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© 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 21 20 19 18 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions

This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) http://creativecommons.org/licenses/by/3.0/igo. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Please cite the work as follows: World Bank. 2018. Budget Crunch. South Asia Economic Focus (October), Washington, DC: World Bank. Doi: 10.1596/978-1-4648-1369-6. License: Creative Commons Attribution CC BY 3.0 IGO Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. Adaptations—If you create an adaptation of this work, please add the following disclaimer along with the attribution: This is an adaptation of an original work by The World Bank. Views and opinions expressed in the adaptation are the sole responsibility of the author or authors of the adaptation and are not endorsed by The World Bank. Third-party content—The World Bank does not necessarily own each component of the content contained within the work. The World Bank therefore does not warrant that the use of any third-party-owned individual component or part contained in the work will not infringe on the rights of those third parties. The risk of claims resulting from such infringement rests solely with you. If you wish to re-use a component of the work, it is your responsibility to determine whether permission is needed for that re-use and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. ISBN (electronic): 978-1-4648-1369-6 DOI: 10.1596/978-1-4648-1369-6 Cover photo: World Bank and JohnnyGreig/istock Design: Alejandro Espinosa/sonideas

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SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18

his report is a joint product of the Office of the Chief Economist for the South Asia Region (SARCE) and the Macroeconomics, Trade and Investment Global Practice (MTI). Its preparation was led by Robert Beyer (Economist) under the oversight of Martin Rama (Chief Economist, South Asia Region) in close collaboration with Manuela Francisco (Practice Manager, MTI). Substantive contributions were made by Milagros Chocce, Ishita Dugar, Lazar Milivojevic and Rucheta Singh (in alphabetical order, all SARCE). The report greatly benefitted from inputs from Temel Taskin and other colleagues in the Development Economics Prospects Group (DECPG) under the supervision of Ayhan Kose (Director DECPG). We are very grateful for comments and suggestions provided by Enrique Blanco Armas, Poonam Gupta, Zahid Hussain, Fernando Gabriel Im, Taehyun Lee, Mona Prasad, Aurelien Kruse, Florian Blum, and Adnan Ashraf Ghumman (all MTI), as well as to Prof. Ila Patnaik (National Institute of Public Finance and Policy, Delhi), Martin Melecky (Finance, Competitiveness and Innovation Global Practice), and to Fan Zhang (SARCE). Colleagues providing information for country briefs include Mona Prasad, Tobias Akhtar Haque, Taehyun Lee, Zahid Hussain, Shegufta Shahriar, Afroza Alam, Nazmus Sadat Khan, Yoichiro Ishihara, Aurelien Kruse, Rangeet Ghosh, Fernando Gabriel Im, Kishan Abeygunawardana, Roshan Darshan Bajracharya, Kene Ezemenari, Enrique Blanco Armas, Adnan Ashraf Ghumman under supervision of Manuela Francisco (Practice Manager, MTI). Alejandro Espinosa at Sonideas signed responsible for the layout, design and typesetting, Alexander Ferguson (Senior Manager, South Asia External Communications) and Yann Doignon coordinated the dissemination, Gonzalo Alberto Villamizar De La Rosa created accompanying videos, and Neelam Chowdhry provided valuable administrative support. South Asia as used in this report includes Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The cutoff date for this report was October 1, 2018.

South Asia Chief Economist Office Macroeconomics, Trade and Investment Global Practice

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Table of Contents

Recent economic developments

A generally positive picture

Five tensions to watch

A turbulent external environment

South Asia economic outlook

Budget crunch

Limited room for maneuver

Amplification of boom-and-bust cycles

A build-up of liabilities

A fiscal â€œreadingâ€? of development challenges

Summing up

South Asia country briefs

South Asia at a glance

SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8

CRS PHOTO / Shutterstock.com

Recent economic developments

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

outh Asia remains the fastest-growing region in the world and its performance has strengthened further, with growth rates exceeding 7 percent in Bangladesh, India and Maldives. Inflation remains near or below targets, but it has picked up in some countries. The external environment, while remaining conducive, has become more turbulent. Monetary policy is being adjusted accordingly, but fiscal policy is not equally responsive and fiscal deficits remain large. Despite strong demand from advanced economies and considerable depreciation of domestic currencies, imports are still growing stronger than exports in most countries. International reserves remain comfortable in most cases, but they are generally declining. Rising oil prices add further pressure on South Asiaâ€™s high current account deficits.

A generally positive picture Global growth has stabilized at a relatively high level and is particularly strong in the United States, a key export destination for the region. The world has been growing above 3 percent since the second quarter of 2017. Growth in the United States accelerated to 2.6 percent in the first quarter of this year and further to 2.9 in the second quarter, roughly twice the growth rate of two years ago. In other OECD countries, on the other hand,

growth has been decelerating since the third quarter of 2017 and was only 2 percent in the second quarter of 2018. Developing countries grew by 5 percent during the first half of this year. In a positive development for the region, remittances are holding well or are even increasing. Remittances are an important source of foreign reserves and a key contributor to domestic demand and poverty reduction in several South Asian countries. With many South Asian migrants working in Gulf countries, remittances are

Figure 1: Growth has plateaued at the global level but is accelerating in the US. Real GDP growth

Percent change, y-o-y 6 5 4 3 2 1 0

2016 Q3

2016 Q4

Developing countries Source: World Bank and staff calculations.

