 2.4 percent with East Asia has even widened. Growth in South in the second quarter of this year. Figure 3: South Asia is consolidating its position as the fastest-growing region. Regional real GDP growth Percent change, y-o-y 14 12 10 8 6 4 2 0 -2 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 East Asia and Pacific Europe and Central Asia Middle East and North Africa Sub-Saharan Africa Latin America and the Caribbean South Asia Source: World Bank and staff calculations. 12 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments Figure 4: Except for Afghanistan, growth rates are relatively strong and stable. Real GDP growth Percent 8 6 4 2 0 Afghanistan (CY) Bangladesh (FY) Bhutan (FY) India (FY) Maldives (CY) Nepal (FY) Pakistan Sri Lanka (CY) (FY, factor prices) 2016 2017 2018 (f) Note: (f) = forecast, CY = calendar year, FY = fiscal year. Afghanistan, Maldives and Sri Lanka are in calendar years. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. Source: World Bank. Growth rates differ across South Asian countries, but stock market is below the level of one year ago, closer they are substantial in most cases and have been quite to the level of Spring 2017. But in Pakistan the Karachi stable over time. Due to its size, India drives regional per- Stock Exchange has been hovering around 40,000 formance. Its growth rate has been steadily increasing over the last year, despite concerns about the country’s since the second quarter of 2017, offsetting a decline that macroeconomic situation. And in India, the stock mar- had lasted for five quarters. From 5.6 percent back then, ket declined somewhat at the beginning of the year but the growth rate has climbed to 8.2 percent in the sec- started increasing again around April and remains high- ond quarter of this year. Growth performance improved er than one year ago. in other South Asian countries as well. In Bangladesh, the growth rate is officially reported to have reached 7.9 percent in FY 2017/18, driven by consumption and public Five tensions to watch investment. In Maldives, growth is projected to reach 8.0 percent this year thanks to strong dynamism in tourism and construction. In Pakistan growth accelerated to 5.8 Growth is strong, but not driven percent during FY 2017/18, and in Sri Lanka it is project- by exports or manufacturing ed to reach 3.9 percent this year. Elsewhere, economic Domestic consumption has been the main contributor growth has slowed down. In Nepal it had been excep- to economic growth across the region, with exports or tionally strong in FY 2016/17, due to reconstruction efforts investment being remarkably subdued. In Bangladesh, after the 2015 earthquakes, and moderated to 6.3 per- private and government consumption contributed 8.5 cent last fiscal year. In Bhutan, growth is decelerating as percentage points to growth in FY 2017/18, compared the investment into hydropower construction is decreas- to only 3.2 percentage points contributed by invest- ing due to major projects nearing completion. Growth in ment. The net effect of exports and imports decreased Afghanistan remains the lowest in South Asia, by far, and growth by over 4 percentage points. Similarly, in Paki- is projected to decrease to 2.4 percent this year. stan growth was overwhelmingly driven by domestic consumption last fiscal year. In India and Sri Lanka, the Stock markets have been relatively stable across contribution of investment is projected to be relatively South Asia, and especially strong in India. Across the more important in 2018, but even there the main driver developing world, the appreciation of the US dollar and remains domestic consumption. In both countries ex- concerns about the normalization of monetary policy ports contribute relatively little to growth. in advanced economies took a toll on share prices. But despite the growing turbulence in international markets, Industrial production is holding well, but it grows slow- declines have been more muted in South Asia. The er than GDP in most countries. South Asia’s industrial stock market in Bangladesh peaked at the beginning of production grew by only 5.4 percent in the second quar- 2018, and since then has decreased by over 10 percent. ter of 2018, slightly lower than a quarter before. In India Similarly, in Sri Lanka, the stock market index fell by 10 it grew by 5 percent, in Pakistan by 4.5 percent, and in percent from January to September. In both cases the Sri Lanka by only 0.6 percent. In Bangladesh industrial 5500 6000 6500 7000 4000 4500 5000 5500 6000 6500 35000 40000 45000 50000 55000 Index Index Index Index 25000 30000 35000 40000 Jul-16 Jul-16 Jul-16 Jul-16 Aug-16 Aug-16 Aug-16 Aug-16 Source: Haver Analytics. Sep-16 Sep-16 Sep-16 Sep-16 Nov-16 Nov-16 Nov-16 Nov-16 Dec-16 Dec-16 Dec-16 Dec-16 Jan-17 Jan-17 Jan-17 Jan-17 Mar-17 Mar-17 Mar-17 Mar-17 Apr-17 Apr-17 Apr-17 Apr-17 Jun-17 Jun-17 Jun-17 Jun-17 Figure 5: Stock markets are performing relatively well. Jul-17 Jul-17 Jul-17 Jul-17 Aug-17 Aug-17 Aug-17 Aug-17 Oct-17 Oct-17 Oct-17 Oct-17 Pakistan, Karachi Stock Exchange 100 India, Bombay Stock Exchange SENSEX Sri Lanka, Colombo Stock Exchange ASPI Bangladesh, Dhaka Stock Exchange DSEX Nov-17 Nov-17 Nov-17 Nov-17 Dec-17 Dec-17 Dec-17 Dec-17 Feb-18 Feb-18 Feb-18 Feb-18 Mar-18 Mar-18 Mar-18 Mar-18 May-18 May-18 May-18 May-18 Jun-18 Jun-18 Jun-18 Jun-18 Jul-18 Jul-18 Jul-18 Jul-18 Sep-18 Sep-18 Sep-18 Sep-18 R ecent economic de velopments S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 13 14 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments Figure 6: Strong growth, but not driven by exports … Contributions to growth forecasts in 2018 Percentage points 15 10 5 0 -5 -10 Bangladesh (FY) India (FY) Pakistan (FY) Sri Lanka (CY) Government consumption Private consumption Imports Gross fixed investment Exports Real GDP growth (percent) Source: World Bank and staff calculations. Figure 7: … while industrial production is generally lagging aggregate growth. Industrial production growth Percent, y-o-y 8 6 4 2 0 -2 -4 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 South Asia Bangladesh India Sri Lanka Pakistan Source: World Bank and staff calculations. production growth moderated for three consecutive benchmark to assess inflationary pressures is to compare quarters but is at over 10 percent still very strong. Ad- actual inflation rates with inflation targets. This comparison mittedly, industrial production is a volatile indicator and reveals whether policy makers are confronting unexpect- changes need to be interpreted with caution, especially ed developments on the price front and allows assessing for individual countries. But it is safe to say that the region how successful stabilization policies have been. In this re- is not experiencing a broad-based manufacturing boom, spect, it is reassuring that inflation rates remain in line with as could be hoped for given its development level. the explicit or implicit inflation targets of the authorities in most South Asian countries. Across South Asia, actual in- Inflation is close to target, but it is flation has been minimally below the target in September. accelerating in some countries In some countries, however, consumer prices are in- The strong growth performance of the region has not creasing faster than in previous years. Consumer prices been accompanied by inflationary pressures so far. A in the region as a whole grew by 3.7 percent in March 2018, S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 15 Figure 8: Headline inflation is generally close to target… Inflation and distance to policy target Percentage points 7 6 5 4 3 2 1 0 -1 -2 Bangladesh India Pakistan Sri Lanka China Japan Euro Area US Difference from inflation target Inflation (Sept 2018) Note: Sri Lanka has not yet moved to explicit inflation targeting; the target used is the center point of the Monetary Policy Consultation Clause (MPCC) of 4.7 percent. For Bangladesh inflation is from August 2018. Sources: Inflation target data is from Haver Analytics (National Authorities). Current inflation data is from Trading Economics. Distance to inflation is based on staff calculations. Figure 9: …but headline inflation has picked up in the largest countries in the region. South Asia consumer price inflation Percent change, y-o-y 12 10 8 6 4 2 0 -2 Dec-17 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Jul-16 Aug-16 Apr-17 South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Source: World Bank and staff calculations. 1.2 percentage points less than a year earlier. Regional External demand has improved, but inflation rates mask the trend because they give equal trade balances remain weak weight to all countries, and the smaller ones have been on a different trajectory. Since May 2017, the inflation rate Import demand in South Asia’s key markets has been has fallen considerably in Afghanistan and the Maldives, strong, and South Asian currencies have generally with both countries experiencing deflation lately. But the depreciated, even more than those of other emerging acceleration is visible in some of the larger countries. In economies. Total imports in the US grew by 4.0 percent Sri Lanka and Pakistan, inflation rates went up from below last year and import growth is projected to strengthen to 4 percent in April to 5.9 percent in August. In September, 5.3 percent this year. In the Euro Area, imports grew by however, inflation in Sri Lanka fell back to 4.3 percent driv- 5.4 percent last year and are expected to continue on en by slower growth in food prices. And in India, inflation the same trend this year. The potential boost to South reached 4.9 percent in May and June but then decreased Asian exports has been amplified by currency deprecia- again to 3.7 percent in August and September. tion. Over the course of 2018, all South Asian currencies 16 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments Figure 10: South Asian currencies are depreciating… US Dollar per national currency Percent change, January to September 2018 2 0 -2 -4 -6 -8 -10 -12 -14 -16 Pakistan Bhutan India Nepal Afghanistan Sri Lanka Bangladesh Indonesia China Thailand Vietnam From January to July 2018 Sources: Haver Analytics and staff calculations. Figure 11: …but the growth of exports remains lower than the growth of imports. Growth of exports Growth of imports Percent, y-o-y Percent, y-o-y 35 35 25 25 15 15 5 5 -5 -5 -15 -15 -25 -25 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 Bangladesh India Pakistan Sri Lanka Bangladesh India Pakistan Sri Lanka Note: The figures refer to merchandise exports and imports only. Source: World Bank and staff calculations. lost ground against the USD. The trend was especially exports. In India and Pakistan recent nominal exchange pronounced in India. The Indian Rupee fell by 14 percent rate depreciations have led to a depreciation of the real since the beginning of the year. The Reserve Bank of effective exchange rates. And indeed, in Pakistan import India has smoothed out the trend, but it has not funda- growth came down quite dramatically from its peak of mentally opposed it. After a period of strong foreign ex- over 30 percent in the first quarter of last year. But at 9.1 change intervention, also Pakistan has allowed its cur- percent it is only marginally lower than the 10.4 percent rency to depreciate substantially. The lowest value was growth in exports. In India, import growth moderated from reached by end-July, at 129 Rupees per USD. Despite a over 30 percent a year ago to 6.9 percent now, and ex- modest rebound subsequently, there was a 10 percent ports are growing faster than imports. But overall, South depreciation compared to the beginning of the year and Asia does not look like an export powerhouse at this point. a 14 percent depreciation compared to one year before. External buffers are generally solid, Despite strong import demand and currency deprecia- but current account deficits are large tion, export performance remains disappointing while imports are still growing rapidly. In Bangladesh and Sri With a few exceptions, the level of international re- Lanka, import growth accelerated in the second quarter serves is relatively high in the region. Reserves in India of 2018, relative to the same period a year before. The and Bangladesh are at comfortable level and can cover 10.1 percent growth in imports experienced by Sri Lanka 9.3 and 7.6 months of imports respectively. Compared stands in sharp contrast with its 2.4 percent growth in to the beginning of the year, this is 0.8 months lower S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 17 Figure 12: The level of international reserves is comfortable in most cases… Foreign exchange reserves Months of imports 14 12 10 8 6 4 2 0 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Jul-16 Aug-16 Apr-17 Bangladesh India Maldives Pakistan Sri Lanka Source: World Bank. Figure 13: … but current account deficits are sizeable. Current account balance Percent of GDP 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 Bangladesh India Nepal Pakistan Sri Lanka Note: Quarterly GDP for Bangladesh, Pakistan, Nepal, Afghanistan is derived from annual GDP and assumed to be constant for all four quarters. Sources: Quarterly current account data is from Trading Economics. Quarterly GDP data for India and Sri Lanka is from Haver Analytics. for India and 0.5 months higher for Bangladesh. In Sri however. In Maldives reserves are increasing but cover Lanka reserves increased by over USD 1 billion due to less than 3 months of imports. And in Pakistan a weaker the issuance of a USD 2.5 billion bond that marked the macroeconomic situation and a delayed adjustment of country’s return to the US capital market. With a cover- the exchange rate led to considerable loss of reserves, age of 5.0 months of imports, the level of reserves is now bringing coverage down to 1.5 months of imports by prudent. Not all countries have such substantial buffers, end-September 2018. 18 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments However, current account deficits have been grow- 5.80 billion in the second quarter of 2018. The growth ing across most of South Asia and buffers are being of imports is partly the result of capital goods imports eroded in some cases. In Sri Lanka, the deficit bottomed for the China Pakistan Economic Corridor (CPEC), but out at the end of 2016, but the balance has remained it is also the consequence of growing macroeconomic negative since then and was still 1.9 percent of GDP in imbalances. the third quarter of 2017. In India, the current account has been in a deficit since 2004 and amounted to 2.2 Monetary policy is responsive, percent of GDP in the second quarter of this year. In Ban- but fiscal policy less so gladesh, the current account was in surplus during most of 2016, but it declined from plus 1.0 percent of GDP in Monetary authorities are responding to the infla- the third quarter of 2016 to minus 3.9 percent of GDP in tionary signs, as well as to growing exchange rate the second quarter of 2018. The sharpest deterioration pressures. Nepal is the only South Asian country that was in Pakistan, with the current account deficit worsen- has left the policy rate unchanged for the last cou- ing from USD 220 million the first quarter of 2016 to USD ple of years, at 7 percent. Pakistan began to raise its Figure 14: Monetary policy is adjusting to rising inflation and external pressure… Official interest rate (policy instrument/base rate) Repo rate (EOP, percent) 10 9 8 7 6 5 4 Dec-17 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Jan-18 Feb-18 Mar-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Jul-16 Aug-16 Apr-17 Apr-18 Bangladesh India Nepal Pakistan Sri Lanka Sources: Haver Analytics and Reuters. Figure 15: … but fiscal policy is not being equally responsive. Fiscal balance Percent of GDP 2 0 -2 -4 -6 -8 -10 -12 2016 2017 2018 (f) Afghanistan (CY) Bangladesh (FY) Bhutan (FY) India (FY) Maldives (CY) Nepal (FY) Pakistan (FY) Sri Lanka (CY) Note: (f) = forecast, CY = calendar year, FY = fiscal year. Afghanistan, Maldives and Sri Lanka are in calendar years. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 19 policy rate in January and India in June of this year. of GDP a year earlier and the deficit of the center be- The policy rate in Pakistan was increased from 6.3 ing stable at 3.5 percent of GDP. Fiscal discipline is not percent in January to 8.5 percent in September to equally strong across all Indian states. contain pressures on the exchange rate. In India, the policy rate increased from 6.0 percent in May 2018 to 6.5 percent in August 2018, in response to a pick-up in inflation. The Central Bank of Sri Lanka has left the A turbulent external policy rate unchanged due to the fragility of economic environment growth but injected liquidity in the domestic market and intervened in the foreign exchange market during The international price of oil has been on an upward September. trend, and this matters to South Asia because the re- gion is a net oil importer. Oil prices started increasing In contrast with the responsiveness of monetary poli- again since January 2016, after having reached a low cy, fiscal policy remains expansionary across most of of 28 USD per barrel. At the beginning of this year, the the region. Fiscal deficits have been traditionally large price stood at 67 USD per barrel and it went up further in South Asia, especially when considering the deficits to above 85 USD in the beginning of October. This is still of sub-national levels of government. In recent years, much lower than before the oil price collapse of 2014 – public expenditures grew much faster than revenue generation in several of the countries. While some coun- the average price of oil during the first half of 2014 was tries used to display a positive budget balance, all of 109 USD per barrel. Nevertheless, the upward trend puts them have been running deficits since 2017. In Sri Lanka, further pressure on South Asian economies. the fiscal deficit is projected to reach 5.2 percent of GDP in 2018, despite a primary surplus, due to heavy interest Higher oil prices put further pressure on current ac- payments. Maldives saw substantial fiscal consolida- counts but may also have an indirect impact on fiscal tion, but its deficit is still expected to stand at 5.3 percent deficits. On the positive side, with many South Asian mi- of GDP this year. In Nepal and Bangladesh, the fiscal grants working in Gulf countries, higher oil prices raise deficit rose to 5.8 percent and an estimated 4.1 percent the prospect of a sustained growth in remittances. But respectively in FY 2017/18. In Pakistan it reached 6.5 all countries in the region are oil importers, raising the percent, up from 5.8 percent in the previous fiscal year. prospect that trade balances may deteriorate further. In And in India it attained 6.6 percent, with state deficits the past, the impacts of higher oil prices on economic improving slightly to 3.1 percent of GDP from 3.5 percent activity have been relatively muted, mainly because Figure 16: International oil prices are increasing again. Crude oil prices: Brent - Europe USD/Bbl 120 100 80 60 40 20 0 Sep-17 Sep-18 Sep-15 Mar-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-14 May-16 Mar-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Nov-15 Jan-16 May-13 Source: Haver Analytics. 