95753 © FLICKR.COM / ZACHARY JEAN PARADIS South Asia Economic Focus Spring 2015 Making the most of cheap oil © 2015 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 17 16 15 14 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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ISBN (electronic): 978-1-4648-0614-8 DOI: 10.1596/978-1-4648-0614-8 Cover photo: © Flickr.com / zachary jean paradis Design: alejandro espinosa/sonideas.com South Asia Economic Focus Spring 2015 Making the most of cheap oil s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 This report is a joint product of the Office of the Chief Economist for the South Asia Region and the Macro and Fiscal Management Global Practice. Its preparation was led by Markus Kitzmuller (Economist) under the oversight of Martin Rama (Chief Economist, South Asia Region) in close collaboration with Shubham Chaudhuri (Practice Manager, Macro and Fiscal Management). Substantive contributions to the focus section were made by Vincent A. Floreani, Markus Kitzmuller, Gladys Lopez Acevedo, Muthukumara S. Mani, Martin Melecky, Dhushyanth Raju and Fan Zhang. The report greatly benefitted from inputs by Tehmina Khan and colleagues in the Development Economics Prospects Group (DECPG) under the supervision of Ayhan Kose (Director DECPG). Colleagues providing information for country briefs include Kishan Abeygunawardana, Genevieve Boyreau, Roshan Darshan, Zahid Hussain, Omar Joya, Faruk Khan, Aurelien Kruse, Jose Lopez Calix, Poonam Gupta, Jaba Misra, Claudia Nassif, Frederico Gil Sander, Saurav Shamsher Rana, Saadia Refaqat, Nadeem Rizwan, Smriti Seth, Saurabh Shome, Ralph Van Doorn and Salman Zaidi. The team is grateful for comments, suggestions and background information provided by Gabi Afram, Mehwish Ashraf, Miklos Bankuti and Sebnem Sahin. and Frederico Gil Sander. Gabriela Aguilar signed responsible for the layout, design and typesetting, Alexander Ferguson (Senior Manager SAREC) coordinated the dissemination, 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 April 12, 2015. South Asia Chief Economist Office Macro and Fiscal Management Global Practice 5 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Table of Contents Recent economic developments··············································································································· 9 Growth remains subdued in advanced economies······················································································· 9 South Asia’s external balances are on a solid footing ················································································ 10 While external balances are strong, export performance is weak ·························································· 13 More upbeat output growth expectations amidst blurred signals·························································· 15 Inflationary pressures have eased significantly ··························································································· 17 The main risks and vulnerabilities remain domestic in nature·································································· 18 Outlook and policy················································································································································· 23 South Asia is set to become the fastest growing region, driven by a strong India ····························· 23 Is South Asia making the most of cheap oil?··········································································27 A diverse pass-through of international oil prices to domestic prices ··················································28 The impact of oil prices is mediated by the structure of the economy ·················································30 The balance of payments and the budget are key transmission channels············································ 32 Households will unambiguously gain but richer households will gain more ······································ 35 Macroeconomic tailwinds provide a unique opportunity to rationalize energy prices····················· 37 South Asia country briefs······························································································································· 42 Afghanistan··································································································································································· 44 Recent developments···························································································································44 Outlook·················································································································································45 Challenges·············································································································································46 Bangladesh······································································································································································47 Recent Developments·························································································································· 47 Outlook ················································································································································48 Challenges·············································································································································49 6 making the most of cheap oil Bhutan················································································································································································ 50 Recent Developments ·························································································································50 Outlook················································································································································· 51 Challenges············································································································································· 51 India ·····················································································································································································52 Recent Developments·························································································································· 52 Outlook ················································································································································ 53 Challenges············································································································································· 53 Maldives············································································································································································ 54 Recent economic developments·········································································································54 Outlook················································································································································· 55 Challenges············································································································································· 55 Nepal···················································································································································································· 56 Recent Developments··························································································································56 Outlook ················································································································································ 57 Challenges·············································································································································58 Pakistan············································································································································································ 59 Recent Development:···························································································································59 Outlook:················································································································································59 Challenges:···········································································································································60 Sri Lanka ·········································································································································································· 61 Recent developments··························································································································· 61 Outlook and risks··································································································································62 Challenges·············································································································································62 South Asia at a glance········································································································································· 64 Notes:······················································································································································································· 66 7 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Recent economic developments A n uneven recovery and diverging monetary policy across major developed countries remain a challenge for developing and emerging market economies. But plunging oil prices bring in real income shifts and a distinct set of opportunities for oil im- porters. In South Asia cheaper oil imports are reducing subsidy bills and easing inflationary pressures. Supported by this benign external envi- ronment and on the back of robust consumption growth in India, South Asia has overtaken East Asia and become the fastest growing region in the world. However, the biggest oil price dividend comes in the form of an opportunity to rationalize energy prices and more permanently decouple fiscal balances from international oil price movements. In many countries this dividend remains to be paid out. Growth remains subdued in advanced economies The US is the only major advanced economy exhibiting signs of sustained recovery. Although improvement in US labor markets slowed a little in March 2015, and severe weather has dampened activity in 2015Q1, the Federal Reserve Bank is still expected to start increasing interest rates in 2015Q3 on the back of solid real GDP growth. This will start a tightening cycle to last until 2018. Meanwhile the Eurozone continues on a soft trajectory in spite of unexpectedly positive signs that quantitative easing may finally start to bite, following recent jitters around Greece and divergent views on how to conduct fiscal policy across member states. Japan’s central bank has announced another round of monetary stimulus in October 2014. However, inflation is not expected to pick up to the targeted 2 percent before FY2016/17, with negative real interest rates set to per- sist. Ultimately, the growth outlook for Japan remains severely constrained by unfavorable demographics (a shrinking population and workforce) and related upward pressures on public debt. Meanwhile, South Asia has become the fastest growing region in the world over the course of 2014H2. Helped by the benign external environment and a first 9 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 1: Real GDP growth is weak in Japan and the Eurozone while the US shows signs of sustained acceleration Percent change, y-o-y saar 6.5 5.5 4.5 3.5 2.5 1.5 0.5 -0.5 -1.5 -2.5 2013Q1 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 Developing countries Eurozone Japan United States Source: World Bank DECPG round of direct effects from the drop in international South Asia’s external balances crude oil prices, almost all South Asian economies saw are on a solid footing improvements on their macroeconomic and fiscal balances as well as in terms of growth. An important Current account balances remain strong across the factor in South Asia’s current growth equation is the region. In continuation of improving external positions significantly lower inflation rate and its contribution in 2014H1, current account balances across South Asia to anchoring expectations. Given its share in regional remain manageable and well financed. Solid remit- GDP, India’s growth performance has set the pace for tances and (for some countries) tourism flows offset the region backed mainly by strong contributions from often large and widening trade deficits – in spite of domestic consumption on the demand side as well as lower oil prices. In Bangladesh a current account deficit services growth on the supply side. Investment per- emerged to the tune of USD 1.3 billion between July formance has been subdued except for Bhutan and Sri and January of FY2014/15, compared with a USD 2.5 Lanka, while export growth has broadly disappointed, billion surplus over the same period of FY2013/14. The though masked by strong remittance flows and weaker deficit reflected weak export growth (2.1 percent) and import growth. a surge in imports (16.4 percent). Nepal, on the other Figure 2: South Asia became the fastest growing region Percent change, y-o-y, saar 9 8 7 6 5 4 3 2 1 0 -1 -2 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa Sub Saharan Africa South Asia Source: World Bank DECPG 10 making the most of cheap oil Figure 4: Unlike other emerging economies India substantially improved its external position Current account deficit (Percent of GDP) 10 -10 -8 -6 -4 -2 India 0 2 4 6 0 Mexico India Indonesia Russian Federation Brazil Mexico Turkey Indonesia South Africa 10 South Africa Turkey Turkey Russian Federation Brazil Mexico Indonesia South Africa India 20 30 2013 Q2 (Q3) 2013 Q4 (2014 Q1) 2014 Q4 (2015 Q1) 40 Russian Federation 50 Source: World Bank sta calculations Nominal exchange rate depreciation (local currency vis-à-vis USD over the previous quarter) hand, continues to enjoy a substantial current account Figure 3: Current account balances across most surplus on account of strong remittance growth more of South Asia are either positive or improving than offsetting the country’s still widening trade deficit. Percent of GDP Similarly, resilient remittance flows and low oil prices 8.0 0.0 kept the current account deficit at a modest 1.1 percent of GDP in Pakistan, despite a chronically negative 6.0 -5.0 trade balance. In Sri Lanka, the current account deficit narrowed to an estimated 3.3 percent of GDP in 2014 4.0 on account of strong tourism and remittance flows at an -10.0 2.0 estimated 12.4 percent of GDP offsetting a very large trade deficit at 11.2 percent of GDP in 2014 (down 0.0 -15.0 from 11.3 percent in 2013). -2.0 -20.0 Maldives and Bhutan remain the region’s current -4.0 account outliers. Bhutan runs a large current account deficit (estimated at about 25 percent of GDP in -6.0 -25.0 FY2014/15), to which the hydropower sector contrib- utes a third. The deficit is essentially financed by donor -8.0 -30.0 2012 2013 2014 2015 resources, with India providing the lion’s share through Bhutan (right axis) Maldives (right axis) loans and grants to finance hydropower development. In Maldives, higher tourism exports and subdued global Afghanistan Bangladesh India food and fuel prices helped reduce the current account Nepal Pakistan Sri Lanka deficit to around 8.4 percent of GDP in 2014. The cur- Source: World Bank and national authorities rent account is expected to narrow over the medium 11 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 5: Capital flows to South Asia have become less volatile but their composition continues to show significant fluctuations USD billion 80 10 70 9 8 60 7 50 6 40 5 30 4 3 20 2 10 1 0 0 2013M01 2013M02 2013M03 2013M04 2013M05 2013M06 2013M07 2013M08 2013M09 2013M10 2013M11 2013M12 2014M01 2014M02 2014M03 2014M04 2014M05 2014M06 2014M07 2014M08 2014M09 2014M10 2014M11 2014M12 2015M01 2015M02 Developing countries bank loans Developing countries bond issue Developing countries equity issue Gross capital flows to South Asia (right axis) USD billion 10 9 8 7 6 5 4 3 2 1 0 2013M02 2013M03 2013M04 2013M05 2013M06 2013M07 2013M08 2013M09 2013M10 2013M11 2013M12 2014M01 2014M02 2014M03 2014M04 2014M05 2014M06 2014M07 2014M08 2014M09 2014M10 2014M11 2014M12 2013M01 2015M01 2015M02 South Asia bank loans South Asia bond issue South Asia equity issue Source: World Bank DECPG term to around 4.7 percent of GDP by 2019 as fiscal to its emerging market peers. Along those lines and restraint and lower oil prices help constrain imports. analyzing the global portfolio rebalancing of 2013, recent research1 suggests that a global surprise factor, Less than two years after the rupee depreciation more than domestic vulnerabilities, was the main driver episode, India has a resilient external position. The of the large rupee depreciation in summer 2013. With steady stream of remittances and services exports the surprise factor gone, further normalization of U.S. helped to bring the current account deficit to USD monetary policy is less likely to have significant effects 26 billion in the first three quarters of FY2014/15, on the rupee exchange rate going forward. compared to USD 32 billion over the corresponding period in the previous fiscal year. The sharp decline in Many South Asian economies saw positive develop- the price of oil helped take off pressure from India’s ments on their capital accounts. In India, Foreign merchandise trade deficit, while gold imports were Direct Investment (FDI) and portfolio flows regained well contained. Overall, the current account deficit is momentum reaching 3.4 percent of GDP during projected to remain well below 2 percent of GDP over FY2015Q1-3, up from 1.4 percent during FY2013/14. the medium term. At the same time, the real effective exchange rate appreciated over the course of CY2014, thereby leaving India in a position of manageable 1 “Advanced-Country policies and Emerging-Market Currencies: the Impact of US tapering on India’s Rupee” by Y. Ikeda, D. Medvedev, and M. Rama. Policy Research Working Paper 7219. external vulnerability, particularly when compared World Bank, March 2015. 