2017 Q1

2017 Q2

United States

2017 Q3

World

2017 Q4

2018 Q1

2018 Q2

OECD (excluding United States)

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

Figure 2: Remittances are holding well or are even increasing. Remittance flows

Percent change, y-o-y 40 30 20 10 0 -10 -20 -30 2016 Q3

2016 Q4

2017 Q1

Bangladesh

India

2017 Q2

2017 Q3

Nepal

2017 Q4

Pakistan

2018 Q1

2018 Q2

Sri Lanka

Source: Haver Analytics and staff calculations.

sensitive to international oil prices. Their amount had decreased substantially after oil prices dropped in 2015 and remained low throughout 2016, but it is now recovering. Over the last year, the flow of remittances has increased strongly in Bangladesh and India. In the second quarter of this year, remittances to these two countries were 18 percent and 28 percent higher than a year earlier, respectively. In Pakistan and Sri Lanka, on the other hand, remittances are nearly at the same level as one year ago. In this conducive environment, South Asia remains the fastest-growing region in the world, and the gap with East Asia has even widened. Growth in South

Asia increased for five consecutive quarters – from 5.5 percent in the second quarter of 2017 to 8.1 percent in the second quarter of 2018. Meanwhile, growth in East Asia and the Pacific – the other leading region – slightly decreased in the second quarter of 2018, to 6.4 percent. Elsewhere the moderation is sharper. Growth in Sub-Saharan Africa decreased from 2.6 percent in the last quarter of 2017 to 1.7 percent in the second quarter of 2018. Growth in Latin America and the Caribbean decreased to 1.8 percent and 1.6 percent in the last two quarters. In the Middle East and North Africa, growth decreased from 5.1 percent in the third quarter of 2017 to 2.4 percent in the second quarter of this year.

Figure 3: South Asia is consolidating its position as the fastest-growing region. Regional real GDP growth Percent change, y-o-y 14 12 10 8 6 4 2 0 -2

2016 Q3

2016 Q4

2017 Q1

2017 Q2

2017 Q3

2017 Q4

2018 Q1

2018 Q2

East Asia and Paciﬁc

Europe and Central Asia

Middle East and North Africa

Sub-Saharan Africa

Latin America and the Caribbean

South Asia

Source: World Bank and staff calculations.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

Figure 4: Except for Afghanistan, growth rates are relatively strong and stable. Real GDP growth Percent 8

0 Afghanistan (CY)

Bangladesh (FY)

Bhutan (FY)

India (FY)

2016

Maldives (CY)

2017

2018 (f)

Nepal (FY)

Pakistan (FY, factor prices)

Sri Lanka (CY)

Note: (f) = forecast, CY = calendar year, FY = fiscal year. Afghanistan, Maldives and Sri Lanka are in calendar years. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. Source: World Bank.

Growth rates differ across South Asian countries, but they are substantial in most cases and have been quite stable over time. Due to its size, India drives regional performance. Its growth rate has been steadily increasing since the second quarter of 2017, offsetting a decline that had lasted for five quarters. From 5.6 percent back then, the growth rate has climbed to 8.2 percent in the second quarter of this year. Growth performance improved in other South Asian countries as well. In Bangladesh, the growth rate is officially reported to have reached 7.9 percent in FY 2017/18, driven by consumption and public investment. In Maldives, growth is projected to reach 8.0 percent this year thanks to strong dynamism in tourism and construction. In Pakistan growth accelerated to 5.8 percent during FY 2017/18, and in Sri Lanka it is projected to reach 3.9 percent this year. Elsewhere, economic growth has slowed down. In Nepal it had been exceptionally strong in FY 2016/17, due to reconstruction efforts after the 2015 earthquakes, and moderated to 6.3 percent last fiscal year. In Bhutan, growth is decelerating as the investment into hydropower construction is decreasing due to major projects nearing completion. Growth in Afghanistan remains the lowest in South Asia, by far, and is projected to decrease to 2.4 percent this year. Stock markets have been relatively stable across South Asia, and especially strong in India. Across the developing world, the appreciation of the US dollar and concerns about the normalization of monetary policy in advanced economies took a toll on share prices. But despite the growing turbulence in international markets, declines have been more muted in South Asia. The stock market in Bangladesh peaked at the beginning of 2018, and since then has decreased by over 10 percent. Similarly, in Sri Lanka, the stock market index fell by 10 percent from January to September. In both cases the

stock market is below the level of one year ago, closer to the level of Spring 2017. But in Pakistan the Karachi Stock Exchange has been hovering around 40,000 over the last year, despite concerns about the countryâ€™s macroeconomic situation. And in India, the stock market declined somewhat at the beginning of the year but started increasing again around April and remains higher than one year ago.

Five tensions to watch Growth is strong, but not driven by exports or manufacturing Domestic consumption has been the main contributor to economic growth across the region, with exports or investment being remarkably subdued. In Bangladesh, private and government consumption contributed 8.5 percentage points to growth in FY 2017/18, compared to only 3.2 percentage points contributed by investment. The net effect of exports and imports decreased growth by over 4 percentage points. Similarly, in Pakistan growth was overwhelmingly driven by domestic consumption last fiscal year. In India and Sri Lanka, the contribution of investment is projected to be relatively more important in 2018, but even there the main driver remains domestic consumption. In both countries exports contribute relatively little to growth. Industrial production is holding well, but it grows slower than GDP in most countries. South Asiaâ€™s industrial production grew by only 5.4 percent in the second quarter of 2018, slightly lower than a quarter before. In India it grew by 5 percent, in Pakistan by 4.5 percent, and in Sri Lanka by only 0.6 percent. In Bangladesh industrial

5500

Source: Haver Analytics.

Mar-18 May-18 Jun-18 Jul-18 Sep-18

May-18

Jun-18

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6000

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Feb-18

Sri Lanka, Colombo Stock Exchange ASPI Dec-17

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35000 Jul-16

25000

Jul-16

4000

Jul-16

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

Figure 5: Stock markets are performing relatively well. Bangladesh, Dhaka Stock Exchange DSEX

6500

6000

5500

5000

4500

India, Bombay Stock Exchange SENSEX

40000

35000

30000

Pakistan, Karachi Stock Exchange 100

55000

50000

45000

40000

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

Figure 6: Strong growth, but not driven by exports … Contributions to growth forecasts in 2018 Percentage points 15

-5

-10

Bangladesh (FY)

India (FY)

Government consumption

Private consumption

Pakistan (FY)

Imports

Gross ﬁxed investment

Sri Lanka (CY)

Exports

Real GDP growth (percent)

Source: World Bank and staff calculations.

Figure 7: … while industrial production is generally lagging aggregate growth. Industrial production growth Percent, y-o-y 8 6 4 2 0 -2 -4

2016 Q3

2016 Q4

2017 Q1

South Asia

2017 Q2

Bangladesh

2017 Q3

India

2017 Q4

Sri Lanka

2018 Q1

2018 Q2

Pakistan

Source: World Bank and staff calculations.

production growth moderated for three consecutive quarters but is at over 10 percent still very strong. Admittedly, industrial production is a volatile indicator and changes need to be interpreted with caution, especially for individual countries. But it is safe to say that the region is not experiencing a broad-based manufacturing boom, as could be hoped for given its development level.

