Fiscal Deficit and External Debt Driven External ...

Fiscal Deficit and External Debt Driven External Vulnerabilities

in South Asia: A Panel Data Analysis

John V. Guria

Reserve Bank of India

Disclaimer: The views expressed in the paper are those of the author and do not represent the views of the Reserve Bank of India.

Structure of PresentationObjective and Motivation of Study

Theoretical Frameworks

Brief Review of Literature

Stylised Facts

Empirical Estimation: Frameworks, Results and Analysis

Policy Implications

Concluding Remarks

2

Objective and Motivation

Objective: • Investigate the contribution of fiscal deficits in external vulnerabilities in

South Asia

Motivation: • Most of countries have persistent fiscal and current account deficits in South

Asia

• All South Asian countries are external indebted

• Countries with high external debt are more prone to external shocks thancountries with low external debt

3

Theoretical Frameworks Linkage between fiscal and current account balances:

X – (M + R) = S – I

CAB = (Sp – Ip) + (T – G)

(where, X = Exports of goods and services; M = Imports of goods and services; R = Net current account transfers and income from abroad; S = Domestic saving; I = Domestic investment; CAB = Current account balance: Sp = Private saving; Ip = Private investment; T = Government (tax) revenue); and G = Government expenditure)

Fiscal deficit → Current account deficit → External Debt

External debt dynamics:

dt = [1 + {(r – g – ρ(1 + g) + εα(1 + r))/(1 + g + ρ + gρ)}]dt-1 – nbt

(where, d = External debt to GDP ratio; r = Interest rate on external debt; g = Real GDP growth rate; ρ = Change in

US dollar GDP deflator (inflation rate); ε = Change in exchange rate defined as US dollar per domestic currency; α= Share of domestic currency-denominated debt in total external debt; and, nb = Non-interest current account balance and non-debt creating inflows as percentage to GDP)

4

Review of Literature

Dornbusch (1984): External shocks (such as oil prices, interest rate, global recession and fall in real commodity prices) cannot be responsible by themselves for the external indebtedness and debt crises of 1980s in the three major Latin American countries, viz., Chile, Argentina, and Brazil. In his words, “these external factors only had made much more apparent and unsustainable an underlying disequilibrium in which exchange rate overvaluation and/or budget deficits were perpetuated by continuing and excessive recourse to the world capital market.”

5

Review of Literature (concld.)

World Bank (1999): In the context of East Asian financial crisis of 1990s says that the main source of external vulnerabilities of East Asia was “a rapid buildup from the late 1980s onward of risky forms of leverage on the balance sheets of financial institutions and nonfinancial corporations, in particular, short-term foreign currency debt in excess of foreign currency resources available on short notice. Mismatches between the currency and maturity of liabilities and assets made firms vulnerable to sudden swings in international investors’ confidence and to the possibility of being unable to borrow from international capital markets to roll over short-term debt or meet other current debt service obligations.”

6

Stylised Facts

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Fiscal Deficit/ GDP (Per cent) External Debt/ GDP (Per cent) (rhs)

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cent

Chart 1(b) : Bangladesh - Fiscal Deficit and External Debt

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Fiscal Deficit/ GDP (Per cent) Current Account Deficit/ GDP (Per cent)

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Chart 1(a): Bangladesh - Fiscal Deficit and Current Account Deficit

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Chart1(d): Bhutan - Fiscal Deficit and External Debt

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cent

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Fiscal Deficit/ GDP (Per cent) Current Account Deficit/ GDP (Per cent) (rhs)

Chart 1(c): Bhutan: Fiscal Deficit and Current Account Deficit

Per

cent

Per

cent

Stylised Facts (contd.)

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Chart 1(f): India - Fiscal Deficit and External debt

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Chart 1(e): India - Fiscal Deficit and Current Account Deficit

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Fiscal Deficit/ GDP (Per cent) External Debt/ GDP (Per cent) (rhs)P

er

cent

Per

cent

Chart 1(h): Maldives - Fiscal Deficit and External Debt

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Chart 1(g): Maldives - Fiscal Deficit and Current Account Deficit


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Chart 1(j): Nepal - Fiscal Deficit and External Debt

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Chart 1(i): Nepal - Fiscal Deficit and Current Account Deficit

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Chart 1(l): Pakistan - Fiscal Deficit and External Debt

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Chart 1(k): Pakistan - Fiscal Deficit and Current Account Deficit


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Chart 1(n): Sri Lanka - Fiscal Deficit and External Debt

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Fiscal Deficit/ GDP (Per cent) Current Account Deficit/ GDP (Per cent)

Per

cent

Chart 1(m): Sri Lanka - Fiscal Deficit and Current Account Deficit

Source: World Bank; IMF; State Bank of Pakistan; Nepal Rastra Bank; Author’s calculations.