12 making the most of cheap oil Figure 6: Foreign exchange reserves are broadly improving across the region Months of imports 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2014M01 2014M02 2014M03 2014M04 2014M05 2014M06 2014M07 2014M08 2014M09 2014M10 2014M11 2014M12 2015M01 Bangladesh India Maldives Pakistan Sri Lanka Source: World Bank and national authorities However, the balance shifted again towards more vola- end CY2014 compared to USD 9.2 billion at end of tile portfolio flows, which totaled about USD 28 billon FY2013/14. In Bangladesh, there has been a sustained in the first three quarters of FY2014/15, compared to surplus in the balance of payments, and reserves have FDI flows at nearly USD 24 billion. In Pakistan the remained at a comfortable level at over 6 months of capital account balance nearly doubled during July imports. Nepal is in a similarly strong position, as for- 2014 to February 2015, compared to the same period eign exchange reserves should continue to rise to over in the previous year. Underlying this improvement were USD 7 billion, equivalent to 8.8 months of imports. Sri the receipts from the issuance of international Sukuks Lanka saw its gross official reserves strengthening to as well as large disbursements from International USD 8.2 billion, equivalent to 5.1 months of imports. Financial Institutions. Bangladesh’s financial account Bhutan’s international reserves had built up to roughly recorded a USD 3.3 billion surplus between July and USD 1.1 billion by November 2014, reflecting prudent January of FY2014/15, compared with a surplus of just management, while Maldives experienced an increased USD 424 million during the same period the previ- supply of dollars in the official market and a related ous year. The move into positive territory reflected a rise in gross official reserves to USD 614 million or 2.8 turnaround in “other investment (net)” from USD 722 months of imports. million of outflows to nearly USD 2 billion of inflows. Gross aid disbursements increased by 11.7 percent while outflows on account of trade credit reversed from While external balances USD 550 million of outflows to USD 905 million of are strong, export inflows during July-January of FY2014/15. Finally, performance is weak Sri Lanka saw a period of strong capital inflows. FDI reached 1.9 percent of GDP in 2014; together with After an encouraging rebound, India’s exports seem to remittances and tourism flows in the magnitude of 12.4 have lost momentum. In FY2014/15 growth in India percent of GDP, it strongly supported the balance of was largely driven by consumption, with only modest payments overall. contributions coming from investment and exports. Even more so, export growth has been worryingly Robust capital flows financed current accounts negative in FY2014/15Q2 and Q3, averaging at only 0.5 across South Asia and even helped building reserve percent over the past three quarters. This was largely on buffers. Most notably, the Reserve Bank of India (RBI) account of a decline in petroleum exports, an important refurbished its international reserves beyond an impres- merchandise export item for India (accounting together sive 10 months of import coverage (USD338 billion) with gems and jewelry for a third of the total export bas- as of February 27, 2015. But India was not alone. In ket) and fairly sensitive to movements in international Pakistan, reserves reached 2.5 months of imports in crude oil prices. From a sectorial point of view, services December 2014, taking the country out of the danger exports remain the bright spot, somewhat offsetting the zone. Official reserves increased to USD 10.6 billion by blow from oil exports and continuing to increase steadily. 13 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 7: Export growth has been involving a significant number of factory closures. The disappointing across South Asia oil windfall on the import side will only gradually ma- Merchandise export growth, quarterly y-o-y, const. 2010 USD terialize because oil imports are contracted forward and 30 non-oil imports have been strong. Pakistan has mildly started to benefit from low oil prices reflected by its 25 import bill contained at USD 626 million per month as 20 of February 2015, but this effect continues to be offset by the fall in the export values of agriculture commodi- 15 ties and lower trade related revenues. Negative export 10 growth was mainly driven by deteriorated exports of textile, food items (wheat and tobacco), petroleum 5 products, as well as chemical and pharmaceutical 0 goods. Also in Nepal, export value growth is expected 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 to decelerate from a modest 5.4 percent in 2014 to 4.5 -5 percent this year. However, import value growth is pro- -10 jected to moderate considerably, given the large share -15 of petroleum products in total imports. Bangladesh India Pakistan Sri Lanka Going forward, many South Asian economies will Source: World Bank GEP be facing weak demand in Europe as well as real effective exchange rate appreciation. In Bangladesh, But overall India’s share in world exports has stagnated the competitiveness of exports is eroding due to grow- recently, reflecting subdued global import demand and ing strength of the USD vis-à-vis other major curren- signaling the need to address supply-side constraints to cies. The Taka has appreciated by 17.6 percent against competitiveness. Furthermore, the lack of momentum the euro so far in FY2014/15. India’s real effective of growth in India’s major export destinations, together exchange rate (REER) appreciated despite decreasing with a possible deterioration in demand from oil export- inflation in light of relatively stable nominal exchange ing countries, may provide further headwinds for India’s rates. Pakistan also saw pressures on its rupee ease, exports to kick start soon. with the real effective exchange rate appreciating over 2014H2, helped by solid capital inflows and decreas- Across the region, export growth is slowing down. In ing inflation. Bangladesh, exports lost momentum because of weak global demand and a transition in the garment industry Figure 8: India lost some of the competitiveness it had gained during the rupee depreciation episode. REER daily 120.00 115.00 110.00 105.00 100.00 95.00 90.00 85.00 80.00 1/1/13 2/1/13 3/1/13 4/1/13 5/1/13 10/1/13 11/1/13 12/1/13 2/1/14 10/1/14 11/1/14 12/1/14 6/1/13 7/1/13 8/1/13 9/1/13 1/1/14 3/1/14 4/1/14 5/1/14 6/1/14 7/1/14 8/1/14 9/1/14 1/1/15 2/1/15 3/1/15 China Euro Area India US Source: Haver, World Bank DECPG 14 making the most of cheap oil Figure 9: Across the region, competitiveness has remained stable or faltered REER daily 150 140 130 120 110 100 90 80 4/1/13 5/1/13 6/1/13 7/1/13 8/1/13 9/1/13 10/1/13 11/1/13 12/1/13 1/1/14 2/1/14 3/1/14 5/1/14 1/1/13 2/1/13 3/1/13 4/1/14 6/1/14 7/1/14 8/1/14 9/1/14 10/1/14 11/1/14 12/1/14 1/1/15 2/1/15 3/1/15 Bangladesh Bhutan Pakistan Sri Lanka Nepal India Source: Haver, World Bank DECPG More upbeat output Figure 10: Purchasing managers growth expectations in manufacturing have become amidst blurred signals more optimistic about India PM Index (March 2015) Regional industrial production growth continues to 57 be volatile, with India surprising on the upside. India’s US improving Purchasing Managers Index (consistently 55 UK above 50) gives hope for an acceleration of growth in the Italy Germany near term. Industrial output, which accounts for nearly 53 Eurozone one-third of India’s GDP, accelerated to 5.3 percent India during the first three quarters of FY2014/15, compared 51 Japan to 4.6 percent last year, and 2.7 percent in the year China before. The manufacturing sector grew at a steady 5.4 49 France Russia percent in the first three quarters of the fiscal year. This 47 upward trend was also reflected in high frequency indi- Brazil cators of industrial production—the Index of Industrial 45 Production, grew by 2.1 percent year-on-year between 45.0 46.0 47.0 48.0 49.0 50.0 51.0 52.0 53.0 54.0 55.0 56.0 57.0 April and December 2014, as compared to stagnant PM Index (Februrary 2015) output in the previous year. While utilities grew at a Source: Markit and Haver Analytics robust 9.6 percent, construction growth slowed in the FY2014/15Q3. in the region. In Bhutan, hydropower construction got back on track after delays due to geological disruptions From a sectorial point of view, agriculture and services and the five-year plan implementation now in full have driven the growth performance across South swing. The country also benefited from a record level Asia. In Pakistan, these two sectors have offset weaker of tourists following a special offer to Thailand over the than expected performance in manufacturing. Afghani- low season of June to August. Maldives saw tourists stan experienced a strong agricultural harvest in 2014, for returning, with a rapid expansion from Asian markets the third year in a row, whereas growth in manufactur- overdoing a tepid recovery from Europe. Sri Lanka saw ing, construction, and services is estimated to have fallen a continuation of its growth momentum based upon further in 2014. Conversely, inclement weather during robust growth in construction, which pushed growth by the peak planting season and limited investments in ir- the industrial sector up to 11.4 percent year-on-year in rigation resulted in lower agricultural growth in Nepal, 2014. Business fluctuations in Bangladesh were driven triggering an overall growth deceleration. Construction by politics rather than by the weather: while growth and tourism played a key role in the smaller countries was gaining momentum in the first half of FY2014/15, 15 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 11: Growth in industrial production remains volatile across South Asian but is showing momentum in India Percentage change, 3m/3m 5 4 3 2 1 0 -1 -2 -3 2013M01 2013M02 2013M03 2013M04 2013M05 2013M06 2013M07 2013M08 2013M09 2013M10 2013M11 2013M12 2014M1 2014M2 2014M3 2014M4 2014M5 2014M6 2014M7 2014M8 2014M9 2014M10 2014M11 2014M12 2015M01 South Asia Bangladesh India Sri Lanka Pakistan Source: World Bank DECPG direct production losses inflicted by recent turmoil could amount to around 1 percent of GDP Figure 12: India has by now the strongest growth performance among emerging markets On the expenditure side, consumption has been the Percent, y-o-y, saar major contributor to regional growth while invest- 9 ment remains subdued, except in Bhutan. In India, 8 private final consumption expenditure (which accounts 7 for close to 60 percent of total demand for output) 6 grew at an average of 6.5 percent year-on-year during 5 FY2014/15Q1 and Q2, but decelerated to 3.5 percent 4 in Q3. This deceleration was countered by a 32 percent 3 spike in public consumption expenditure in Q3. On 2 the other hand, investment, after growing rapidly in 1 the first quarter at 7.7 percent, lost momentum sub- 0 sequently, growing at an average 2.2 percent over Q2 -1 and Q3. In Afghanistan the protracted political process 2014Q1 2014Q2 2014Q3 2014Q4 in 2014, combined with uncertainties associated with India Brazil Russia China the security transition, dealt a further blow to investor Indonesia Turkey Mexico and consumer confidence. Nepal’s growth continues Source: World Bank DECPG to be based on remittance driven consumption, while investment growth continues as constrained by project implementation bottlenecks as well political and policy side, its strong growth performance is clearly driven uncertainty, especially in the hydropower sector. In Pak- by the services sector, which continues to outperform istan, growth is picking up on the back of slightly better manufacturing. Within services, growth was driven energy availability, a continuous revival of credit and by a sharp acceleration in public administration and (to a lesser extent) growing investor confidence. Only defense, which expanded at 20 percent year-on-year in Nepal is investment performance substantive, with in FY2014/15Q3, compared to an average growth the new dynamism in hydropower construction push- of 4 percent during the first two quarters. Growth in ing its growth up to 22.4 percent. Private consumption, services was also supported by continued buoyancy in supported by an increase in wages, is estimated to have financial services and real estate services, which grew grown by 6.6 percent. by 13.7 percent year-on-year in the first three quarters of FY2014/15. On the other hand, agricultural output India’s growth performance vis-à-vis its emerging growth continued to decelerate (turning negative in market peers remains strong. On the production FY2014/15Q3, y-o-y) due to deficient rainfall. 16 making the most of cheap oil Figure 13: South Asia’s inflation rate dropped from highest to lowest among all regions in less than one year CPI percent change, y-o-y 9 8 7 6 5 4 3 2 1 0 2014M1 2014M2 2014M3 2014M4 2014M5 2014M6 2014M7 2014M8 2014M9 2014M10 2014M11 2014M12 2015M1 2015M2 2015M3 East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Source:World Bank DECPG Inflationary pressures price inflation, has also contributed to the decrease in have eased significantly CPI inflation, except for an uptick in India since the start of 2015. The drop in food price inflation is partly Helped by easing pressures on commodity prices, attributable to robust food harvests across the region. tight monetary policy stances, and relatively stable currencies, South Asia ceded its long-held top spot Inflationary pressures have consistently eased across as the region with the highest inflation rate. The all South Asian economies. In Afghanistan, consumer Consumer Price Index (CPI) increased by 3.2 percent price inflation dropped from 7.7 percent in 2013 to year-on-year in February 2015, below its regional 4.4 percent in 2014 as both food and non-food price counterparts for Latin America and Caribbean and for increases slowed down. Bangladesh’s inflation appears Sub Saharan Africa, at 3.5 and 3.8 percent respectively. contained showing decreasing momentum with the March 2015 saw a further pronounced decrease for twelve-month moving average decelerating to 6.8 South Asia. Besides commodity prices, another crucial percent in February 2015, compared with 7.6 percent component of consumer prices in South Asia, food in February 2014. Headline inflation (year-on-year) Figure 14: All countries in South Asia experienced a deceleration in inflation Percent change, y-o-y 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2013M09 2013M10 2013M11 2013M12 2014M01 2014M02 2014M03 2014M04 2014M05 2014M06 2014M07 2014M08 2014M09 2014M10 2014M11 2014M12 2015M01 2015M02 South Asia Bangladesh India Nepal Pakistan Afghanistan Bhutan Maldives Sri Lanka Source: The World Bank DECPG 17 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 15: Monetary policy has recently started to soften in Pakistan and India Repo rate, percent 11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 2013 Jan 2013 Feb 2013 Mar 2013 Apr 2013 May 2013 Jun 2013 Jul 2013 Aug 2013 Sep 2013 Oct 2013 Nov 2013 Dec 2014 Jan 2014 Feb 2014 Mar 2014 Apr 2014 May 2014 Jun 2014 Jul 2014 Aug 2014 Sep 2014 Oct 2014 Nov 2014 Dec 2015 Jan 2015 Feb 2015 Mar 2015 Apr Bangladesh Nepal India Pakistan Sri Lanka Source: National central banks declined to 6.1 percent in February 2015, compared lowered the rate by another 50 basis points on March with 7.4 percent in February 2014. Given their cur- 24th 2015. rency peg to the Indian rupee, both Bhutan and Nepal both saw consumer price inflation slowing down in line with trends in India. There, inflation declined to The main risks and 5.1 percent (or to 4.3 according to the new CPI series) vulnerabilities remain during October 2014-January 2015, from an average domestic in nature 7.7 percent (or 7.3 percent according to the new CPI series) in FY2014/15H1. Similarly, in Pakistan infla- Fiscal improvements due to lower subsidy bills and tion rates reached a 13-year low of 2.5 percent at the expenditure compression mask the real sources of end of March 2015, down from a peak of 10.9 percent fiscal risk going forward: weak revenue generation in November 2013. In Maldives, inflation is forecasted and continued exposure to international oil prices. In to be just 0.3 percent in 2015 but to pick up with the light of strong and well cushioned external positions increase in import duties, to settle at around 4 percent and favorable tailwinds from low oil prices expected to in the medium term. Last but not least, Sri Lanka continue in the short term, major downside risks remain saw its annual average inflation, as measured by the domestic in nature. Continued revenue weakness across Colombo Consumer Price index (CCPI‐2006/07), the region as well as policy reform complacency in light decline for 19 consecutive months. On a year-on-year of favorable economic development pose important basis, inflation hit its lowest point in March 2015, at fiscal risks. Political uncertainty and potential turmoil just 0.1 percent. continue to be risk factors in Afghanistan, Bangladesh, Pakistan and Sri Lanka. The deceleration of inflation has already triggered monetary policy responses. Lower inflation rates and Many South Asian governments were able to con- well-anchored inflationary expectations led the Reserve solidate their fiscal balance from the expenditure Bank of India (RBI) and the State Bank of Pakistan side. A mixture of slow project implementation, active (SBP) to lower their interest rates in a move to support spending compression and lower energy subsidy bills credit growth. RBI has adopted a framework based to due to low oil prices has resulted in some fiscal modera- on flexible inflation target, and the recent decline in tion. Total public expenditure in Bangladesh increased inflation and fiscal restraint generated some room for by 4.5 percent in the first four months of FY2014/15 monetary accommodation, making it possible to lower relative to the same period the previous year, compared the policy rate twice in the recent past (while keeping with the 31 percent annual growth target. Develop- it constant at the latest meeting). The SBP lowered ment expenditure increased by a meager 1.3 percent, a the policy rate (called SBP reverse repo rate) from 10 consequence of resource constraints, overly optimistic percent to 9.5 percent on November 17th 2014 and planning, and procedural lapses from initiation to further to 8.5 percent on January 26th 2015. It further completion of a project life cycle. Slow execution of the 18 making the most of cheap oil Figure 16: Fiscal deficits in the region fell slightly due to lower energy subsidy bills but remain high due to weak revenue generation Percent of GDP 0 -1 -2 -3 -4 -5 -6 -7 -8 2013 2014 2015 Middle East and North Africa South Asia Latin America and Caribbean Sub Saharan Africa East Asia and Pacific Europe and Central Asia Source: The World Bank DECPG planned capital budget has also been pervasive in Ne- GDP, offsetting the decline in petroleum subsidies. In pal. In Bhutan, civil service wages and allowances were Pakistan, recurrent expenditures of the federal govern- increased by 19 and 23 percent respectively, but the ment increased by 4.8 percent in FY2014/15, because impact on spending is expected to be offset by a reduc- of additional defense-related expenditures and fed- tion in other current and capital expenditures. In India, eral grants to state-owned enterprises. Development the subsidy bill (at 2.1 percent of GDP) was larger than spending of the consolidated government registered a budgeted (2 percent) because of higher food subsidies. marginal increase of 1.5 percent only. However, fiscal Declining global crude prices and a phased increase space was created as subsidies registered a decline for in retail diesel prices allowed for a complete deregu- the third consecutive year, from 0.7 percent of GDP lation of this market segment in October 2014. As a in H1-FY 2014 to 0.4 percent of GDP during H1- result, petroleum subsidies declined from 0.8 percent FY 2015. Maldives stands out as an outlier, as a sharp of GDP in FY2013/14 to 0.5 percent in FY2014/15. rise in recurrent expenditures (pensions, and wages) is But food subsidy expenditure during the same period likely to have widened the fiscal deficit to 11.6 percent increased from 0.8 percent of GDP to 1.1 percent of of GDP in 2014. Figure 17: Overall fiscal deficits remain sizeable in many South Asian countries Percent of GDP 4 2 0 -2 -4 -6 -8 -10 -12 -14 FY2013 FY2014 FY2015 Maldives Sri Lanka India Bhutan Bangladesh Pakistan Afghanistan Nepal Source: The World Bank, IMF and national authorities 19 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Revenue generation and collection remain the key H1 stood at PKR 388 billion compared to PKR 493 fiscal challenge across most of the region. With the billion during same period last year. As a note of cau- exception of Nepal, which sustained high revenue tion, collection last year however was abnormally high growth, government revenues either stagnated