Inflation is close to target, but it is accelerating in some countries The strong growth performance of the region has not been accompanied by inflationary pressures so far. A

benchmark to assess inflationary pressures is to compare actual inflation rates with inflation targets. This comparison reveals whether policy makers are confronting unexpected developments on the price front and allows assessing how successful stabilization policies have been. In this respect, it is reassuring that inflation rates remain in line with the explicit or implicit inflation targets of the authorities in most South Asian countries. Across South Asia, actual inflation has been minimally below the target in September. In some countries, however, consumer prices are increasing faster than in previous years. Consumer prices in the region as a whole grew by 3.7 percent in March 2018,

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Figure 8: Headline inflation is generally close to target… Inflation and distance to policy target Percentage points 7 6 5 4 3 2 1 0 -1 -2

Bangladesh

India

Pakistan

Sri Lanka

China

Japan

Difference from inflation target

Euro Area

Inflation (Sept 2018)

Note: Sri Lanka has not yet moved to explicit inflation targeting; the target used is the center point of the Monetary Policy Consultation Clause (MPCC) of 4.7 percent. For Bangladesh inflation is from August 2018. Sources: Inflation target data is from Haver Analytics (National Authorities). Current inflation data is from Trading Economics. Distance to inflation is based on staff calculations.

Figure 9: …but headline inflation has picked up in the largest countries in the region. South Asia consumer price inflation Percent change, y-o-y 12 10 8 6 4 2

South Asia

Afghanistan Maldives

Bangladesh Nepal

Bhutan Pakistan

Sep-18

Aug-18

Jul-18

Jun-18

May-18

Apr-18

Mar-18

Feb-18

Jan-18

Dec-17

Nov-17

Oct-17

Sep-17

Aug-17

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Jun-17

May-17

Apr-17

Mar-17

Feb-17

Jan-17

Dec-16

Nov-16

Oct-16

Sep-16

Aug-16

-2

Jul-16

India Sri Lanka

Source: World Bank and staff calculations.

1.2 percentage points less than a year earlier. Regional inflation rates mask the trend because they give equal weight to all countries, and the smaller ones have been on a different trajectory. Since May 2017, the inflation rate has fallen considerably in Afghanistan and the Maldives, with both countries experiencing deflation lately. But the acceleration is visible in some of the larger countries. In Sri Lanka and Pakistan, inflation rates went up from below 4 percent in April to 5.9 percent in August. In September, however, inflation in Sri Lanka fell back to 4.3 percent driven by slower growth in food prices. And in India, inflation reached 4.9 percent in May and June but then decreased again to 3.7 percent in August and September.

External demand has improved, but trade balances remain weak Import demand in South Asia’s key markets has been strong, and South Asian currencies have generally depreciated, even more than those of other emerging economies. Total imports in the US grew by 4.0 percent last year and import growth is projected to strengthen to 5.3 percent this year. In the Euro Area, imports grew by 5.4 percent last year and are expected to continue on the same trend this year. The potential boost to South Asian exports has been amplified by currency depreciation. Over the course of 2018, all South Asian currencies

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

Figure 10: South Asian currencies are depreciatingâ€Ś US Dollar per national currency

Percent change, January to September 2018 2 0 -2 -4 -6 -8 -10 -12 -14 -16

Pakistan

Bhutan

India

Nepal

Afghanistan Sri Lanka

Bangladesh

Indonesia

China

Thailand

Vietnam

From January to July 2018 Sources: Haver Analytics and staff calculations.

Figure 11: â€Śbut the growth of exports remains lower than the growth of imports. Growth of exports

Growth of imports

-5

-15

-25

Bangladesh

India

Pakistan

Sri Lanka

Bangladesh

India

Pakistan

2018 Q2

2018 Q1

2017 Q4

2017 Q3

2017 Q2

2017 Q1

2016 Q4

2016 Q3

2018 Q2

2018 Q1

2017 Q4

2017 Q3

2017 Q2

Percent, y-o-y

2017 Q1

2016 Q4

Percent, y-o-y

2016 Q3

Sri Lanka

Note: The figures refer to merchandise exports and imports only. Source: World Bank and staff calculations.

lost ground against the USD. The trend was especially pronounced in India. The Indian Rupee fell by 14 percent since the beginning of the year. The Reserve Bank of India has smoothed out the trend, but it has not fundamentally opposed it. After a period of strong foreign exchange intervention, also Pakistan has allowed its currency to depreciate substantially. The lowest value was reached by end-July, at 129 Rupees per USD. Despite a modest rebound subsequently, there was a 10 percent depreciation compared to the beginning of the year and a 14 percent depreciation compared to one year before. Despite strong import demand and currency depreciation, export performance remains disappointing while imports are still growing rapidly. In Bangladesh and Sri Lanka, import growth accelerated in the second quarter of 2018, relative to the same period a year before. The 10.1 percent growth in imports experienced by Sri Lanka stands in sharp contrast with its 2.4 percent growth in

exports. In India and Pakistan recent nominal exchange rate depreciations have led to a depreciation of the real effective exchange rates. And indeed, in Pakistan import growth came down quite dramatically from its peak of over 30 percent in the first quarter of last year. But at 9.1 percent it is only marginally lower than the 10.4 percent growth in exports. In India, import growth moderated from over 30 percent a year ago to 6.9 percent now, and exports are growing faster than imports. But overall, South Asia does not look like an export powerhouse at this point.

External buffers are generally solid, but current account deficits are large With a few exceptions, the level of international reserves is relatively high in the region. Reserves in India and Bangladesh are at comfortable level and can cover 9.3 and 7.6 months of imports respectively. Compared to the beginning of the year, this is 0.8 months lower

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

Figure 12: The level of international reserves is comfortable in most cases… Foreign exchange reserves Months of imports 14 12 10 8 6 4

Bangladesh

India

Maldives

Pakistan

Aug-18

Jul-18

Jun-18

May-18

Apr-18

Mar-18

Feb-18

Jan-18

Dec-17

Nov-17

Oct-17

Sep-17

Aug-17

Jul-17

Jun-17

May-17

Apr-17

Mar-17

Feb-17

Jan-17

Dec-16

Nov-16

Oct-16

Sep-16

Aug-16

Jul-16

Sri Lanka

Source: World Bank.