20 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments Figure 17: Emerging markets have become more vulnerable… External vulnerability 50 Nominal exchange rate depreciation (local currency vis-a-vis the USD) ARG 40 30 TUR 20 BR ZAF 10 RUS MEX IND ARG BR CHN ARG MEX Current account deficit (percent of GDP) 0 -30 -20 -10 TUR IND 0 RUS 10 20 30 40 50 CHN 60 CHN ZAF IND TUR ZAF -10 MEX RUS BR -20 2016 Q1 2017 Q1 2018 Q1 Note: ARG=Argentina, BR=Brazil, CHN=China, IND=India, MEX=Mexico, TUR=Turkey, ZAF=South Africa. Sources: Haver Analytics, national central banks, World Bank, and staff calculations. Figure 18: … and capital flows may not differentiate sufficiently across markets. Total portfolio flows of India and Turkey USD billion, 3-month moving average 6 4 2 0 -2 -4 -6 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 India Turkey Source: International Institute of Finance. of limited pass-through to consumers. But limited pass- account deficit widened to 7.3 percent of GDP. In Turkey, through leads to a loss of government revenue, either the Lira depreciated by over 20 percent over the same through subsidies or through lower taxation. Fiscal defi- period, and the current account widened to 5.5 percent cits could therefore increase even further. of GDP. At 10 percent, currency depreciation was more modest in South Africa, but the current account deficit Contagion is another source of risk, as external vul- widened to 18 percent of GDP. Commentators have at nerabilities have increased in important emerging times linked these developments to those in India, where markets across the world. The economic situation of the Rupee depreciated by 6 percent during this period Argentina, Turkey, and South Africa has deteriorated and the current account deficit reached 2.8 percent of considerably in recent months. In the first quarter of this GDP in the first quarter of this year. The comparison is year, the Argentinian Peso depreciated by over 40 per- far-fetched, but the fact that it is being made highlights cent compared to six months earlier, while the current the risks from international turbulence. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 21 Figure 19: Economic shocks abroad increase bond spreads in South Asia… Change in emerging market bond spreads after Taper Tantrum and latest market correction Basis points change 140 120 100 80 60 40 20 0 -20 0 5 10 15 20 25 30 35 40 Days EMDEs after latest market correction South Asia after latest market correction EMDEs after Taper Tantrum South Asia after Taper Tantrum Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes only India, Pakistan and Sri Lanka. Source: JP Morgan and staff calculations. Figure 20: … lead to considerable capital outflows in India... Change in EMDE and India portfolio flows after Taper Tantrum and latest market correction USD, billion 5 0 -5 -10 -15 -20 -25 0 5 10 15 20 25 30 35 40 Days EMDEs after latest market correction India after latest market correction EMDEs after Taper Tantrum India after Taper Tantrum Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. Source: International Institute of Finance and staff calculations. Figure 21: … and to weaker currencies in the region. Change in currencies after Taper Tantrum and latest market correction Percent change 1 0 -1 -2 -3 -4 -5 -6 0 5 10 15 20 25 30 35 40 Days EMDEs after latest market correction South Asia after latest market correction EMDEs after Taper Tantrum South Asia after Taper Tantrum Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes Bangladesh, India, Pakistan and Sri Lanka. Sources: Bloomberg, Haver Analytics, and staff calculations. 22 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments Short-term capital flows to emerging economies outflows and cause currency depreciation. In May tend to be synchronized, because they are affected 2013, the Federal Reserve announced that it would start by market sentiment. For example, the domestic eco- reducing the quantitative easing program established nomic situation has been different in Turkey and India, after the Global Financial Crisis. This ‘tapering talk’ led and yet the correlation coefficient between the capital to a broad-based surge in bond spreads across emerg- flows to these two economies from 2013 onwards is a ing markets. Bond spreads increased more in South sizeable 0.64. If international investors do not differen- Asia than in other regions. Similarly, in April 2018 the tiate sufficiently across emerging markets, an external expectation that interest rates would start increasing in event leading to a change of investor sentiment may advanced economies led to a widespread stock mar- result in broad-based impacts. Countries with substan- ket correction. In India, the only South Asian country tial stocks of foreign portfolio investments and large for which daily data on portfolio flows is available, the current account deficits may be more vulnerable to capital outflow 40 days after the tapering talk of May contagion. 2013 amounted to USD 7.6 billion. It reached USD 6.9 billion 40 days after the stock market correction of April Experience shows that economic shocks abroad can 2018. Outflows of this sort exert considerable pressure increase bond spreads in South Asia, lead to capital on exchange rates. Box 1: Views from the South Asia Economic Policy Network The South Asia Economic Policy Network, launched by the office of the regional Chief Economist at the World Bank in 2017, represents an attempt to engage more strongly with thinkers and practitioners across South Asia. The objective is to nurture the exchange of ideas and to learn more systematically from local colleagues and counterparts. The network focuses broadly on macroeconomics and includes over 350 members from seven South Asian countries. Members stand out in terms of peer recognition, participation in professional conferences and research outputs. Many of them are ac- ademics at renowned universities, others are researchers in central banks and think tanks, and some are affiliated with policy-making units. Figure 22: We asked over 350 economists from seven countries about their views. Survey among South Asia Economic Policy Network Number of experts 25 20 15 10 5 0 India Bangladesh Pakistan Nepal Sri Lanka Bhutan Undisclosed country Source: World Bank South Asia Economic Policy Network. As for the last two editions of this report, a short opinion survey was conducted among the members of the network for this edition of South Asia Economic Focus. The objective was to take the pulse of informed and influential experts about economic developments in their countries. The response rate exceeded 20 percent, with 84 filled-in questionnaires from 7 countries. Nearly all respondents identi- fied themselves as academics and as macroeconomists. Three quarters of the respondents are involved in policy advising and a quarter in policy making. The expectations of network members regarding economic developments over the next six months are summarized in a single number, using so-called diffusion indices. For every indicator, a value of the diffusion index above 50 indicates that an increase is expected, whereas a value below 50 corresponds to an expected decrease. The farther away the number is from 50, the greater the consensus among network members that an important change is under way. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments 23 Based on the responses, network members do not anticipate much change in economic growth in their countries. The exception is Pakistan, where there is a strong consensus that the growth rate will decline. Network members also expect that inflation and interest rates will pick-up across all countries. In Bangladesh, imports are expected to increase strongly, while exports are expected to remain stable. In Pakistan, imports are on the contrary expected to decrease, while an increase in exports is anticipated. In all countries except Pakistan, network members foresee an increase in the fiscal deficit. Finally, there are strong views across South Asia that exchange rates will depreciate, and that financial sector stress will rise. Figure 23: Network members expect higher inflation, interest rates and financial stress. What do you expect to happen in your country within the next six months? Diffusion index 100 90 80 Increase 70 60 50 40 30 Decrease 20 10 0 Real GDP growth Headline inflation Interest rates Imports Exports Fiscal deficit Exchange rate Financial sector stress India Pakistan Bangladesh Others Note: The index is calculated as follows: Index=(P1*100) + (P2*50) + (P3*0), where P1 is the proportion of responses that report that the variable is too large/overvalued/too high, P2 is the proportion of responses that report that the variable is stable, and P3 is the proportion of responses that report that the variable is too low/undervalued/too small. For the exchange rate, a value smaller than 50 signals and expected depreciation of the currency against the USD. Source: World Bank South Asia Economic Policy Network and staff calculations. There are two stark differences between these responses and those to the last survey, conducted six months ago. First, inflationary expectations have gone up across South Asia, despite the increase of policy rates by some central banks. Second, views on Pakistan’s economic prospects have changed substantially. While in the last survey respondents still anticipated faster economic growth and larger fiscal deficits, there now is a strong majority expecting fiscal consolidation, lower current account deficits, and slower economic growth. 24 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 South Asia economic outlook By singh lens / Shutterstock 26 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook S outh Asia is expected to remain the fastest-growing region in the world and its performance could strengthen even further. But economic growth will mainly be driven by domestic demand, not by exports. This inward orientation may sound justified at a time when there are concerns about ‘trade wars’, and financial markets have become more jittery. But import demand in the traditional destination markets for South Asian exports – the United States and Europe – will remain robust. And so far, the region has been subject only to minimal trade barriers. Therefore, South Asia’s export opportunity has not gone away. Instead of seizing it by reorienting resources towards foreign markets, especially through fiscal consolidation, countries in the region seem to be drifting toward more traditional protectionist policies. The international environment will remain conducive 5.6 percent next year, and to accelerate to 5.8 percent on the real side of the economy, but somewhat more the following year. These growth forecasts are broadly turbulent on the financial side. Global growth is project- in line with the expectations in June 2018. ed to reach 3.0 percent in 2019, only a slight decline from 3.1 percent in 2018. Global merchandise trade growth is Growth rates will be robust across most countries in expected to reach 3.9 percent in 2018, and 3.7 percent the South Asia, with the exception of Afghanistan. More next year. Both figures are higher than the corresponding specifically: GDP growth rates. This marks a difference with the period after the global financial crisis and suggests that there › Afghanistan. Growth is projected to pick up, but only are opportunities to increase exports. But the internation- to 3.2 percent by 2020. Importantly, this projection al price of oil may remain high for a while, exerting pres- presumes a recovery of confidence after a temporary sure on the current accounts of oil importers, including weakening due to security challenges and political South Asian countries. And the continued appreciation of uncertainty in the context of the upcoming parliamen- the US dollar, together with greater nervousness in finan- tary and presidential elections. cial markets, may exert pressure on many economies. › Bangladesh. Growth will be strong, driven by con- South Asia is projected to remain the fastest-growing sumption and public investment, but it is expected to region in the world and its lead could consolidate slow to an average of 6.9 percent over the forecast further in the coming years. Mainly due to a stronger horizon. This is due to a projected slowdown of pri- performance in India, growth in South Asia is estimated vate investment and an increase of imports. to accelerate to 6.9 percent in 2018 and to strengthen to 7.1 percent from next year onwards. Consequently, › Bhutan. Growth will accelerate with the commission- South Asia will maintain its position as the fastest-grow- ing of two major hydropower projects, Mangdechhu ing region. It will even extend its lead over East Asia and and Punatsangchhu-II. The growth rate is projected the Pacific, which is projected to grow at 6.1 percent next to jump from 4.6 percent in this fiscal year to 7.6 per- year and at 6.0 percent in 2020. Growth in the rest of the cent in FY 2019/20, before moderating again to 6.4 region, excluding India, is expected to remain stable at percent in FY 2020/21. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Economic outlook 27 Figure 24: Growth in South Asia is projected to accelerate slightly... Real GDP growth Percent Latin America and Caribbean Middle East and North Africa Sub Saharan Africa Europe and Central Asia East Asia and Pacific South Asia 0 2 4 6 8 2018 (f) 2019 (f) 2020 (f) Note: (f) = forecast. Source: World Bank. › India. Prompted by the adoption of the Goods and Table 1: … and changes in growth rate across countries Services Tax and the recapitalization of banks, growth will be minor. in India is firming up and it is projected to accelerate further. Growth is expected to rise to 7.3 percent in FY 2017 2018 (f) 2019 (f) 2020 (f) 2018/19, and to 7.5 percent in the following two years, Afghanistan (CY) 2.7 2.4 2.7 3.2 with stronger private spending and export growth as the key drivers. Bangladesh (FY) 7.3 7.9 7.0 6.8 › Maldives. Growth is projected at a very strong 8.0 Bhutan (FY) 5.8 4.6 7.6 6.4 percent this year, based on the dynamism of the India (FY) 6.7 7.3 7.5 7.5 construction and tourism sectors. But it is projected to decelerate in the next two years as new capital Maldives (CY) 7.1 8.0 6.3 5.6 investment projects gradually begin to taper off. Nepal (FY) 7.9 6.3 5.9 6.0 › Nepal. Economic activity is set to grow on average Pakistan (FY, 5.4 5.8 4.8 5.2 6 percent over the medium term. However, perfor- factor prices) mance could be less impressive if the challenging Sri Lanka (CY) 3.3 4.0 3.9 4.2 transition to a federalist system affects infrastructure Note: (f) = forecast, CY = calendar year, FY = fiscal year. For Bangladesh, Nepal and Pakistan, year provision and service delivery. 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. The numbers for 2018 are either estimates or forecasts. Source: World Bank. › Pakistan. Macroeconomic stabilization policies will take a toll on growth this fiscal year. GDP growth is expected to lower to 4.8 percent in FY This solid growth performance will be anchored not on 2018/19, reflecting a tighter fiscal and monetary private investment or exports, but rather on domestic policy. However, with improved macroeconomic conditions, growth could reach 5.2 percent in FY consumption. Private consumption is expected to slight- 2019/20. ly firm and to offset the moderation in public consumption that a gradual fiscal tightening would bring about. Simi- › Sri Lanka. Economic growth is projected to recover larly, private investment is expected to accelerate and from the effects of last year’s weather disruptions, offset moderating public investment. The contribution of which negatively impacted agriculture, and to remain private consumption to growth is projected to rise from 4.1 around 4 percent in the next two years. this year to 4.2 percent in the next year. With an annual 28 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook Figure 25: Private consumption will remain the main contributor to growth. Contributions to growth in South Asia Percentage points 10 8 6 4 2 0 -2 -4 2017 2018 (f) 2019 (f) 2020 (f) Private consumption Government consumption Gross fixed investment Exports Imports Real GDP growth (percent) Source: World Bank. growth over 7.5 percent over the forecast horizon, invest- have proven overly optimistic over the last few years. ment is projected to remain strong. Its contribution to In January 2017, the growth of imports for the full year growth is projected to increase from 2.4 percent this year was forecasted at 5.1 percent, and that of exports at 5.6 to 2.5 percent next year. Import growth is set to decline percent. Over time, the projection for import growth in- to 6.5 percent in 2019, and to moderate further to 6.0 per- creased, while the projected export growth decreased. cent in the following year. Export growth is expected to Actual growth of imports in 2017 turned out to be above remain at around 6 percent over the next years. 6 percent, while export growth was only 4.5 percent. For this year, revisions to the January trade forecasts follow Uncertainty about the external policy environment is the same pattern: upwards for imports and downwards rising and the promise of a strong South Asian trade for exports. For 2019, the new projections now entail performance is becoming elusive. Trade forecasts Figure 26: The external policy environment is becoming more uncertain ... US trade and global policy uncertainty Index, 3-month moving average 400 350 300 250 200 150 100 50 0 2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 2017 Q3 2018 Q1 2018 Q3 US trade uncertainty Global policy uncertainty Note: The policy uncertainty is computed by Baker, Bloom, and Davis (2016). They are based on the frequency of articles in domestic newspapers mentioning economic policy uncertainty and terms related to trade policy uncertainty. Source: Bake, Bloom, and Davis (2016). Updated results are available at www.policyuncertainty.com. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Economic outlook 29 Figure 27: … and trade forecasts are becoming more pessimistic. Change in export forecasts for South Asia over the years Change in import forecasts for South Asia over the years Percent Percent 8 10 9 7 8 6 7 6 5 5 4 4 2017 2018 2019 2017 2018 2019 Jan-17 Jun-17 Jan-18 Jun-18 Oct-18 Source: World Bank. Box 2: The implications of US-China trade tensions for South Asia Since the beginning of this year, the US has imposed tariffs on a set of imports from China whose combined value is close to USD 250 billion. An initial round of tariffs affected USD 50 billion worth of imports from China, including solar panels, aircraft parts, and batteries. China retaliated with tariffs on an equal value of imports from the US, covering goods like fuel, steel products, autos, and medical equipment. In the latest development, the US government imposed an additional round of US tariffs on USD 200 billion worth of imports from China, with a near immediate reaction from China, imposing duties on USD 60 billion worth of US imports. Both countries have announced that additional tariffs are possible. South Asia has not been affected to a large extent by tariff increases. One exception is a new US tariff on certain steel and aluminum products from India. The corresponding tariff rates are 25 and 10 percent respectively. In response, India proposed to raise import duties on 30 US products ranging from motorcycles to apples and almonds. These tariffs would amount to over USD 240 million, equivalent to the steel and aluminum tariffs imposed by the US on India. However, India has deferred its plan to impose retaliatory tariffs on the US until the end of the year, in the expectation that trade talks may lead to an exception for India’s steel and aluminum products from tariffs imposed by the US. Figure 28: Proposed and imposed tariffs – restrictive trade measures do not target the region Imports subject to new tariffs in 2018 Percent of 2017 imports 100 75 50 25 0 Imposed Additionally Imposed Additionally Imposed Additionally proposed proposed proposed US imports from China Chinese imports from US US imports from India Sources: United States Census Bureau, National Bureau of Statistics of China, Peterson Institute of International Economics, and staff calculations. While India has not been substantially impacted by tariff increases so far, it could be affected by two other measures by the US government. First, the US sanctions on Iran may result in higher oil prices for India, which used to be the second largest importer of oil from Iran. Crude oil imports from Iran declined sharply, from 787,000 barrels/day in July to only 50,000 barrels/day in mid-August, and they are set to decline further. Since Iran offered extremely competitive terms, India is facing a higher oil import bill in the future. Second, the US government tightened its visa regime, which may make it more difficult for Indian companies to send employees to work temporarily to the US. 30 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook South Asian countries export mainly to the US and Europe, and therefore a key question is how a potential ‘trade war’ may affect import demand in these two markets. Current projections suggest that effects will be quite muted. Despite increasing tariffs, US imports are growing faster than in the last two years, and