Stylised Facts (contd.)India, Maldives, Nepal, Pakistan, and Sri Lanka have persistently higher

fiscal deficits than Bangladesh and Bhutan

11

Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka

Fiscal Deficit/ GDP (Per cent) 2.3 1.8 8.1 6.8 4.6 5.7 6.6

Current Account Deficit/ GDP (Per cent) 0.2 12.7 1.3 8.8 -0.6 2.5 3.8

External Debt/ GDP (Per cent) 27.0 65.1 21.8 32.4 38.0 39.0 50.0

Reserves/ Total External Debt (Per cent) 27.1 99.5 63.9 42.9 68.1 18.6 20.1

Short-term External Debt/ Reserves (Per cent) 19.6 1.6 26.8 37.4 3.8 81.0 55.8

Short-term External Debt/ Total External Debt (Per cent) 6.1 1.2 11.5 12.6 2.7 7.5 10.1

Net Foreign Assets/ GDP (Per cent) -24.2 1.4 -21.8 -46.2 -14.8 -34.1 -48.6

Debt Service Ratio (Per cent) 10.6 11.9 18.8 4.1 9.1 22.2 13.4

Key Indicators (1990-2017)

Vulnerability

Low High

Source: Author’s calculations based on data from World Bank, IMF, State Bank of Pakistan, Nepal Rastra Bank, and Lane and Milesi-Ferreti’s

“The External Wealth of Nations Mark II” database.


12


Fiscal Deficit/ GDP (Per cent) 3.4 0.7 7.1 6.6 3.8 5.3 5.9

Current Account Deficit/ GDP (Per cent) -0.6 26.4 1.3 11.8 -3.8 2.4 2.6

External Debt/ GDP (Per cent) 17.9 101.0 21.6 27.6 20.1 25.6 55.1

Reserves/ Total External Debt (Per cent) 65.5 58.4 73.6 50.1 169.0 24.3 17.1

Short-term External Debt/ Reserves (Per cent) 21.7 2.3 26.1 24.9 4.5 40.6 101.3

Short-term External Debt/ Total External Debt (Per cent) 17.1 1.1 19.0 10.0 8.1 9.4 16.5

Net Foreign Assets/ GDP (Per cent) -11.5 -41.5 -26.5 -84.3 11.4 -30.5 -55.3

Debt Service Ratio (Per cent) 5.4 13.6 13.0 3.3 8.6 18.1 22.0

Key Indicators (2013-2017)

Vulnerability

Low High

Source: Author’s calculations based on data from World Bank, IMF, State Bank of Pakistan, Nepal Rastra Bank, and Lane and Milesi-Ferreti’s“The External Wealth of Nations Mark II” database.

Empirical Frameworks

II) Regression of Current Account Deficit:

cad = f(fd, g, dep, opn, nfa)

Where,

cad = Current account deficit to GDP ratio (per cent);

fd = Fiscal deficit to GDP ratio (per cent);

g = Real GDP growth rate (per cent);

dep = Age dependency ratio (per cent);

opn = Trade openness; and

nfa = Initial (lagged) net foreign assets to GDP ratio (per cent)

13

Empirical Frameworks (concld.)

I) Regression of External Debt:

d = f(fd, g, def, r, sdd, rxr)

Where,

d = External debt to GDP ratio (per cent);

fd = Fiscal deficit to GDP ratio (per cent);

g = Real GDP growth rate (per cent);

def = Change in US dollar GDP deflator (per cent);

r = Interest rate on external debt (per cent);

sdd = Share of Short-term external debt in total external debt (per cent); and,

rxr = Real appreciation/depreciation of domestic currency

(i.e., rxr = ε – def)14

Graphical Analysis: Scatter Plots

15

R² = 0.7101

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20

25

30

35

40

-1 -1 0 1 1 2 2 3 3 4 4Fiscal Deficit/ GDP (Per cent)