Figure 13: … but current account deficits are sizeable. Current account balance Percent of GDP 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8

2016 Q3

2016 Q4

Bangladesh

2017 Q1

2017 Q2

India

2017 Q3

Nepal

2017 Q4

Pakistan

2018 Q1

2018 Q2

Sri Lanka

Note: Quarterly GDP for Bangladesh, Pakistan, Nepal, Afghanistan is derived from annual GDP and assumed to be constant for all four quarters. Sources: Quarterly current account data is from Trading Economics. Quarterly GDP data for India and Sri Lanka is from Haver Analytics.

for India and 0.5 months higher for Bangladesh. In Sri Lanka reserves increased by over USD 1 billion due to the issuance of a USD 2.5 billion bond that marked the country’s return to the US capital market. With a coverage of 5.0 months of imports, the level of reserves is now prudent. Not all countries have such substantial buffers,

however. In Maldives reserves are increasing but cover less than 3 months of imports. And in Pakistan a weaker macroeconomic situation and a delayed adjustment of the exchange rate led to considerable loss of reserves, bringing coverage down to 1.5 months of imports by end-September 2018.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

However, current account deficits have been growing across most of South Asia and buffers are being eroded in some cases. In Sri Lanka, the deficit bottomed out at the end of 2016, but the balance has remained negative since then and was still 1.9 percent of GDP in the third quarter of 2017. In India, the current account has been in a deficit since 2004 and amounted to 2.2 percent of GDP in the second quarter of this year. In Bangladesh, the current account was in surplus during most of 2016, but it declined from plus 1.0 percent of GDP in the third quarter of 2016 to minus 3.9 percent of GDP in the second quarter of 2018. The sharpest deterioration was in Pakistan, with the current account deficit worsening from USD 220 million the first quarter of 2016 to USD

5.80 billion in the second quarter of 2018. The growth of imports is partly the result of capital goods imports for the China Pakistan Economic Corridor (CPEC), but it is also the consequence of growing macroeconomic imbalances.

Monetary policy is responsive, but fiscal policy less so Monetary authorities are responding to the inflationary signs, as well as to growing exchange rate pressures. Nepal is the only South Asian country that has left the policy rate unchanged for the last couple of years, at 7 percent. Pakistan began to raise its

Figure 14: Monetary policy is adjusting to rising inflation and external pressure… Ofﬁcial interest rate (policy instrument/base rate) Repo rate (EOP, percent) 10 9 8 7 6 5

Bangladesh

India

Nepal

Pakistan

Sep-18

Aug-18

Jul-18

Jun-18

May-18

Apr-18

Mar-18

Feb-18

Jan-18

Dec-17

Nov-17

Oct-17

Sep-17

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May-17

Apr-17

Mar-17

Feb-17

Jan-17

Dec-16

Nov-16

Oct-16

Sep-16

Aug-16

4 Jul-16

Sri Lanka

Sources: Haver Analytics and Reuters.

Figure 15: … but fiscal policy is not being equally responsive. Fiscal balance Percent of GDP 2 0 -2 -4 -6 -8 -10 -12

2016

2017

Afghanistan (CY) Maldives (CY)

Bangladesh (FY) Nepal (FY)

2018 (f)

Bhutan (FY) Pakistan (FY)

India (FY) Sri Lanka (CY)

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

policy rate in January and India in June of this year. The policy rate in Pakistan was increased from 6.3 percent in January to 8.5 percent in September to contain pressures on the exchange rate. In India, the policy rate increased from 6.0 percent in May 2018 to 6.5 percent in August 2018, in response to a pick-up in inflation. The Central Bank of Sri Lanka has left the policy rate unchanged due to the fragility of economic growth but injected liquidity in the domestic market and intervened in the foreign exchange market during September.

of GDP a year earlier and the deficit of the center being stable at 3.5 percent of GDP. Fiscal discipline is not equally strong across all Indian states.

A turbulent external environment The international price of oil has been on an upward trend, and this matters to South Asia because the region is a net oil importer. Oil prices started increasing again since January 2016, after having reached a low of 28 USD per barrel. At the beginning of this year, the price stood at 67 USD per barrel and it went up further to above 85 USD in the beginning of October. This is still much lower than before the oil price collapse of 2014 â€“ the average price of oil during the first half of 2014 was 109 USD per barrel. Nevertheless, the upward trend puts further pressure on South Asian economies.

In contrast with the responsiveness of monetary policy, fiscal policy remains expansionary across most of the region. Fiscal deficits have been traditionally large in South Asia, especially when considering the deficits of sub-national levels of government. In recent years, public expenditures grew much faster than revenue generation in several of the countries. While some countries used to display a positive budget balance, all of them have been running deficits since 2017. In Sri Lanka, the fiscal deficit is projected to reach 5.2 percent of GDP in 2018, despite a primary surplus, due to heavy interest payments. Maldives saw substantial fiscal consolidation, but its deficit is still expected to stand at 5.3 percent of GDP this year. In Nepal and Bangladesh, the fiscal deficit rose to 5.8 percent and an estimated 4.1 percent respectively in FY 2017/18. In Pakistan it reached 6.5 percent, up from 5.8 percent in the previous fiscal year. And in India it attained 6.6 percent, with state deficits improving slightly to 3.1 percent of GDP from 3.5 percent

Higher oil prices put further pressure on current accounts but may also have an indirect impact on fiscal deficits. On the positive side, with many South Asian migrants working in Gulf countries, higher oil prices raise the prospect of a sustained growth in remittances. But all countries in the region are oil importers, raising the prospect that trade balances may deteriorate further. In the past, the impacts of higher oil prices on economic activity have been relatively muted, mainly because

Figure 16: International oil prices are increasing again. Crude oil prices: Brent - Europe USD/Bbl 120

100

Source: Haver Analytics.