or fell, due to one-off inflows, i.e. universal service fund and and broadly registered below target. In Bangladesh, dis- the mark-up received from SOEs against the circular ruptions related to the political turmoil led to a short- debt settlement. In Sri Lanka, in 2014, tax revenue is fall in tax revenue collection relative to the FY2014/15 estimated to have remained unchanged at 11.6 percent target (5.9 percent growth, instead of 20.9 percent). of GDP. The tax revenue shortfall was compounded by a large drop in non-tax revenues, driven mainly by lower divi- Afghanistan is faced with the risk of a fiscal crisis due dends from the Bangladesh Bank (BB). Total revenue to a large and persistent finance gap. Domestic rev- collection in the first four months of FY2014/15 was enues fell from a peak of 11.6 percent of GDP in 2011 3.2 percent lower than in the corresponding period of to 8.4 percent in 2014, because of the economic slow- FY2013/14, due entirely to a 36.5 percent decline in down and weaknesses in tax and customs enforcement. non-tax revenue collection. Bhutan’s domestic revenues The decline in revenue collection took place across all measured as a share of GDP have declined over the sources, including tax revenues, customs duties, and last three years, from 22 percent to an estimated 18.9 non-tax revenues. In spite of measures to restrain ex- percent. Grants, mainly from India, finance about 27 penditures, the authorities faced a financing shortfall percent of total spending. In India, revenue collection of about USD 500 million in 2014. The authorities was weak as indirect tax collection and disinvestment managed the shortfall by drawing down cash reserves, proceeds were smaller than anticipated. While almost accumulating arrears, and relying on exceptional donor all tax collection targets slipped, the lower outturn was assistance. They also curtailed civilian operations and predominantly due to underperformance in service tax maintenance (O&M) and discretionary development collection, which reached 1.3 percent of GDP, instead expenditures, which ended up being lower in nominal of the 1.7 percent target. Tax collection improved in terms in 2014 compared to 2013. However, overall Pakistan, but it remained slightly below target due to le- expenditures increased because of higher security and gal challenges and lower-than-expected revenues from mandated social benefit spending. taxes on oil imports. The budget envisaged a 24 percent growth in its tax collection over last year, however, Public debt remains broadly sustainable but contin- floods and major political turbulence during the first ues to resist swift reduction. In Bangladesh the ratio half of FY2014/15 created significant headwinds and of central government debt to GDP is projected to FBR’s tax collection during FY 2014/15 H1 grew only remain on a gradual downward path with the country by 13.6 percent. Non-tax revenues during FY2014/15 remaining at low risk of debt distress. Pakistan is also Figure 18: Government debt is high across most countries in the region, and especially in Bhutan and Maldives Percent of GDP 110 100 90 80 70 60 50 40 30 20 2013 2014 2015 Nepal Bangladesh Pakistan India Bhutan Maldives Sri Lanka Source: The World Bank, IMF and national authorities 20 making the most of cheap oil likely to see decreasing public debt ratios in the medium term. In Sri Lanka, on the other hand, a slowdown in GDP growth might reverse the decline in the public debt-to-GDP ratio observed in recent years. Public debt levels are similarly high in Bhutan and Maldives, but the two countries differ in their debt sustainability. Bhutan’s public and publicly guaranteed external debt stood at 95 percent of GDP by end-2014, compared to 5 percent of GDP in domestic debt. But the risk of debt distress continues to be moderate, as two thirds of the external debt are from commercially profitable hydropower projects. The risk-sharing agree- ment with India for hydropower loans, Bhutan’s strong track record in project implementation, rapid growth in energy demand from India, committed donor support, and the country’s high level of international reserves, imply that its high public debt is not much of a con- cern. Maldives, on the other hand, remains at moderate risk of external debt distress. Persistent fiscal deficits have led to high and increasing public debt levels, pro- jected to continue its upward path from 61.7 percent of GDP at end 2013, towards 75 percent in 2014. The current account deficit meanwhile has entailed increas- ing shares of external debt. All of this makes Maldives highly dependent on the performance of its tourism- related revenue. 21 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Outlook and policy T he short- and medium-term outlook for South Asia is set to become South Asia points towards continued the fastest growing region, macroeconomic stability and relatively driven by a strong India strong growth, with potential downside risks concentrated on the fiscal side. Fu- South Asia is expected to take the global lead in eco- ture growth dynamics will strongly hinge on higher nomic growth region in 2015. While Asia as a whole investment rates as well as improved export perfor- remains the hot spot of the world economy, dynamism mance. A key factor for South Asia’s success going within the continent is shifting from East to South. forward will be the ability of its policy makers to seize The two major economies in the region tell the tale. As the decline in global oil prices to address the inef- China appears to be gradually landing into growth rates ficiencies and the fiscal burden from the inadequate around 7 percent between 2015 and 2017, India is ex- pricing of energy in the region. pected to accelerate continuously towards 8 percent real GDP growth by FY2017/18. While China is trying to transition from an investment- and export-led growth model to one based a consumption, India is confronted with accomplishing the opposite. Cementing South Figure 19: South Asia’s GDP growth will continue to outperform that of other regions 8 Percent change 7 6 5 4 3 2 1 0 2013 2014e 2015f 2016f 2017f World Developing Countries East Asia and Pacific Europe and Central Asia Latin America and Carribbean Middle East and Northern Africa South Asia Sub Saharan Africa Source: World Bank DECPG Note: based on constant GDP in 2010 USD at market prices, calendar years 23 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Table 1: South Asia’s strong growth performance is expected to be driven by investment over the coming years 2013 2014 2015 2016 2017 South Asia real GDP (at market prices, calendar years) 6.3 6.8 7.0 7.4 7.6 Percent change Private Consumption 5.6 5.9 6.6 7.4 7.9 Government Consumption 6.6 8.2 7.9 7.5 7.1 Gross Fixed Investment 2.6 5.7 8.1 10.6 11.5 Exports, GNFS 6.5 2.0 4.4 6.8 7.8 Imports, GNFS -2.9 -0.6 6.3 10.3 12.2 Statistical Discrepancy -0.2 -0.5 -0.1 0.0 0.1 Change in inventories 0.0 0.1 0.0 0.0 0.0 SAR Current account balance -2.1 -0.8 -0.8 -1.5 -2.3 (Percent of GDP, calendar year) Asia’s leadership in global growth will indeed require Table 2: In the medium term growth that India switches from the largely consumption- performance will improve across driven growth performance of FY2014/15 towards the all countries in the region ignition of investment and the reinvigoration of exports Real GDP growth (at as the main drivers of its economic dynamism. market prices, by 2013 2014 2015 2016 fiscal year) Regional growth in South Asia is projected to con- Afghanistan 3.7 2.0 2.5 5.0 tinue its upward trajectory over the next years. The Bangladesh 6.0 6.1 5.6 6.3 main pillars of this regional growth forecast remain Bhutan 2.0 5.2 6.7 5.9 strength in consumption and most importantly a India 6.9 7.2 7.5 7.9 pronounced pick-up in gross fixed investment. Given Maldives 4.7 5.0 5.0 - India’s weight in regional GDP, these projections Nepal 3.9 5.5 5.0 5.0 reflect to a large extent an expected investment boom Pakistan 3.7 4.1 4.4 4.6 driven by broad macroeconomic stability and improved Sri Lanka 7.3 7.4 6.9 6.6 business sentiment. South Asia is expected to grow at 7 percent in 2015, picking up pace to 7.6 percent by Note: Estimates and projections are based on GDP at market prices per respective country fiscal year, except for Pakistan where factor costs were used. 2017 as more productive capital is brought on stream. Source: World Bank MFM Global Practice Exports dynamism is expected to remain lackluster and will only gradually increase its contribution to Indian overheating. In Pakistan, a gradual recovery to around and regional growth as demand in developed econo- 4.6 percent growth by end of FY2015/16 will be aided mies recovers. by low inflation, fiscal consolidation and the rebuild- ing of the external position. But its success will remain There is potential for sustaining or even improving contingent on tackling key growth constraints: power growth across many South Asian countries. In India, load-shedding, a cumbersome business environment, GDP growth is expected to increase to 7.5 percent in and low access to finance. Economic activity in Bhutan FY2015/16 and reach 8.0 percent two years later, on is expected to gain momentum with real GDP growing the back of an acceleration of investment growth to at 6.7 percent in 2015, driven by new hydropower con- 12 percent during FY2016-FY2018. Consumption struction and innovative tourism measures. However, is expected to remain an important contributor to this boost could risk a resumption of overheating and growth in the near term with government consump- macroeconomic imbalances. tion expenditure receiving a push in FY2015/16 on account of the anticipated revision in public salaries In the short term Bangladesh, Nepal and Sri Lanka under the ambit of the 7th Pay Commission. In the may face a more sluggish economic activity. In Ban- medium term, low crude prices, improved production gladesh, potential GDP growth is on a declining path capacity, and flexible inflation targeting are likely to due to slower labor force growth as well as stagnant keep inflationary pressures under check and prevent productivity growth and capital accumulation. Actual 24 making the most of cheap oil growth is projected to slow down in FY2015/16 be- light of the large financing gap, restoring fiscal stability cause of repercussions from political turmoil. However, will require accelerating revenue enhancing reforms, a medium-term recovery seems possible if stability pre- additional discretionary assistance, and the prioritiza- vails, on the back of a strong domestic demand base, a tion of expenditures. Beyond restoring confidence, the gradually improving investment climate, and moderate new government must address formidable medium inflation. Nepal’s outlook is largely framed by supply- term development challenges. Ultimately, jobs for side constraints, with growth remaining in the 4.5 to 5 400,000 new entrants into the labor force will need to percent range. The fact that consumption remains the be created each year in spite of declining international country’s main driver of growth makes its prospects assistance. vulnerable to a slowdown in remittances and highlights the need to kick-start investment and domestic pro- Political developments in South Asia remain a two- duction. In Sri Lanka, growth is expected to decelerate sided risk factor. On the upside they may be able to to 6.9 percent year-on-year in 2015 due to slowing ignite reform, and boost investor confidence; on the construction activity, as the new government reassesses downside, they may inject uncertainty or even cause the country’s growth model. economic disruption. In Bangladesh, the biggest chal- lenge going forward will indeed be ensuring durable Afghanistan remains as a special case where the post- political stability, a precondition for accelerated, inclu- transition outlook remains highly contingent on a sive, and sustainable growth. In Pakistan, a key risk is relatively stable political and security environment, the repetition of the political events of the first half of as well as a successful management of the fiscal situ- FY2014/15, which could keep FDI flows and private ation. Agriculture and services are likely to be the key investment low, affect foreign reserves, slow down the drivers of economic growth. But extractive industries government’s privatization program and ultimately may play an increasing role in the medium term. In undermine growth prospects. 25 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Is South Asia making the most of cheap oil? T he biggest oil price dividend to be cashed South Asia is a major beneficiary of the recent fall in in by South Asia is one yet to be earned, international oil prices, as all countries in it are net but it is not one that will automatically oil importers. Cheaper imports should boost their transit through government or consumer trade and current account balances. But also fiscal accounts. The current constellation of balances should see relief, as fuel subsidies have been macroeconomic tailwinds provides a unique oppor- significant expenditure items across South Asian bud- tunity for policy makers to rationalize energy prices gets. From a microeconomic perspective, oil-intensive and to improve fiscal policy. Decoupling external oil sectors such as energy or transport should see lower prices from fiscal deficits may decrease vulnerability costs translate into lower market prices, in turn put- to future oil price hikes – something that may very ting significant downward pressure on consumer price well happen in the medium term. Furthermore, inflation. Ultimately, from a social welfare perspective, cheap oil offers a great opportunity to introduce car- consumers and households should experience positive bon taxation and address the negative externalities income effects – both directly through lower consumer from the use of fossil fuels. prices and indirectly through faster economic growth. Figure 20: Average spot prices of crude oil have dropped significantly since mid-2014 Brent, Dubai and WTI in USD per barrel 140 120 100 80 USD/BBL 60 40 20 0 2005-Mar 2005-Jun 2005-Sep 2005-Dec 2006-Mar 2006-Jun 2006-Sep 2006-Dec 2007-Mar 2007-Jun 2007-Sep 2007-Dec 2008-Mar 2008-Jun 2008-Sep 2008-Dec 2009-Mar 2009-Jun 2009-Sep 2009-Dec 2010-Mar 2010-Jun 2010-Sep 2010-Dec 2011-Mar 2011-Jun 2011-Sep 2011-Dec 2012-Mar 2012-Jun 2012-Sep 2012-Dec 2013-Mar 2013-Jun 2013-Sep 2013-Dec 2014-Mar 2014-Jun 2014-Sep 2014-Dec 2015-Mar Source: World Bank 27 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 21: The impact of oil prices on welfare country’s main distributor of oil products, incurred is mediated by multiple mechanisms losses in every fiscal year between 1990 and 2013. In the fiscal year of 2012, this policy resulted in US$ 890 REMITTANCES million of subsidies for oil products.1 The prices of oil products were increased by up to 11 percent in January 2013. But even after that, diesel and kerosene products still suffered from under-recoveries of about Tk 12 per Policy Balance of liter. The price of LPG in 12.5-kg cylinders sold by Oil (Regulation, payments BPC has not changed since 2009. taxes and Welfare prices subsidies) Fiscal balance India completely deregulated gasoline prices in Inflation June 2010 and diesel prices in November 2014. and However, household kerosene is still subsidized in- relative prices directly, through OMC under-recoveries and cross- subsidies from industrial customers. Household Source: World Bank LPG is largely supplied in 14.2 kg cylinders, and is sold at both subsidized and commercial rates. The The impact of international oil prices on the do- subsidized prices of kerosene and LPG have remained mestic economy is calibrated by government poli- unchanged since October 2012 and November 2014, cies that vary substantially across countries. South respectively.2 But in recent months the excise duty on Asian countries are not only net importers of oil: diesel and gasoline has been increased periodically to they are characterized by prevalence of fuel subsidies. match the decline in international oil prices. Pakistan Impacts also depend on the extent to which different has deregulated the price of diesel since June 2002 fuel types are consumed by households, or used for and the price of gasoline since June 2011. The ceiling production and for the generation of electricity. For for the price of kerosene is set based on an import- instance, poorer households spend relatively less on parity formula. For LPG, the government sets ceil- gasoline and diesel and relatively more on kerosene ings for the prices for domestic production but not when compared to richer households. There are also for imports. Fuel prices are subsidized through a differences in the energy mix across countries. In petroleum levy.3 South Asia, Bangladesh relies relatively more on coal for electricity generation, whereas fuel plays a more Because of these different interventions by govern- important role in Pakistan. The decline in oil prices ments, the extent of pass-through from international may also have indirect effects, through the remit- to domestic prices of oil products is substantially tances sent by workers who migrated from the region different by country and by oil product. The pass- to oil-rich countries. If economic growth declined through rate is defined as the ratio of the change in do- in these countries, South Asian households could be mestic prices to the change in international crude price affected. over a certain period. In what follows, the period from the beginning of 2014 to February 2015 is considered. Since international crude oil prices are denominated in A diverse pass-through US dollars, the pass-through to domestic prices is also of international oil prices affected by the movement in exchange rate between the to domestic prices US dollar and the local currency. Using this approach, no price pass-through took place in Bangladesh. In In- The domestic prices of oil products follow inter- dia, the pass-through rates of diesel and gasoline are 33 national prices to very different extents across the percent and 20 percent, respectively. There was no price three largest economies in the region. This is despite adjustment in the case of subsidized kerosene. It is in the fact that all three economies have historically regulated the price of oil products at the retail level. The administered prices were at times set below im- 1 Mujeri et al. “Energy Sector in Bangladesh: An Agenda for Reforms.” International Institute for port costs and were not adjusted regularly, resulting Sustainable Development. March 2014. 2 Subsidies to Liquefied Petroleum Gas in India: An overview of recent reforms. International in large losses (under-recoveries) to public sector Institute for Sustainable Development. March 2014. oil-marketing companies (OMCs). For example, 3 Kojima, M. “Petroleum Product Pricing and Complementary Policies. Experience of 65 Developing Countries since 2009.” Policy Research Working Paper 6396. Washington DC: the Bangladesh Petroleum Corporation (BPC), the the World Bank. April 2013. 