Implications of Stimulus Packages on Public Sector Fiscal Balance

At the end of 2008, 11 out of 13 reporting East Asian economies had incurred fiscal deficits—the two exceptions being Singapore and the Republic of Korea (see Table 7 [ PDF 26.6KB | 1 page ]). None of these deficits can be considered particularly serious—the highest was Malaysia's deficit of 4.8% of its GDP, and only four of the deficits were higher than those in 2007. In comparison, all 13 East Asian economies are expected to post fiscal deficits in 2009. In six of these cases, the projected deficits are 5% or more, and all of these may rise further if aggregate output continues to lag and more public spending is implemented.

Some countries could face difficulties in financing their fiscal stimulus because they had persistent fiscal deficits prior to the crisis. However, the mere existence of fiscal deficits does not necessarily indicate that there is a problem. Fiscal imbalances must be viewed in conjunction with other macroeconomic targets such as output growth, inflation, balance of payments, and currency stability. An economy that has such an imbalance but shows no sign of over-heating or financing difficulties cannot be considered to be troublesome. Whether these deficits are rising or falling is also of great interest, especially for investors who are always on the lookout for falling interest rates and strengthening exchange rates.

Another important factor in assessing the desirability of fiscal deficits is the prevailing level of public debt. International Monetary Fund studies have found that the higher the level of public debt, the lower the effectiveness of fiscal policy and vice versa. This is intuitive given the fact that the crowding out effect is more likely to be greater at high rather than low levels of debt. The ability to service external debt and holdings of foreign reserves is another common indicator of fiscal sustainability. Economies that have internationally tradable currencies are also more likely to have fiscal deficits than those that do not.

In short, fiscal deficits must be viewed against the entire backdrop of economic data and not just in isolation. More importantly, it is critical to note that economies do not all have identical capacities to run such deficits. In general, East Asian countries have relatively low public debt (Table 8 [ PDF 57.4KB | 1 page ]). Countries like Japan can regularly incur deficits of over 6% because of their other inherent financial strengths such as their strong export revenues and profitable private sectors, while those like Indonesia cannot. The PRC can add fiscal stimulus equal to 13% of its GDP and still end up running a deficit of only around 3.5%. The PRC's ability to finance this is not in question because of its strong exports and accumulated foreign reserves. The same, however, is not true of Cambodia.

The central issue, therefore, is how East Asian economies are able to finance an increasing amount of infrastructure spending, and the resulting fiscal deficits, in ways that are considered to be wholly prudent and productive. The case of Thailand and Viet Nam is a good illustration of this challenge. If a country has a high public debt the additional public spending could be seen as undesirable and lead to the disinvestment, capital flight, and currency instability that has afflicted many countries in the developing world in the past. Financing of the fiscal deficit should not be confined to macroeconomic policies. The development of domestic private sector and financial institutions also has a vital role to play.

Recessions have an immediate impact on a government's fiscal position through automatic stabilizers, other non-discretionary effects such as lower commodity prices, and discretionary fiscal stimulus. The weakening economic conditions affect the automatic stabilizers, which are computed on the basis of changes in the output gap, and negatively impact the fiscal position. The International Monetary Fund (2009) estimated that a uniform 1% point of GDP worsening in the Group of Twenty economies translates into a 0.3% GDP increase in the fiscal deficit. In fact, the report also estimated that the emerging countries of the Group of Twenty will have a deficit of 1.1% of their GDP in 2009, compared to 0.1% surplus in 2008. The non-discretionary effects will come through lower tax revenues as private sector profits decline. The discretionary responses to the crisis can have either a temporary or a permanent effect. Most of the discretionary measures responding to the crisis are for infrastructure projects or specific transfers to help the lower income groups, and they have no permanent effects on the fiscal balance. Only a few countries have introduced measures such as tax cuts that permanently reduce the government revenue capacity. As such, the overall medium- and long-term impact of the present response measures has not adversely affected the fiscal position of East Asia.

In the case of Malaysia, policy has been deliberately made conservative by ensuring that a major part of the financing requirements comes from internally-generated funds and that there is not a high reliance on external borrowings. Debt service ratios have therefore tended to be modest, and the government has further actively managed external debt by using opportunities of currency strength to prepay or retire foreign loans. Malaysia has also worked to ensure that there is no excessive build-up of short-term debt, which is risky, and that there are strong efforts to attract foreign direct investment.

One way to finance these fiscal stimuli is to utilize funding from domestic resources, and the experience of Malaysia is worthy of note. In the 1990s, Malaysia's privatization policy was pursued in earnest meaning that the government was able to earn revenue from asset sales, while transferring much of the responsibility and the development and operating costs to the private sector. Initially, privatization agreements had to be made appealing in order to ensure adequate private sector participation. Subsequent to this, and with a more developed private sector, the government has been able to pursue private finance initiatives, which are more stringent performance-based arrangements and more along the lines of public–private partnerships.

The capital market is another important source from which to raise funds. The development of Malaysia's capital market over the past 25 years has been an integral component of its ability to finance public infrastructure. As in most developing economies, the market for long-term funding was originally dominated by government securities, with equity issues playing only a small role. As the economy became more sophisticated and with more privatized infrastructure projects in the pipeline, the market for equities and private debt securities emerged and grew rapidly. This has enabled fiscal policy to be pursued more efficiently than would otherwise have been the case.

Given that not all economies have the same ability to sustain and finance fiscal deficits, any regional infrastructure financing arrangement would seem to need to provide access to a source of internationally traded currencies on both competitive and concessionary terms. During the Asian Financial Crisis of 1998, for example, Japan's “New Miyazawa Initiative” provided useful and timely funding for the affected countries. A total of US$30 billion was made available—US$15 billion for medium- to long-term financial needs for economic recovery, while the other US$15 billion was for short-term capital needs during the process of implementing economic reforms. Likewise, the Japan International Cooperation Agency's assistance of over JPY120 billion given to Indonesia in 2008–2009 has provided important economic growth stimulus at a critical time.

Countries that have the ability, however, should be able to draw on financing sources on a more flexible and efficient basis. It would be particularly helpful if the financing arrangement could be tailored to meet two particular needs of infrastructure. The first of these is duration mismatch or the difference between the period of investment (which in the case of infrastructure is typically long) and the period when financing is available. The second is the need to hedge currency risks or the potential losses between the home currency and the currency in which the financing is denominated. Financing arrangements that are able to assist in resolving these two problems would greatly enhance the viability and sustainability of infrastructure projects and would help in financing the higher fiscal deficits that will be incurred.

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