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Time for South Asia to deal with fiscal weaknesses

Annette Dixon's picture
South Asia Economic Focus Spring 2016 Fading Tailwinds cover


There’s a lot of good news in the World Bank’s latest economic report on South Asia: the region is the fastest growing in the world and its limited exposure to global economic turbulence means that its near-term prospects look good. 

The South Asia Economic Focus, released last week, sees economic growth gradually accelerating to 7.3 percent in 2017 from 7.1 percent in 2016.  South Asia’s economy has been helped by low oil prices, strong capital flows, and robust remittances from South Asians sending pay home from abroad.
 
Chart 1a

This economic growth is critical to lift hundreds of millions of people out of poverty in a region with the world’s second largest concentration of poor people.
 
Chart 1b


That’s the good news.

The bad news is that what has been boosting economic growth in South Asia is unlikely to last. In fact, there are signs that the good times may already be coming to an end. Capital flows to the region have declined and remittances from oil exporting countries have started to weaken. Fuel and food prices remain low but are unlikely to keep falling. Inflation may be creeping up.
 
Chart 2


These are the reasons why this latest World Bank report is called “Fading Tailwinds”.  Like a sailing ship driven by a strong wind, South Asia is now feeling those winds weaken. The growth forecasts the report makes may look good. But they are marked down from what we expected only a few months ago.

What does this mean for policy makers in South Asia? While the good times last, they should be looking at addressing weaknesses in their economies that could easily turn into big problems during bad times.

South Asian countries have built up solid buffers against economic turmoil by accumulating large foreign exchange reserves. They have also worked on getting their fiscal affairs in order by trimming budgets, mostly on the expenditure side. These are welcome moves because the region stands out globally as having large budget deficits and the highest levels of debt compared to the size of economies in countries. However, South Asian countries are collecting too little tax to support vital government services or needed infrastructure investments.
 
Graph 3

The report’s analysis of fiscal policy across the region suggests that governments need to find a balanced path towards fiscal consolidation. This is because putting their fiscal houses in order will affect their economies and societies in a number of ways:
  • the pace at which they address their fiscal problems will have a big impact on economic stability
  • the extent to which expenditure supports capital accumulation will matter for economic growth
  • taxes, subsidies and spending on basic services will affect equity
  • how they reduce energy subsidies and introduce carbon taxation will have implications for environmental sustainability.
Governments in South Asia should seize the opportunity to address fiscal challenges. As this new World Bank report shows, the window with strong tailwinds may be closing and reforms will be more difficult to introduce later on.
 

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