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SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

Figure 17: Emerging markets have become more vulnerable…

Nominal exchange rate depreciation (local currency vis-a-vis the USD)

External vulnerability

ARG

TUR

ZAF

-30

-20

ZAF

BR RUS

MEX

CHN

IND ARG BR ARG MEX 0 -10 TUR IND 0 RUS ZAF IND TUR

Current account deﬁcit (percent of GDP) 10

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50 CHN

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RUS 2016 Q1

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2018 Q1

Note: ARG=Argentina, BR=Brazil, CHN=China, IND=India, MEX=Mexico, TUR=Turkey, ZAF=South Africa. Sources: Haver Analytics, national central banks, World Bank, and staff calculations.

Figure 18: … and capital flows may not differentiate sufficiently across markets. Total portfolio flows of India and Turkey USD billion, 3-month moving average 6 4 2 0 -2 -4

Jul-18

Sep-18

May-18

Jan-18

Mar-18

Nov-17

Jul-17

Sep-17

May-17

Jan-17

Mar-17

Nov-16

Jul-16

Sep-16

May-16

Jan-16

Mar-16

Sep-15

India

Nov-15

Jul-15

Mar-15

May-15

Jan-15

Sep-14

Nov-14

Jul-14

Mar-14

May-14

Jan-14

Sep-13

Nov-13

Jul-13

Mar-13

May-13

-6 Jan-13

Turkey

Source: International Institute of Finance.

of limited pass-through to consumers. But limited passthrough leads to a loss of government revenue, either through subsidies or through lower taxation. Fiscal deficits could therefore increase even further. Contagion is another source of risk, as external vulnerabilities have increased in important emerging markets across the world. The economic situation of Argentina, Turkey, and South Africa has deteriorated considerably in recent months. In the first quarter of this year, the Argentinian Peso depreciated by over 40 percent compared to six months earlier, while the current

account deficit widened to 7.3 percent of GDP. In Turkey, the Lira depreciated by over 20 percent over the same period, and the current account widened to 5.5 percent of GDP. At 10 percent, currency depreciation was more modest in South Africa, but the current account deficit widened to 18 percent of GDP. Commentators have at times linked these developments to those in India, where the Rupee depreciated by 6 percent during this period and the current account deficit reached 2.8 percent of GDP in the first quarter of this year. The comparison is far-fetched, but the fact that it is being made highlights the risks from international turbulence.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

Figure 19: Economic shocks abroad increase bond spreads in South Asia… Change in emerging market bond spreads after Taper Tantrum and latest market correction Basis points change 140 120 100 80 60 40 20 0 -20 0

EMDEs after latest market correction

20 Days

EMDEs after Taper Tantrum

South Asia after latest market correction South Asia after Taper Tantrum

Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes only India, Pakistan and Sri Lanka. Source: JP Morgan and staff calculations.

Figure 20: … lead to considerable capital outflows in India... Change in EMDE and India portfolio flows after Taper Tantrum and latest market correction USD, billion 5 0 -5 -10 -15 -20 -25

EMDEs after latest market correction

20 Days

EMDEs after Taper Tantrum

India after latest market correction India after Taper Tantrum

Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. Source: International Institute of Finance and staff calculations.

Figure 21: … and to weaker currencies in the region. Change in currencies after Taper Tantrum and latest market correction Percent change 1 0 -1 -2 -3 -4 -5 -6 0

EMDEs after latest market correction EMDEs after Taper Tantrum

20 Days

South Asia after latest market correction South Asia after Taper Tantrum

Note: 0 = April 15, 2018 for latest market correction and 0 = May 23, 2013 for Taper Tantrum. The average for South Asia includes Bangladesh, India, Pakistan and Sri Lanka. Sources: Bloomberg, Haver Analytics, and staff calculations.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Recent economic de v elopments

Short-term capital flows to emerging economies tend to be synchronized, because they are affected by market sentiment. For example, the domestic economic situation has been different in Turkey and India, and yet the correlation coefficient between the capital flows to these two economies from 2013 onwards is a sizeable 0.64. If international investors do not differentiate sufficiently across emerging markets, an external event leading to a change of investor sentiment may result in broad-based impacts. Countries with substantial stocks of foreign portfolio investments and large current account deficits may be more vulnerable to contagion.

outflows and cause currency depreciation. In May 2013, the Federal Reserve announced that it would start reducing the quantitative easing program established after the Global Financial Crisis. This â€˜tapering talkâ€™ led to a broad-based surge in bond spreads across emerging markets. Bond spreads increased more in South Asia than in other regions. Similarly, in April 2018 the expectation that interest rates would start increasing in advanced economies led to a widespread stock market correction. In India, the only South Asian country for which daily data on portfolio flows is available, the capital outflow 40 days after the tapering talk of May 2013 amounted to USD 7.6 billion. It reached USD 6.9 billion 40 days after the stock market correction of April 2018. Outflows of this sort exert considerable pressure on exchange rates.

Experience shows that economic shocks abroad can increase bond spreads in South Asia, lead to capital

Box 1: Views from the South Asia Economic Policy Network The South Asia Economic Policy Network, launched by the office of the regional Chief Economist at the World Bank in 2017, represents an attempt to engage more strongly with thinkers and practitioners across South Asia. The objective is to nurture the exchange of ideas and to learn more systematically from local colleagues and counterparts. The network focuses broadly on macroeconomics and includes over 350 members from seven South Asian countries. Members stand out in terms of peer recognition, participation in professional conferences and research outputs. Many of them are academics at renowned universities, others are researchers in central banks and think tanks, and some are affiliated with policy-making units.

Figure 22: We asked over 350 economists from seven countries about their views. Survey among South Asia Economic Policy Network Number of experts 25

India

Bangladesh

Pakistan

Nepal

Sri Lanka

Bhutan

Undisclosed country

Source: World Bank South Asia Economic Policy Network.