28 making the most of cheap oil Figure 22: Domestic prices of oil products have not always followed international prices Bangladesh 120 800 700 100 600 80 500 LCU/liter LCU/liter 60 400 300 40 200 20 100 0 1/1/14 2/1/14 3/1/14 4/1/14 5/1/14 6/1/14 7/1/14 8/1/14 9/1/14 10/1/14 11/1/14 12/1/14 1/1/15 2/1/15 0 Gasoline Diesel Kerosene Brent Crude LPG (right axis) Pakistan 140 120 100 80 LCU/liter 60 40 20 0 1/1/14 2/1/14 3/1/14 4/1/14 5/1/14 6/1/14 7/1/14 8/1/14 9/1/14 10/1/14 11/1/14 12/1/14 1/1/15 2/1/15 Gasoline Diesel LPG Kerosene Brent Crude India 120 418 100 417 80 416 LCU/Liter LCU/liter 60 415 40 414 20 413 0 412 1/1/14 2/1/14 3/1/14 4/1/14 5/1/14 6/1/14 7/1/14 8/1/14 9/1/14 10/1/14 11/1/14 12/1/14 1/1/15 2/1/15 Gasoline Diesel LPG (right axis) Kerosene Brent Crude Sources: Bangladesh Petroleum Corporation, India Petroleum Planning & Analysis Cell, Pakistan State Oil, Thomson Reuters 29 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 23: The decline in oil prices The impact of oil prices is was passed on to domestic prices to mediated by the structure a very large extent in Pakistan of the economy Price Pass-through Transportation is the sector that relies on oil prod- 60% ucts the most, followed by agriculture. In India, gasoline and diesel account for 96 percent of the fuel 50% used for transportation. The share is relatively lower in Bangladesh and Pakistan (it reaches 70 and 83 percent of the total, respectively) due to the promotion of com- 40% pressed natural gas in the two countries. In agriculture, almost 90 percent of the energy inputs to the sector in Bangladesh come from oil products. By contrast, only in % of Fuel Price 30% 12 percent of energy consumption by the industry sec- tor comes from oil in India and Pakistan. Residential 20% sectors in all three countries have a low dependency on oil and oil products, reflecting the region’s low access to modern energy in the household sector. 10% Fertilizers and transportation costs make agriculture 0% a highly energy-intensive sector, and as a result of it Pakistan India Bangladesh lower domestic prices for oil products may also trans- late into lower food prices. As the agricultural produc- -10% tion costs recede, and getting the produce from farm to Gasoline Diesel LPG Kerosene market becomes cheaper, a deceleration of food inflation can be expected. This effect is independent from food Source: World Bank. price fluctuations in international markets, from which Pakistan that domestic prices were most responsive to many South Asian economies are partially isolated. the changes in international prices. The pass-through Moreover, the high energy-intensity of the agricultural was around 54 percent in case of LPG and kerosene, sector implies that energy subsidies and food subsidies and 56 percent and 47 percent in case of gasoline and are potentially correlated. Put differently, if energy prices diesel respectively. are lower than in other countries, food prices should be Figure 24: Dependence on the consumption of oil products varies widely across sectors Final energy dependency on oil 120% 100% 80% 60% In % 40% 20% 0% TFC Agriculture Industry Residential Transport Bangladesh India Pakistan Source: World Bank (TFC stands for total final consumption of energy). 30 making the most of cheap oil Figure 25: Energy subsidies are lower as well. This seems to be the case in South Asia. If correlated with food subsidies the decline in oil prices makes it possible to reduce en- ergy subsidies, it could also result in lower food subsidies. 20 Oil prices also affect the cost of generating energy, 16 but they do so differently across countries depending on their energy mix. For instance, Pakistan produces 12 more than one third of its electricity through fuel-oil 8 powered thermal plants. In fact, imported heavy fuel oil has become the single largest fuel source for Pakistan’s 4 power generation in recent years. In Bangladesh, on the other hand, fuel oil only accounts for 10 percent of 0 electricity generation. But its contribution has increased Food subsidies/capita Petroleum subsidies/capita rapidly in recent years. Oil is not important in India’s In USD case, where its share in the energy mix has fallen from 5 to 2 percent between 2000 and 2012. However, prices Bangladesh India Pakistan of Liquefied Natural Gas (LNG) tend to follow crude oil prices with a time lag. If so, the cost of energy could Source: World Bank sta calculations and national authorities Figure 26: Pakistan is highly dependent on oil for electricity generation and Bangladesh increasingly so Pakistan 50000 45000 40000 35000 30000 In ktoe 25000 20000 15000 10000 5000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Coal oil products Natural gas Nuclear Hydro Bangladesh 6000 45000 40000 5000 35000 4000 30000 25000 In ktoe In ktoe 3000 20000 2000 15000 10000 1000 5000 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Coal Oil products Hydro Natura gas (right axis) Source: International Energy Agency Energy Balance and Statistics. 31 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 decline further, especially in Bangladesh and Pakistan. the predictions (or impulse responses) from a Structural Even India would benefits, as LNG and oil together Vector Auto Regression (SVAR) estimated with Indian account for 9.5 percent of its electricity generation. data for the years 1995-2014. The impulse responses to an oil price decrease of 20 percent suggest a relatively pronounced effect on the trade and budget deficits. The The balance of payments former increases while the latter decreases in response and the budget are key to lower oil prices. Furthermore, remittances seem to be transmission channels negatively affected while GDP, inflation, interest rates and the real effective exchange rate show minor responses. Based on India’s experience over the last decade, oil price shocks affect the economy mainly through Whether there will be a negative impact of the oil current account balances and fiscal accounts. Using price shock on remittances to South Asia will to a an empirical approach to identify the key transmission large extent depend on the policy response of Gulf mechanisms is justified in light of the varying degree countries. Based on the empirical exercise above, a 20 of price pass-through across countries, as well as their percent decline in the world price of oil leads in the different dependence on oil across sectors. In these cir- medium-term to a 5 percent decline in remittances. cumstances, attempting to predict the impact of cheaper Traditionally, the GDP of oil exporting countries and oil on the basis of conceptual arguments could be mis- the volume of remittances from migrant workers in leading. An arguably more reliable picture is provided by those countries have been highly correlated. However, Figure 27: Simulated impulse responses to a 20 percent decline in crude oil prices based on historic data from India REM GDP TRB 0.06 0.02 0 0.01 0.04 -0.02 0 -0.04 0.02 -0.01 -0.06 0 -0.02 -0.08 10 20 30 40 10 20 30 40 10 20 30 40 CON INFL FID 0.02 0 0.01 -0.05 0.01 0 -0.1 0 -0.15 -0.01 -0.01 -0.2 10 20 30 40 10 20 30 40 10 20 30 40 ITR RER CRP 0.02 0 0.02 0.01 -0.05 0 0 -0.1 -0.02 -0.01 -0.15 -0.04 -0.02 -0.2 -0.06 10 20 30 40 10 20 30 40 10 20 30 40 Source: World Bank sta calculations using quarterly data from World Bank, IMF, RBI, MoF, and JPM. 32 making the most of cheap oil Figure 28: There has been no noticeable slowdown in remittances to South Asia, except for Bangladesh and Pakistan 250 Remittances Index in US$ (100 = 2009 Q2) 110 Average Crude Oil Prices(US$/BBL) 100 200 90 150 80 70 100 60 50 50 2009q1 2010q3 2012q1 2013q3 2015q1 quarter Crude Oil Prices Bangladesh India Pakistan Sri Lanka 120 110 Remittances Index in US$ (100 = 2014 M7) Average Crude Oil Prices(US$/BBL) 100 100 80 90 60 80 70 40 2014m7 2014m10 2015m1 2015m4 Month Oil prices Bangladesh (From GCC) Pakistan (From GCC) Source: World Bank, national central banks and World Bank sta calculations oil exporting countries have substantial international can be tradeoffs in the short term, especially in India’s reserves and can afford prolonged budget deficits in case, where diesel and other petroleum products also order to support their domestic economic activity. account for a significant share of exports. The quantities Recent research has found that the elasticity of remit- of oil products imported and exported are not equally tances to international oil prices is positive but small.4 sensitive to changes in prices. The number of vehicles So far, there seems to be a decline in remittances only in circulation in a country is given in the short term, in the cases of Bangladesh and Pakistan, and it is implying that there is little room of maneuver to reduce marginal. oil imports in volume. The response is even more muted when there is limited pass-through of cheaper oil prices The impact of cheaper oil on the trade balance de- globally onto cheaper domestic prices for oil products. pends on the oil component of both imports and ex- In that case, domestic consumers may not “notice” the ports, as well as on indirect effects from the change in oil price shock immediately, and therefore may not economic activity. Because all countries in the region adjust their demand for oil products. But at a time of are net importers of oil products a positive impact on global surpluses in oil, sales abroad may decline in vol- the trade balance can be expected in all cases. But there ume. Hence the difference in the elasticity of the value of imports and exports to changes in oil prices. Using quarterly data from South Asia during the years 1995 to 4 This research is summarized in the blogpost http://blogs.worldbank.org/peoplemove/will- 2014, it appears that exports are indeed more sensitive falling-oil-prices-lead-decline-outward-remittances-gcc-countries. to oil prices than imports in India, implying a relatively 33 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015  tructural Vector Auto Regression: methodology and data Box 1. S An SVAR links a series of economic variables through a dynamic structure implying that changes in the level of one of them are transmitted to all the others through multiple channels over time. The amplitude and speed of these mutual impacts can be estimated using historic data on the variables considered. Once the impact coefficients have been estimated, it is possible to simulate impulse responses to a shock across all the variables in the SVAR. The SVAR model used here contains ten variables: crude-oil prices, global GDP growth, remittances, CPI infla- tion, domestic GDP growth, the trade balance, private consumption, the fiscal deficit, the monetary policy rate, and the real effective exchange rate. The lag length of the dynamic system is determined using the BIC and HQC information criteria, which are well suited for small samples. The lag was set to one quarter, but first-order autocorrelation in residuals was allowed, which effectively sets the lag order to two. The system contains two blocks. One of them, representing the domestic economy, includes all domestic vari- ables. The other, for the world economy, includes crude oil prices and global GDP growth. The latter block assumes that crude oil prices affect global GDP contemporaneously and with a lag, while oil prices are only affected by global GDP with a lag. The latter restriction identifies the oil price shock. Both oil prices and global GDP affect the domestic economy contemporaneously and with one period lag. For the domestic economy, remittances are only affected by other domestic variables with one period lag. GDP growth is affected contemporaneously only by remittances and will a lag by all domestic variables. The trade balance and private consumption are affected contemporaneously only by remittances and GDP growth, and with lag by all other variables. Remittances and GDP (including the trade balance and private consumption as its sub-components), affect inflation contemporaneously. Impacts on the fiscal deficit come afterwards. Monetary policy takes into account inflation and the budget situation. The exchange rate comes last in the chain, because the foreign currency markets is considered to be the most efficient, reflecting information on all variables at once. In practice this amounts to ranking the SVAR variables from most exogenous to most endogenous. The assumed ordering for the variables in the domestic block is as follows: remittances, GDP, trade balance, consumption, in- flation, fiscal balance, interest rate, and exchange rate. This ordering is consistent with the recent SVAR literature on the impacts of lower oil prices on the economy. For estimation purposes, all variables are measured in log differences, quarterly, year-on-year, demeaned and de-trended. The average of three crude oil prices (UK Brt Lt, Dubai Med and Alaska NS heavy) is used as the impulse variable. The estimation relies on Bayesian methods combining classical full information likelihood with prior information. We impose very mild priors on all unrestricted coefficients using wide-spread Normal distri- bution centered on zero, with the exception of autoregressive coefficient for which we assume Beta (0.2, 0.1) distribution. Standard errors are assumed to have inverse Gamma (0.4, 0.2) distribution. For all coefficients, the posterior distribution heavily dominates the priors. We use Bayesian confidence intervals of 90 percent to draw inference on the generated impulse responses. stronger adjustment of exports than imports with less experience during 1995-2014, a 20 percent decline positive effects on the trade balance in the short term. in international oil prices should lead to a 10-to-15 The opposite is true mostly everywhere else in the re- percent decline in the budget deficit. This is mainly the gion. Based on these estimates, Bhutan, Maldives and result of lower spending on energy subsidies. But the Sri Lanka should see the biggest improvements in their policy cushioning of the impact also results in more trade balance as a result of the oil shock. modest impacts on inflation and on economic activity. Overall, the empirical exercise conducted for India sug- In the presence of limited pass-through of the decline gests that a 20 percent decline in oil prices leads to an in oil prices to domestic prices, most of the impact is increase in GDP by roughly 0.5 percentage points over bound to be felt on the fiscal balance. Based on India’s four quarters. 34 making the most of cheap oil Figure 29: Except possibly for India, most countries in the region can expect an improvement in their trade balance. Oil price elasticity of Exports Oil price elasticity of Imports Sri Lanka Sri Lanka** Pakistan*** Pakistan** Nepal Nepal Maldives Maldives*** India*** India Bhutan* Bhutan** Bangladesh* Bangladesh Afghanistan* Afghanistan -0.2 0 0.2 0.4 0.6 0.8 1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Source: World Bank sta calculations Note: * statistically significant at 10percent; ** at 5percent; *** at 1percent; robust standard errors. Households will here using household survey data from Bangladesh, unambiguously gain but richer India and Pakistan.5 Key inputs are the estimation of households will gain more the pass-through effect in each of the three countries, and the expected increase in GDP following the oil The decline in oil price affects household welfare shock. The share of oil products in total consumption directly through the resulting change in the do- expenditure is generally low for poorer households. mestic price of oil products, and indirectly through Many among the poor are farmers, who do not rely on its overall impact on economic activity. Both effects transportation much. As for the urban poor, they com- are likely to be positive. Cheaper oil products result mute to work by foot, bicycle or public transportation in greater purchasing power for the same income. much more frequently than in their own vehicles. Only More buoyant economic activity implies more drops in kerosene prices benefit the poor more than the household income for the same level of prices. But rich. Moreover, the pass-through of international oil not all households will benefit to the same extent. prices to the domestic prices of oil products is partial at Some consume more oil products than others; simi- most. As discussed above, there is no pass-through in larly, some may see their income growing faster than the case of Bangladesh, and the extent of pass-through others. While there is limited information to infer is limited in India’s case. Only in Pakistan is the decline how the oil price will affect the incomes of different in domestic oil prices substantial. Indirect effects are es- population groups, household surveys allow to esti- timated in two ways. One of them applies to household mate what share of consumption expenditures goes expenditures the cumulative impact from a 20 percent into oil products. The direct welfare effect is defined drop in oil prices on GDP based on the SVAR analysis as the percent of total consumption expenditure above. The other relies on the differences in growth “freed up” from the household having to pay less for forecasts between October 2014 and April 2015 over a oil products for a given income. The indirect welfare one-year horizon. Overall effects range from a gain of 2 effect is the percent change in income from more percent for households in the poorest decile to a gain of buoyant economic activity, for a given price of oil 4 to 5 percent for those in the richest decile. products. The sum of the direct and indirect effects provides a crude measure of the gain experienced by a household, expressed as a percentage of household consumption. Welfare effects in Bangladesh, India and Pakistan are 5 The sources used are 2010 Household Income and Expenditure Survey for Bangladesh, the positive and not negligible, but they are skewed to- 2011–12 National Sample Survey (68th round) for India, and the 2010–11 Household Integrated Economic Survey for Pakistan. All of them are representative, at the minimum, at the urban/ wards richer households. These effects are quantified rural level. 35 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015  he fuel consumption patterns of households in Bangladesh, India, and Pakistan Box 2. T Using recent household survey data with consumption expenditure information, fuel consumption rates and mean fuel expenditure shares for households are estimated. The estimates are disaggregated by location (urban versus rural) and by product (for example, petrol, diesel, liquid petroleum gas, kerosene). Bangladesh: The oil products examined were liquid petroleum gas (LPG), kerosene, petrol, diesel, and com- pressed natural gas (CNG). In rural areas, 87 percent of the bottom 40 percent of the population consume kerosene. But their consumption of other oil products is negligible. In urban areas, 23 percent and 55 percent of the bottom 40 percent consume LPG and kerosene, respectively. The consumption of other fuel types is negligible as well. Except for kerosene, the mean expenditure share for each of the fuel types is lower for the bottom 40 percent of the population than for the top 60 percent in both urban and rural areas. For kerosene, the mean expenditure share in rural areas is 1.1 percent for the bottom 40 percent versus 0.7 percent for the top 60 percent. The corresponding shares in urban areas are 0.6 percent and 0.2 percent respectively. Pooling fuel types, the mean expenditure share in rural areas is 1.2 percent for the bottom 40 percent and 1 percent for the top 60 percent. The corresponding figures for urban areas 1.2 percent and 1.6 percent. India: The analysis considered kerosene, LPG, petrol, and diesel. The household survey captures information on kerosene separately by whether the kerosene was obtained through the Public Distribution System (PDS) or other sources. In rural areas, 92 percent of the bottom 40 percent of the population consume kerosene, fol- lowed by 13 percent for LPG, and single-digit rates for petrol and diesel. Similarly, in urban areas, 55 percent of the bottom 40 percent consume kerosene, followed by 36 percent for LPG, and single-digit rates for petrol and diesel. In both urban and rural areas, the bottom 40 percent is more likely to directly consume kerosene than the top 60 percent. For all other fuel types, the top 60 percent has higher consumption rates than the bottom 40percent in both urban and rural areas. The bottom 40 percent is more likely to directly consume kerosene obtained from the PDS than the top 60 percent but the difference is not large. Apart from kerosene, the mean expenditure share for each of other oil products is lower for the bottom 40 percent than for the top 60 percent. For kerosene, the mean expenditure share for the bottom 40 percent is 1.5 percent in both rural and urban areas. The shares are 0.7 percent and 0.5 percent for the top 60 percent of the population in rural and urban areas, respectively. Pooling fuel types, the mean expenditure share is 2.1 percent for the bottom 40 percent of the population and 3.7 percent for the top 60 percent in rural areas. The corresponding shares in urban areas are 4.1 percent for the bottom 40 percent and 6.5 percent for the top 60 percent. Pakistan: The analysis covered kerosene, LPG, and petrol/diesel. In rural areas, 19 percent of the bottom 40 percent directly consumes kerosene, 11 percent LPG, and 15 percent diesel/petrol. In urban areas, 3 percent of the bottom 40 percent consumes kerosene, 69 percent LPG, and 17 percent petrol/diesel. Apart from kerosene, the bottom 40 percent is less likely to directly consume each of the fuel types than the top 60 percent. This is so in both urban and rural areas. Except for kerosene in rural areas, the bottom 40 percent of the population has an equal or lower expenditure share for each of the fuel types than the top 60 percent. For kerosene, the mean expenditure share is 0.2 percent for the rural bottom 40 percent versus 0.1 percent for the rural top 60 percent. Pooling fuel types, the mean expenditure share is 1.1 percent for the bottom 40 percent versus 2.7 percent for the top 60 percent in rural areas and 2.4 percent for the bottom 40 percent versus 4.7 percent for top 60 percent in urban areas. 