Exte

rnalD

ebt/ G

DP

(P

er

cent) r = -0.843

Chart 2(b): Bangladesh - Fiscal Deficit and External debt

R² = 0.195

-3

-2

-1

0

1

2

3

-1 0 1 2 3 4

Fiscal Deficit/ GDP (Per cent)Curr

ent

Account D

eficit/ G

DP

(P

er

cent)

r = -0.442

Chart 2(a): Bangladesh - Fiscal Deficit and Current Account Deficit

R² = 0.000

0

20

40

60

80

100

120

-5 -3 -1 1 3 5 7 9 11 13 15

Exte

rnal D

ebt/ G

DP

(P

er

cent)

Fiscal Deficit/ GDP (Per cent)

r = 0.002

Chart 2(d): Bhutan - Fiscal Deficit and External Debt

R² = 0.030

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-10

0

10

20

30

40

-5 -3 -1 1 3 5 7 9 11 13 15


ent A

ccount D

eficit/ G

DP

(Per

cent) r = 0.172

Chart 2(c): Bhutan - Fiscal Deficit and Current Account Deficit


16

R² = 0.003

15

19

23

27

31

35

4 5 6 7 8 9 10 11 12Exte

rnal

Deb

t/ G

DP

(P

er c

ent)


r = -0.053

Chart 2(f): India - Fiscal Deficit and External Debt

R² = 0.155

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-1

0

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6

4 5 6 7 8 9 10 11 12

Cu

rren

t A

cco

un

t D

efic

it/

GD

P (

Per

cen

t)


r = -0.394

Chart 2(e): India - Fiscal Deficit and Current Account Deficit

R² = 0.285

0

2

4

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8

10

12

14

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20 25 30 35 40 45 50 55 60Ex

tern

al D

ebt/

GD

P (

Per

cen

t)


r = 0.534

Chart 2(h): Maldives - Fiscal Deficit and External Debt

R² = 0.001

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-10

-5

0

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10

15

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25

30

0 2 4 6 8 10 12 14 16 18 20

Curr

entA

ccountD

eficit/ G

DP

(P

er

cent)


r = 0.023

Chart 2(g): Maldives - Fiscal Deficit and Current Account Deficit


17

R² = 0.140

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25

30

35

40

45

50

55

60

0 2 4 6 8 10Exte

rnal

Deb

t/ G

DP

(P

er c

ent)


r = 0.375

Chart 2(j): Nepal - Fiscal Deficit and

External Debt

R² = 0.288

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0

2

4

6

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0 3 5 8 10


ent A

ccount D

eficit/ G

DP

(P

er

cent)

r = 0.537

Chart 2(i): Nepal - Fiscal Deficit and Current Account Deficit

R² = 0.075

20

25

30

35

40

45

50

55

60

2 3 4 5 6 7 8 9 10Ex

tern

al D

ebt/

GD

P(P

er c

ent)


r = 0.273

Chart 2(l): Pakistan - Fiscal Deficit and External Debt

R² = 0.111

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0

2

4

6

8

10

2 3 4 5 6 7 8 9 10

Curr

ent A

ccount D

eficit/ G

DP

(P

er

cent)


r = 0.334

Chart 2(k): Pakistan - Fiscal Deficit and Current Account Deficit


18

R² = 0.000

35

40

45

50

55

60

65

5 6 6 7 7 8 8 9 9

Exte

rnal

Deb

t/ G

DP

(P

er c

ent)


r = -0.015

Chart 2(n): Sri Lanka - Fiscal Deficit and External Debt

R² = 0.008

0

2

3

5

6

8

9

5 6 6 7 7 8 8 9 9


ent A

ccount D

eficit/ G

DP

(P

er

cent)

r = -0.090

Chart 2(m): Sri Lanka - Fiscal Deficit and Current Account Deficit

Source: Author’s calculations based on data from World Bank, IMF, State Bank of Pakistan, and Nepal Rastra Bank.

Estimation: Results and Analysis (1)

19

Table 1: Regressions: Dependent Variable - Current Account Deficit (cad)

Pooled Fixed

Effects System-

GMM

cad(-1) 0.67*** 0.55*** 0.53***

fd 0.23 0.39* 0.47***

g 0.01 0.03 -0.07

dep -0.04 -0.07 -0.13**

opn 0.08*** 0.04 0.08

nfa(-1) 0.02 -0.02 0.05

Constant -0.14 2.04 6.48

R2 0.61

Within R2 0.44

Between R2 0.80

Overall R2 0.56

Arellano-Bond test AR(1) (p-value) 0.15


Countries 7 7 7

Observations 189 189 189

***, **, and * indicate significance level of 1 per cent, 5 per cent, and 10 per cent, respectively. Note: Robust standard errors were calculated for all regression models.