As for the last two editions of this report, a short opinion survey was conducted among the members of the network for this edition of South Asia Economic Focus. The objective was to take the pulse of informed and influential experts about economic developments in their countries. The response rate exceeded 20 percent, with 84 filled-in questionnaires from 7 countries. Nearly all respondents identified themselves as academics and as macroeconomists. Three quarters of the respondents are involved in policy advising and a quarter in policy making. The expectations of network members regarding economic developments over the next six months are summarized in a single number, using so-called diffusion indices. For every indicator, a value of the diffusion index above 50 indicates that an increase is expected, whereas a value below 50 corresponds to an expected decrease. The farther away the number is from 50, the greater the consensus among network members that an important change is under way.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 R ecent economic de velopments

Based on the responses, network members do not anticipate much change in economic growth in their countries. The exception is Pakistan, where there is a strong consensus that the growth rate will decline. Network members also expect that inflation and interest rates will pick-up across all countries. In Bangladesh, imports are expected to increase strongly, while exports are expected to remain stable. In Pakistan, imports are on the contrary expected to decrease, while an increase in exports is anticipated. In all countries except Pakistan, network members foresee an increase in the fiscal deficit. Finally, there are strong views across South Asia that exchange rates will depreciate, and that financial sector stress will rise.

Figure 23: Network members expect higher inflation, interest rates and financial stress. What do you expect to happen in your country within the next six months? Diffusion index 100 90

Increase

80 70 60 50 40

Decrease

30 20 10 0

Real GDP growth Headline inflation

Interest rates

India

Imports

Pakistan

Exports

Fiscal deﬁcit

Bangladesh

Exchange rate

Others

Financial sector stress

Note: The index is calculated as follows: Index=(P1*100) + (P2*50) + (P3*0), where P1 is the proportion of responses that report that the variable is too large/overvalued/too high, P2 is the proportion of responses that report that the variable is stable, and P3 is the proportion of responses that report that the variable is too low/undervalued/too small. For the exchange rate, a value smaller than 50 signals and expected depreciation of the currency against the USD. Source: World Bank South Asia Economic Policy Network and staff calculations.

There are two stark differences between these responses and those to the last survey, conducted six months ago. First, inflationary expectations have gone up across South Asia, despite the increase of policy rates by some central banks. Second, views on Pakistan’s economic prospects have changed substantially. While in the last survey respondents still anticipated faster economic growth and larger fiscal deficits, there now is a strong majority expecting fiscal consolidation, lower current account deficits, and slower economic growth.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8

South Asia economic outlook

By singh lens / Shutterstock

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook

outh Asia is expected to remain the fastest-growing region in the world and its performance could strengthen even further. But economic growth will mainly be driven by domestic demand, not by exports. This inward orientation may sound justified at a time when there are concerns about ‘trade wars’, and financial markets have become more jittery. But import demand in the traditional destination markets for South Asian exports – the United States and Europe – will remain robust. And so far, the region has been subject only to minimal trade barriers. Therefore, South Asia’s export opportunity has not gone away. Instead of seizing it by reorienting resources towards foreign markets, especially through fiscal consolidation, countries in the region seem to be drifting toward more traditional protectionist policies. The international environment will remain conducive on the real side of the economy, but somewhat more turbulent on the financial side. Global growth is projected to reach 3.0 percent in 2019, only a slight decline from 3.1 percent in 2018. Global merchandise trade growth is expected to reach 3.9 percent in 2018, and 3.7 percent the next year. Both figures are higher than the corresponding GDP growth rates. This marks a difference with the period after the global financial crisis and suggests that there are opportunities to increase exports. But the international price of oil may remain high for a while, exerting pressure on the current accounts of oil importers, including South Asian countries. And the continued appreciation of the US dollar, together with greater nervousness in financial markets, may exert pressure on many economies.

5.6 percent next year, and to accelerate to 5.8 percent the following year. These growth forecasts are broadly in line with the expectations in June 2018.

South Asia is projected to remain the fastest-growing region in the world and its lead could consolidate further in the coming years. Mainly due to a stronger performance in India, growth in South Asia is estimated to accelerate to 6.9 percent in 2018 and to strengthen to 7.1 percent from next year onwards. Consequently, South Asia will maintain its position as the fastest-growing region. It will even extend its lead over East Asia and the Pacific, which is projected to grow at 6.1 percent next year and at 6.0 percent in 2020. Growth in the rest of the region, excluding India, is expected to remain stable at

sumption and public investment, but it is expected to slow to an average of 6.9 percent over the forecast horizon. This is due to a projected slowdown of private investment and an increase of imports.

Growth rates will be robust across most countries in South Asia, with the exception of Afghanistan. More specifically:

› Afghanistan. Growth is projected to pick up, but only to 3.2 percent by 2020. Importantly, this projection presumes a recovery of confidence after a temporary weakening due to security challenges and political uncertainty in the context of the upcoming parliamentary and presidential elections.

› Bangladesh. Growth will be strong, driven by con-

› Bhutan. Growth will accelerate with the commission-

ing of two major hydropower projects, Mangdechhu and Punatsangchhu-II. The growth rate is projected to jump from 4.6 percent in this fiscal year to 7.6 percent in FY 2019/20, before moderating again to 6.4 percent in FY 2020/21.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Economic outlook

Figure 24: Growth in South Asia is projected to accelerate slightly... Real GDP growth Percent

Latin America and Caribbean

Middle East and North Africa

Sub Saharan Africa

Europe and Central Asia

East Asia and Paciﬁc

South Asia 0

2018 (f)

2019 (f)

2020 (f)

Note: (f) = forecast. Source: World Bank.

› India. Prompted by the adoption of the Goods and Services Tax and the recapitalization of banks, growth in India is firming up and it is projected to accelerate further. Growth is expected to rise to 7.3 percent in FY 2018/19, and to 7.5 percent in the following two years, with stronger private spending and export growth as the key drivers.

› Maldives. Growth is projected at a very strong 8.0

percent this year, based on the dynamism of the construction and tourism sectors. But it is projected to decelerate in the next two years as new capital investment projects gradually begin to taper off.

› Nepal. Economic activity is set to grow on average

6 percent over the medium term. However, performance could be less impressive if the challenging transition to a federalist system affects infrastructure provision and service delivery.

› Pakistan.