the growth of imports by the Euro Area remains stable. From this perspective, the export prospects of South Asian countries have improved, not deteriorated. Figure 29: Import demand by advanced economies will remain strong. Import growth in advanced economies Percent 6 5 4 3 2 1 0 United States Euro Area 2016 2017 2018 (f) Note: (f) = forecast. Euro Area values do not include Malta and Cyprus due to data unavailability. Source: OECD. South Asia could even benefit from the current trade dispute between the US and China through trade diversion. As the US and China increase their tariffs on each other, the prices of mutual imports increase and the demand for substitutes from other exporting economies – including South Asian countries - grows. But it will not be easy for South Asian countries to reap the benefits and currently other countries seem better prepared, especially to replace imports from the US (Freund et al. 2018). The Spring 2017 edition of this report argued that South Asia’s benefits from trade diversion may be small indeed but that they increase with the elasticity of domestic supply and the extent of export diversification (World Bank 2017). To benefit from the opportunities offered by strong import demand in the US and Europe, South Asian countries need to improve logistics, reduce red tape, and enhance competitiveness. Unfortunately, some of the policy measures recently adopted in the region to address widening current account deficits go in the opposite direction. Regulatory duties have been increased in Pakistan; import tariffs on vehicles have been raised in Sri Lanka; and India did the same on 19 products worth 13 USD billions in imports. References: Freund, C., Ferrantino M., Maliszewska, M., Ruta, M. (2018). Impacts on Global Trade and Income of Current Trade Disputes (Number 2). MTI Practice Notes. Washington DC: The World Bank. World Bank. (2017). South Asia Economic Focus, Spring 2017 - Globalization Backlash. Washington DC: The World Bank. stable export growth and a strong decrease of import elections in some countries. Also on the downside, the growth. security environment remains fragile in Afghanistan, while adverse weather conditions and natural disasters Risks to the forecasts remain tilted towards the down- are frequent across the region. On the external side, side. On the domestic side, vulnerabilities are being ex- the risks to watch are a further deterioration in current acerbated by rising inflation and fiscal slippages. Struc- accounts due to higher global oil prices and increased tural reforms to address the balance sheet issues faced turbulence in international capital markets. But perhaps by the banking sector and non-financial corporates may the biggest uncertainty concerns the escalation of tariff be delayed. In addition, the region is vulnerable to po- measures between the US and China, and their possible litical uncertainty, which may increase with upcoming impacts on value chains and investor sentiment. CRStudio / Shutterstock 32 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 Budget crunch DeMenace / iStock 34 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch W idening current account deficits and increased turbulence in international markets call for prudent economic policy, and fiscal discipline is at the core of prudent management. However, most South Asian countries generate low tax revenue. They also run large fiscal deficits, often amplified by economic shocks and political cycles, which limits their room to maneuver. Tax revenue increases with economic growth, but so does government expenditure. Since spending multipliers are positive, the procyclicality of spending amplifies boom-and-bust cycles instead of smoothening them. In several countries debt levels are high and hidden liabilities are a concern. Not all these patterns are present in all countries, but they combine into a specific set of challenges in each, putting fiscal matters at the core of development policy. Government spending is not as low as tax revenue Limited room for maneuver however, and as a result fiscal deficits are larger than in most other regions. Substantial government spend- Tax revenue in South Asia is generally lower than ing is understandable, given South Asia’s enormous de- could be anticipated given the region’s level of eco- velopment needs. But spending needs to be financed, nomic development. South Asian countries are not and the alternatives to taxation – from artificially low different from other developing countries in terms of the borrowing rates to excessively high money printing – tax instruments they use. But their tax bases are small, are costly too. At 4.4 percent of GDP, South Asia’s fiscal tax exemptions are common, and tax evasion is wide- deficit is projected to be the second largest in the world spread. Some countries in the region have been making this year. The only region with an even higher deficit is progress on these fronts. In India, the introduction of the the Middle East and North Africa, which is still suffering Goods and Services Tax and the drive towards electron- from the relatively low oil prices over the last years. ic payments have fostered the formalization of transac- Fiscal deficits in several South Asian countries have tions, which should increase tax revenue in the future. been large for quite some time. The average deficit By broadening the base, encouraging compliance, and over the last three years has been around 5.5 percent fighting evasion, Nepal managed to boost its tax reve- in Pakistan and above 6 percent in Maldives, India, and nue from 8 percent of GDP in 2000 to over 20 percent Sri Lanka. today. In Sri Lanka, tighter macroeconomic manage- ment increased tax revenue by 2 percent of GDP over a The level of fiscal deficits is often affected by devel- short period of time. But overall, for the period 2010-17, opments beyond the control of policy makers, includ- tax revenue in the region remained below that of other ing economic shocks. Between 1980 and 2017, South developing countries with a similar income per capita, in Asian countries experienced over 100 downturns in five some cases by a vast margin. key global and domestic variables. These key variables S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 35 Figure 30: Tax revenue is generally low... Tax revenue Percent of GDP 35 30 25 20 IND 15 10 NPL MDV BTN LKA PAK 5 BGD AFG 0 6.5 7.5 8.5 9.5 10.5 GDP per capita (in logs, PPP adjusted) South Asian countries OECD countries Non-OECD countries Note: Values are averages from 2000 to 2017 (2016, 2015, or 2014 for some countries). The red line is a linear trend line between tax revenues and the logarithm of the per capita GDP (PPP adjusted). Source: World Bank. Figure 31: … and fiscal deficits remain uncomfortably large. Fiscal balance forecasts for 2018 Percent of GDP 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 Europe and Central Asia Sub-Saharan Africa East Asia and Pacific Latin America South Asia Middle East and Caribbean and North Africa Source: IMF and staff calculations. include global GDP growth, the growth of world trade, contests, 20 were parliamentary elections and 19 were the international oil price, the level of remittances, and presidential elections. In the year before elections, the the country’s terms of trade. The downturns in these fiscal deficit rose on average by 0.5 percent of GDP. The variables can be combined to construct an aggregate average fiscal deficit remained high during the election measure of the economic conditions faced by a coun- year, to decrease only in subsequent years. While the try. During the troughs of this aggregate measure, fis- pattern holds both for presidential and parliamentary cal deficits were on average 0.75 percentage points of elections, it is stronger for the latter. Fiscal deficits rose GDP larger than two years earlier and 0.85 percentage on average from 5.5 percent of GDP two years before a points higher than two years later. parliamentary election to 6.3 percent one year before and further to 6.4 percent in the year when the election Not surprisingly, fiscal deficits in South Asia are also took place. amplified in times of intense political competition. Be- tween 1990 and 2015, 39 national elections took place Regional experts are well aware of the influence eco- in Bangladesh, India, Pakistan, and Sri Lanka. Of these nomic and political cycles have on their countries’ 36 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Figure 32: Fiscal deficits increase with adverse economic shocks. Average fiscal deficits over downturns Percent of GDP -2 -1 Trough of the downturn +1 +2 -3.0 -3.5 -4.0 -4.5 -5.0 -5.5 Global and national shocks Global shocks Note: The bars show the average fiscal deficit computed from 104 cycles in world GDP growth, world trade, oil prices, countries’ received remittances, and terms of trade. The cycle is defined as follows: the value of the respective variable is smaller than ‘mean - one standard deviation’ in trough, the value which precedes is smaller than the respective mean and the value which follows is bigger than the value in the trough period. The figure shows average five-year periods for all South Asian countries. Sources: Federal Reserve Bank of St. Louis, World Bank, and staff calculations. Figure 33: Fiscal deficits increase in times of national elections. Average fiscal deficit before and after elections Percent of GDP -5.0 -2 -1 Election year +1 +2 -5.5 -6.0 -6.5 Presidential and parliamentary elections Parliamentary elections Note: The bars show the average fiscal deficit computed from 39 national elections between 1990 and 2015 in Bangladesh, India, Pakistan, and Sri Lanka. Of these, 19 were presidential and 20 were parliamentary elections. Sources: World Bank, National Election Commissions, and staff calculations. Figure 34: Regional experts see deficits increasing with external shocks and national elections. How does the budget deficit in your country react to How does the budget deficit in your country evolve a negative external shock? when national elections approach? Number of responses Number of responses Increases Increases Stays the same Stays the same Decreases Decreases 0 10 20 30 40 50 60 70 80 0 10 20 30 40 50 60 70 80 Source: South Asia Economic Policy Network. Survey conducted for this report. fiscal stance. In a survey conducted for this report negative external shocks and fiscal deficits in their among researchers and practitioners affiliated with countries. Similarly, almost 90 percent said that fiscal the South Asia Economic Policy Network, a strong ma- deficits in their countries increased when national elec- jority of respondents reported a relationship between tions approached. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 37 Figure 35: Tax revenue responds positively to economic growth... Correlation between cyclical components of tax revenues and GDP 0.8 0.6 0.4 0.2 0 India Maldives Nepal Bhutan Pakistan Sri Lanka Bangladesh Since Global Financial Crisis Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations. Figure 36: … and so does the level of public expenditures. Correlation between cyclical components of government expenditures and GDP 0.8 0.6 0.4 0.2 0 -0.2 -0.4 Bhutan Nepal Bangladesh Pakistan India Maldives Sri Lanka Since Global Financial Crisis Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations. Amplification of boom- to compare revenue and expenditures when growth is above or below its trend. Fluctuations around a trend and-bust cycles are also known as cyclical components. In most coun- tries in the region, the cyclical components of tax rev- From the point of view of macroeconomic stability, it enue and GDP move closely together. In India and the would be desirable if fiscal deficits increased during Maldives, for example, the correlation between the two economic downturns and shrank during growth ac- variables is above 0.6. The conclusion is similar when celerations. Higher public spending and lower taxes analyzing the growth rates of tax revenue and GDP. The can stimulate economic activity, and therefore can be correlation between these two growth rates is statisti- used to mitigate a downturn. In economic parlance, a cally significant in India, Maldives, Nepal and Bhutan. countercyclical fiscal policy is desirable, because it can The correlation between tax revenue and growth is also contribute to macroeconomic stability. By contrast, a pro- positive in Sri Lanka and Pakistan, but at around 0.2 it is cyclical fiscal policy may amplify boom-and-bust cycles. not statistically significant. Across South Asia, faster economic growth leads When GDP growth accelerates, most governments to higher tax revenue. Studies on the relationship in South Asia also tend to spend more. The cyclical between the fiscal stance and economic growth in ad- components of public spending and GDP move strongly vanced economies focus on changes in revenue and ex- together in Bhutan, Nepal, Bangladesh, and Pakistan. penditures before and after recessions. But in a region Analyzing the correlation between growth rates, rath- where rapid growth is the norm, it makes more sense er than cyclical components, yields similar results. But 38 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Box 3: A statistical budget ‘crunch’ Short-term tax buoyancy and spending cyclicality can be assessed by regressing the growth rate of tax revenues or government expenditure on the growth rate of GDP (Lane 2003): In this expression, ∆ indicates the change between two consecutive years, Xit is the tax revenue or the government expen- diture of country i in year t, ai is the change when growth remains on trend, and is the estimated short-term tax buoyancy or spending cyclicality. Rather than estimating this expression for every country separately, we construct a data panel for all South Asian coun- tries and allow for the trend change ai to vary across countries (we do this by using fixed effects in the estimation). Where necessary, the estimated models include a correction for first-order serial correlation in the error term. The simple expression above concerns the short-term, not taking into consideration the possible long-run relation- ship between the two variables. If a cointegration relationship exists between the change in Xit and the change in GDPit, the estimation of this expression yields distorted results. To address this concern, we also employ an error-cor- rection model, which allows a distinction between the short- and long-term relationships between fiscal variables and output. The panel error-correction model with fixed effects is estimated in the following form (Akitoby et al. 2006; Belinga et al. 2014): where θ refers to the short-run effect, b to the long-term relationship between the variables, and g represents the rate of adjustment to the gap between the actual level of the fiscal variable considered and the level predicted by the long-term relationship. To estimate fiscal multipliers, we use a three-dimensional panel vector auto-regression (VAR) model with fixed effects. The model includes the first differences of the logarithmic values of real government expenditure (∆git), GDP (∆yit), and tax revenues (∆tit). This specification turns out to be proper, given that all the variables are unit-root processes and the hypothesis of panel cointegration between them is rejected. The estimated model has the following reduced-form: where (∆Zit) and are matrices of the VAR model parameters. We estimate the model with the optimal lag length determined in accordance with standard information criteria. After ensuring the stability of the model, structural shocks are identified following broadly the identification approach proposed Blanchard and Perotti (2002). The approach relies on the assumption that governments cannot change expen- ditures in reaction to changes in economic growth and tax revenue within the same period. Economic growth, on the other hand, is affected by changes in government expenditure and taxes contemporaneously. Originally, this approach was applied to advanced economies with quarterly data. Due to limited data availability, we implement it here with annual data. Stronger assumptions are needed for the results to be valid in this case (Beetsma et al. 2014). But it can be argued that the approach is justified, because lags in implementing fiscal policies are longer in developing countries (Diop and Ben Abdallah 2009). The contemporaneous effect of changes in economic activity on tax revenues (tax elasticity) is not estimated but is instead added exogenously from other empirical estimations. We use a tax elasticity of one, but results are robust to slightly smaller and larger elasticities. The estimation of the structural VAR model provides impulse response functions and con- sequently the values of fiscal multipliers. We rely mostly on World Bank data for the estimations. This is the case for GDP data for all the countries and for most of the tax revenue data. For some countries, ADB tax data goes back in time longer than World Bank data. When the correlation of the two series is very high, we use ADB tax data to extend the World Bank series backwards. For India, we compute consolidated tax revenue from IMF and Reserve Bank of India data and for Bangladesh we rely on tax revenue information from the ADB. Data on government expenditure is from the IMF. The breakdown for capital and current expen- diture is from the ADB. by this metric Pakistan’s government spending is the Pakistan. Except for Sri Lanka, the procyclicality of public most procyclical in the region. A further refinement is to spending has increased since 2008 across South Asia. break down public spending into recurrent expenditures and capital expenditures. Results are similar for both For the region as a whole, tax revenue increases pro- components across most countries, but capital spend- portionally with economic activity, but public spending ing is much more procyclical than current spending in increases more than proportionally. Statistically, a one S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 39 Table 2: Tax buoyancy is around one, but spending is strongly procyclical. South Asia Observations Simple regression Error correction model Short-term tax buoyancy 162 1.02*** 1.06*** Spending cylicality 162 1.16*** 1.28** Note: Panel regression models with fixed effects are estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Three stars mean significant at the 1 percent level, two starts at the five percent level. Sources: ADB, IMF, World Bank, and staff calculations. Figure 37: The tax multiplier is negative but insignificant … Impulse response to an unexpected one USD increase in tax revenues 1.0 0.5 0.0 -0.5 -1.0 -1.5 0 1 2 3 4 5 6 7 8 9 10 Note: Unbalanced panel VAR model with four lags and fixed effects is estimated using the annual data from 1987 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. Figure 38: … while the expenditure multiplier is positive and significant. Impulse response to an unexpected one USD increase in government expenditure 1.2 1.0 0.8 0.6 0.4 0.2 0.0 0 1 2 3 4 5 6 7 8 9 10 Note: Unbalanced panel VAR model with four lags and fixed effects is estimated using the annual data from 1987 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. percent increase in GDP growth translates into a one per- Considering the inverse relationship, from fiscal vari- cent increase in tax revenue. In economic parlance, tax ables to economic activity, the tax multiplier in South buoyancy is around one. However, for every additional Asia is insignificant but the expenditure multiplier is percentage point of growth, public spending increases by large. In a panel of six South Asian countries, an addi- 1.3 percentage points. Such a more-than-proportionate tional USD in tax revenue for the government, reduces increase in expenditures is referred to as a voracity effect. growth initially by 0.3 USD. The largest negative effect is 40 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Figure 39: The expenditure multiplier is driven by public investment. Current and capital expenditure multipliers 1.0 0.8 0.6 0.4 0.2 0 Impact Peak Cumulative (4 years) Current expenditure Capital expenditure Note: Both models are balanced panel VAR models with variables current and capital expenditure respectively, instead of the total expenditure. The