Source: Author’s estimates.

Estimation: Results and Analysis (2)

20

Table 2: Regressions: Dependent Variable - External Debt (d)

Pooled Fixed Effects

System-GMM

d(-1) 1.02*** 0.95*** 1.04***

fd -0.20 0.07 -0.16

g -0.17 -0.19** -0.23***

def -0.22*** -0.21*** -0.30***

r 0.31 0.40** 0.42

sdd 0.15** 0.19*** 0.41***

rxr -0.18 -0.15* -0.13

Constant -1.26 -0.40 -3.80*

R2 0.94

Within R2 0.87

Between R2 0.99

Overall R2 0.93



Countries 7 7 7

Observations 189 189 189

***, **, and * indicate significance level of 1 per cent, 5 per cent, and 10 per cent, respectively. Note: Robust standard errors were calculated for all regression models. Source: Author’s estimates.

Sensitivity Analysis

21

Table 3: Sensitivity Analysis of GMM

Robustness of Regressions of Current Account Deficit (cad)

cad(-1) 0.55***

fd 0.49***

g 0.16

dep -0.14*

opn 0.08

nfa(-1) 0.05

g2 -0.02

Constant 6.40



Countries 7

Observations 189

***, **, and * indicate significance level of 1 per cent, 5 per cent, and 10 per cent, respectively. Note: Robust standard errors were calculated for the regression model. Source: Author’s estimates.

Table 4: Sensitivity Analysis of System-GMM

Robustness of Regressions of External Debt (d)

I II

d(-1) 1.04*** 0.99***

fd -0.15 -0.07

g -0.21** -0.25***

def -0.30*** -0.20*

r 0.44 0.28

sdd 0.42***

rxr -0.13 -0.04

g2 0.00

str 0.04

Constant -4.00 0.55

Arellano-Bond test AR(1) (p-value) 0.14 0.11

Arellano-Bond test AR(2) (p-value) 0.44 0.33

Countries 7 7

Observations 189 189

***, **, and * indicate significance level of 1 per cent, 5 per cent, and 10 per cent, respectively. Note: Robust standard errors were calculated for all regression models.

Source: Author’s estimates.

Why no association between fiscal deficits and external debt despite “twin deficits” in South Asia?

22

0.0

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40.0

60.0

80.0

100.0


Net Equity Inflows Net Debt Inflows

Chart 3(a): Composition of Capital Inflows (Percentage share)

(1990-2017)

0.0

20.0

40.0

60.0

80.0

100.0


Non-concessional Debt/ Total External Debt (Per cent) Concessional Debt/ Total External Debt (Per cent)

Chart 3(b): Concessional Debt/ Total External Debt (Per cent)

(1990-2017)

Source: IMF; Author’s calculations. Source: World Bank; Author’s calculations.

Policy Implications

▪ Fiscal discipline – Fiscal consolidation (prudent fiscal management) – Implication for sustainable current account deficit/balance

▪ Reserves accumulation – Benefits [Qian and Steiner (2017)]: • Insurance and liquidity buffers against external shocks and financial crises

• Induces foreign capital inflows that reduce the vulnerability in the times of sudden stops or capital reversals

• Increases share of long-term external debt in total external debt, making the economy more resilient to shocks

• Enhances financial stability

▪ Real growth enhancing policies

▪ Preference of equity flows over debt flows

▪ Preference of stable flows over volatile flows

▪ Preference of long-term debt over short-term debt

▪ Productive utilisation of FDI – Enhancing exports earnings and debt repayment capacity

23

Concluding RemarksSri Lanka has lower reserves cover for total and short-term external debt, and

higher debt service ratio; while, Pakistan has lower reserves cover for total external debt and higher debt service ratio

The study finds “twin deficits” problem in South AsiaHowever, fiscal deficit does not significantly contribute in external vulnerabilities

in South Asia through external debtEquity capital inflows play important role in financing current account deficit in

Maldives, India, Pakistan, and Bangladesh; However, debt inflows are in form of concessional debt in all countries (except India), resulting in no significant association between fiscal deficit and external indebtedness in South Asia

Given the developmental needs of South Asian countries, current account deficit and external debt are not problems as long as they are sustainable

Policies should aim at increasing reserves cover for short-term and total external debt, real GDP growth, exports/ current account receipts, preferring equity flows over debt flows, long-term debt over short-term debt, stable flows over volatile flows, and productive utilization of FDI

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Thank You!

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Fiscal Deficit and External Debt Driven External ...

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