Macroeconomic stabilization policies will take a toll on growth this fiscal year. GDP growth is expected to lower to 4.8 percent in FY 2018/19, reflecting a tighter fiscal and monetary policy. However, with improved macroeconomic conditions, growth could reach 5.2 percent in FY 2019/20.

› Sri Lanka. Economic growth is projected to recover from the effects of last year’s weather disruptions, which negatively impacted agriculture, and to remain around 4 percent in the next two years.

Table 1: … and changes in growth rate across countries will be minor. 2017

2018 (f)

2019 (f)

2020 (f)

Afghanistan (CY)

2.7

2.4

2.7

3.2

Bangladesh (FY)

7.3

7.9

7.0

6.8

Bhutan (FY)

5.8

4.6

7.6

6.4

India (FY)

6.7

7.3

7.5

Maldives (CY)

7.1

8.0

6.3

5.6

Nepal (FY)

7.9

6.3

5.9

6.0

Pakistan (FY, factor prices)

5.4

5.8

4.8

5.2

Sri Lanka (CY)

3.3

4.0

3.9

4.2

Note: (f) = forecast, CY = calendar year, FY = fiscal year. For Bangladesh, Nepal and Pakistan, year 2016 refers to fiscal year 2015/16. For Bhutan and India, year 2016 refers to fiscal year 2016/17. The numbers for 2018 are either estimates or forecasts. Source: World Bank.

This solid growth performance will be anchored not on private investment or exports, but rather on domestic consumption. Private consumption is expected to slightly firm and to offset the moderation in public consumption that a gradual fiscal tightening would bring about. Similarly, private investment is expected to accelerate and offset moderating public investment. The contribution of private consumption to growth is projected to rise from 4.1 this year to 4.2 percent in the next year. With an annual

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook

Figure 25: Private consumption will remain the main contributor to growth. Contributions to growth in South Asia Percentage points 10 8 6 4 2 0 -2 -4

2018 (f)

2017

Private consumption

Government consumption

2019 (f)

Gross ďŹ xed investment

Exports

2020 (f)

Imports

Real GDP growth (percent)

Source: World Bank.

growth over 7.5 percent over the forecast horizon, investment is projected to remain strong. Its contribution to growth is projected to increase from 2.4 percent this year to 2.5 percent next year. Import growth is set to decline to 6.5 percent in 2019, and to moderate further to 6.0 percent in the following year. Export growth is expected to remain at around 6 percent over the next years. Uncertainty about the external policy environment is rising and the promise of a strong South Asian trade performance is becoming elusive. Trade forecasts

have proven overly optimistic over the last few years. In January 2017, the growth of imports for the full year was forecasted at 5.1 percent, and that of exports at 5.6 percent. Over time, the projection for import growth increased, while the projected export growth decreased. Actual growth of imports in 2017 turned out to be above 6 percent, while export growth was only 4.5 percent. For this year, revisions to the January trade forecasts follow the same pattern: upwards for imports and downwards for exports. For 2019, the new projections now entail

Figure 26: The external policy environment is becoming more uncertain ... US trade and global policy uncertainty Index, 3-month moving average 400 350 300 250 200 150 100 50 0 2015 Q1

2015 Q3

2016 Q1

2016 Q3

US trade uncertainty

2017 Q1

2017 Q3

2018 Q1

2018 Q3

Global policy uncertainty

Note: The policy uncertainty is computed by Baker, Bloom, and Davis (2016). They are based on the frequency of articles in domestic newspapers mentioning economic policy uncertainty and terms related to trade policy uncertainty. Source: Bake, Bloom, and Davis (2016). Updated results are available at www.policyuncertainty.com.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Economic outlook

Figure 27: … and trade forecasts are becoming more pessimistic. Change in export forecasts for South Asia over the years

Change in import forecasts for South Asia over the years

Percent

10 9

7 6

5 4

5 2017

2018

Jan-17

2019

Jun-17

2017

Jan-18

2018

Jun-18

2019

Oct-18

Source: World Bank.

Box 2: The implications of US-China trade tensions for South Asia Since the beginning of this year, the US has imposed tariffs on a set of imports from China whose combined value is close to USD 250 billion. An initial round of tariffs affected USD 50 billion worth of imports from China, including solar panels, aircraft parts, and batteries. China retaliated with tariffs on an equal value of imports from the US, covering goods like fuel, steel products, autos, and medical equipment. In the latest development, the US government imposed an additional round of US tariffs on USD 200 billion worth of imports from China, with a near immediate reaction from China, imposing duties on USD 60 billion worth of US imports. Both countries have announced that additional tariffs are possible. South Asia has not been affected to a large extent by tariff increases. One exception is a new US tariff on certain steel and aluminum products from India. The corresponding tariff rates are 25 and 10 percent respectively. In response, India proposed to raise import duties on 30 US products ranging from motorcycles to apples and almonds. These tariffs would amount to over USD 240 million, equivalent to the steel and aluminum tariffs imposed by the US on India. However, India has deferred its plan to impose retaliatory tariffs on the US until the end of the year, in the expectation that trade talks may lead to an exception for India’s steel and aluminum products from tariffs imposed by the US.

Figure 28: Proposed and imposed tariffs – restrictive trade measures do not target the region Imports subject to new tariffs in 2018 Percent of 2017 imports

100 75 50 25 0

Imposed

Additionally proposed

US imports from China

Imposed

Additionally proposed

Imposed

Chinese imports from US

Additionally proposed

US imports from India

Sources: United States Census Bureau, National Bureau of Statistics of China, Peterson Institute of International Economics, and staff calculations.

While India has not been substantially impacted by tariff increases so far, it could be affected by two other measures by the US government. First, the US sanctions on Iran may result in higher oil prices for India, which used to be the second largest importer of oil from Iran. Crude oil imports from Iran declined sharply, from 787,000 barrels/day in July to only 50,000 barrels/day in mid-August, and they are set to decline further. Since Iran offered extremely competitive terms, India is facing a higher oil import bill in the future. Second, the US government tightened its visa regime, which may make it more difficult for Indian companies to send employees to work temporarily to the US.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Economic outlook

South Asian countries export mainly to the US and Europe, and therefore a key question is how a potential ‘trade war’ may affect import demand in these two markets. Current projections suggest that effects will be quite muted. Despite increasing tariffs, US imports are growing faster than in the last two years, and the growth of imports by the Euro Area remains stable. From this perspective, the export prospects of South Asian countries have improved, not deteriorated.