36 making the most of cheap oil Figure 30: As richer households spend more on oil products they tend to benefit more from cheap oil prices BANGLADESH Predicted change in consumption (%) 6.0% 4.0% 2.0% 0% 1 2 3 4 5 6 7 8 9 10 Consumption Deciles 2016 INDIA Predicted Change in consumption (%) 6.0% 4.0% 2.0% 0% 1 2 3 4 5 6 7 8 9 10 Consumption Deciles 2015 SVAR PAKISTAN Predicted change in consumption (%) 6.0% 4.0% 2.0% 0% 1 2 3 4 5 6 7 8 9 10 Consumption Deciles 2015 Source: World Bank. Macroeconomic tailwinds resemble an L-shape rather than a U-shape pattern. provide a unique opportunity The market forecast and swap curves for oil prices sug- to rationalize energy prices gest slow convergence of WTI oil prices to USD 60 per barrel by April, 2017. However, this market consensus Future development in oil prices is surrounded forecast is surrounded by large uncertainty. While in 68 by great uncertainty. The current market sentiment percent of the time the price is predicted to stay in the suggests that the sharp decline in oil prices could be range of USD 44.8 to USD 75.2 per barrel by April more sustained compared with the transitory, V-shaped 2017, a 95 percent confidence requires this interval to decline of oil prices in 2008-2009. While many could widen to USD 29.6-90.4 per barrel. Ultimately, many agree that the V-shape pattern may be put to rest this patterns of future price development are probable, time around, the market sentiment provides a little in- including significant further decline in oil prices. Low sight into whether the future dynamics in oil prices will oil prices may thus very well be transitory and a fast 37 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 31: Forecasts for crude oil prices suffer from great uncertainty 140 West Texas Intermediate (in USD/BBL) 120 100 80 60 40 20 0 2004-Jun 2005-Jun 2005-Oct 2006-Feb 2006-Jun 2006-Oct 2007-Feb 2007-Jun 2007-Oct 2008-Feb 2008-Jun 2008-Oct 2009-Feb 2009-Jun 2009-Oct 2010-Feb 2010-Jun 2010-Oct 2011-Feb 2011-Jun 2011-Oct 2012-Feb 2012-Jun 2012-Oct 2013-Feb 2013-Jun 2013-Oct 2014-Feb 2014-Jun 2014-Oct 2015-Feb 2004-Feb 2004-Oct 2005-Feb JUN 15 OCT 15 FEB 16 JUN 16 OCT 16 FEB 17 JUN 17 OCT 17 FEB 18 JUN 18 OCT 18 FEB 19 JUN 19 OCT 19 FEB 20 JUN 20 OCT 20 FEB 21 JUN 21 OCT 21 FEB 22 JUN 22 OCT 22 FEB 23 JUN 23 OCT 23 WTI SWAP 68% CI 86% CI 95% CI Source: World Bank sta estimates increase could quickly put back pressure on fiscal bal- Table 3: Selected global hedging options ance sheets. Therefore, the time to strategically choose with over-the-counter derivatives government exposure, pass through mechanisms as well as social welfare and growth implications related PERIOD WTI* BRNT* NYULSD* NYRB* to international oil price movements is now. Dec-15 54.11 60.85 182.49 151.97 In principle, hedging options are available to help Dec-16 58.90 66.41 194.34 161.85 governments and larger businesses mitigate this Dec-17 61.93 69.60 200.65 168.95 uncertainty. But there are also important risks asso- Dec-18 63.82 72.07 201.50 173.24 ciated with hedging. Government and businesses can Dec-19 65.77 74.17 na 177.64 choose to live with the uncertainty or try to reduce it Dec-20 67.18 76.04 na 180.84 through self-insurance or hedging. The self-insurance mechanism could work through buying oil in times Dec-21 67.89 77.78 na 182.65 when prices are deemed low and using the accumulated Dec-22 68.22 Na na 183.56 stock when prices rise again. This approach has been Dec-23 68.24 Na na 183.71 applied by India recently. Alternatively, governments WTI – NYMEX Crude Monthly Average, OTC Swap in USD/bbl; and firms can use long-term hedges to lock in prices BRNT – ICE Brent Crude Monthly Average, OTC Swap in USD/bbl; NY ULSD – NYMEX Heating Oil Monthly Average, OTC Swap in USD/gal that they see as fair and variable for their future busi- NYRB – NYMEX RBOB Gasoline Monthly Average, OTC swap in USD/gal ness and focus on better investment planning. Some of the available hedging options, their markets of origin, quoted prices, and term structure are presented in the a high level, the framework for implementing a com- table below. They indicate some possibilities to lock modity hedging strategy should always cover the points in the price of oil even 7-8 years ahead—that is the outlined in the Box below. time needed for most medium term investment proj- ects to start generating returns. However, to use those A more workable option to reduce fiscal vulnerability markets effectively and transparently, solid governance in face of large international commodity price swings frameworks need to be implemented, especially by is to take advantage of cheap oil to cut energy subsi- governments both at the central level and at the level dies. The subsidy channel, though muted in face of low of the SOEs, and sub nationals. The fundamental steps oil prices at the moment, remains an important poten- supporting commodity risk management are well es- tial driver of fiscal deficits in South Asia. Furthermore, tablished in the commercial world, and apply to any current tailwinds for fiscal balances may send the wrong interested organization, whether public or private. At signal to fiscal policy makers and take off pressure from 38 making the most of cheap oil  high-level framework for implementing a commodity hedging strategy Box 3. A Governments should not embark in hedging without previously considering the following: ‹‹Formulating the hedging-strategy objectives. ‹‹Assessing the impacts of short-term price volatility and carefully quantifies price exposure. ‹‹Documenting the reasons for selecting a specific hedging product, including details on terms of coverage. ‹‹Verifying adequate legal and regulatory infrastructure to support the use of commodity derivatives. ‹‹Describing operational arrangements, including roles and responsibilities of actors and agencies and mechanisms for cost accounting and managing potential payouts associated with the hedging instruments. ‹‹Establishing procedures for those authorized to (i) negotiate, (ii) approve, (iii) execute, and (iv) audit transactions and reports; these authorizations should include the limits act. ‹‹Review of accounting policies and tax regulations related to the management of hedging instruments. ‹‹Establishing procedures to select counterparties and brokers; this could involve establish- ing requests for proposals (RFPs) to help guide choice and evaluation of counterparties. ‹‹Setting clear limits for acceptable market and counterparty risks. ‹‹Establishing back-office and control procedures for monitoring and manag- ing the hedge position, including the process for valuing transactions; ‹‹Developing procedures for oversight and supervision of and reporting on risk management operations. Source: World Bank addressing structural weaknesses in revenue genera- terminate price subsidies for kerosene under PDS given tion. These arguments constitute a solid case for taking the expansion of electrification and the current low use the opportunity to replace risky subsidies with other of kerosene primarily for lighting purposes among support measures and transfer schemes able to better poorer households in rural areas.    target those in need while allowing fiscal balances to be permanently decoupled from uncertain and volatile India has already started to take advantage of the international oil price movements. This also is an oppor- opportunity to rationalize energy prices by getting tunity to reform poor performing electric utilities and rid of subsidies whilst shifting taxes towards negative state owned refineries that are often highly subsidized. externalities of energy use. India began by deregu- lating diesel prices while at the same time increasing Running in parallel with the decline in petroleum excise duty on petroleum and diesel. As shown below, fuel prices but conceived and initiated well before, under-recoveries to diesel have been eliminated and reforms in subsidy programs to reduce inefficien- in a series of actions since October 2014, excise du- cies and distortions can yield additional dividends. ties on diesel and petro have been gradually increased. Under the Direct Benefit Transfer (DBT) scheme, The Economic Survey of India suggests that using low the Indian government has started to directly deposit oil prices, subsides for both LPG and kerosene will be entitled subsidies into the bank accounts of consum- reformed as well. The new government budget for the ers for the purchase of market-priced LPG cylinders. fiscal year 2015/16 has slashed the petroleum subsidy Government reports indicate that the majority of estimate by 50 percent to INR 30,000 crore (USD 4.9 intended households are now covered under the DBT billion), from the FY2014/15 budget estimate of INR scheme, which stems leakage from the diversion of 60,000 crore. The government has also decided that LPG from household to other uses that occurred under most welfare schemes including subsidies for food, fuel the previous arrangement of at-purchase subsidies. and fertilizer will be delivered through cash transfer. The government also reports that large numbers of (well-off ) households appear to have opted out of the India is bound to reap significant environmental DBT scheme, which has generated significant savings. benefits from these measures. Calculating the CO2 The price of kerosene sold outside the PDS has been emission reduction from the measures taken for petrol deregulated, leaving subsidized kerosene under PDS and diesel suggests that there will be a net reduction of which is intended for poorer households. These steps 11 million tons of CO2 emissions in less than a year, in reforming subsidies are progressive in nature. The more than the entire CO2 emissions of Luxembourg government is also considering ways to eventually in 2012, compared to the baseline or 0.6 percent India’s 39 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Figure 32: India has eliminated under-recoveries for diesel products and raised excise duties on both diesel and petrol Diesel (Rs/liter) 15 10 5 0 -5 -10 -15 2012 2013 Abr-14 May-14 Jun-14 Jul-14 Ago-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan 2 Jan 6 2015 2015 Under-recoveries excise duty (unbranded) excise duty (branded) Petro (Rs/liter) 20 15 10 5 0 Abr-14 May-14 Jun-14 Jul-14 Ago-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan 2 Jan 6 2015 2015 Under-recovery Excise duty (ubranded) Excise duty (branded) Source: Economic Survey of India, 2015. annual emissions. In addition to serving as a carbon tax, input costs for electricity generation enabling tariffs an excise on petrol and diesel may, of course, also price to be adjusted downwards. However, a gap of about other externalities associated with burning petrol or PKR 2/kWh remains and the sector continues to suf- diesel. This includes congestion costs (from using ve- fer acute liquidity shortages. As a result, accumulated hicles), noise and local air pollution (of various forms) arrears of payment by the public electricity distribution which can be deeply damaging for health. companies to their suppliers, commonly known as the circular debt, has started to re-emerge and currently However, countries highly and increasingly depen- stands at an estimated PKR 245 billion, or one percent dent on oil for power generation, have not yet taken of FY2013/14 GDP. Without the proper payment action. No pricing reform has taken place in Bangla- (from consumers or covered by subsidies from the gov- desh and Pakistan so far. Although at current interna- ernment), the power producers have been unable to buy tional prices, there would be no need for subsidizing and/or produce adequate fuel to generate electricity fuel sales, both countries remain vulnerable to volatility that causes up to 5,000 MW of capacity to lie idle and of international oil prices. This is particularly the case contributed to several power shortage. Amid lower oil in Pakistan due to its high reliance on oil for electricity prices, electricity pricing reform has regained momen- generation. Electricity tariffs are heavily subsidized in tum. The government intends to adjust electricity tariffs Pakistan, accounting for 1.2 percent of GDP in the and bring subsidies for electricity down to 0.7percent fiscal year of 2013/14. Falling oil prices have reduced of GDP in FY2014-2015. 40 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 © FLICKR.COM / ZACHARY JEAN PARADIS South Asia country briefs In alphabetical order Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka 43 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Afghanistan Economic growth has fallen sharply in Afghanistan from uncertainty surrounding the political and security transition in 2013-14. A fiscal crisis is underway with declining revenues leading to accumulating arrears and exceptional financing needs. Progress on key reforms and a stable political and security outlook are critical to improving a weak growth outlook and restoring fiscal stability. Poverty remains high and persistent and is likely to have worsened since 2011, although an improved outlook for growth and stability should lead to modest progress on poverty in the medium term. Recent developments The agricultural harvest in 2014 was strong for the third year in a row, but was up only marginally The political and security transition continues to take from the bumper year of 2012. Agriculture growth a heavy toll on Afghanistan’s economy. Economic (estimated at 1.9 percent in 2014, compared to -0.2 growth is estimated to have fallen further to 2 percent percent in 2013 and 18.2 percent in 2012) benefited in in 2014 from 3.7 percent in 2013 and an average of 9 large part from robust cereals production, thanks both percent during 2003-12. The protracted political pro- to well distributed, timely rainfall and an increase in cess in 2014 combined with weak reform progress dealt irrigated area for wheat cultivation. Opium production a further blow to investor and consumer confidence, (not part of estimated GDP) grew strongly in 2014 for which were already in a slump from uncertainty build- the second year in a row, although the farm-gate price ing since 2013. The economy also faces headwinds of opium declined by 20 percent. The total farm-gate from the drawdown in aid. As a result, growth in the value of opium was about $850 million or about 4 non-agricultural sectors (manufacturing, construction, percent of GDP, although the export value of opiates is and services) is estimated to have fallen further in 2014. likely twice as large. New firm registrations, which is a proxy for investor confidence, dropped further to 2,470 in 2014 from Afghanistan is in the midst of a fiscal crisis, with 3,370 in 2013 and 5,300 in 2012, with this sharp drop declining revenues leading to an unfinanced fiscal occurring across all sectors. gap in 2014. Domestic revenues fell from a peak Growth of real GDP and sectors 45 35 25 Percent 15 5 -5 -15 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013 Real GDP growth Agriculture growth Services growth Industries growth 44 making the most of cheap oil Domestic Revenues 120 14 12 100 10 80 in percent of GDP 8 in billion Afs 60 6 40 4 20 2 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 in nominal value (bn Afs) in percent of GDP of 11.6 percent of GDP in 2011 to 8.4 percent in 2014, because of the economic slowdown and weak- nesses in tax and customs enforcement. The decline in revenue collection took place across all sources, including tax revenues, customs duties, and non-tax revenues. As a result, in spite of measures to restrain expenditures, the authorities faced a financing shortfall of about $500 million in 2014, managed by drawing down cash reserves, accumulating arrears, and exceptional donor assistance. The authori- ties curtailed civilian operations and maintenance (O&M) and discretionary development expendi- tures, which were both lower even in nominal terms in 2014 compared to 2013. However, overall expen- ditures increased in 2014 because of higher security and mandated social benefit spending. These fiscal trends raise serious concerns about development outcomes going forward. Consumer price inflation dropped in 2014 as both food and non-food inflation softened. Period average inflation was recorded at 4.4 percent in 2014 compared to 7.7 percent in 2013. The exchange rate remained stable during 2014, depreciating by only 2.4 percent unity government is yet to deliver significant economic vis-à-vis the US dollar as aid flows financed the large reforms and parliamentary elections are scheduled for trade deficit. 