model with 3 lags is estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations. found after four years, before the effect recedes again. quarters of the respondents expect capital expenditure After seven years, the cumulative effect on growth is multipliers to be larger than current account multipliers. minimal and not significant. The effect of public spending on economic activity, on the other hand, is positive and Procyclical public spending and a positive expenditure significant. An additional USD of government spending multiplier imply that fiscal policy in South Asia ampli- leads to an immediate increase in GDP of 0.3 USD. Over fies boom-and-bust cycles. When growth accelerates, time, the effect builds-up and each USD of additional both tax revenue and government spending increase, spending results in 0.7 USD additional GDP in the third but spending increases more strongly than revenue. year. In the long-run, the cumulative effect settles at 0.6 The impact of larger tax revenue on subsequent eco- USD. The expenditure multiplier is statistically signifi- nomic activity is not significant but that of larger public cant at the five percent level in all years. spending is, which further accelerates economic growth. And the reverse is true in economic downturns, with the The positive impact of public spending on economic deceleration of economic activity being amplified by fis- activity comes entirely from capital expenditures. The cal policy. The analyses above, on a country-by-country expenditure multiplier of current government spending basis, suggest that the amplification of boom-and-bust is very small and not statistically significant. The expen- cycles may be severe in Pakistan and Bangladesh, and diture multiplier of public investment, on the other hand, sizeable in Bhutan and Sri Lanka. is very large and always statistically significant. On im- pact, an additional USD of capital expenditure by the government results in an increase of GDP by 0.6 USD. A build-up of liabilities Over time, additional benefits drive up the cumulative effect close to 1 USD. Public debt levels are low in some South Asian coun- tries, but remarkably high in others. Public debt in The statistical estimates of the relationship between South Asia is projected to be above 55 percent of GDP fiscal variables and growth coincide with the views of this year. This average figure masks a strong heteroge- regional experts. Among the respondents to the sur- neity within the region. With 7 percent of GDP, debt is vey conducted for this report, only around 20 percent extremely low in Afghanistan, where the vast majority expect an additional USD of public spending to have of foreign aid is provided on grant terms. At the other a negative impact on economic activity, or no impact end, public debt stands at very high 94 percent of GDP at all. Around 40 percent expect a positive impact, but in Bhutan, but it is mostly driven by borrowing for com- smaller than 0.3 USD. In line with the estimation results, mercially viable hydropower projects whose returns a quarter expects an effect between 0.3 USD and 1 will bring the debt level down strongly over the next USD and a few expect an even stronger effect. Three years. The debt levels of other countries lie somewhere S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 41 Figure 40: Regional experts report that there is both tax buoyancy and procyclical spending … How do the following fiscal variables react to a change in economic growth in your country? Distribution of responses Tax revenue Current public spending Capital public spending 0 20 40 60 80 100 Opposite direction Stays the same Same direction Source: South Asia Economic Policy Network. Survey conducted for this report. Figure 41: ... they believe that the expenditure multiplier is substantial … If public expenditure in your country grows by one USD, by how much do you think output changes? Number of responses 40 30 20 10 0 Output decreases Output growth is negligible Output grows but Output grows between Output grows by by less than 0.3 USD 0.3 and 1 USD more than 1 USD Source: South Asia Economic Policy Network. Survey conducted for this report. Figure 42: ... and they attribute the multiplier effect entirely to capital expenditures. What kind of spending has a larger effect on output? Number of responses 70 60 50 40 30 20 10 0 Capital expenditure Current expenditure Both the same Source: South Asia Economic Policy Network. Survey conducted for this report. in between these extremes. In Nepal and Bangladesh, Debt sustainability requires prudent borrowing and debt is relatively low, at 23 percent of GDP and 31 per- smaller fiscal deficits. Debt sustainability analysis joint- cent of GDP respectively. In the Maldives and India, debt ly conducted by the World Bank and the IMF project that is around 65 percent of GDP. In Pakistan it reaches 74 the public debt of most South Asian countries – mea- percent of GDP and in Sri Lanka it is close to 80 per- sured as a fraction of GDP – will decline in the coming cent of GDP. These debt levels are high in international years. In Sri Lanka, for example, public debt is expect- perspective. ed to fall by nearly ten percentage points by 2022. In 42 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Box 4: Research on spending procyclicality and multiplier effect in South Asia A vast empirical literature suggests that developing countries tend to follow procyclical fiscal policy: they increase spend- ing (or curb taxes) in good times and cut spending (or raise taxes) during periods of recession (Gavin and Perotti 1997; Kaminsky, Reinhart and Végh 2004; Frankel, Végh and Vuletin 2013). Procyclical fiscal policy reinforces business cycles by exacerbating booms and aggravating busts. The procyclical bias in fiscal policy is arguably a reflection of two fun- damental challenges faced by developing countries. These are the inability to access external finance timely and weak institutions that cannot contain overspending when growth is high. Hussain and Siddiqi (2013) analyze the cyclicality of government expenditure in six South Asian countries using data from 1980 to 2010. While they find evidence that fiscal policy was procyclical in these countries, they find no evidence that the strength or quality of political systems or institutions affects this outcome. Zakaria and Junyang (2015) discuss the cyclical properties of fiscal policy in seven South Asian economies and explore the factors responsible for fiscal cyclicality. They find strong procyclicality of government expenditure and argue that limited access to domestic and international borrow- ing, as well as a wider dispersion of political power, are factors contributing to procyclicality. The empirical evidence on the size of multipliers in developing countries is relatively scarce, but it suggests that multipliers are quite small. Using a Panel VAR model and quarterly data for 44 developing countries, Ilzezki, Mendoza and Végh (2012) argue that the government spending multiplier is around 0.3. They find that multipliers tend to be larger in advanced economies, in countries with fixed exchange rates, in more closed economies, and in economies with lower levels of public debt. Similarly, Huidrom et al. (2016), using an Interactive Panel VAR model and a large sample of advanced economies and de- veloping countries, conclude that fiscal multipliers depend on fiscal positions. They find that multipliers tend to be larger when government debt and deficits are low. Using a large sample of developing countries, Kraay (2012, 2014) obtains an average government spending multiplier somewhere between 0.4 and 0.5. Hayat and Qadeer (2016) estimate fiscal multipliers for Bangladesh, India, Pakistan and Sri Lanka over the period 1982- 2014 using a Panel VAR model. They find an initial impact close to 0.4 and a surprisingly large long-run effect. Tax multi- pliers, on the other hand, are statistically insignificant. Yadav et al. (2012) estimate the impact of fiscal shocks on the Indian economy using quarterly data from 1997 Q1 to 2009 Q2. They find that, on impact, unexpected changes in tax revenue have a much larger effect on GDP than unexpected changes in government spending. Jain and Kumar (2013) estimate the size of the expenditure multiplier in India at the center and state levels using annual data for the period from 1980 to 2011. The size of the multiplier for all categories of expenditure by state governments is estimated to be larger than that of the central government. Furthermore, capital spending has a higher multiplier than current spending. Depending on the model specification, the aggregate tax multiplier is found to be between 0.1 to 0.5, lower than the expenditure multiplier. Finally, Bose and Bhanumurthy (2015) present a structural macroeconomic model for the estimation of fiscal multipliers in India. Based on annual data from 1991 to 2012, they find a large capital expenditure multiplier of 2.5, a transfer payment and current spending multiplier of 1, and a tax multiplier of -1. India, public debt is expected to decline to 63 percent China, Saudi Arabia, Abu Dhabi, and the OPEC Fund. by 2023. Only in Bangladesh and Maldives is the debt Total external disbursements to service these debts are ratio projected to increase, but the anticipated increases estimated to be USD 1.4 billion until 2021. In Pakistan, are small. And without exception, the primary balance external financing needs reached USD 21.5 billion in (the fiscal balance without counting interest payments) FY 2016/17, or 7.1 percent of GDP. They are expected to is projected to be more favorable than it is today. Debt increase further over the next few years, partly due to sustainability is thus closely associated with smaller loan repayments and profit repatriation related to proj- budget deficits. ects in the China-Pakistan Economic Corridor (CPEC). In Sri Lanka, more than half of the central government’s Some countries face substantial repayments of obli- external debt stock is denominated in USD, making Sri gations in the coming years, and currency deprecia- Lanka especially vulnerable. Financing needs are pro- tion will increase debt service payments associated jected to be around 18.6 percent of GDP in 2018 and with foreign debt. In Maldives, rising debt levels are substantial international bond repayments will fall due reflecting the large infrastructure investments of recent over the coming years. years. These investments were aimed at facilitating pop- ulation consolidation around the main island and at de- In addition to explicit public debt, the growth of hidden veloping the airport. Major creditors of Maldives include liabilities is an important concern. Hidden liabilities are 40 30 43 20 S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 10 Budget C runch 0 Latin America Sub-Saharan Africa Middle East and South Asia Europe and Central Asia East Asia and Pacific Public Figure 43:and debt is reaching high levels in Caribbean frica countries. some North Government debt forcasts for 2018 in South Asia Percent of GDP 100 90 80 70 60 50 40 30 20 10 0 Bhutan Sri Lanka Pakistan India Maldives Bangladesh Nepal Afghanistan (FY) (CY) (FY) (FY) (CY) (FY) (FY) (CY) Source: World Bank. Table 3: Debt sustainability requires prudent borrowing. First-year Last-year First-year Last-year Annual debt Country First-year Last-year government debt government debt primary balance primary balance space (percent of GDP) (percent of GDP) (percent of GDP) (percent of GDP) (percent) Afghanistan 2017 2022 7.2 5.9 0.1 0.1 0.2 Bangladesh 2016 2021 35.8 38.5 -2.3 -1.6 4.7 Bhutan 2017 2021 115.0 80.0 0.1 7.6 1.7 India 2018 2023 69.2 62.8 -1.8 -1.5 8.3 Maldives 2017 2022 69.4 73.2 -5.7 -0.8 6.9 Nepal 2018 2022 23.2 22.0 -1.8 -1.1 2.5 Pakistan 2017 2022 69.1 60.9 -0.1 0.0 8.6 Sri Lanka 2017 2022 87.0 75.1 -0.2 2.3 6.8 Note: Initial projection years range from fiscal years 2016/17 or 2017/18, depending on available DSAs. Space refers to the annual increase in nominal debt over the next four/five projection years under the baseline scenario as a share of first-year GDP. Sources: World Bank-IMF debt sustainability analysis (DSA) and staff calculations. obligations that may end up in the government’s books not due to a deliberate borrowing decision, but rather A fiscal “reading” of because of a default on debt obligations outside of development challenges the government. Important sources of hidden liabilities include borrowing by state-owned enterprises and the The nature of fiscal issues in South Asia is intrinsically failure of infrastructure projects involving the private linked to the development challenges the countries sector. In South Asia, one of the main sources of hidden in the region face. Not all the fiscal patterns described liabilities is the “circular debt” of distribution companies above are present in all countries in the region. Never- in the power sector. Other unplanned government obli- theless, these patterns combine into a distinctive set of gations arise from overly optimistic or poorly designed fiscal issues in each case. And these fiscal issues are Public-Private-Partnerships. Liabilities can also be hid- very telling about the constraints each of the countries den in the banking sector in the form of non-performing faces in its quest for greater prosperity. loans. The recapitalization of banks in India, for exam- ple, was already accompanied by considerable capital infusions by the Indian government. › Afghanistan. Foreign aid, aimed at increasing se- curity and fostering development, is very large rel- ative to the size of the economy. Security spending is huge, and despite great efforts a large fraction of 44 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Figure 44: In Afghanistan, the level of aid-dependence is unsustainable in the long run. External/core budget and domestic revenue in Afghanistan Percent of GDP 70 60 50 40 30 20 10 0 2012 2013 2014 2015 2016 2017 Domestic revenue Aid on-budget Aid off-budget Source: Islamic Republic of Afghanistan National Statistics and Information Authority. Figure 45: In Bangladesh, the cost of energy is increasing while electricity demand is surging. Wholesale subsidies in Bangladesh Tk/kWh 7 6 5 4 3 2 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 Wholesale purchase costs Price paid by distributors Source: International Energy Agency. aid remains off-budget. There is a limit to how much exploitation and are leading to a growing reliance on domestic revenue can increase and there is also a more expensive fuels. Generation costs are amplified limit to how much more aid donors will be willing to by a dispatch that does not follow merit order and provide in the future. Hence, without peace bringing by poorly designed contracts with private electricity down security spending substantially, the fiscal sit- generating companies. Passing on the high costs to uation of Afghanistan could become unsustainable. consumers is politically difficult, which results in a growing subsidy burden for the budget. › Bangladesh. The energy mix is becoming increasing- ly expensive, at a time when the demand for elec- › Bhutan. Exports of electricity from large hydropower tricity is surging. Distortions in the natural gas sector projects are an important source of government rev- are getting on the way of further exploration and enue, but they are lumpy. When Tala, a large dam, S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 45 Figure 46: In Bhutan, revenue from hydropower exports is lumpy and creates instability. Domestic revenue and total expenditure in Bhutan Percent of GDP Percent of GDP 45 15 Tala 40 10 35 5 30 25 0 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Rupee crisis Total expenditure less energy capital spending Non-tax revenue (rhs) Note: Vertical line refers to the Tala hydropower plant getting commissioned. Source: Ministry of Finance of Bhutan. Figure 47: In India, competitive federalism requires strong discipline in the states. Fiscal deficit and resource transfer in India Percent of total reciepts Percent of GDP 60 7 6 50 5 40 4 30 3 20 2 10 1 0 0 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Resource transfer from center to states Fiscal deficit of center (rhs) Fiscal deficit of states (rhs) Source: Reserve Bank of India. became operational in FY 2006/07, non-tax revenue become increasingly important. But fiscal disci- surged, which created strong pressure for larger cur- pline is stronger at the center than it is in the states. rent public spending. Higher government spending The fiscal deficit of the center decreased from 3.9 fueled domestic demand and imports of consumer percent of GDP in FY 2015/16 to 3.5 percent in FY goods, leading to the so-called Rupee crisis a couple 2016/17 and FY 2017/18, while that of the states in- of years later. Without a mechanism to smooth out creased for four consecutive years to 3.5 percent public spending, similar turbulence could arise as in FY 2016/17 before moderating to 3.1 percent last other large dams start operation. fiscal year. In addition, states could be a source of contingent liabilities, for example due to borrowing › India. In the drive towards competitive federalism, by unreformed utilities and due to waivers of bank spending decisions by state governments have debts for specific groups. 