2015. Furthermore, unfavorable weather conditions point toward a contraction in agriculture. Growth is projected at 2.5 percent in 2015 and about 5 percent Outlook during 2016-18. The post-transition growth outlook is contingent on a relatively stable political and security The growth outlook for 2015 remains weak. Contin- environment and progress in key reforms, with agri- ued uncertainty and sluggish reforms mean that inves- culture and services likely to be among the key drivers, tor and consumer confidence show no signs of picking and extractive industries playing an increasing role in up before the second half of the year. The national the medium term. 45 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Afghanistan 2010 2011 2012 2013 2014 2015p 2016p 2017p 2018p Nominal GDP (billion US$) 15.9 17.9 20.5 20.3 20.8 22.2 24.1 26.0 28.2 Real GDP growth (%) 8.4 6.1 14.4 3.7 2.0 2.5 5.0 5.1 5.3 GDP per capita (US$) 561 616 689 665 666 693 735 778 825 CPI inflation (period average, %) 7.7 10.2 6.4 7.7 4.4 5.0 5.5 5.0 5.0 Population (millions) 28.4 29.1 29.8 30.6 31.3 32.0 32.7 33.5 34.2 In % of GDP, unless otherwise noted Domestic revenues 11.0 11.6 10.3 9.7 8.4 9.3 9.8 10.5 11.6 Donor grants 12.0 11.3 13.0 14.5 15.1 17.4 18.3 19.8 21.0 Total core expenditures 21.1 23.3 23.8 24.7 26.0 29.2 30.1 32.6 35.1 Overall fiscal balance 1.9 -0.4 -0.5 -0.5 -2.5 -2.5 -2.0 -2.3 -2.5 (after grants) Trade balance -45.9 -42.0 -41.9 -40.8 -38.2 -37.0 -36.1 -35.3 -33.4 Current acct balance 3.1 3.5 4.2 3.7 5.1 1.3 -0.9 -2.2 -2.5 (incl. grants) In light of the fiscal crisis, restoring fiscal stability Challenges will require accelerating revenue enhancing reforms, additional discretionary assistance, and prioritizing The new government of Afghanistan faces the dual expenditures. The government began 2015 with a challenge of restoring confidence in its economic weak cash reserve position ($150 million) and sig- prospects and addressing formidable medium term nificant arrears (around $200 million). Reforms to development challenges. Afghanistan faces the improve revenues continued to stall through the first challenge of creating jobs for 400,000 new entrants three months of 2015 and a long delayed VAT appears into the labor force each year in the face of declining to have been delayed for another three years. Afghani- international assistance. Furthermore, fragility and stan thus faces a financing gap in 2015 that is as large conflict remain pervasive. Addressing these chal- as last year, against the backdrop of a weaker cash posi- lenges will require reforms from the new government tion. This would thus require additional discretionary in three areas: (i) restoring fiscal stability; (ii) restoring assistance and expenditure prioritization to mitigate confidence and creating private sector jobs; and (iii) impact on development outcomes. In the medium strengthening social cohesion and service delivery. term, contingent on improvements in tax and customs Above all, high level commitment to tackle corruption administration and additional tax measures, revenues and strengthen governance across the board will be are projected to improve from 8.4 percent of GDP in critical to delivering on the success of reforms in these 2014 to 11.6 percent by 2018. priority areas. 46 making the most of cheap oil Bangladesh Supply chain disruptions across the country due to political unrest dampened growth prospects. Buoyant imports and weak exports pushed the external current account into deficit but foreign exchange reserves continue rising. Undershooting of development expenditures and reduced subsidies have kept fiscal deficit in check despite revenue shortfall. The banking system remains vulnerable. With political stability, growth in the near-term is expected to recover underpinned by strong domestic demand, some improvement in the investment climate and continued macroeconomic stability. Recent Developments export growth reflected the adjustment of the garment industry to stricter labor and safety standards and weak FY15 growth is expected to be around 5.6 percent. external demand. Remittance growth rebounded. How- The economy benefitted from sustained political ever, the current account moved to a $1.3 billion deficit stability in 2014. Private consumption, imports and during July-January, FY15, compared to a $2.5 billion public investment grew faster in the first half of FY15 surplus during the same period of the preceding year. than a year earlier. However, a resurgence of political Foreign exchange reserves surpassed the $23 billion level unrest since January 5, 2015 has taken a heavy toll on by end-February 2015, equivalent to more than 5 months economic activity, in particular the services sector, ag- of imports. Foreign exchange intervention by BB to keep riculture, exports, and non-formal sector. Inter-district the $/taka rate relatively stable has resulted in a 17.6 per- transportation has been disrupted, affecting domestic cent appreciation of the taka against the euro so far and a supply chains. Private investment has stagnated since sustained appreciation of the real effective exchange rate. FY12 due to growing political uncertainty and inad- equate progress in addressing the structural constraints, The banking system is vulnerable. Overall, the finan- particularly in providing land, transport, and energy. cial sector is still shaky because of limited actions to improve corporate governance and accountability. The External balances remain comfortable despite weak sector remains vulnerable to potential term shocks and export growth and strong imports. Weak 2.1 percent economic slowdown. Contribution to Annual GDP Growth 10 7.1 8 6.5 5.6 6.0 6.5 5.6 6.0 6.1 6 5.0 In Percent 4 2 0 -2 -4 2007 2008 2009 2010 2011 2012 2013 2014 2015(P) Final consumption Gross Fixed Investment Net Export Statistical Discrepancy GDP Growth Rate Source: World Bank 47 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Bangladesh 2012 2013 2014 2015 (P) 2016 (P) 2017 (P) Real gross domestic product 6.5 6.0 6.1 5.6 6.3 6.7 Private consumption 4.1 5.1 2.7 7.3 6.7 8.0 Government consumption 3.1 5.8 11.9 14.3 19.7 20.1 Gross fixed capital investment 10.6 5.4 6.4 7.4 12.0 12.1 Change in Inventories, % contribution 0.0 0.0 0.0 0.0 0.0 0.0 Statistical discrepancy, % contribution 0.4 0.4 0.3 -1.1 0.0 0.0 Exports, goods & services 12.5 2.5 6.3 7.0 8.2 10.1 Imports, goods & services 10.5 1.2 -0.9 11.2 20.2 22.9 GDP, at market price 6.5 6.0 6.1 5.6 6.3 6.7 Agriculture, % contribution 0.5 0.4 0.5 0.9 0.9 1.0 Industry, % contribution 2.5 2.6 2.3 1.0 1.9 1.8 Services, % contribution 3.4 2.9 3.0 3.0 3.5 3.7 Output Gap -0.5 -0.7 -0.6 -0.8 -0.3 0.7 Inflation (Household Consumption Deflator) 9.9 6.8 7.5 7.0 7.1 7.2 Current account balance, % of GDP -0.3 1.6 0.9 -0.5 -0.3 -0.7 Fiscal balance (excluding grants), % of GDP -3.5 -3.9 -3.7 -3.5 -3.4 -2.8 Source: Bangladesh Bureau of Statistics and WB staff projection Fiscal prudence has continued. The fiscal deficit is demand base, gradually improving investment climate, projected to remain 3.5 percent of GDP in FY15. and continued macroeconomic stability are expected to Politics related disruptions and weak domestic econ- raise GDP growth to 6.3 percent in FY16, enabled by omy led to shortfall in tax revenue collection relative large investment in infrastructure and energy. Recovery to target in FY15. Expenditures have remained con- in export growth and private investment is expected to tained, helped by lower fuel subsidies with domestic boost aggregate demand while contributing to capac- fuel prices unchanged. Time and cost overruns ity creation. However, with rising imports boosted by continue to plague the implementation of develop- private investment and export growth, the current ac- ment projects. Along with a steep rise in nonbank count deficit is projected at 0.7 percent in FY17 after financing, undershooting of expenditure target has dropping to 0.3 percent in FY16 because of decline in kept net bank credit to the central government in oil import bill. negative territory. Fiscal deficit is projected to remain stable at 3.4 per- Inflation is contained. Inflation (y-o-y) declined cent of GDP in FY16 before declining to 2.8 percent to 6.1 percent in February 2015, compared with 7.4 in FY17 when the revenue impact of the implementa- percent in February 2014, driven mainly by a good tion of the new VAT law kicks in. The central govern- rice harvest and lower global prices. Nonfood inflation ment’s debt-to-GDP ratio is projected to remain on a showed greater volatility in recent months within the downward path with a low risk of debt distress. 5.5 to 6.5 percent range. Cautious monetary policy helped limit inflation volatility. Monetary policy stance in the near term will remain restrained. It will provide space for lending to activities which support investment and inclusive growth. BB’s Outlook Monetary Policy Statement for January-June 2015 BB plans to limit broad money growth to 16.5 percent, Outlook for the near term is mixed. Assuming sus- while aiming to raise private credit growth to 15.5 tained political stability, Bangladesh’s strong domestic percent. A tighter monetary policy may be warranted 48 making the most of cheap oil if non-food inflation resumes an upward trend due to 2021. The average annual GDP growth rate needs to demand pressures. Taka should be allowed to depreci- rise to 7.5-8 percent to accelerate the pace of poverty ate if market forces push it in that direction. reduction through the creation of more and better jobs in the domestic economy. This will have to be coupled with increases in female labor force participation rate Challenges to cushion the shrinkage in the demographic divi- dend due to declining rate of growth of working age Domestic factors dominate the risk to the near term population. outlook. The central risk is the prolongation of politi- cal instability. There are also concerns about financial The biggest, though not the only, challenge in in- sector vulnerability. These have potential fiscal impli- creasing investment and female labor participation cations. A protracted depreciation of the Euro could is ensuring durable political stability. In addition, hurt exports, compounding the weaknesses due to real Bangladesh needs to make faster progress on easing exchange rate appreciation. Even though international barriers to women’s participation in economic activi- financial linkage is growing, Bangladesh’s vulnerability ties, establishing special economic zones; pay adequate to global financial volatility remains small. attention to the private sector regulatory environment; improve the functioning of land markets to ensure the Growth remains below what is needed for Bangla- availability of land for manufacturing enterprises out- desh to be in a comfort zone of middle-income by side SEZs; and address the transport problem. 49 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Bhutan Growth rebounded in 2014 along with the lift of restrictions over credit and imports and with hydropower investment back on schedule. Bhutan’s significant dissaving is illustrated by a large current account deficit. Priority will have to be given to private sector development and asset diversification if Bhutan wants to reduce its vulnerability to donor finance and address rising youth unemployment. Recent Developments by a reduction in other current and capital expenditures. Domestic revenues as a share of GDP have declined over GDP growth in 2014 is estimated to 5.2 percent, after the last three years, from 22 percent to an estimate of reaching a bottom low 2.05 percent in 2013. Restric- 18.9 percent in FY14/15, while grants finance about 27 tions on credit, foreign exchange and imports put in place percent of total spending, 70 percent of which is from in 2013 to address the shortage of Indian Rupees were India. Bhutan’s public and publicly guaranteed external removed in July and August 2014 and replaced by more debt stood at 95 percent of GDP by end-2014, two market friendly measures on credit and higher taxes to thirds of which are from commercially profitable hydro curb domestic demand. Additional drivers of growth in projects. Domestic debt is limited to 5 percent of GDP. 2014 include hydropower construction back on track after the 2013 delays due to geological disruptions, the five-year Bhutan runs a large current account deficit (esti- plan implementation now in full swing and a record level mated at about 25 percent of GDP in 2014/15), to of tourists following a special offer to Thailand over the low which the hydropower sector contributed a third. It is season of June-August. On the demand side, private con- essentially financed by donor resources, of which India sumption, supported by an increase in wages, is estimated contributes the most through loans and grants to fi- to have grown by 6.6 percent. Growth of gross capital nance hydropower development. Foreign direct invest- fixed investment is estimated to 22.4 percent, masking an ment finances a low 8 percent of the capital account. even larger increment in the hydropower sector. Invest- International reserves had built up to US$ 1196 million ment elsewhere has contracted, against the background by November 2014, reflecting prudent management. of lagging investment climate reforms. Export earnings grew at 12.9 percent, supported by tourism expansion. Consumer price inflation in Bhutan has slowed to 6.3 percent in January 2015 from 11.3 percent at the end The fiscal balance in FY14/15 is budgeted to remain of 2013. This decline was mainly driven by the decline balanced at 0.2 percent of GDP. Civil service wages and in oil prices and India’s easing of inflation (Bhutan has allowances were increased by 19 to 23 percent respec- a fixed exchange rate with India from which it imports tively but the impact on spending is expected to be offset the majority of its consumption). Contributions to Annual GDP Growth 20% 15% 10% 5% 0 -5% 2007 2008 2009 2010 2011 2012 2013 2014) Net taxes on products Services Industry Agriculture, livestock, and forestry Source: National Bureau of Statistics, World Bank sta estimates 50 making the most of cheap oil Bhutan   2012 2013 2014e 2015f 2016f 2017f Real gross domestic product 5.1 2.0 5.2 6.7 5.9 6.0 Private consumption 5.0 12.7 6.6 6.6 6.6 6.6 Government consumption -0.8 -9.6 22.4 7.5 5.8 5.7 Gross fixed capital investment 2.9 -26.2 2.6 19.7 13.8 -0.7 Change in inventories (% contrib) Statistical discrepancy (%GDP) 7 6 14 7 6 7 Exports, goods and services -1.2 7.4 12.9 8.4 5.1 7.9 Imports, goods and services -6.1 1.6 18.2 5.9 9.4 3.6 GDP, at market prices 5.1 2.0 5.2 6.7 5.9 6.0 Agriculture 2.3 2.9 2.3 2.6 1.8 1.8 Industry 6.8 3.5 3.6 6.5 5.8 5.6 Services 0.9 1.7 7.9 8.0 6.9 7.0 Output gap n.a. n.a. n.a. n.a. n.a. n.a. CPI inflation, period average 9.5 11.3 6.3 6.0 6.0 6.0 Current account balance (%GDP)** -21.7 -26.1 -25.9 -24.1 -26.5 -28.5 Fiscal balance (%GDP)** 2.0 -1.6 0.6 0.2 -0.3 0.2 Notes: e: estimates; f: forecasts; * In annual percentage change percent, unless otherwise noted; ** Fiscal years (e.g. 2014 is 2013/2014). Sources: National Statistical Bureau, Royal Monetary Authority, Ministry of Finance, World Bank staff forecasts Outlook of the hydropower projects, the risk-sharing agreement with India for hydropower loans, Bhutan’s strong track 2015 economic activity is expected to gain momentum, record of project implementation, rapid growth in driven by new hydropower construction and innovative energy demand from India, committed donor support, tourism measures (“Visit Bhutan 2015”). Agriculture is and Bhutan’s high level of international reserves. projected to grow at its low historic rate of 2 percent. This boost in economic activity could risk a resumption of over- heating and macro imbalances. GDP will remain around 6 Challenges percent in the years after. Domestic demand will be driven by hydropower investment and, to a lesser extent, govern- The outlook is positive but macroeconomic pressures ment consumption. Consumer inflation will closely follow on domestic demand will have to be managed. Hydro- India’s tracks. power projects coming on line in 2018 and 2019 will provide the much needed domestic resources to finance The current account deficit is expected to continue the -- fiscal and external current -- twin deficit. However, growing over the next years, driven by hydropower the extent to which this relief will be lasting depends on projects in their construction phase. The current ac- whether hydropower rents will be used to diversify the count deficit outside the hydropower sector is forecasted country’s economic assets. Similarly, shared prosperity to remain stable, supported by a robust growth in the will depend on the ability of the economy to provide tourism sector. Fiscal policy is assumed to remain in jobs to the educated youth whose aspirations increas- balance, supported by donor grants, with current spend- ingly differ from existing employment opportunities. ing contained, and capital spending following the pat- terns of the five-year plan disbursements. The revenue While debt risk is still moderate, the rapid-build-up effort should weaken slightly, unless new measures to over the recent years’ cautions against any additional strengthen the tax base and limit the many exemptions non-concessional borrowing, given that Bhutan’s and holidays are introduced. With moderate growth, debt carrying capacity will only improve in the long poverty is expected to decline further, slowly shifting run reflecting significantly higher electricity exports from rural to urban, along with migration. when hydropower projects come on stream. Efforts to deepen the financial sector will need to be sustained to The risk of Bhutan’s external debt distress continues to provide the country the basis for financing sound and be moderate. This is based on the commercial viability sustainable development and diversification 51 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 India Recent Developments Underpinned by an unanticipated decline in food and oil prices – inflation moderated, public subsidies Indian economy has taken strong strides towards declined, and external balances improved. Inflation higher and more inclusive growth. Recent economic pressures eased primarily on account of moderating activity has been on an upturn--growth has acceler- food prices and generated some room for monetary ated, inflation has declined, current account deficit has accommodation – the Central Bank lowered policy narrowed, and external buffers have been replenished. rates twice in the current quarter. Simultaneously, an When evaluated on a longer-term horizon, growth has unanticipated decline in global crude prices bode well been inclusive and is correlated with a sharp decline in for India’s current account balance; driven largely by a poverty during the last decade. sharp decline in merchandise imports. Public finances also benefitted as declining global crude prices al- GDP growth accelerated to 7.4 percent (at market lowed for a significant reduction in fuel subsidies and prices) during the first three quarters, after being a complete deregulation of diesel prices in October, subdued at an average of 6 percent for the last eight 2014. However, the government slowed down the pace quarters. On the production side, growth was driven of medium term fiscal consolidation to make room for by services, which outperformed manufacturing. On “infrastructure investment”, aiming to reduce the defi- the expenditure front, growth was driven largely by cit to 3 percent of GDP in the next three years, instead consumption, with modest contributions from invest- of two, as was proposed in the previous budget. ment and exports. Public and private sector invest- ments suffered as many projects were held up, due to lack of timely regulatory clearance; land acquisition and inadequate access to finance. 10.0 Decomposition of GDP growth (y/y percent) 8.0 6.0 4.0 2.0 0.0 Q1-2012-13 Q2-2012-13 Q3-2012-13 Q4-2012-13 Q1-2013-14 Q2-2013-14 Q3-2013-14 Q4-2013-14 Q1-2014-15 Q2-2014-15 Q3-2014-15 -2.0 Agriculture and allied Industry Services Source: World Bank and national authorities 52 making the most of cheap oil Outlook land acquisition reforms. The Union Budget for 2015- 16 also presented a medium-term vision focused on India’s economy is poised to accelerate on the back unlocking private investment, improving the delivery of an ambitious reform agenda, and faster growth is of social benefits, and enhancing fiscal federalism by expected to further drive down poverty. Real GDP devolving more resources and more spending discre- growth (at market prices) is expected to accelerate to tion to the states. 7.2 percent in 2014-15, accelerating to 7.6 percent in 2015-16 and 8.0 percent in 2017-18. If the past Inflationary pressures are likely to ease gradually growth experiences are sustained, then the poverty on account of lower crude prices, and an improved rate is projected to decline to 15.5 percent by 2016, on production capacity will prevent overheating in back of higher growth projections. The outlook for the the medium-term. The central bank’s new inflation Indian economy is underpinned by two main trends: (i) targeting stance is likely to further boost credibility contained crude oil prices, and (ii) a reform program of medium-term inflation of ~5 percent. The current which, if fully implemented, can unlock investment account deficit is expected to narrow in the near-term and boost TFP growth. Higher production capacity, due to lower value of crude imports (which account for commensurate with accumulating capital and increase more than one-third of total merchandise imports); but in factor-productivity, and continued but targeted fis- widen somewhat to meet the capital goods and invest- cal consolidation will help curb domestic and external ments requirements of the economy. imbalances in the face of rising domestic demand in the medium-term. Challenges Acceleration in real GDP growth will be driven largely by higher investments, which are expected to Multiple downside risks suggest caution and high- grow at an average of 12 percent during 2015-2017. light the importance of vigilance in implementation. Three broad measures have been taken to kick-start On the external front, major risks stem from: low investments: (i) boosting direct budgetary support for growth of India’s key sources of trade, investment and infrastructure; (ii) executive action to expedite stalled remittance flows; and a possible increase in oil prices. critical projects; and (iii) legislative action for reducing On the domestic front, the most significant risks to commercial disputes in public contracts. Much of the the outlook are related to the implementation of the pickup in output will be reflected in an expansion of the Government’s ambitious and wide-ranging reform industrial sector in response to several reforms mea- program. Effective policy implementation on many sures, which could improve the business environment challenging fronts will be necessary to realize the and ease regulatory constraints, such as introduction meaningful and sustainable increase in investments of GST, single window clearance for registration, and embodied in the baseline scenario. Table India 2012 2013 2014f 2015 f 2016 f 2017 f GDP, at constant market prices 5.1 6.9 7.2 7.5 7.9 8 Private consumption 5.5 6.2 6.1 7.4 8.5 9.0 Government consumption 1.7 8.2 8.6 8.7 8.0 7.5 Gross fixed capital investment -0.3 2.9 4.0 9.0 12.0 13.0 Change in inventories, % contribution -0.1 -1.8 0.5 0.4 0.1 -0.1 Exports, goods & services 6.6 7.2 0.5 6.3 7.5 8.5 Imports, goods & services 5.9 -8.4 -0.4 9.1 13.0 15.0 GDP, at constant factor prices 4.9 6.6 7.1 7.5 7.9 8.1 Agriculture 1.7 3.9 1.2 2.1 2.8 2.8 Industry 2.3 4.4 5.0 5.5 6.1 6.4 Services 7.9 9.1 10.6 10.5 10.5 10.5 Inflation (Household Consumption Deflator) 9.4 8.5 8.1 6.8 6.1 5.2 Inflation (Consumer Price Index) 9.7 10.7 6.7 .. .. .. Current account balance, % of GDP -4.8 -1.8 -0.7 -0.9 -1.7 -2.7 Fiscal balance, % of GDP -7.2 -6.8 -6.7 -6.1 -5.6 -4.7 53 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Maldives Economic growth continued its recovery from the 2012 dip, while inflation has slowed down, although recent political developments present a downside risk. The dominant tourism industry is operating on an enclave model of development, while fisheries, with largest share of employment, is only weakly linked. The challenges are fiscal and external imbalances driven by large and rising public spending leading to high debt, limited fiscal space and depleted reserves, and an undiversified economy, which primarily depends on tourism and fisheries. Recent economic developments Annual average inflation moderated even further in 2014, falling to 2.4 percent in 2014, down from 4.0 Economic growth in 2014 is estimated to amount to in 2013 driven by low food prices and international 5.0 percent,1 continuing the recovery in growth since crude prices. The fall is particularly steep considering hitting 1.3 percent in 2012. This is lower than the gov- the double digit 10.9 percent inflation recorded only ernment’s provisional full-year estimate of 6.8 percent, in 2012. As measured by the overall consumer price which was published in October. The main determinant index (CPI) inflation in Malé has been unstable since of this estimate is the sharp slowdown in the growth in 2009 with fluctuations large in magnitude. This decline tourism bed-nights in November and December 2014, was primarily driven by a slow growth of food and partly caused by the water crisis in Malé. Most other non-alcoholic beverages which grew at a slow pace of service sectors are estimated to have grown as well in 1 percent in 2014 as opposed to 7.5 percent in 2013. 2014, while the industrial sector expanded by 13.2 During the second half of 2014, inflation fell even percent in 2014. However, the agriculture and fisheries further driven largely by the drop in food prices. sector is estimated to have contracted by 2.1 percent in 2014 vis-à-vis a growth of 5 percent recorded in 2013. In 2014 the fiscal deficit widened further to projected 11.6 percent of GDP in 2014. Despite high revenue of 32.4 percent of GDP, Maldives is spending beyond 1 Data for 2014 and projections are in line with the projections in the joint Bank-Fund LIC-DSA its means reaching 44 percent of GDP, leading to and the IMF Article IV of January 2015; World Bank staff estimates. persistent fiscal imbalances. Driven by expenditure the Sectoral contributions to growth Drivers of change in tourism arrivals Percentage point contribution to growth Percentage point contribution to annual change 20 25 15 20 15 10 10 5 5 0 0 -5 -5 -10 -10 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 2014 Other Education, health, social services Europe Americas Middle East Goverment administration Manufacturing China Other Total Agriculture Fisheries Tourism related Tourism GDP Source: National Bureau of Statistics, MMA, sta calculations 54 making the most of cheap oil Fiscal accounts, actuals, budget and estimates Percent of GDP 50 40 30 20 10 0 -10 -20 2009 2010 2011 2012 2013 2014 2014 2014 2015 budget Authorites estimate budget estimate Total revenue and grants Total expenditure and net lending Fiscal balance Primary balance Source: MoFT, MMA, IMF, sta calculations fiscal deficit has been on an upward trajectory since covering 2.8 months of imports of goods and services. 2011 and is estimated at 11.6 percent of GDP in 2014 However, net usable reserves remain low at USD 120 from 7.8 percent of GDP in 2013, despite a budgeted million, covering less than a month of imports. Faced deficit of only 2.8 percent of GDP. Subsidies, transfers with limited investment opportunities in the private and social welfare payments contributed substantially sector, banks are parking their assets elsewhere; to the expansive spending. It should be noted that the meanwhile financial soundness indicators have been authorities project the fiscal deficit in 2014 at only 3.4 improving percent of GDP. Although the country’s risk of external debt distress Outlook has been reduced from high to moderate, overall public debt is high at 74.6 percent of GDP in 2014, Going forward growth is projected to remain at 5 and subject to vulnerabilities. Meanwhile, the per- percent in 2015, supported by tourism arrivals, while sistent current account deficit has led to an increasing additional fiscal adjustment may have a negative level of external debt. Thanks to data revisions and a impact on growth. The 2015 budget foresees an ambi- more favorable outlook, the country’s risk of external tious fiscal consolidation mostly by increasing one-off debt distress has been reduced from high (2013 DSA revenue and planning a fiscal consolidation. Inflation update) to moderate. Although the level of external is projected to remain subdued as global commodity public and publicly guaranteed debt remains below prices are expected to remain low. Lower commodity the policy-dependent thresholds under the baseline, a prices will also benefit the current and fiscal accounts. shock to tourism exports could make it difficult for the country to service its external debt. Domestic and external risks remain. Recent political developments may lead to travel advisories and reduc- The external accounts look much better thanks to a tions in tourism. The country remains vulnerable to revision of balance of payments numbers. Goods im- external shocks, especially to tourism and global com- ports and tourism services exports nearly balance each modity prices. SOEs may pose further risks to fiscal other out, but substantial outflows through interest sustainability, as most are loss-making and depend on payments, dividends and remittances keep the current government support, with only nine companies having account in a deficit at 8.0 percent of GDP. The current contributed dividends to the budget in the last four years. account is more than fully financed by Foreign Direct Investment (FDI), and gross international reserves are estimated to have increased. Net FDI inflows are Challenges estimated at 13.3 percent of GDP. The immediate macroeconomic challenge is the fis- While usable reserves are estimated at less than half cal and external imbalances driven by high and rising a months of imports, the private sector is able to public spending. However, the economy also remains supply sufficient quantities of foreign exchange. As a undiversified and sources of growth and employment result of the large improvement in net capital inflows, remain misaligned. Besides, Maldives’ form of tourism- gross official reserves have increased from USD 368 led growth has followed an enclave model, reliant on million at end-2013 to USD 614 million at end-2014, imported goods, labor and finance. 55 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Nepal Development progress remains tributary –to a large extent- to exogenous factors, namely: weather patterns driving agricultural performance and remittance flows supporting domestic consumption and services sector activity. Public investment bottlenecks and the related infrastructure deficit (energy, roads, and irrigation) continue to constrain the productive potential of the economy, while political uncertainty undermines the environment for private investment. Despite an expected increase in recurrent spending and modest growth in capital spending, the budget is expected to remain in surplus largely thanks to high revenue growth and slower than planned capital budget execution. Inflation remains overwhelmingly determined by price trends in India and is thus projected to moderate in FY15 and going forward. External balances continue to be characterized by a widening trade deficit, though at a slower pace, essentially thanks to lower oil prices. Remittance inflows are expected to continue to make up for the gap, resulting in a significant current account surplus and accumulation of reserves. Excess liquidity in the financial system has eased as evidenced by the increase in the credit-to-deposit ratio of BFIs. Overall financial sector consolidation has continued to progress with improvements in CDR and NPLs. Main sources of uncertainty relate to: (i) political developments: though unlikely a breakdown of the constitutional drafting process could result in conflict and further depress investor confidence, and; (ii) the possible repercussion of falling oil prices on GCC demand for Nepali labor which could impact both consumption and financial sector stability via slower remittance growth. Recent Developments exchange reserves should continue to rise to over US$7 billion, equivalent to 8.8 months of imports. FY15 growth is expected to be around 5 percent. This moderate deceleration relative to FY14 is es- Financial sector consolidation has continued to sentially on account (i) a ‘base effect’ following a very progress. Excess liquidity in the financial system has good FY14 performance (by historical standards), considerably decreased from a surplus of NRs 60 bil- and (ii) lower agricultural output growth reflecting lion at the end of FY14 to NRs 2 billion six months inclement weather during the peak planting season into FY15 reflecting increased loan disbursements, and limited investments in irrigation. On the expen- slower deposit growth and interventions by the NRB diture side, the effect of slower remittance growth to mop up excess liquidity. The credit-to-deposit ratio is expected to be counterbalanced by the impact increased to 85 percent by mid-FY15 from 80 percent of lower oil prices, while investment growth will a year before. At mid-year, major indicators of financial continue to be constrained by (i) PIM and project implementation bottlenecks (public), as well politi- Contributors to GDP Growth cal and policy uncertainty (private), especially in the 15.0 Percentage point contribution hydro sector. 10.0 External balances remain comfortable, despite weak 5.0 export and strong import growth, thanks to lower oil prices and stable remittances. Export value growth 0.0 is expected to decelerate from a modest 5.4% in 2014 to 4.5%; however, import value growth is projected to -5.0 moderate considerably, reflecting lower oil prices and the significant share of petroleum products in total -10.0 2008 2009 2010 2011 2012 2013 imports. Though slowing down somewhat from FY14, Imports G&S Exports G&S remittance growth is expected to remain healthy at Domestic capital formation Consumption 9.8% offsetting the trade deficit and helping Nepal Total demand maintain a current account surplus equivalent to 4 Source: Central Bank of Sri Lanka percent of GDP (excluding grants). As a result, foreign 56 making the most of cheap oil sector health were positive including: exposure to real estate loans (6%); NPLs (2.7%); CAR (11.3%). Fiscal policy remains consistent with macroeco- nomic stability, and in fact possibly too timid given the available fiscal space. The budget is expected to remain in surplus in FY15 (for the third consecutive year), by over 1 percent of GDP. This reflects inter alia continued revenue collection growth, somewhat ex- panded current expenditures but constrained expansion of capital spending. Inflation is expected to moderate significantly. Infla- tion averaged 7.3% in the first half of FY15 (down from 9.1% during the same period in FY14). The decline is mostly on account of a sharp slowdown in non-food inflation. Though the decline in global fuel prices has had no impact on inflation to date, the adoption of an automatic price adjustment mechanism is expected to lower prices in the second half of the year. As a result, and following trends in India, inflation is expected to moderate to 7.1 percent in FY15. GDP in FY15 to 0.6% of GDP in FY17 as the expan- Outlook sion of spending gradually catches up with revenue growth. Reflecting the limited financing needs of the The growth outlook for the near term is largely GoN, public debt is to further decline to 22 percent framed by supply side constraints. With actual output of GDP by FY17 with Nepal remaining at low risk of at or possibly above potential and structural constraints debt distress. to expanding the productive frontier of the economy, growth is expected to (i) remain in the 5-4.5% range Slower remittance growth going forward, together over the near term (ii) be driven essentially by domestic with a deteriorating trade balance should gradually consumption. On the supply side, the services sector is bring the current account surplus down: from 4 per- expected to continue to drive economic activity, with cent of GDP in FY15 to 0.4% (excluding grants) in lackluster industrial growth (on account of energy FY17. constraints and labor market inefficiencies) and agri- cultural productivity growth constrained by low levels Inflation is expected to moderate significantly: of investment in irrigation. While large hydro-projects reflecting both the overwhelming influence of price may result in higher construction activity, significant developments in India and the impact of lower fuel lead times before exploitation begins means that pro- prices – as the automatic pricing mechanism allows duction linkages will only materialize in the long run. prices of petrol, diesel and kerosene to reflect inter- On the demand side, domestic consumption enabled national prices. Moreover, faced with the challenge of by remittances will continue to make the greatest managing excess liquidity in the financial sector, the contribution to output growth. Given the very modest NRB is expected to maintain a relatively conservative export base, external conditions are unlikely to make stance and to make use of liquidity mopping instru- a significant difference. Expected large investments in ments as needed. CPI inflation therefore is expected the hydropower sector may materialize but with limited to moderate from 7.1 percent in FY15 to 6.1 percent positive (output, employment) spillovers initially and in FY17. continued absorption capacity constraints will prevent a significant expansion of public investment. Short run outlook for prices and remittances bode well for poverty reduction and welfare of the bottom The budget is expected to remain in surplus over the 40%. The easing of prices of everyday commodities in near term, though declining gradually from 1.1% of particular will provide welcome respite to the urban 57 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Table: Nepal 2012 2013 2014 2015 (P) 2016 (P) 2017 (P) Real gross domestic product (% contribution) 4.8 3.9 5.5 5.0 5.0 4.5 Private consumption 12.2 2.9 2.9 2.9 2.8 2.4 Government consumption 1.6 -0.8 1.8 2.1 2.4 1 Gross fixed capital investment -1.1 2 1.6 1.5 1.7 1.8 Change in inventories -7.1 3.9 3.7 3.8 3.3 0.8 Exports, goods & services 0.2 1.1 2.7 2.7 2.3 0.8 Imports, goods & services 1.3 5.2 7.2 8.1 7.6 2.3 Statistical discrepancy 0.2 0 0 0.1 0 0.1 GDP (factor cost) 4.6 3.5 5.2 4.6 4.6 4.1 Agriculture 1.6 0.4 1.5 1 1 0.9 Industry 0.4 0.4 0.4 0.4 0.4 0.4 Services 2.2 2.4 2.8 2.8 2.8 2.4 Inflation 8.3 9.9 9 7.1 6.4 6.1 Current account balance, % of GDP 4.8 3.3 4.6 5.8 3.8 2.1 Fiscal balance (Excluding grants), % of GDP -0.6 2.1 2.2 1.1 0.9 0.6 Source: GoN Statistics and WB staff projection poor who, as a group, have witnessed stagnating in- and perceptions of country risk. Though unlikely it comes and declining consumption in all occupation could lead to sporadic unrest. categories in recent years. Projections suggest a steady decline in poverty in the near term with the $1.25/day A slowdown of growth in GCC countries could im- PPP poverty incidence potentially reaching 15.6 in pact Nepal via remittances. Though lower oil prices 2016. are unlikely to affect growth in GCC and the large infrastructure projects there are expected to continue as planned, any change affecting demand for Nepali labor Challenges could have significant economic repercussions. Risks to the near term outlook stem essentially from Growth remains below what would be needed for domestic factors. After the failure of political parties Nepal to achieve the target of graduating to MIC to agree on the main parameters of a new constitution status by 2020. For this annual GDP growth would by the self-imposed deadline of January 22, there has need to reach at least 7 percent per annum. That said, been no progress and in fact greater polarization. A remittances should continue to support disposable perpetuation of the current deadlock would (i) hamper income growth and to drive down poverty incidence legislative activity, and (ii) depress investor confidence further. 