46 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Figure 48: In Maldives, service delivery is costly but bringing it down is expensive too. General government expenditure Percent of GDP 70 Predicted given GDP per capita, population, and being an archipelago 60 50 40 Maldives 30 20 Predicted given GDP per capita only 10 0 6 7 8 9 10 11 12 GDP per capita (in logs, PPP adjusted) Note: All data is for 2016. Sources: IMF and World Bank, and staff calculations. Figure 49: In Nepal, decentralization may make budget execution even more challenging. Actual expenditure relative to budget in Nepal Percent 0 -5 -10 -15 -20 -25 -30 -35 -40 -45 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 Current expenditure Capital expenditure Sources: Ministry of Finance of Nepal, Finance General and Comptroller Office, and staff calculations. › Maldives. Providing universal public services is costly this borrowing in a way that does not compromise when the population is scattered among remote is- debt sustainability will be challenging. lands with a few thousand inhabitants each. From that perspective, consolidating the population around the › Nepal. Low capacity even at the federal government capital city could reduce public spending in the long level prevents full spending of the budget, especially run. It could also contribute to job creation and thus of the capital budget. In 2016/17, for example, current increase government revenue. But population con- spending was 16 percent lower than budgeted and solidation requires huge infrastructure investments, capital spending was 33 percent lower than budget- hence large borrowing, in the short term. Managing ed. Capacity is even lower in the provinces and local S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 47 Figure 50: In Pakistan, a procyclical budget deficit reinforces the boom-and-bust. GDP growth and fiscal deficit in Pakistan Percent Percent of GDP 10 0 8 -2 6 -4 4 -6 2 -8 0 -10 2000/01 2002/03 2004/05 2006/07 2008/09 2010/11 2012/13 2014/15 2016/17 Procyclical fiscal policy GDP growth Fiscal balance (rhs) Note: Grey shaded areas indicate years when the fiscal deficit widens as GDP growth accelerates, or narrows down as GDP growth decelerates. Source: World Bank. Figure 51: In Sri Lanka, population aging will put pressure on public spending. Population 60 years and above and tax revenue in Sri Lanka Percent of GDP Percent of total 20 16 14 18 12 10 16 8 14 6 4 12 2 10 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Tax revenue Population 60 years and above (rhs) Sources: UN Population Database and World Bank. governments. The welcome move to fiscal federalism triggering the next boom-and-bust cycle. Fiscal policy may hence result in even stronger underspending has thus amplified macroeconomic fluctuations. and could end up affecting the delivery of public ser- vices in a country that really needs them. › Sri Lanka. Population aging could make the country’s generous social programs unaffordable in a not-so-dis- › Pakistan. The recent economic history of Pakistan is tant future. Sri Lanka is the only aging society in South one of slow growth punctuated by recurrent macro- Asia. With older populations come higher health care economic adjustments, often supported by Interna- costs and larger spending on public pensions. Further- tional Monetary Fund programs. Adjustment programs more, much job creation has been in the public sector, brought in macroeconomic stability, but often at the which puts additional pressure on expenditures. Sri cost of a temporary (and often substantial) deceler- Lanka thus needs to keep social programs affordable. ation in economic activity. And once the economy It also needs to increase tax revenues, which until re- was back on track, fiscal pressures mounted again, cently were steadily declining relative to GDP. 48 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Table 4: The region’s fiscal patterns affect countries Summing up differently. The region’s fiscal patterns affect countries different- Fiscal patterns ly, but all of them face fiscal challenges. The precise Country Amplification of nature of these challenges is related to deeper devel- Limited room for A build-up of boom-and-bust maneuver liabilities opment issues that are specific to each country. But all cycles of them face at least one of the three fiscal patterns identified, namely limited room for maneuver, the am- Afghanistan √ plification of boom-and-bust cycles and the build-up of liabilities. Some of them face two of these patterns, and Bangladesh √ √ all three are present in Pakistan’s case. The most im- portant reason for limited room to maneuver across the Bhutan √ region is low revenue generation, but in some countries inadequate spending is a concern too. This challenge is India √ shared among most countries in the region and the only exceptions may be India and Bhutan. The amplification Maldives √ √ of boom-and-bust cycles is caused by procyclical public spending which is strong in Bangladesh, Bhutan, Nepal, and Pakistan. The build-up of liabilities is a concern Nepal √ √ across South Asia but especially in India, the Maldives, Pakistan, and Sri Lanka. Pakistan √ √ √ South Asian experts see limited room for maneuver as Sri Lanka √ √ the biggest fiscal challenge faced by the region. In the survey conducted for this report, members of the South Asia Economic Policy Network were asked whether the another third was somewhat concerned about it. A ma- fiscal patterns identified for the region as a whole were jority saw the procyclicality of spending as somewhat relevant in their own countries. More than 60 percent of a challenge, but less than a quarter answered that it of respondents, and nearly all respondents from Paki- matters a lot. Not surprisingly, respondents from Paki- stan and Bangladesh, saw low revenue generation as a stan are the most concerned about the procyclicality of major issue in their countries. Around a third considered public spending. Responses were similar, if somewhat that inadequate spending was a major challenge, and weaker, for the build-up of liabilities. Figure 52: Limited room for maneuver is seen as South Asia’s biggest fiscal challenge. Do you think your country faces the following challenges? Distribution of responses Low revenue generation Limited room for maneuver Inadequate spending Amplification of Procyclicality of public boom-and-bust cycles spending A build-up of liabilities Liability build up 0 20 40 60 80 100 A lot Somewhat No Source: South Asia Economic Policy Network. Survey conducted for this report. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 49 References Akitoby, B., Clements, B., Gupta, S. and Inchauste, G. (2006). Public spending, voracity, and Wagner’s law in developing countries. European Journal of Political Economy, 22(4), 908-924. Belinga, V., Benedek, M.D., de Mooij, R.A. and Norregaard, M.J. (2014). Tax buoyancy in OECD countries (No. 14-110). International Monetary Fund Working Paper. Beetsma, R., Giuliodori, M. and Klaassen, F. (2008). The effects of public spending shocks on trade balances and budget deficits in the European Union. Journal of the European Economic Association, 6(2-3), 414-423. Blanchard, O. and Perotti, R. (2002). An empirical characterization of the dynamic effects of changes in government spending and taxes on output. Quarterly Journal of Economics, 117(4), 1329-1368. Diop, N., and Ben Abdallah, N. (2009). The dynamic effects of countercyclical fiscal stimulus on output in Tunisia (5087). World Bank Policy Research Working Paper 5087. Lane, P. R. (2003). The cyclical behaviour of fiscal policy: evidence from the OECD. Journal of Public Economics, 87(12), 2661-2675. Bose, S., and Bhanumurthy, N. R. (2015). Fiscal multipliers for India. Margin: The Journal of Applied Economic Research, 9(4), 379-401. Frankel, J. A., Vegh, C. A., and Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32-47. Gavin, M., and Perotti, R. (1997). Fiscal policy in Latin America. NBER Macroeconomics Annual, 12, 11-61. Hayat, M. A., and Qadeer, H. (2016). Size and impact of fiscal multipliers: an analysis of selected South Asian countries. Pakistan Economic and Social Review, 54(2), 205. Huidrom, R., Kose, M. A., Lim, J. J., and Ohnsorge, F. L. (2016). Do fiscal multipliers depend on fiscal positions?. World Bank Policy Research Working Paper 7724. Hussain, T., and Siddiqi, M. W. (2013). Fiscal policy, institutions and governance in selected South Asian countries. Pakistan Journal of Commerce & Social Sciences, 7(2). Ilzetzki, E., Mendoza, E. G., and Végh, C. A. (2013). How big (small?) are fiscal multipliers?. Journal of Monetary Economics, 60(2), 239-254. Jain, R., and Kumar, P. (2013). Size of government expenditure multipliers in India: a structural VAR analysis. Reserve Bank of India Working Paper Series, 7. Kaminsky, G., Reinhart, C., and Végh, C. (2004). When it rains, it pours: procyclical macropolicies and capital flows. NBER Macroeconomics Annual, 2004, 11-53. Kraay, A. (2012). How large is the government spending multiplier? Evidence from World Bank lending. The Quarterly Journal of Economics, 127(2), 829-887. Kraay, A. (2014). Government spending multipliers in developing countries: evidence from lending by official creditors. American Economic Journal: Macroeconomics, 6(4), 170-208. Yadav, S., Upadhyay, V., and Sharma, S. (2012). Impact of fiscal policy shocks on the Indian economy. Margin: The Journal of Applied Economic Research, 6(4), 415-444. Zakaria, M., and Junyang, X. (2015). The cyclicality of fiscal policy in South Asia. Argumenta Oeconomica, (1 (34)), 33-60. 50 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch Box 5 Views from the region on fiscal policy In preparation for a new edition of this report, we convene a technical workshop with experts from the region. This time a two-day Regional Workshop on Fiscal Policy in South Asia was held in Kathmandu, Nepal. Following a broadly dissem- inated call for papers, this event brought together researchers and practitioners from most countries across the region. Over 60 papers were submitted, and ten of them were selected for discussion at the workshop. The selection process was run by experts from the South Asia Network on Economic Modelling (SANEM, Bangladesh), the National Institute for Public Finance and Policy (NIPFP, India), the Sustainable Development Policy Institute (SDPI, Pakistan), and the Institute of Policy Studies (IPS, Sri Lanka). The discussants of the papers included authors of related papers participating in the workshop, as well as economists from the ADB, IMF, and the World Bank. Prof. Ila Patnaik (NIPFP), a renowned expert on fiscal policy in South Asia, delivered a special lecture on fiscal cyclicality. She discussed the role of business cycles and how to measure them in emerging markets, before analyzing the procycli- cality of public spending in South Asia. She argued that the high costs of postponing public spending may potentially be a defensible justification for the procyclicality of fiscal policy in developing countries. Some of the papers focused on the impacts of public spending on economic and social outcomes. Priyatharsiny Selvarasa and Sangaran Vijesandiran (both with the University of Peradeniya, Sri Lanka) analyzed the relationship between fiscal policies and social indicators. They did so by assessing the impact of public spending and taxation on the provision of infrastructure, education, and health services in Sri Lanka. Impacts of public spending on economic activity deserved special attention. Pawan Gopalakrishnan (Reserve Bank of India), Chetan Ghate (Indian Statistical Institute), Chetan Dave (New York University) and Suchismita Tarafdar (Shiv Nadar University, India) evaluated the consequences of fiscal shocks for growth using a real business cycle model of a small open economy calibrated for India. They concluded that when tax rates on capital and labor income are low, a contrac- tionary fiscal shock has an expansionary effect on GDP. Not surprisingly, this finding was intensely debated. In a less controversial way, Iffat Anjum and Selim Raihan (both with SANEM, Bangladesh) concluded that fiscal policy has been effective in stimulating economic growth. In their paper they establish that there is bi-directional causality between economic growth and government consumption in Bangladesh. A similar relationship is found with tax revenue. Other papers dealt with the reasons for low tax revenue generation in South Asia. Vaqar Ahmed and Ahad Nazir (both with SDPI, Pakistan) identified the fragmented structure of revenue mobilization and weak capacity in the provinces as key reasons in Pakistan’s case. They presented a public-private dialogue approach that in their view has helped push tax reform on the country’s political agenda. In India, the newly adopted GST broadens the tax base, harmonizes tax rates across states, and encourages formal- ization, but this is not without implementation costs. Bornali Bhandari (National Council of Applied Economic Research, India) and Astha Sen (Sonoma State University, USA) used detailed taxpayer surveys to gauge these costs, finding that they were high in the initial phases but decline later. According to the surveys, GST led to reduced corruption due to the digitization of the reporting system. In some South Asian countries state-owned enterprises and public utilities can indirectly affect fiscal discipline. Priti Dubey and Rishika Shankar (both with University of Delhi, India) point out that the poor performance of Central Public-Sector S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch 51 Enterprises in India can lead to a build-up of contingent liabilities and may cause a drain on public resources if they are bailed out at the expense of taxpayers. The discussion centered on the interpretation of aggregate data, and the insights detailed enterprise data can provide. Monzur Hossain, Mahbubur Rahman and Atiqur Rahman (all from Bangladesh Institute for Development Studies) used a large macro-econometric model to analyze the consequences of energy price adjustments in Bangladesh. The results suggest that price increases are inflationary and cause a decline in GDP growth. There was debate on whether a model with microeconomic foundations, with firms and consumers changing their behavior after the adjustment, would yield the same conclusion. Due to their large fiscal deficits over time, many countries in South Asia have high levels of public debt. Sima Rani Dey and Mohammed Tareque (both with the Bangladesh Institute of Governance and Management) argued that the accumu- lation of external debt has a negative effect on GDP growth, but that better macroeconomic policies can neutralize this effect. Ranjan Kumar Mohanty (NIPFP, India) and Sidheshwar Panda (Indian Institute for Technology) reached a similar conclusion. The workshop concluded with a public session graced by a keynote speech by Nepal’s Finance Minister, Dr. Yuba Raj Khatiwada. Minister Khatiwada offered a thorough review of the challenges posed by the transition to federalism in his Nepal and explained the steps the government is taking to address them. His talk was followed by a panel discussion attended by over one hundred guests, including representatives from think tanks, donors, civil society and the media. Papers presented Ahad Nazir (SDPI, Pakistan) and Vaqar Ahmed (SDPI, Pakistan): National and Sub-National Tax Reforms in Pakistan: A Public- Private Dialogue (PPD) Approach. Astha Sen (Sonoma State University, USA) and Bornali Bhandari (NCAER, India): Lost in Transition? Case Studies Based Approach of Firm’s Compliance cost of India’s GST. Iffat Anjum (SANEM, Bangladesh) and Selim Raihan (SANEM, Bangladesh): The effectiveness of fiscal policy in stimulating private investment and growth: An Empirical Study on Bangladesh. Monzur Hossain (BIDS, Dhaka), Mahbubur Rahman (BIDS, Dhaka) and Atiqur Rahman (BIDS, Dhaka): Impact of energy price adjustments on Bangladesh economy: A macro-econometric modeling approach. Pawan Gopalakrishnan (Reserve Bank of India), Chetan Ghate (ISI, Delhi), Chetan Dave (NYU, Abu Dhabi) and Suchismita Tarafdar (Shiv Nadar University, India): Fiscal austerity in emerging market economies. Ranjan Kumar Mohanty (NIPFP, India) and Sidheswar Panda (IIT, India): How Does Public Debt affect the Indian Macro-economy? A Structural VAR Approach. Rishika Shankar (University of Delhi, India) and Priti Dubey (University of Delhi, India): Loss making public sector undertakings and their impact on fiscal deficit. Sangaran Vijesandiran (University of Peredeniya, Sri Lanka) and Priyatharsiny Selvarasa (University of Peredeniya, Sri Lanka): An Empirical Analysis of the Impact of Fiscal Policy on Human Development in Sri Lanka. Sima Rani Dey (Bangladesh Institute of Governance and Management) and Mohammed Tareque (Bangladesh Institute of Governance and Management): Debt and Growth: Role of Stable Macroeconomic Policy. 52 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 South Asia country briefs Afghanistan········································ 54 Bangladesh ·······································56 Bhutan·····························································59 India········································································· 61 Maldives····················································· 63 CRS PHOTO / Shutterstock.com Nepal···································································65 Pakistan······················································· 67 Sri Lanka·····················································69 54 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs Afghanistan Although economic activity remains subdued, growth has accelerated 2017 gradually over 2016 and 2017 reflecting slowly recovering confidence and reform progress. Building momentum now appears to be at some Population, million 35.5 risk, with declining business confidence in the context of upcoming GDP, current USD billion 19.6 parliamentary and presidential elections (scheduled for October 2018 GDP per capita, current USD 550 and April 2019, respectively), worsening drought conditions, and an Source: World Bank. ongoing displacement crisis. Over the medium-term, Afghanistan needs to mobilize new sources of growth in the context of declining aid and stubbornly-high poverty. Contributions to real GDP growth Percentage points 4 3 2 1 0 -1 -2 2015 2016 2017 2018 (f) 2019 (f) 2020 (f) 2021 (f) Agriculture Industry Services Real GDP growth (percent) Note: (f) = forecast. Afghanistan’s fiscal year is the calendar year. Source: World Bank. Recent economic developments Exports grew strongly in 2017 and into 2018. In 2017 exports were 28 percent higher than in 2016, while Q1 2018 exports Afghanistan has experienced a slight recovery in growth were up nearly 50 percent on Q1 2017 levels. Export growth since 2015, with growth accelerating slightly to 2.3 per- has been driven by the establishment of new air corridors cent in 2016 and reaching 2.7 percent in 2017. Growth to India, the resolution of border issues that constrained in 2017 was driven mostly by the services sector, which trade with Pakistan during 2016 and continued gradual expanded by 2.6 percent in the context of recovering depreciation of the Afghani relative to major trading cur- confidence and investment. The agricultural sector grew rencies. Imports also increased, however, driven by higher by 3.8 percent, with strong growth in fruit and vegeta- energy prices and increased grain imports in the context bles offsetting declining wheat production in the context of drought-related disruption to domestic wheat production. of an ongoing drought impacting Northern and Eastern Consequently, the merchandise trade balance widened areas. further, from 31.6 percent of GDP to 33.6 percent of GDP. Inflation remained moderate through 2017 and has de- The wide trade deficit is financed by aid inflows, and the clined through 2018. Period-average inflation for 2017 current account remains in surplus (1.6 percent of GDP at was 4.7 percent, with declining domestic food prices end-2017). Driven by the current account surplus, foreign (fruit and vegetables) and weakening prices for import- exchange reserves continued to accumulate (8.2 USD bil- ed grains offsetting increased energy prices. Low infla- lion at end-2017, more than one year of merchandise im- tion through 2018 (reaching -1 percent y-o-y in June) has port cover). The Afghani depreciated steadily by around 4 been driven by declining food prices, with strong local percent against the USD during 2017 (end period) and into production of fruit and vegetables, and steady interna- 2018 (6 percent depreciation against the USD in the first tional grain prices. half of 2018), driven mostly by the general strengthening S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 55 of the USD but possibly reflecting capital flight in the con- the context of gradually declining aid, the current account text of election-related uncertainties. surplus is expected to narrow to 0.2 percent of GDP in 2018 before moving into a slight deficit from 2019 (1.2 percent Revenues continued to grow strongly in 2017, increasing of GDP) onwards. Foreign exchange reserves are expect- by around 15 percent in nominal terms and exceeding ed to remain at comfortable levels, however, at around budgeted levels by 5.5 percent, driven by administra- 11 months of import cover by 2020, reflecting very large tive and compliance improvements. However, donor current reserves. Inflation is expected to remain moderate, grants fell well short of budgeted levels, leading to a with higher energy prices offset by low domestic fruit and fiscal deficit of around 0.5 percent of GDP, even despite vegetable prices. Drought is not expected to have a major a 2.5 percentage decline in overall expenditure. Reve- impact on food prices given stable international grain pric- nue growth has ceased in the first half of 2018, reflecting es. With flattening of recent revenue growth, a fiscal deficit slowing economic activity and potential deterioration in of around 0.4 percent of GDP is expected in 2018. governance around upcoming elections. With the population growing faster than the economy, poverty has increased significantly. A quarter of the labor Risks and challenges force is unemployed, and 80 percent of employment is Afghanistan faces substantial risks in the short-term aris- vulnerable and insecure, comprising self- or own-account ing from the possibility of political instability and violence employment, day labor, or unpaid work. With almost half in the context of upcoming elections. The contested 2014 the population below the age of 15, each year, 483,000 presidential elections had a negative impact on confi- to 600,000 Afghans enter the working age population, dence, investment, and governance, feeding into lower most with little education and few productive employ- growth and revenues. A similarly disruptive election pe- ment opportunities. The impact of slow growth on poverty riod could have a major negative impact on revenues, and livelihoods is compounded by growing insecurity, investment, and growth over 2018, 2019, and beyond. On internal displacement, refugee repatriation, and declining the other hand, progress with a negotiated peace settle- aid. In the past, there has been little relationship between ment with the Taliban could have a major positive impact economic growth and poverty. Economic growth in Af- on investment confidence, potentially spurring accelerat- ghanistan has translated to changes in welfare to the top ed growth and improved government revenues. 