58 making the most of cheap oil Pakistan Recent Development: provincial surpluses. Federal tax collection growth is positive but slightly below target due to lower infla- Helped by cheap international oil prices and steady tion and lower imported oil prices. On the expenditure implementation of its reforms program, the economy side, much of adjustments are made on investment side. has showed resilience. Despite political uncertainty in Public debt remains above the 60% of GDP, a ceiling H1-FY15 and the September 2014 floods in Punjab imposed by legislation, but on a decreasing trend. that affected agricultural crops, macroeconomic indica- Inflation is moderating. Average (12-m moving) CPI tors have improved during ongoing FY15. Supported by inflation remained in single digit, and hovering around a favorable slump in international oil prices, and stellar 6.8% by January 2015 and expected to fall to about implementation of the IMF reform program reinforced 5.5% at end FY15. Core inflation also softening. by two Bank’s Development Policy Credits at end FY14 to restructure the energy sector, foster private and finan- Pakistan’s economic growth is showing signs of sus- cial sector developments and improve social protection tained recovery despite persistent energy constraints. and revenue mobilization; growth recovery remains un- This is driven mainly by better harvest of cotton, wheat derway, with projected GDP growth now at 4.4-4.6%. and rice crops, better performance in services and posi- tive, albeit weaker than expected, manufacturing growth. The external position is fragile but improving. Exter- Nevertheless energy constraints and weak external de- nal current account deficit remains modest, at around mand continue to pose challenge for growth outlook. On 0.8% of GDP during H1-FY15 and on track to achieve the demand side, growth continues to be driven by private about 1.2% of GDP by end-FY15. This outcome is consumption supported by growing worker remittances. supported by strong workers’ remittances, which offset a chronically negative trade balance, a sustained decline in international commodity prices including oil, improved Outlook: inflows in services account. Foreign exchange reserves held by central bank are considerably higher at $10.5 The medium-term framework FY15-18 projects billion, inducing stability in foreign exchange market gradual growth recovery-cum-low inflation, sup- ported by fiscal consolidation and rebuilding of the The fiscal deficit is expected to be contained around external position. This path assumes tackling of the 5% of GDP due to improved, but below target, key growth constraints: power load-shedding, cumber- tax collection, restricted current (especially power some business environment, low access to finance and subsidies) and development expenditure, and small stable commodity prices. GDP growth is expected to Contributions to Annual GDP Growth in percent 6.0 4.0 2.0 0.0 -2.0 2007 2008 2009 2010 2011 2012 2013 2014 Final consumption Gross fixed capital formation Change in inventories Net exports GDP Growth (right axis) Source: Pakistan Economic Survey 59 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Pakistan 2012 2013 2014 2015 f 2016 f 2017 f Real gross domestic product 3.5 4.4 5.4 6.0 3.7 4.5 Private consumption 5.0 2.5 5.9 10.9 3.7 4.1 Government consumption 7.3 10.2 12.7 -10.7 4.7 3.8 Gross fixed capital investment 2.4 0.2 0.5 23.4 9.4 8.7 Change in inventories, % contrib 0.1 0.1 0.1 0.1 0.1 0.1 Statistical discrepancy (% GDP) 0.0 0.0 0.0 0.0 0.0 0.0 Exports, goods & services -15.0 13.6 -1.4 5.1 8.9 7.3 Imports, goods & services -3.1 1.6 3.7 31.8 11.8 7.3 GDP, at factor costs 3.8 3.7 4.1 4.4 4.6 4.8 Agriculture 3.6 2.9 2.1 3.0 3.1 3.3 Industry 2.5 1.4 5.8 5.7 6.1 6.3 Services 4.4 4.9 4.3 4.5 4.6 4.8 Output Gap -2.5 -1.8 -0.2 1.6 0.8 0.9 CPI Inflation , period average 11.0 7.4 8.6 5.5 5.0 5.0 Current account balance, % of GDP -2.1 -1.1 -1.3 -1.2 -1.2 -1.6 Fiscal balance, % of GDP -8.4 -8.1 -4.7 -4.6 -4.2 -4.0 Note: a. Annual percentage change, b. Fiscal balance includes grants, f = forecast Source: World Bank. recover to 5% in FY18 and onwards. On the supply (including oil) of raw materials. Export recovery and side, growth is expected to be driven by the services and strong dynamism of remittances—despite some nega- large-scale manufacturing sectors, which would benefit tive spillovers from lower oil prices in short to medium from decreased power load-shedding, improved busi- run on remittance catchment area of oil producing ness climate, and better availability of credit ensuing countries would keep financing the current account from fiscal consolidation. On the demand side growth deficit in the medium term. Official foreign exchange will be supported by strong remittances, with strength- reserves are expected to keep building from $9.2 billion ened private investment, renewed export dynamism, by the end of FY14, and projected to reach to $15.4 and to an increase in public investment. Inflation which billion (about 3.5 months of import coverage) by end is already below double digit since last two fiscal years FY15. It is expected that reserve build up will continue is expected to settle around 5% by FY16 owing to con- in medium term based on strong financial inflows. tinued fiscal prudence. Relatively steady international commodity prices and stable exchange rate are expected to help contain imported inflationary pressures. Challenges: Fiscal consolidation is expected to continue in me- The outlook is subject to downside risk. First is the dium-term on the basis of effort to raise tax revenue, prospect of an early reversal of the fall in oil prices. curtail subsidies, and while at the same time increase Second are the replication of political events of the first the spending for key public infrastructure and hu- semester that keep FDI flows and private investment man resource development. Revenues are projected low; which also affects foreign reserves, privatization to increase from 14.3% of GDP in FY14 to 15.4% in program and growth prospects. An uncertain politi- FY17 as a result a sound tax reform strategy. On the ex- cal environment undermines investor confidence and penditure side, energy-related budgeted subsidies keep depresses economic activity. Third is the continuation being reduced with power tariff adjustments, favored of a troubled domestic energy sector that continues to by the oil price windfall. The overall fiscal deficit will endure a long-due complex inheritance on its circular therefore decline from 5.5% of GDP in FY14 to 4.2% debt. Its accumulation might affect the magnitude of of GDP in FY17 and decline marginally thereafter. the fiscal deficit. In the meantime, markets seem to underplay such risks. Pakistan’s Emerging Markets The current account deficit is expected to increase Bonds Index Plus (EMBI+) risk spread keeps declining to 1.6% in FY17-- up from modest 1.2% of GDP from the high levels 1,011 basis points in March 2013 in FY15. Faster growth will require higher imports to around 525 basis points as of December 31, 2015. 60 making the most of cheap oil Sri Lanka Sri Lanka has benefited from a peace dividend since the internal conflict ended in 2009. Sustained growth has contributed to a significant reduction in poverty; yet many pockets of poverty remain. Public debt is still high, fiscal revenue is low, and the external current account is in deficit. Much needs to be done in order to attract FDI, improve external sector competitiveness and arrest declining fiscal revenues. Recent developments Contributors to GDP Growth 15.0 Percentage point contribution Focus on election and constitutional reforms has not allowed much room for clarity on economic policies: 10.0 Mr. Maithripala Sirisena emerged the victor in the January 2015 Presidential election. A cabinet minister 5.0 under the previous ten-year strongman president, Mr. 0.0 Sirisena left the governing party in late 2014 and con- tested from the opposition. After securing the victory, -5.0 he appointed a new Premier and a Cabinet mainly from the opposition that helped him to win the election. -10.0 2008 2009 2010 2011 2012 2013 Although the previous governing party still holds the Imports G&S Exports G&S majority in the parliament that could create fluid po- Domestic capital formation Consumption litical situations, it has pledged the support to the new Total demand President’s 100 day program1. The new government has Source: Central Bank of Sri Lanka announced that it would go for a parliamentary elec- tion by June 2015 to seek a fresh mandate. administered LP Gas prices and a few selected food Growth remains high thanks to a peace dividend, but items along with few rounds of reduction of taxes on it is reliant on non-tradable sectors: Average growth fuel contributed significantly to the overall reduction. stood at 7.5% for the period 2010-2013 reflecting a peace dividend and an aggressive policy thrust to- The current account deficit declined to 3.3% of GDP wards growth since the internal civil conflict ended 2014 (est) compared to 3.9% in 2013 supported by in 2009. The growth was mainly driven by non-tradable strong tourism flows. The deficit was financed by sectors and related investments. Indeed 50% of the to- Foreign Direct Investment (FDI) flows of 1.9 percent tal growth came from four non-tradable sectors during of GDP; and government borrowings were more than this period led by construction, transport and trade. The adequate to cover the remainder. Gross official reserves growth for 2014 is estimated at 7.4% y-o-y. strengthened to USD 8.2 billion, equivalent to 5.1 months of imports. The currency remained broadly Inflation remains benign mainly due to reduction stable with a marginal depreciation of 0.2 percent of administered prices on fuel and energy: Inflation against the US Dollar for 2014. decreased to 2.1% in December 2014 compared to 4.7% in December 2013 on a y-o-y basis. Annual Av- The budget deficit declined to 5.7% of GDP (est) in erage inflation which followed a declining trend for 19 2014 down from 5.9% recorded in 2013 thanks mainly consecutive months reached 3.3% in December 2014 to reduced interest cost in a low interest environment. from 6.9% in December 2013. Downward revision of The government has been reducing expenditures in the face of persistently low fiscal revenues relative to GDP. Despite the deficit; with high growth rates and low 1 This program is intended provide relief to people, investigate alleged corruption under the average interest rates on debt, public debt is expected previous regime and reform the existing powerful executive presidency. to have declined from 86.1 percent of GDP in 2009 to 61 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 75.5 percent of GDP while contingent liabilities in the year. Any upward pressure on oil prices could adversely form of treasury guarantees are estimated at 5.7 percent affect the external balance. Tightening global financial of GDP as of end 2014. conditions could lead to capital flight and debt roll-over could become expensive. Recent depreciation of Euro could affect competitiveness of exports given that Euro Outlook and risks Zone is purchasing over 30% of Sri Lanka’s exports. Growth is expected to decline to 6.9% y-o-y in 2015 due to deceleration of construction activities with Challenges the new government reassessing the investment-led growth model, partially set off by increased con- Fiscal revenue has been declining for the last decade, sumption thanks to increased public sector wages. placing Sri Lanka among the lowest levels in South Inflation is expected to remain around 3.0%, as global Asia, and below average for its income level. This commodity prices remain subdued and the taxes on key restricts the space for public investment and counter- commodities are lowered. cyclical policy. The fiscal deficit expected to narrow to 5.0% of A persistent current account deficit is linked to GDP in 2015 thanks to proposed one-time revenue structural issues in the export sector, which is in need measures. Going forward, measures are needed to in- of improved competitiveness and diversification. crease revenues to avoid widening of the deficit in the Recent growth has been driven mainly by non-tradable wake of some populist proposals increasing costs on a sectors. Going forward, it will be difficult to sustain its permanent basis for 2015 and beyond. A slowdown in high growth path without increasing growth in manu- GDP growth might reverse the decline in the public facturing and export sectors. debt-to-GDP ratio, which was largely dependent on fast GDP growth. With limited public and private national sav- ings compared to national investment, Sri Lanka The current account deficit is expected to narrow to needs to attract FDI—in order to maintain its high 1.8% of GDP in 2015, reflecting savings on petro- growth rate. However, Sri Lanka attracts less FDI leum bill. Exchange rate that came under depreciation than expected despite its geographic, education and pressure due to forex outflows in the first quarter of infrastructure advantages. With the country on course 2015 would likely to be managed using reserves in the to join upper middle income countries, concessional next few months. A planned sovereign bond and other borrowing sources are drying up and are being replaced capital flows to the government would help mitigat- by borrowings on commercial terms, which could affect ing pressures on the currency in the second half of the affordability. 2012 2013 2014e 2015f 2016f 2017f Real gross domestic product 6.3 7.3 7.4 6.9 6.6 6.5 Private consumption 6.8 3.6 7.4 6.9 6.6 6.5 Government consumption -0.6 1.5 11.0 10.5 2.6 3.2 Gross fixed capital investment 10.7 9.1 9.5 14.8 12.6 12.4 Exports, goods & services 0.2 5.9 8.6 3.2 3.0 3.1 Imports, goods & services 0.5 -0.3 10.6 11.9 7.8 8.3 GDP, at market prices 6.3 7.3 7.4 6.9 6.6 6.5 Agriculture 5.2 4.7 0.3 3.5 3.5 3.5 Industry 10.3 9.9 11.4 8.7 7.6 7.5 Services 4.6 6.4 6.5 6.5 6.5 6.4 CPI Inflation, period average 7.6 6.9 3.3 3 5.3 5.5 Current account balance, % of GDP -6.7 -3.9 -3.3 -1.8 -2.3 -2.6 Fiscal balance, % of GDP -6.5 -5.9 -5.7 -5 -6.1 -5.9 Sources: Sources: CBSL. DCS, World Bank staff forecasts; Notes: e = estimate, f = forecast; 1/ In annual percentage change percent, unless otherwise noted 62 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 South Asia at a glance AFG (1) BGD (3) BTN (6) IND (9) MDV (11) NPL (12) PAK (15) LKA (17) SAR (19) 2012 14.4 6.5 5.1 5.1 1.3 4.8 3.8 6.3 .. 2013 3.7 6.0 2.0 6.9 4.7 3.9 3.7 7.3 6.3 Real GDP Growth 2014 2.0 6.1 5.2 7.2 (p) 5.0 (est) 5.5 4.1 7.4 (est) 6.8 Q3 .. .. .. 8.1 .. .. .. 7.7 8.0 Q4 .. .. .. 7.6 .. .. .. 6.3 7.6 2012 7.2 6.5 3.4 9.7 10.7 9.4 9.7 7.5 8.5 2013 7.6 7.5 8.6 10.7 3.6 9.0 7.7 6.9 7.7 Inflation (y-o-y %) 2014 4.6 7.0 8.2 6.7 2.1 8.4 7.2 3.3 6.8 (CY) 2015 Jan 0.7 6.0 6.3 5.2 0.1 .. 3.9 3.2 3.9 2015 Feb .. 6.1 6.3 5.4 .. .. 3.2 0.6 5.4 2012 .. 103.7 88.0 96.0 .. 111.5 111.6 96.3 104.4 2013 .. 120.0 85.8 95.2 .. 111.4 107.4 98.2 102.3 REER (CY) 2014 .. 138.4 86.9 94.6 .. 112.0 116.7 100.2 109.8 2015 Jan .. 144.1 87.5 97.7 .. 121.4 122.3 103.8 118.2 2015 Feb .. 144.5 87.4 99.5 .. 121.8 123.3 101.3 118.1 2012 4.24 (2) -0.3 -21.7 -4.8 -10.6 4.8 -2.1 -6.7 -4.1 Current 2013 3.71 (2) 1.6 -26.1 -1.8 -6.5 3.3 -1.1 -3.9 -2.0 Account (% BALANCE of PAYMENTS of GDP) 2014 5.1 (2) 0.9 -25.9 -0.7 (p) -8.4 (est) 4.6 -1.2 -3.3 (est) -1.1 2015 1.3 (2) (p) -0.5 (p) -24.1 (p) -0.9 (p) -5 (p) 5.8 (p) -1.2 (f) -1.4 (p) -1.2 2012 -41.9 -8.2 (4) -31.0 (7) -10.61 (10) .. -23.5 (13) -9.5 (16) -15.8 (18) .. Trade in Balance 2013 -40.8 -5.9 (4) -29.0 (7) -7.99 (10) .. -26.8 (13) -8.8 (16) -11.6 (18) .. (% of GDP) 2014 -38.2 .. -23.0 (7) -7.02 (10) .. .. .. -10.9 (18) .. 2015 -37.0 (p) .. .. .. .. .. .. .. .. 2012 .. .. -7.1 (8) 5.9 .. 3.4 (14) 4.8 -3.9 4.9 Merchandise 2013 .. 0.8 (5) -1.8 (8) -1.4 .. 14.2 (14) 3.4 -3.3 -0.5 Import Growth (CY) 2014 .. 8.9 (5) .. 4.6 .. .. 8.3 8.1 5.9 2015 .. 12.9 (5) (p) .. .. .. .. .. .. .. 2012 .. .. -2.4 (8) 2.0 .. 1.9 (14) -1.1 -5.2 1.7 2013 .. 10.7 (5) 3.9 (8) 8.2 .. 10.3 (14) 4.8 7.7 8.3 Merchandise Export Growth 2014 .. 12 (5) .. 4.0 .. .. 0.4 8.9 4.1 (CY) Q3 .. 1.1 .. 2.2 .. .. -8.9 7.4 1.5 Q4 .. 2.3 .. 2.3 .. .. 3.1 -6.0 2.1 2012 .. 4.5 .. 7.3 1.7 .. 3.7 4.4 6.9 2013 .. 6.0 .. 7.6 1.9 .. 1.9 5.0 7.1 Reserves in Months of 2014 .. 6.4 .. 8.3 2.8 (est) .. 3.6 5.1 (est) 7.8 Import 2015 .. .. .. .. .. .. .. 6.0 (p) .. (CY) Jan .. 7.3 .. 10.5 3.6 .. 4.8 .. 9.8 Feb .. .. .. 11.3 .. .. 4.2 .. 10.3 2011 0.3 12.1 0.01 28.2 0.003 4.2 12.2 5.1 62.1 Remittances 2012 0.4 14.2 0.02 20.7 0.003 4.8 14.0 6.0 60.1 (20) (US$ billion) (CY) 2013 0.5 13.8 0.01 32.3 .. 5.6 14.6 6.4 73.3 (20) 2014 .. 14.9 .. 39.0 .. .. 17.0 7.0 78.0 (20) 64 making the most of cheap oil AFG (1) BGD (3) BTN (6) IND (9) MDV (11) NPL (12) PAK (15) LKA (17) SAR (19) 2012 -0.6 (2) -3.5 2.0 -7.2 -7.6 -0.6 -8.4 -6.5 -7.2 (21) GOVERNMENT FINANCES 2013 -0.5 (2) -3.9 -1.6 -6.8 -7.8 2.1 -8.1 -5.9 -6.9 (21) Fiscal Deficit (% of GDP) 2014 -2.5 (2) -3.7 0.6 -6.7 (p) -11.6 (est) 2.2 -4.7 -5.6 (est) -6.7 (21) 2015 -2.5 (2) (p) -3.5 (p) 0.2 (p) -6.1 (p) -8.1 (p) 1.1 (p) -4.7 (f) -4.8 (p) -6.5 (21) 2012 .. 35.1 72.2 67.7 61.7 34.3 64.3 79.2 61.0 (20) 2013 .. 35.2 89.2 66.8 63.0 31.2 61.3 78.3 63.3 (20) Public Debt to GDP (%) 2014 .. 33.9 (est) 108.1 (est) 65.1 (p) 74.6 (est) 26.3 60.3 75.6 (est) 66.8 (20) 2015 .. 32.9 (est) 117.7 (est) 63.4 (p) 75.5 (p) 24.3 (est) 63.1 (est) 71.5 (p) 68.6 (20) 2012 104.5 78.0 (4) 44.2 (7) 69.8 .. 81.8 (13) 92.9 (16) 69.6 (18) 64.2 2013 112.8 76.6 (4) 54.5 (7) 71.0 .. 83.2 (13) 92.1 (16) 66.8 (18) 64.1 Consumption (% of GDP) 2014 .. .. .. 71.8 (p) .. .. 92.5 (16) .. .. CONSUMPTION and INVESTMENT 2015 .. .. .. 72.4 (p) .. .. .. .. .. 2012 16.8 28.4 (4) 65.8 (7) 31.4 .. 20.8 (13) 15.1 (16) 28.9 (18) 28.3 2013 17.7 28.7 (4) 50.3 (7) 29.7 .. 22.6 (13) 14.6 (16) 29.2 (18) 26.6 Investment (% of GDP) 2014 .. .. .. 28.8 (p) .. .. 14.0 (16) .. .. 2015 .. .. .. 30.8 (p) .. .. .. .. .. 2012 0.1 1.7 0.02 24.0 0.5 0.1 0.7 0.9 28.2 (20) FDI (US$ billion) 2013 0.1 1.6 0.05 28.2 0.8 0.1 1.3 0.9 33.0 (20) (CY) 2014 .. .. .. 34.4 0.84 (est) 0.1 1.5 1.0 36.9 (20) 2012 0.1 0.4 .. 30.3 0.01 .. -0.1 2.1 32.8 (20) Portfolio Investment 2013 0.1 0.8 .. 7.0 -0.01 .. 0.1 2.1 10.1 (20) (US$ billion) (CY) 2014 .. .. .. 38.0 .. .. 2.7 2.0 42.7 (20) 65 s o u t h a s i a e c o n o m i c f o c u s s p r i n g 2015 Notes: est Estimate f Forecast p Projections prov Provisional CY Series for Calendar Year unless otherwise mentioned Afghanistan Source: World Bank, IMF, National Authorities and Haver 1 2013 onwards is calender year, preceding years correspond to solar year (Apr-Mar) 2 Including grants Bangladesh Source: World Bank, IMF, National Authorities and Haver 3 These numbers are for fiscal year (July-June) unless otherwise mentioned For example; for 2014 numbers, 2013-2014 values are used. 4 WB Staff Calculations 5 Fiscal Year Bhutan Source: World Bank, IMF, National Authorities and Haver 6 These numbers are for fiscal year unless otherwise mentioned (July-June). For example; for 2014 numbers, 2013-2014 values are used. 7 WB Staff Calculations 8 WDI Series, Goods and Services India Source: World Bank, IMF, National Authorities and Haver 9 These numbers are for fiscal year unless otherwise mentioned (Apr-Mar). For example; for 2014 numbers, 2014-2015 values are used. 10 WB Staff Calculations Maldives Source: World Bank, IMF, National Authorities and Haver 11 These numbers are for calendar year unless otherwise mentioned. Nepal Source: World Bank, IMF, National Authorities and Haver 12 These numbers are for fiscal year unless otherwise mentioned (16 July - 15 July). For example; for 2014 numbers, 2013-2014 values are used. 13 WB Staff Calculations 14 WDI Series, Goods and Services Pakistan Source: World Bank, IMF, National Authorities and Haver 15 These numbers are for fiscal year unless otherwise mentioned (July-June). For example; for 2014 numbers, 2013-2014 values are used. 16 WB Staff Calculations Sri Lanka Source: World Bank, IMF, National Authorities and Haver 17 These numbers are for calendar year unless otherwise mentioned. 18 WB Staff Calculations SAR Source: World Bank, IMF, National Authorities and Haver 19 These numbers are for calendar year unless otherwise mentioned. 20 WB Staff Calculations 21 Figures from World Bank GEP June 2014 66 STOCKPICTURESFOREVERYONE.COM / NITA JATAR KULKARNI 1818 H Street, N.W. Washington, DC 20433