20 percent of the distribution, whose consumption has increased and fallen with GDP per capita. Over the medium-term, and in the context of expected declines in aid, economic development progress will depend on mobilizing the sectors with greatest capacity Outlook to support increased growth, job creation, exports, and Recent recovery appears increasingly vulnerable. Growth government revenues. This is likely to require a balanced is expected to slow to 2.4 percent in 2018, in the context growth strategy, including increased investment in agri- of election-related uncertainties and weak business confi- cultural productivity (including through expanded irriga- dence. Growth is expected to accelerate gradually to over tion), increased investment in human capital, and the real- 3 percent by 2020, as confidence is projected to recover. In ization of Afghanistan’s substantial extractives potential. Afghanistan macroeconomic outlook 2015 2016 2017 2018 (f) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 1.5 2.3 2.7 2.4 2.8 3.2 Real GDP growth, at constant factor prices 1.1 2.0 2.3 2.5 2.7 3.2 Agriculture -5.7 6.0 3.8 2.0 2.0 3.0 Industry 4.2 -0.8 0.6 2.5 2.0 2.8 Services 2.1 2.0 2.6 2.6 3.3 3.5 Inflation (Consumer Price Index) 4.6 4.3 4.7 3.1 5.0 5.0 Current account balance (percent of GDP) 7.5 7.1 1.6 0.2 -1.2 -1.6 Financial and capital account (percent of GDP) 7.9 8.5 6.9 6.7 6.0 5.3 Net foreign direct investment (percent of GDP) 0.0 -0.1 -0.1 0.0 -0.1 0.1 Fiscal balance (percent of GDP) -0.8 0.0 -0.5 -0.4 -0.2 -0.1 Debt (percent of GDP) 9.1 7.9 7.2 6.8 6.2 6.6 Primary balance (percent of GDP) -0.7 0.2 -0.4 -0.2 0.0 0.1 Note: (f) = forecast. Source: World Bank. 56 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs Bangladesh Strong growth, driven by consumption and public investment, is 2018 expected to continue to support poverty reduction. Macroeconomic stability is increasingly stressed by the widening current account Population, million 166.9 deficit because of a surge in imports, and accelerating inflation. GDP, current USD billion 275.8 Downside risks include fiscal slippages, delays in banking reforms, GDP per capita, current USD 1653 loss of monetary policy predictability due to diminished central bank Source: World Bank. independence and weakening reform momentum in the run-up to the elections. Contributions to real GDP growth Percentage points 12 10 8 6 4 2 0 -2 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Final consumption Gross fixed investment Net exports Statistical discrepancy Real GDP growth (percent) Note: Bangladesh’s fiscal year runs from July 1st to June 30th. Source: Bangladesh Bureau of Statistics and staff calculations. than in the past. Close to a million Rohingya people Recent economic developments have crossed over into Bangladesh since August 2017. Without aid, 76 percent of these displaced people would GDP growth in FY18 remained strong, underpinned by be unable to meet basic needs. The localized effects private consumption, public investment, and a recovery are estimated to have significantly reduced wages. in ready-made garment exports. Remittances posted 17 percent increase after declining for two consecutive Supply shocks accelerated food inflation from 6 percent years. Capital machinery imports have been buoyant. in FY17 to 7.1 percent in FY18, pushing headline inflation Growth in agriculture was limited in the beginning of to 5.8 percent in FY18, from 5.4 percent in FY17. Mon- the year due to above-normal flooding, but harvests etary growth has been below nominal GDP growth, recovered subsequently. Real private investment flows contributing to a decline in non-food inflation. However, increased by 9 percent over its level the previous year, non-food inflation increased from its recent low of 3.5 notwithstanding cumbersome business regulations, percent in December to 4.9 percent (y-o-y) in June due to substantial infrastructure deficits and mounting policy spillovers from higher commodity prices and exchange uncertainties. The competitiveness ranking improved rate depreciation. marginally, but the Logistics Performance Index ranking slipped 13 places in 2018 relative to 2016. Interest rates came under pressure as excess liquidity shrank due to credit growth exceeding deposit growth, Progress in reducing poverty has been notable. Howev- tightening of the Advance-Deposit Ratio by Bangladesh er, recent GDP growth delivered less poverty reduction Bank (BB) and high non-performing loans in the banking S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 57 system. In March, ceding to pressures from the Bank- Inflation is projected to increase as global commodity ers Association of Bangladesh, BB reduced the Cash prices pick up and an expansionary fiscal policy cou- Reserve Ratio from 6.5 percent to 5.5 percent; the repo pled with election-induced rise in private expenditures rate from 6.75 percent to 6.25 percent; and increased overheat the economy. Adherence to a tight monetary the cap on government holding of deposits in private policy, announced in July, will help contain excess de- domestic banks from 25 percent to 50 percent. With the mand. The current account deficit is projected to narrow administered rates on the National Savings Certificates moderately due to sustained strong imports, owing unchanged at double digit levels, the deposit and lend- partly to large import payments associated with foreign ing rates remained downwardly rigid. Subsequently, debt financed mega projects. The payment obligations the government directed commercial banks to cap the will largely be funded by foreign debt accumulation. A deposit rates at 6 percent and the lending rates at 9 large shortfall in government revenue is expected due percent. The banks are yet to comply. These devel- to reduced taxes on garments and banks and lack of opments indicate that BB autonomy has substantially revenue enhancing administrative measures. Also, eroded. additional pressures on expenditures are likely due to expanded export subsidies after the budget was The overall balance of payments swung into the largest announced, as well as inadequate provisions for bank deficit in recent memory, driven by a surge in consumer recapitalizations and spending associated with the and capital machinery imports. Despite a recovery in Rohingya crisis. These together may widen the budget exports, the current account deficit jumped from 0.5 per- deficit. cent of GDP in FY17 to 3.5 percent in FY18, driven by 25.2 percent growth in merchandize imports. BB managed the resulting pressure on the exchange rate through a combination of direct sales of foreign exchange and Risks and challenges directing foreign exchange dealers to keep their buying With elections approaching, a major domestic risk is the and selling rates stable. The nominal taka-US dollar weakening of ongoing efforts to improve economic gov- rate depreciated by 1.8 percent in July-August 2018 fol- ernance. Donor fatigue in providing resources to meet lowing 4 percent depreciation in FY18. the needs of the Rohingya could increase pressure on the budget, while the quasi-fiscal deficit could rise with Fiscal underperformance has continued. The fiscal increasing international oil prices. Unfavorable weather outcomes in FY18 differed markedly from what was could further slow poverty reduction among households envisaged in the original budget. Underperformance in in agriculture. Rising food inflation may dampen gains development spending relative to the original budget made through increased investment in industry, while offset a revenue shortfall, thus containing the deficit at exacerbating the situation for food-deficit households in around 4 percent of GDP. Public debt increased mod- agriculture. However, export demand and remittances estly to 31.2 percent of GDP and continues at low risk of could surprise on the upside. debt distress. Excessive reliance on the more expensive nonbank sources of domestic financing has continued. External imbalances and tight liquidity need to be han- Consequently, interest expenditures remained high. dled urgently. Exchange rate flexibility can help BB maintain sufficient foreign exchange reserves. Timely resolution of external imbalances will also contribute Outlook to expanding liquidity in the banking system. Howev- Output growth in FY19 is projected at 7 percent, driven er, efforts to reduce interest rates without reducing the by industry and services on the supply side and private NSC rates may be futile. Allowing the BB to function consumption and investment on the demand side. Pub- independently, avoiding regulatory forbearance, and lic investment will remain strong as the implementation strengthening banking supervision is a high priority. of mega projects gains further momentum. Private in- vestment growth will remain subdued due to structural The potential for export-led manufacturing growth re- constraints. Continued strength in imports is projected mains significant as productivity levels lag the global to keep net exports negative despite healthy export technological frontier. Apart from structural reforms to growth. Increased investment in manufacturing will foster diversification of the economy, this requires put- re-energize job creation and contribute further to pov- ting ever-increasing emphasis on education, skills, and erty reduction. adaptability to rapidly changing technology. 58 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs Bangladesh macroeconomic outlook 2015 2016 2017 2018 2019 (f) 2020 (f) Real GDP growth, at constant market prices 6.6 7.1 7.3 7.9 7.0 6.8 Private consumption 5.8 3.0 7.4 11.0 7.1 7.2 Government consumption 8.8 8.4 7.8 15.4 11.4 10.0 Gross fixed capital investment 7.1 8.9 10.1 10.5 8.9 7.8 Exports, goods and services -2.8 2.2 -2.3 8.1 4.9 5.1 Imports, goods and services 3.2 -7.1 2.9 27.0 10.1 9.5 Real GDP growth, at constant factor prices 6.5 7.2 7.2 7.9 7.0 6.7 Agriculture 3.3 2.8 3.0 4.2 3.1 3.1 Industry 9.7 11.1 10.2 12.1 9.5 9.6 Services 5.8 6.2 6.7 6.4 6.5 5.8 Inflation (Consumer Price Index) 6.4 5.9 5.4 5.8 6.7 6.2 Current account balance (percent of GDP) 1.5 1.9 -0.5 -3.5 -3.4 -2.4 Net foreign direct investment (percent of GDP) 0.9 0.6 0.7 0.6 1.0 1.0 Fiscal balance (percent of GDP) 1/ -3.7 -3.7 -3.4 -4.3 -4.3 -4.6 Debt (percent of GDP) 31.8 31.5 30.6 31.2 32.6 34.2 Primary balance (percent of GDP) 1/ -1.7 -1.8 -1.8 -2.6 -2.4 -2.6 Note: (f) = forecast; 1/ Including grants Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 59 Bhutan Delays in hydropower construction lowered Bhutan’s growth rate in 2017 2017/18 and the trend is likely to persist over the medium term. The fiscal deficit is projected to decline because of lower public capital Population, million 0.8 expenditures during the initial years of the 12th five-year plan (2018- GDP, current USD billion 2.7 23). As hydropower projects contribute little to job creation, the direct GDP per capita, current USD 3276 impact of growth on poverty reduction is modest. Source: World Bank. Contributions to real GDP growth Percentage points 8 7 6 5 4 3 2 1 0 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 Agriculture Industry Services Real GDP growth (percent) Sources: National Statistics Bureau, Royal Monetary Authority, Ministry of Finance, World Bank, and staff calculations. year earlier. NPLs are especially high in the services Recent economic developments sector. To boost financial resources to strategic sectors such as cottage and small industries and agriculture, GDP growth in 2017/18 is estimated at 5.8 percent. On the central bank introduced the Priority Sector Lending the supply side, growth was driven by hydropower con- program in early 2018. struction and the services sector (especially financial services, hotels and restaurants, and transportation). On High imports due to increased government spending as the demand side, gross fixed capital formation, primarily well as construction of hydropower projects kept current in hydropower and government-financed infrastructure account deficit elevated at 21.7 percent of GDP in 2017/18. projects, supported output expansion. The deficit was almost fully financed by loans from India. As a result, as of May 2018, gross international reserves The Consumer Price Index remained under 3 percent remained comfortable at 1.1 USD billion, equivalent to 11 in the first half of 2018, mainly due to stable non-food months of imports of goods and services. prices, although the Ngultrum – pegged to the Indian Rupee – depreciated slightly against the USD. The fi- To support the last year of implementation of the 11th nancial sector remained sound with a risk-weighted FYP, government spending increased. The fiscal deficit capital adequacy ratio of 14.5 percent in March 2018, was at 4.1 percent of GDP despite an increase in tax col- above the minimum requirement of 12.5 percent. How- lections to 14.3 percent of GDP in 2017/18 from 13.6 per- ever, the gross non-performing loans (NPLs) increased cent a year before. Public debt, including hydropower to 14.6 percent in March 2018, up from 12.4 percent a debt, remained at about 100 percent of GDP in 2017/18. 60 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs Outlook farming into more productive jobs will likely happen at a slow pace. Economic growth is projected to average 6 percent a year over the medium term, largely supported by on-going hydropower projects and the services sector, Risks and challenges especially tourism. However, downside risks to growth There are four key risks facing the Bhutanese economy: remain, particularly from the delay in the completion of (a) given the size of hydropower projects relative to the two mega hydropower projects. With the completion of size of the economy, any further delays in hydropower the Mangdechhu hydro project in late 2018, exports are construction will negatively affect the economy through likely to increase while imports will decline because of lower exports and revenues; (b) donor financing in Bhu- lower public capital spending. This will help narrow the tan is getting scarce while domestic debt markets are current account deficit to 12 percent of GDP by 2020/21 not yet developed (limited financing sources could con- and reduce external debt to 87 percent. Lower capital strain government spending and negatively affect future spending during the first few years of the new 12th FYP growth and development); (c) the ongoing 2018 general is expected to bring the fiscal deficit to below 3 percent election could lead to policy uncertainty which could of GDP during the forecast period. As the hydropow- impact growth and investment; and (d) adverse weather er projects contribute little to direct job creation, the events could negatively impact the economy through impact of growth on poverty reduction is expected to lower electricity generation from existing hydropower be modest. Low-productivity agricultural activities still plants and lower tourist traffic. Longer-term challenges account for nearly 60 percent of employment and with center on boosting dynamism and job creation in the limited private sector development, the transition out of private sector. Bhutan macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 7.3 7.4 5.8 4.6 7.6 6.4 Private consumption 3.4 3.7 -2.0 0.8 10.8 9.6 Government consumption 7.3 4.6 8.5 6.1 6.0 4.9 Gross fixed capital investment 14.1 7.2 1.8 -1.3 4.2 -0.1 Exports, goods and services -2.7 -2.0 -1.4 -2.0 0.2 4.4 Imports, goods and services 3.4 -2.4 -10.3 -10.5 1.7 0.4 Real GDP growth, at constant factor prices 7.8 7.5 5.9 5.0 7.4 6.2 Agriculture 4.3 3.9 4.5 3.7 2.7 2.7 Industry 7.5 5.7 5.4 5.1 4.4 2.1 Services 9.2 10.7 6.7 5.1 11.9 11.0 Inflation (Consumer Price Index) 3.3 4.3 5.0 5.0 5.0 5.0 Current account balance (percent of GDP) -29.3 -24.7 -21.7 -17.8 -13.3 -12.2 Net foreign direct investment (percent of GDP) 0.4 -0.6 1.0 1.1 1.5 1.6 Fiscal balance (percent of GDP) -1.1 -1.2 -4.1 -3.0 -1.9 -2.6 Debt (percent of GDP) 90.6 104.2 97.9 93.6 87.9 87.5 Primary balance (percent of GDP) 0.5 0.3 -2.9 -1.6 -0.4 -0.8 Note: (e) = estimate; (f) = forecast. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 61 India The economy appears to have recovered from the temporary 2017 disruptions caused by demonetization and the introduction of the GST: growth reached 6.7 percent in FY17/18, with a significant acceleration Population, million 13417.0 in recent months. However, domestic risks and a less benign external GDP, current USD billion 2600.8 environment impact the macroeconomic outlook. GDP per capita, current USD 1938 Source: World Bank. Contributions to real GDP growth Percentage points 10 8 6 4 2 0 -2 -4 2011 2012 2013 2014 2015 2016 2017 2018 (e) Final consumption Gross fixed capital formation Net exports Other Real GDP growth (percent) Note: (e) = estimate; India’s fiscal year runs from April 1st to March 31st. Source: Indian Central Statistics office and staff calculations. Recent economic developments has raised policy rates twice by a cumulative 50 basis points since April 2018 (from 6.0 percent to 6.5 percent). The economy has recovered from the ‘twin shocks’ of demonetization and GST introduction. GDP growth is The external situation has become less favorable and estimated at 6.7 for FY17/18, with an acceleration to 7.4 the current account balance has deteriorated. A wors- percent in the second half. On the production side, the ening trade deficit has led the current account deficit to turnaround in the second half was led by manufacturing widen (on the back of strong import demand, higher oil (that grew at 8.8 percent vs. 2.7 percent in the first half). prices and exchange rate depreciation) from a benign Agriculture growth improved, and services growth held 0.7 percent of GDP in FY16/17 to 1.9 percent in FY17/18. steady at 7.7 percent. On the demand side, the pick-up External headwinds - monetary policy ‘normalization’ in in growth was reflected in a sharp acceleration in gross the US coupled with recent stress in some EMDEs - have fixed capital formation to 11.7 percent in the second half, triggered portfolio outflows from April 2018 onwards. from 3.4 percent in the first. Consumption, growing at 7 As a result, the nominal exchange rate depreciated percent in the second half, remained the major driver of by about 12 percent from January to September 2018, growth. and foreign reserves declined by over 5 percent since March, while remaining comfortable at about 9 months Meanwhile, some inflationary pressures have emerged of imports. due to the convergence of price effects (higher oil prices and exchange rate depreciation) and growth dynamics Public finances have broadly remained on a gradual (closing output gap). Inflation reached 4.2 percent in consolidation path. In FY17/18 the fiscal deficit of the cen- July 2018, exceeding the central parity of 4 percent, tral government remained at 3.5 percent (unchanged though remaining within the policy band. As a result, RBI from FY16/17). At the sub-national level, the gross fiscal 62 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs deficit of states declined from 3.5 to 3.1 percent of GDP (y-o-y), mostly on account of lower capital outlays (as Risks and challenges a share of GDP). General government debt remained The higher degree of uncertainty in the global environ- stable and sustainable at around 67 percent of GDP; ment and remaining sources of domestic fragility imply however, questions remain as to the magnitude of con- that the risks to the outlook are tilted to the down side. tingent liabilities at the state level. This puts a premium on prudent macroeconomic man- agement, including in containing spending pressures ahead of elections and continuing to address the “twin Outlook balance sheet” problems of banks and corporates. With little room for fiscal and monetary levers to sup- Growth is projected to firm-up gradually over 2018-21. port aggregate demand, structural reforms will deter- It is projected to rise to 7.3 percent in FY18/19, on the mine the prospects of economic growth in the medium back of a recovery in investment and continued support term; namely addressing bottlenecks to private credit from consumption. On the production side, industry is growth and wider issues related to the banking sector, projected to make a more significant contribution. From alleviating supply side bottlenecks, and adopting other FY19-20 onwards, growth is projected to rise further to competitiveness enhancing measures. Policies to im- 7.5 percent and possibly higher, in line with potential prove competitiveness will also be needed to support growth. export growth and address external imbalances. While the recent real depreciation of the Rupee helps ceteris India faces continued internal and external risks. High paribus tightening global financing conditions can bring oil prices and an uncertain global trade environment challenges in financing the current account deficit. Pre- may pose challenges for the current account. A wid- venting fiscal slippage will be key to signal commitment ening trade deficit is likely to lead to a current account to macroeconomic stability. deficit of around 2.6 percent of GDP in FY18/19, and tighter global financing conditions will put added em- Broad-based poverty reduction remains a big chal- phasis on India’s ability to attract FDI. Fiscal consoli- lenge. India needs to accelerate the responsiveness dation is expected to resume in FY18/19, but slippages of poverty reduction to growth, including for presently could happen on both the revenue side (as the GST is excluded groups (such as women and scheduled tribes), still stabilizing) and the expenditure side (ahead of state and to extend gains to a broader range of human de- and federal elections). Elevated oil prices, a recent hike velopment outcomes, where it continues to rank poorly. in agricultural support prices, and further exchange rate The persistent negative impact of uneven monsoons depreciation, could keep the inflation outlook chal- on agricultural growth, amplified by low uptake of crop lenging, possibly resulting in further monetary policy insurance, underlines the medium-term risk of climate actions. change on the rural poor. India macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 8.2 7.1 6.7 7.3 7.5 7.5 Private consumption 7.4 7.3 6.6 6.2 8.2 7.7 Government consumption 6.8 12.2 10.9 11.2 9.5 9.0 Gross fixed capital investment 5.2 10.1 7.6 10.2 7.3 7.5 Exports, goods and services -5.6 5.0 5.6 7.9 7.1 7.7 Imports, goods and services -5.9 4.0 12.4 9.5 8.0 7.5 Real GDP growth, at constant factor prices 8.1 7.1 6.5 7.2 7.4 7.4 Agriculture 0.6 6.3 3.4 3.2 3.2 3.2 Industry 9.8 6.8 5.5 7.1 7.2 7.2 Services 9.6 7.5 7.9 8.3 8.7 8.6 Inflation (Consumer Price Index) 4.9 4.5 3.6 5.0 4.0 4.0 Current account balance (percent of GDP) -1.0 -0.7 -1.9 -2.6 -2.4 -1.3 Net foreign direct investment (percent of GDP) 1.7 1.6 1.2 1.4 1.6 1.8 Fiscal balance (percent of GDP) -6.9 -7.0 -6.6 -6.1 -5.9 -5.6 Debt (percent of GDP) 70.0 69.5 68.8 67.2 66.1 63.9 Primary balance (percent of GDP) -2.2 -2.2 -1.7 -1.7 -1.8 -1.8 Note: (e) = estimate; (f) = forecast. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 63 Maldives Growth is expected to continue to be driven by construction and 2017 tourism, supported by the opening of 13 new resorts in 2017. Real GDP growth is expected at 8.0 percent in 2018, and to gradually decline Population, million 0.4 to 5.6 percent over the forecast period. Efforts to contain recurrent GDP, current USD billion 4.7 spending to accommodate the increase in capital spending have been GDP per capita, current USD 10675 effective, yet the level of public debt is projected to rise further, and Source: World Bank. foreign exchange reserves are low. Contributions to real GDP growth Percentage points 8 6 4 2 0 -2 2012 2013 2014 2015 2016 2017 Taxes less subsidies Construction Tourism Real GDP growth (percent) Transport Transport Other Note: Maldives fiscal year is the calendar year. Source: National Bureau of Statistics. Recent economic developments to Malé. Limited uptake of the cash transfer to compensate for the partial removal of food subsidies may have impact- Real GDP grew by 7.1 percent in 2017, on the back of ed on the poor households’ purchasing power. strong performance of the tourism sector, an accelera- tion of construction, transportation and communication, Growth in goods exports outpaced that of imports, nar- and fisheries. These sectors contributed about 5 per- rowing the trade deficit by 2.7 percentage points of GDP centage points to headline growth (or over 70 percent). in 2017. Strong performance of services exports against Preliminary estimates for 2018 indicate that GDP growth the backdrop of strong tourism receipts was more than accelerated to 12 percent (y-o-y) in the first quarter of offset by growing services imports, rendering the bal- 2018 against 6 percent in Q1 2017, driven by strong out- ance of goods and services virtually unchanged. The ings from tourism (4.1 percentage points), the construc- current account deficit is estimated to have narrowed to tion sector (2.1 percentage points), trade (1.1 percentage 18.8 percent of GDP in 2017 (from 24.4 percent in 2016), points), and the transportation and communication (1.1 mainly supported by significant improvements in the percentage points) sectors. secondary income account balance. The financing of the current account was mainly through direct investment Headline inflation averaged 2.8 percent in 2017, driven by and, to a lesser extent, portfolio flows. Gross official the increases in prices of food and housing and utilities, reserves recovered from 467 USD million at end-2016 reflecting the partial removal of food subsidies and the to 586 USD million at end-2017 (206 USD million after pass-through of rising electricity prices. Over the first half netting out short-term foreign currency liabilities to do- of 2018, major components of the CPI basket receded, with mestic banks, representing 1.1 month of goods imports). the overall consumer price index falling by 0.4 percent. This decline in prices was more pronounced in the atolls, The government made progress in rebalancing fiscal ex- given the relatively higher weight of food items compared penditure to accommodate increased capital expenditure. 64 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs The fiscal deficit narrowed from a 10.6 percent of GDP in 2016 to a 2.5 percent in 2017, driven mainly by a reduction Risks and challenges in public investment from 10.9 percent of GDP in 2016 to Risks to the outlook are tilted to the downside. A downturn 8.2 percent in 2017, and a reduction in spending on food in the global economy could impact Maldives’ tourism in- subsidies and on the Aasandha unlimited health care dustry. Increases in global commodity prices could impact system. Excluding the Public Sector Investment Program, external sector performance given the heavy reliance on the underlying current fiscal balance went from a deficit diesel imports. In the domestic front, the challenging po- of 2.0 percent of GDP in 2015 to an estimated surplus of litical environment along with major elections due in the 5.7 percent of GDP in 2017, reflecting revenue increases coming months could adversely impact the reform mo- and current expenditure reforms. Public debt is estimated mentum, including measures to improve budget credibility. to have reached 61.2 percent of GDP in 2017, an increase from 59.7 percent of GDP in 2016, driven by external proj- One key challenge for the Maldives is to find the ap- ect-related borrowing and the 200 USD million Eurobond propriate balancing act between, on the one hand, the issuance, while domestic T-bills were redeemed. ongoing large infrastructure projects to close some of the existing infrastructure gaps that potentially would The construction and tourism sectors, the main drivers allow to boost tourism, reduce the impact of climate of recent growth, have not generated sufficient jobs for change and ease constraints in the delivery of key pub- Maldivians since they rely mostly on foreign labor and lic services, and on the other, the rapid accumulation of male employment. Youth and female unemployment are high. More than a quarter of women are either unem- public debt, the widening current account deficits and ployed or not looking for a job. Almost a quarter of Mal- the limited fiscal space available. Vulnerability of the divian youth are not employed, in education, or training overall debt portfolio, with indebtedness levels at over (NEET). The driver for the high NEET rate among females 60 percent of GDP, is heightened by the short maturity is inactivity, whereas for males it is unemployment. of domestic debt and low reserve coverage. Large vol- ume of external loans and guarantees on non-conces- sional terms to finance infrastructure projects represent Outlook significant risks to the downside. Real GDP growth is expected at 8.0 percent in 2018, and The government is still the top employer among Maldiv- to gradually fall to 5.6 percent at the end of the forecast ians, and about two thirds of Maldivians are employed period, as growth in the tourism sector returns to histori- in jobs not related to tourism, suggesting a misalign- cal levels and capital investment projects are gradually tapering off. The current account is projected to narrow ment between the drivers of growth and aspirations of over the forecast period, as investment-related imports jobseekers. Measures that foster private sector job cre- gradually subside. ation can help reduce pressure on the public sector to create jobs for an expanding working age population. The outlook assumes no major fiscal slippages related to The consolidation of population from vulnerable islands current expenditure or the realization of contingent liabil- and atolls into Greater Malé, while also reducing pres- ities through guarantees. The overall fiscal deficit is pro- sure on Malé, may eventually allow for new forms of jected to narrow over the forecast period. Public debt is economic activity, create employment, improve quality projected to rise to 2020 and peak soon after. Maldives’ of public service delivery, and increase resilience to cli- risk of external debt distress is assessed as high. mate change. Maldives macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 2.2 6.2 7.1 8 6.3 5.6 Real GDP growth, at constant factor prices 2.8 6 7.2 7.9 6.3 5.6 Agriculture -0.5 1.4 12.8 0.8 2.8 2.8 Industry 16.5 15.1 19.4 14.4 12.5 12.1 Services 1.4 5.2 5.1 7.3 5.5 4.6 Inflation (Consumer Price Index) 1 0.5 2.8 1 1.4 1.2 Current account balance (percent of GDP) -7.5 -24.4 -18.8 -18 -17.8 -17.7 Fiscal balance (percent of GDP) -7.1 -10.6 -2.5 -5.3 -5 -4.8 Debt (percent of GDP) 54.4 59.7 61.2 61.7 62.6 63.5 Primary balance (percent of GDP) -4.9 -8.8 -0.8 -3 -2.6 -2 Notes: (e) = estimate; (f) = forecast. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 65 Nepal At 6.3 percent, economic growth remained strong in FY2018, driven 2017 mainly by investment in earthquake reconstruction. To sustain investment and maintain high levels of growth, additional private sector Population, million 29.3 resources and engagement - including foreign direct investment (FDI) GDP, current USD billion 249.0 - are needed. This necessitates timely implementation of reforms to GDP per capita, current USD 849 support an enabling environment for the private sector and to increase Source: World Bank foreign investment. As Federalism proceeds, it will be particularly important to enhance implementation capacity and revenue potential at subnational levels of government. Contributions to real GDP growth Percentage points 14 12 10 8 6 4 2 0 -2 -4 2010 2011 2012 2013 2014 2015 2016 2017 2018 Note: Nepal’s fiscal year runs from Private consumption July 16th to July 15th. Investment Real GDP growth (percent) Source: Central Bureau of Statistics and staff calculations. Recent economic developments adequacy ratio of 10 percent with an NPL ratio of 1.7 percent in Q3 FY2018. Growth in FY2018 remained strong at 6.3 percent despite less favorable monsoons and the easing of rapid growth A higher trade deficit and slower remittances growth that ensued following the 2015 earthquake. Services widened the current account deficit, which was offset by were the main driver contributing 3.6 percentage points, errors and omissions, government borrowing, and trade over 60 percent of which came from trade and hotels. For credit. The trade deficit surged to 37.7 percent of GDP industry, over 90 percent of growth came from construc- (from 33.9 percent in FY2017), primarily from imports to tion and manufacturing. On the demand side, investment build government subnational offices, construction and and private consumption were the main drivers of growth. reconstruction materials, as well as higher fuel prices. Remittances grew by 10 percent, but as a share of GDP Inflation was 4 percent driven by non-food items declined from 26.3 percent in FY2017 to 25.1 percent in whose prices grew at 5.5 percent, compared to food FY2018. In addition, the USD-Rupee exchange rate de- prices which grew at 3.1 percent. Consumption fueled preciated 6.2 percent. Gross official reserves declined by remittances continued to drive private sector cred- slightly but remained adequate to cover 8.3 months of it growth which contributed 17.2 percentage points to imports (compared to 9 months in FY2017). money (M2) growth of 19.4 percent. Saving deposits growth increased to 18.8 percent in July but credit grew Poor execution of the budget continued with overall ex- faster at 22.5 percent, causing the weighted average ecution of 82.4 percent (71.2 percent for capital expendi- lending rates of commercial banks to remain high at ture). In FY2018, 37.5 percent of total spending (or 54.6 12.5 percent in July. All banks met the minimum capital percent of capital expenditure) was spent in the last 66 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs quarter of the fiscal year. Revenue growth was strong The government is shifting from consumption to invest- due to higher taxes from high imports (which constitute ment-based growth, with emphasis on engaging the just under half of all revenue) coupled with collection private sector and raising the very low levels of FDI. In rates that were close to planned targets. The fiscal addition to infrastructure investments, key reforms will deficit increased in FY2018, primarily driven by higher include establishing public private partnerships (PPPs), spending to establish sub-national governments and to one-stop investor services, and e-government services finance the transition to Federalism. This was financed for citizens. Consolidated spending of government is by government deposits and higher public debt. expected to reach 34 percent of GDP over the medium term (versus 28 percent in FY2017), with 3 to 4 percent of the increase from Federalism alone. Transfers to Outlook sub-nationals are expected to increase by 4 percentage points to reach 6 percent of GDP by 2021. Raising rev- GDP growth is projected to average 6 percent over enue potential of subnational governments will be criti- the medium term, driven primarily by total investment. cal as will be their capacity to implement their projects The FY2019 budget includes investments to promote and programs. Overall, taxes on rising imports, luxury improved inputs and storage facilities for farmers, in- items and incomes of wealthier households, including a cluding for irrigation. These investments focus on mod- broadening of the tax base, will help increase revenue ernization, commercialization, mechanization and the to 29 percent of GDP over the medium term. Public debt expansion of value chains. As these programs ramp up, as a share of GDP will increase but remain sustainable. the agriculture sector growth is expected to increase from 2.8 to 4.5 in FY2020. Also, the Visit Nepal 2020 program aims to bring in two million foreign tourists Risks and challenges annually by 2020. This will be supported by key infra- Risks to the outlook include: (i) slow implementation of structure projects and includes linking completed hydro reforms needed to increase private investment, particu- projects to the transmission grid. A new large private ce- larly foreign investment; (ii) low implementation capacity ment factory is expected to boost construction activities, at decentralized levels that worsens budget execution while the agreement to build a second cement factory and the quality of expenditure; (iii) external shocks to out- with Chinese investment will likely enhance FDI in the migration and remittances leading to deterioration of the next fiscal year. Growth in industry and services is pro- balance of payments, a reduction in growth of financial jected to average 8 and 6 percent respectively, as infra- deposits, a shortage of loanable funds and credit, low- structure constraints are eased, and capacity utilization er consumption and increased poverty; and (vi) natural expanded.  Inflation is projected to reach 5 percent over disasters. Each of the above factors individually would the medium term, assuming oil prices increase, and the seriously undermine growth. A combined occurrence exchange rate depreciates. The current account deficit could lead to growth below the average 4.4 percent per will gradually improve as import growth moderates. annum that was observed in previous decades. Nepal macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 3.3 0.6 7.9 6.3 5.9 6.0 Private consumption 2.9 -0.7 2.6 2.5 4.7 4.7 Government consumption 7.4 -0.4 10.4 9.4 30.2 7.0 Gross fixed capital investment 19.6 -12.3 44.2 15.7 13.2 7.7 Exports, goods and services 6.8 -13.7 13.7 4.4 7.6 9.5 Imports, goods and services 9.6 2.8 30.3 14.8 12.7 6.2 Real GDP growth, at constant factor prices 3.0 0.2 7.4 5.9 5.9 6.0 Agriculture 1.1 0.2 5.2 2.8 4.0 4.5 Industry 1.4 -6.4 12.4 8.8 8.8 8.0 Services 4.8 2.3 7.4 7.1 6.2 6.3 Inflation (Consumer Price Index) 7.2 9.9 4.4 4.0 4.7 4.7 Current account balance (percent of GDP) 5.1 6.2 -0.4 -8.2 -7.8 -6.8 Fiscal balance (percent of GDP) 1.0 1.4 -3.1 -5.8 -5.8 -5.5 Debt (percent of GDP) 25.6 27.9 26.6 30.5 32.7 35.2 Primary balance (percent of GDP) 1.5 1.8 -2.8 -4.9 -4.8 -4.2 Note: (e) = estimate; (f) = forecast. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 67 Pakistan Pakistan’s macroeconomic situation remains fragile. Consumption led 2018 growth is expected to slow down due to fiscal and possibly monetary tightening. However, short term measures for fiscal consolidation Population, million 200.4 and export growth need to be complemented with implementation of GDP, current USD billion 312.6 medium term structural reforms to uplift the economy out of frequent GDP per capita, current USD 1560 boom-and-bust cycles. Source: World Bank. Trade deficit and import coverage Percent Months of imports 6 6 3 3 0 0 -3 -3 -6 -6 2012 2013 2014 2015 2016 2017 2018 Current account balance Import coverage (rhs) Note: Pakistan’s fiscal year runs from July 1st to June 30th. Sources: Ministry of Finance and State Bank of Pakistan. intervened heavily in the foreign exchange market in Recent economic developments the first half of FY18 to maintain the value of the Paki- Pakistan’s macroeconomic imbalances are increasing. stani Rupee, resulting in a large decline in international Economic growth reached 5.8 percent in FY18, 0.4 per- reserves from 16.1 USD billion (2.9 months of imports) centage points higher than in FY17. On the demand side, at end-June 2017 to 10.2 USD billion (or 1.7 months of growth was driven by consumption which contributed imports) by August 24th, 2018. Under intense market seven percentage points towards GDP growth. On the pressure, the currency depreciated by almost 18 per- supply side, recovery in the agricultural and industrial cent between 1st December 2017 and 25th of July 2018. sectors and consistent acceleration in the services sec- Post-election, with emerging political certainty, the Paki- tor contributed to the GDP growth. Although headline stani Rupee recovered 3 percentage points against the inflation remained benign and was recorded at 3.9 USD and was trading at 124.3 Pakistani Rupees per USD percent in FY18, core inflation rose indicating underly- on 7th September 2018. ing inflationary pressures. Therefore, the State Bank of Pakistan increased the policy interest rate by 175 bps to The fiscal deficit has widened over the past two years 7.5 percent between January 2018 and July 2018. – reversing fiscal consolidation efforts in previous years and raising public debt levels. The FY18 fiscal deficit The current account deficit increased to 5.8 percent of (including grants) reached 6.5 percent of GDP—a slip- GDP in FY18, up from 4.1 percent in FY17. The widening page of 2.5 percentage points compared to the budget current account deficit reflects the growing trade deficit target. This was due to limited revenue growth and large as exports are not growing as fast as imports. Imports increases in recurrent spending at both the federal and are growing fast due to high domestic demand and im- provincial levels. Consequently, Pakistan’s public debt port-intensive investments related to the China Pakistan reached 73.5 percent of GDP by end-June 2018, sig- Economic Corridor (CPEC). The State Bank of Pakistan nificantly raising debt-related risks. The newly elected 68 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs government recognizes the need for macroeconomic It is expected that there will be some scaling down of adjustments to overcome these challenges and has al- public investment spending at the federal and provincial ready announced its plans to cut expenditures, improve levels, and increase in revenue collection through tax the management of State Owned Enterprises, and un- base expansion and other administrative measures. Fis- dertake revenue mobilization reforms. cal consolidation would improve debt dynamics, but the public debt to GDP ratio is expected to stay around 70 percent of GDP during FY19 and FY20 - the debt burden Outlook benchmark for high-risk in case of Emerging Markets (as per the IMF Market-Access Countries public debt GDP growth is projected to decelerate to 4.8 percent in sustainability analysis). Growth deceleration and higher FY19 as authorities are expected to tighten fiscal policy inflation are expected to slow-down poverty reduction to correct imbalances. However, growth is expected to in FY19 though overall poverty decline is projected to recover in FY20 and reach 5.2 percent as macroeco- continue reflecting GDP growth. The presence of safety nomic conditions improve. This recovery is conditional net programs will mitigate the negative impact of infla- upon the restoration of macroeconomic stability, a sup- tion on poverty. portive external environment, including relatively stable international oil prices, and a strong recovery in exports. Inflation is expected to rise to 8 percent (average) in FY19 Risks and challenges and remain high in FY20, driven by exchange rate pass Immediate macroeconomic adjustments are required through to domestic prices and a moderate increase in to correct the large twin deficits. Rising global interest international oil prices. rates and tighter liquidity situation will pose challenges to Pakistan given the high gross external financing re- The pressure on the current account is expected to per- quirements. With declining reserves and elevated debt sist and the trade deficit is projected to remain elevated ratios, Pakistan’s ability to withstand external shocks during FY19 and FY20. Remittances will continue to part- is diminished and risks will remain predominantly on ly finance the current account deficit, although slower the downside. Appropriate policy responses to correct growth in the Gulf Cooperation Council (GCC) countries these imbalances and increased buffers to absorb future will affect remittances. FDI, multilateral, bilateral, and shocks will reduce these risks and support a positive private debt-creating flows are expected to be the main growth outlook. Such responses would entail increased financing sources in the near to medium term. flexibility of the exchange rate, strengthening the fiscal position through renewed efforts to improve revenue The fiscal deficit is projected to narrow in FY19 due to collection and better coordination between federal and post-election adjustments and some fiscal measures. provincial governments to reduce public spending. Pakistan macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 4.7 5.5 5.7 5.4 4.8 5.2 Private consumption 2.9 7.6 8.7 6.3 4.6 2.8 Government consumption 8.1 8.2 5.3 14.2 1.6 4.2 Gross fixed capital investment 15.8 7.5 10.0 5.7 -0.8 13.5 Exports, goods and services -6.3 -1.6 -0.8 9.9 13.4 10.1 Imports, goods and services -1.6 16.0 21.0 17.5 1.9 3.5 Real GDP growth, at constant factor prices 4.1 4.6 5.4 5.8 4.8 5.2 Agriculture 2.1 0.2 2.1 3.8 3.5 3.4 Industry 5.2 5.7 5.4 5.8 5.0 5.7 Services 4.4 5.7 6.5 6.4 5.1 5.5 Inflation (consumer price index) 4.5 2.9 4.2 3.9 8.0 7.5 Current account balance (% of GDP) -1.0 -1.7 -4.1 -5.8 -5.2 -4.2 Net Foreign Direct Investment (% of GDP) 0.3 0.8 0.9 0.9 1.7 2.0 Fiscal balance (% of GDP) -5.2 -4.5 -5.8 -6.5 -5.0 -4.6 Debt (% of GDP) 64.3 68.7 67.9 73.5 72.6 69.6 Primary balance (% of GDP) -0.5 -0.2 -1.5 -2.1 0.2 0.0 Notes: e = estimate; f = forecast. Source: World Bank. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 69 Sri Lanka The recent fiscal and monetary policy measures have broadly 2017 contributed to stability amid continued natural calamities. Growth is projected to be around 4.0 percent in the medium-term and the outlook Population, million 21.4 remains stable. Poverty is projected to further decline as growth GDP, current USD billion 87.3 recovers. However, risks are downward tilted. The country is vulnerable GDP per capita, current USD 4073 to global financial conditions due to large external refinancing Source: World Bank. requirements starting from 2019. Although some vital reforms were carried out, the process has slowed down in a challenging political environment. The impending election cycle elevates the uncertainty. Real GDP growth Percent 10 8 6 4 2 0 2010 2011 2012 2013 2014 2015 2016 2017 Average Real GDP growth Average of the period Note: Sri Lanka’s fiscal year is the calendar year. Source: Department of Census and Statistics and staff calculations. effects of increasing fuel prices increased inflation to 5.6 Recent economic developments percent by August 2018. The country-wide drought conditions continue to take a toll on macroeconomic performance. The economy is On the external front, exports rebounded thanks to the estimated to have grown by 3.6 percent in the first half reinstatement of GSP+ preferential access to the Euro- of 2018, following a 16-year low growth of 3.3 percent pean Union. Nevertheless, the gradually rising fuel bill in 2017. Agriculture and related industry sectors are ex- and increased imports of vehicles and gold widened pected to have recovered in the first half of 2018 with the trade deficit. External liquidity received a boost from relatively benign weather. However, the ongoing epi- the proceeds of sovereign bonds and increased FDI sode of drought, which has been more pronounced from compared to the previous year. While reserve cover of the beginning of the third quarter of 2018, has already imports has improved from 2017, external vulnerability impacted more than 900,000 people in 18 districts. remains elevated with relatively high short-term liabili- ties. Amid tightening global financial conditions, the Sri Increased agriculture output led to benign inflation in Lankan Rupee depreciated by 5.6 percent against the the first quarter of 2018. Favorable inflation outlook USD by end-August 2018. prompted the central bank to marginally relax policy rates in April, as the growth in monetary aggregates de- Albeit lower than expected, the government recorded celerated in response to a tight monetary policy. How- a primary surplus for the first quarter of 2018; howev- ever, subsequent currency depreciation and spill-over er, the higher than budgeted interest costs masked the 70 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs improvement. The debt portfolio of the central govern- the medium term, supported by the implementation of ment is subject to important risks with over 50 percent revenue measures. being denominated in foreign currencies, of which around 30 percent is expected to mature in the next five years. While implementation of the cost-reflective fuel Risks and challenges pricing will enhance fiscal sustainability, the flip side will be the need for targeted measures to protect the poor A further slowdown in reform implementation, in a chal- and vulnerable who may be affected more. lenging political environment, remains the key domestic risk to the baseline. Impending election cycle exacer- The gradual rebound of growth from last year’s re- bates this risk. External risks include steeper than ex- cord-low rate is expected to have helped improve the pected global financial conditions that would increase incomes of the poor. However, droughts continue to the cost of debt and make rolling over the maturing Eu- disrupt livelihoods and agricultural activities, and may robonds from 2019 more difficult; disappointing growth have contributed to the recent notable drop in employ- in key countries that generate foreign exchange inflows ment, especially among women in rural areas. In ad- to Sri Lanka through exports, tourism, remittances, FDI, dition, inflation reached 6.5 percent in 2017, its highest and other financing flows; faster than expected rises in levels since 2014, which likely offset some of the gains. commodity prices that would increase pressure on the balance of payments; and capital outflows that would further increase currency pressure. On the fiscal and debt management front, risks include the delay in im- Outlook plementing revenue measures, and slower than expect- The outlook remains stable, conditional on reforms to ed improvement in tax administration. The increasing improve competitiveness, governance and public finan- occurrence and impact of natural disasters could have cial management. Together with the IMF program, these an adverse impact on growth, the fiscal budget, the ex- reforms will add to confidence and lead to sustained ternal sector and poverty reduction. growth and development. Sri Lanka needs to address several challenges that in- Growth is projected to rebound in 2018 from a low base creasingly put its economic growth and stability at risk, and continue to be marginally above 4.0 percent in the through macroeconomic and structural reforms: (1) con- medium term, driven by private consumption and invest- tinue fiscal consolidation by broadening the tax base ment. Inflation will hover around mid-single digit level, and aligning spending with priorities: this is important although currency depreciation and rising oil prices may given high public debt, contingent liabilities and large exert some upward pressure. Despite global uncertain- gross financing needs; (2) shift towards a private invest- ties, exports will benefit from spill-over effects of the ment-tradable sector-led growth model by improving reinstatement of GSP+, while tourism and remittances trade, investment, innovation and the business environ- support the external balances. With improved hydro- ment; (3) improve governance and accountability and power generation, the growth in imports will normalize improve SOE performance; and (4) reduce vulnerability in the medium-term. External reserves are expected and risks by enhancing disaster preparedness and miti- to improve, thanks to debt inflows to the government, gating the impact of reforms on the poor and vulnerable providing a buffer for debt redemptions. The Liability with well-targeted spending. The government recently Management Act, passed in early 2018, will provide the announced plans to expand coverage of the main so- flexibility for managing some important risks of the debt cial protection program (Samurdhi), but details remain portfolio. The overall fiscal deficit is projected to fall in unclear. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs 71 Sri Lanka macroeconomic outlook 2015 2016 2017 2018 (e) 2019 (f) 2020 (f) Real GDP growth, at constant market prices 5.0 4.5 3.3 3.9 4.0 4.1 Private consumption 7.5 -3.9 1.3 4.0 4.0 4.1 Government consumption 10.2 2.3 -5.2 3.7 3.7 4.6 Gross fixed capital investment 2.5 7.8 5.0 5.9 5.9 6.0 Exports, goods and services 4.7 -0.7 7.5 4.0 4.7 3.3 Imports, goods and services 10.6 7.9 19.3 3.6 3.8 3.4 Real GDP growth, at constant factor prices 4.8 4.3 3.3 3.9 4.1 4.1 Agriculture 4.7 -3.8 -0.8 4.0 3.4 3.4 Industry 2.2 5.8 4.6 3.9 4.1 4.2 Services 6.0 4.7 3.2 3.9 4.1 4.2 Inflation (Consumer Price Index) 0.9 4.0 6.6 5.0 5.0 5.0 Current account balance (percent of GDP) -2.3 -2.1 -2.6 -2.9 -3.0 -3.1 Net foreign direct investment (percent of GDP) 0.8 0.8 1.5 2.0 1.2 0.9 Fiscal balance (percent of GDP) -7.6 -5.4 -5.5 -5.2 -4.6 -4.4 Debt (percent of GDP) 77.7 78.8 77.4 77.8 77.1 76.3 Primary balance (percent of GDP) -2.8 -0.3 0.0 0.5 1.2 1.3 Note: (e) = estimate; (f) = forecast. Source: World Bank. 72 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 South Asia at a glance South Asia at a glance Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South Asia 2015 1.5 6.6 7.3 8.2 2.2 3.3 4.1 5.0 7.1 2016 2.3 7.1 7.4 7.1 6.2 0.6 4.6 4.5 7.5 Real GDP 2017 2.7 7.3 5.8 6.7 7.1 7.9 5.4 3.3 6.6 growth 2018 (f) 2.4 7.9 4.6 7.3 8.0 6.3 5.8 3.9 6.9 2018 Q1 (CY) .. .. .. 7.7 .. .. .. 8.9 .. 2018 Q2 (CY) .. .. .. 8.2 .. .. .. 7.1 .. 2015 4.6 6.4 3.3 4.9 1.0 7.2 4.5 0.9 4.5 OUTPUT and PRICES 2016 4.3 5.9 4.3 4.5 0.5 9.9 2.9 4.0 4.4 Inflation 2017 4.7 5.4 5.0 3.6 2.8 4.4 4.2 6.6 3.8 (Consumer Price Index) 2018 (f) 3.1 5.8 5.0 5.0 1.0 4.0 3.9 5.0 3.5 2018 July .. 5.6 .. 4.2 .. .. 5.9 5.4 .. 2018 August .. 5.5 .. 3.7 .. .. 5.9 5.9 .. 2015 .. .. .. 103.7 .. .. 110.3 .. 104.3 2016 .. .. .. 105.0 .. .. 109.6 .. 105.5 REER 2017 .. .. .. 109.8 .. .. 106.4 .. 109.4 (CY) 2018 (f) .. .. .. 105.5 .. .. 102.0 .. 105.2 2018 August .. .. .. 106.2 .. .. 104.1 .. 106.0 2018 September .. .. .. 102.7 .. .. 104.4 .. 102.9 Current 2015 7.5 1.5 -29.3 -7.5 5.1 -2.3 -3.4 account 2016 7.1 1.9 -24.7 -0.7 -24.4 6.2 -1.7 -2.1 -4.8 balance (percent of 2017 1.6 -0.5 -21.7 -1.9 -18.8 -0.4 -4.1 -2.6 -6.1 GDP) 2018 (f) 0.2 -3.5 -17.8 -2.6 -18.0 -8.2 -5.8 -2.9 -7.3 2015 -41.8 -7.4 -28.5 -2.3 9.4 -29.9 -6.4 -7.5 -3.6 Trade balance (percent of 2016 -42.1 -4.7 -23.4 -1.7 -1.2 -29.9 -7.0 -7.3 -3.1 GDP) 2017 .. -5.2 -22.0 -2.9 -4.8 -32.3 -9.3 -7.2 -4.0 2015 4.6 3.2 3.4 -5.9 .. 9.6 -1.6 10.6 -3.8 2016 25.8 -7.1 -2.4 4.0 .. 2.8 16.0 7.9 0.3 2017 8.0 2.9 -10.3 12.4 .. 30.3 21.0 19.3 6.2 BALANCE of PAYMENTS Import growth (percent, y-o-y) 2018 (f) 4.1 20.6 -10.5 9.5 .. 14.8 17.5 3.6 -2.3 2018 May .. 36.8 .. 14.5 .. .. 14.3 7.7 .. 2018 June .. 17.0 .. 20.5 .. .. 26.3 17.9 .. 2015 2.4 -2.8 -2.7 -5.6 .. 6.8 -6.3 4.7 -5.0 2016 -0.3 2.2 -2.0 5.0 .. -13.7 -1.6 -0.7 0.9 Export growth 2017 7.0 -2.3 -1.4 5.6 .. 13.7 -0.8 7.5 4.5 (percent, y-o-y) 2018 (f) 8.0 7.5 -2.0 7.9 .. 4.4 9.9 4.0 1.1 2018 April .. 8.0 .. 6.1 .. .. 18.5 -0.3 .. 2018 May .. 14.1 .. 26.8 .. .. 31.9 10.2 .. 2015 .. 7.6 .. 10.7 4.1 .. 4.6 4.5 9.8 Foreign 2016 .. 8.8 .. 12.1 3.4 .. 5.4 3.8 11.0 reserves (months of 2017 .. 8.4 .. 10.3 2.8 .. 4.0 3.8 9.5 goods import 2018 January .. 7.2 .. 10.0 2.7 .. 3.0 4.0 9.0 cover, CY) 2018 February .. 7.2 .. 10.4 2.9 .. 3.1 3.7 9.3 S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 S outh Asia at a glance 73 Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South Asia 2015 341 15,296 20 68,910 4 6,730 19,306 7,000 117,606 BALANCE of 2016 368 13,544 34 62,744 4 6,612 19,808 7,262 110,376 PAYMENTS Personal remittances 2017 378 13,498 43 68,967 4 6,928 19,689 7,190 116,698 received (USD million, CY) 2018 Q1 .. 3,829 .. 10,744 .. .. 4,862 1,979 .. 2018 Q2 .. 4,221 .. 11,498 .. .. 5,016 1,645 .. 2015 -0.8 -3.7 -1.1 -6.9 -7.1 1.0 -5.2 -7.6 -3.8 Fiscal balance GOVERNMENT FINANCES 2016 0.0 -3.7 -1.2 -7.0 -10.6 1.4 -4.5 -5.4 -3.6 (percent of GDP) 2017 -0.5 -3.0 -4.1 -6.6 -2.5 -3.1 -5.8 -5.5 -4.3 2018 (f) -0.4 -4.3 -3.0 -6.1 -5.3 -5.8 -6.5 -5.2 -4.4 2015 9.1 31.8 90.6 70.0 54.4 25.6 64.3 77.7 53.7 Public debt 2016 7.9 31.5 104.2 69.5 59.7 27.9 68.7 78.8 57.4 (percent of GDP) 2017 7.2 30.6 97.9 68.8 61.2 26.6 67.9 77.4 56.8 2018 (f) 6.8 31.2 93.6 67.2 61.7 30.5 73.5 77.8 56.5 2015 6.8 5.8 3.4 7.4 .. 2.9 2.9 7.5 5.5 Private consumption 2016 -0.2 3.0 3.7 7.3 .. -0.7 7.6 -3.9 8.4 growth 2017 4.3 7.4 -2.0 6.6 .. 2.6 8.7 1.3 7.6 (percent, y-o-y) 2018 (f) 3.1 11.0 0.8 6.2 .. 2.5 6.3 4.0 4.2 CONSUMPTION and INVESTMENT Gross fixed 2015 4.8 7.1 14.1 5.2 .. 19.6 15.8 2.5 5.5 capital 2016 -6.0 8.9 7.2 10.1 .. -12.3 7.5 7.8 4.7 investment growth 2017 6.4 10.1 1.8 7.6 .. 44.2 10.0 5.0 10.3 (percent, y-o-y) 2018 (f) 2.5 10.5 -1.3 10.2 .. 15.7 5.7 6.3 2.5 Net foreign 2015 0.0 0.9 0.4 1.7 7.4 0.2 0.3 0.8 1.5 direct 2016 -0.1 0.6 -0.6 1.6 10.8 0.5 0.8 0.8 1.4 investment (percent of 2017 -0.1 0.7 1.0 1.2 11 0.8 0.9 1.5 1.1 GDP) 2018 (f) 0.0 0.6 1.1 1.4 .. .. 0.9 2.0 .. Net foreign 2015 82 -203 .. -9,487 -123 .. -916 -686 .. portfolio 2016 99 -42 .. 4,725 132 .. -153 -993 .. investment (USD million, 2017 -29 367 .. -30,638 -279 .. -1,200 -1,772 .. CY) 2018 Q1 .. 87 .. -2,276 .. .. -42 .. .. 74 SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 South Asia at a glance Notes (f) Forecast CY Series for calendar year FY Series for fiscal year Afghanistan’s fiscal year is the calendar year. Bangladesh’s fiscal year runs from July 1st to June 30th. Bhutan’s fiscal year runs from July 1st to June 30th. India’s fiscal year runs from April 1st to March 31st. Maldives’s fiscal year is the calendar year. Nepal’s fiscal year runs from July 16th to July 15th. Pakistan’s fiscal year runs from July 1st to June 30th. Sri Lanka’s fiscal year is the calendar year. Real GDP growth Real GDP growth rates (percent change, y-o-y) at market prices; Pakistan is in factor costs. Source: Central Statistics Office of India, Sri Lanka Department of Census and Survey, World Bank DEC GEP, and World Bank MTI. Inflation (Consumer Price Index) Period average percent change in CPI inflation. Source: World Bank DEC GEM and World Bank MTI. REER (CY) Real effective exchange rate is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. An increase in REER implies that exports become more expensive and imports become cheaper. Source: World Bank DEC GEM. Current account balance (percent of GDP) Does not include grants unless otherwise stated. Source: World Bank MTI. Trade balance (percent of GDP) Trade balance in goods and services is derived by substracting imports of goods and services from exports of goods and services as ratio to GDP. Source: World Bank WDI. Import growth (percent, y-o-y) Annual trade change is in (respective) fiscal year and covers goods and non-factor services (GNFS) imports. Monthly trade change is in calender year and covers only merchandise. Source: World Bank DEC GEM, World Bank DEC GEP, World Bank MTI, and staff calculations. S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 S outh Asia at a glance 75 Export growth (percent, y-o-y) Annual trade change is in (respective) fiscal year and covers goods and non-factor services (GNFS) exports. Monthly trade change is in calender year and covers only merchandise. Source: World Bank DEC GEM, World Bank DEC GEP, World Bank MTI, and staff calculations. Foreign reserves, months of import cover Source: World Bank DEC GEM. (CY) Remittances (USD million, CY) Personal remittances including personal transfers and compensation of employees in current USD. Source: Haver Analytics, World Bank WDI, and staff calculations. Fiscal balance (percent of GDP) Does not include grants unless otherwise stated. Source: IMF, World Bank MTI, and staff calculations. Public debt (percent of GDP) Gross public debt stock including domestic and foreign liabilities, end of Period. Source: IMF, World Bank MTI, and staff calculations. Private consumption growth (percent, y-o-y) Annual (respective) fiscal year percent change in gross consumption expenditure. Source: World Bank DEC GEP and World Bank MTI. Gross fixed capital investment growth Annual (respective) fiscal year percent change in gross fixed capital expenditure. (percent, y-o-y) Source: World Bank DEC GEP and World Bank MTI. Net foreign direct investment (percent of Net balance of Foreign Direct Investment assets and liabilities as ratio to GDP. GDP) Source: Haver Analytics and World Bank MTI. Portfolio investment (USD million) Portfolio investment covers transactions in equity securities and debt securities. Balances are calculated as net assets minus net liabilities. Data is in current USD. Source: Haver Analytics and staff calculations. 76 SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8 CRS PHOTO / Shutterstock.com