Figure 29: Import demand by advanced economies will remain strong. Import growth in advanced economies Percent 6 5 4 3 2 1 0 United States

2016

Euro Area

2017

2018 (f)

Note: (f) = forecast. Euro Area values do not include Malta and Cyprus due to data unavailability. Source: OECD.

South Asia could even benefit from the current trade dispute between the US and China through trade diversion. As the US and China increase their tariffs on each other, the prices of mutual imports increase and the demand for substitutes from other exporting economies – including South Asian countries - grows. But it will not be easy for South Asian countries to reap the benefits and currently other countries seem better prepared, especially to replace imports from the US (Freund et al. 2018). The Spring 2017 edition of this report argued that South Asia’s benefits from trade diversion may be small indeed but that they increase with the elasticity of domestic supply and the extent of export diversification (World Bank 2017). To benefit from the opportunities offered by strong import demand in the US and Europe, South Asian countries need to improve logistics, reduce red tape, and enhance competitiveness. Unfortunately, some of the policy measures recently adopted in the region to address widening current account deficits go in the opposite direction. Regulatory duties have been increased in Pakistan; import tariffs on vehicles have been raised in Sri Lanka; and India did the same on 19 products worth 13 USD billions in imports.

References: Freund, C., Ferrantino M., Maliszewska, M., Ruta, M. (2018). Impacts on Global Trade and Income of Current Trade Disputes (Number 2). MTI Practice Notes. Washington DC: The World Bank. World Bank. (2017). South Asia Economic Focus, Spring 2017 - Globalization Backlash. Washington DC: The World Bank.

stable export growth and a strong decrease of import growth. Risks to the forecasts remain tilted towards the downside. On the domestic side, vulnerabilities are being exacerbated by rising inflation and fiscal slippages. Structural reforms to address the balance sheet issues faced by the banking sector and non-financial corporates may be delayed. In addition, the region is vulnerable to political uncertainty, which may increase with upcoming

elections in some countries. Also on the downside, the security environment remains fragile in Afghanistan, while adverse weather conditions and natural disasters are frequent across the region. On the external side, the risks to watch are a further deterioration in current accounts due to higher global oil prices and increased turbulence in international capital markets. But perhaps the biggest uncertainty concerns the escalation of tariff measures between the US and China, and their possible impacts on value chains and investor sentiment.

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SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8

Budget crunch

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SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch

idening current account deficits and increased turbulence in international markets call for prudent economic policy, and fiscal discipline is at the core of prudent management. However, most South Asian countries generate low tax revenue. They also run large fiscal deficits, often amplified by economic shocks and political cycles, which limits their room to maneuver. Tax revenue increases with economic growth, but so does government expenditure. Since spending multipliers are positive, the procyclicality of spending amplifies boom-and-bust cycles instead of smoothening them. In several countries debt levels are high and hidden liabilities are a concern. Not all these patterns are present in all countries, but they combine into a specific set of challenges in each, putting fiscal matters at the core of development policy.

Limited room for maneuver Tax revenue in South Asia is generally lower than could be anticipated given the region’s level of economic development. South Asian countries are not different from other developing countries in terms of the tax instruments they use. But their tax bases are small, tax exemptions are common, and tax evasion is widespread. Some countries in the region have been making progress on these fronts. In India, the introduction of the Goods and Services Tax and the drive towards electronic payments have fostered the formalization of transactions, which should increase tax revenue in the future. By broadening the base, encouraging compliance, and fighting evasion, Nepal managed to boost its tax revenue from 8 percent of GDP in 2000 to over 20 percent today. In Sri Lanka, tighter macroeconomic management increased tax revenue by 2 percent of GDP over a short period of time. But overall, for the period 2010-17, tax revenue in the region remained below that of other developing countries with a similar income per capita, in some cases by a vast margin.

Government spending is not as low as tax revenue however, and as a result fiscal deficits are larger than in most other regions. Substantial government spending is understandable, given South Asia’s enormous development needs. But spending needs to be financed, and the alternatives to taxation – from artificially low borrowing rates to excessively high money printing – are costly too. At 4.4 percent of GDP, South Asia’s fiscal deficit is projected to be the second largest in the world this year. The only region with an even higher deficit is the Middle East and North Africa, which is still suffering from the relatively low oil prices over the last years. Fiscal deficits in several South Asian countries have been large for quite some time. The average deficit over the last three years has been around 5.5 percent in Pakistan and above 6 percent in Maldives, India, and Sri Lanka. The level of fiscal deficits is often affected by developments beyond the control of policy makers, including economic shocks. Between 1980 and 2017, South Asian countries experienced over 100 downturns in five key global and domestic variables. These key variables

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch

Figure 30: Tax revenue is generally low... Tax revenue

Percent of GDP 35 30 25 20

IND 15 10

NPL

BTN

LKA

MDV

PAK 5

BGD

AFG

0 6.5

7.5

8.5

9.5

10.5

GDP per capita (in logs, PPP adjusted) South Asian countries OECD countries Non-OECD countries Note: Values are averages from 2000 to 2017 (2016, 2015, or 2014 for some countries). The red line is a linear trend line between tax revenues and the logarithm of the per capita GDP (PPP adjusted). Source: World Bank.

Figure 31: … and fiscal deficits remain uncomfortably large. Fiscal balance forecasts for 2018 Percent of GDP 0 -1 -2 -3 -4 -5 -6 -7 -8 -9

Europe and Central Asia

Sub-Saharan Africa

East Asia and Paciﬁc

Latin America and Caribbean

South Asia

Middle East and North Africa

Source: IMF and staff calculations.

include global GDP growth, the growth of world trade, the international oil price, the level of remittances, and the country’s terms of trade. The downturns in these variables can be combined to construct an aggregate measure of the economic conditions faced by a country. During the troughs of this aggregate measure, fiscal deficits were on average 0.75 percentage points of GDP larger than two years earlier and 0.85 percentage points higher than two years later. Not surprisingly, fiscal deficits in South Asia are also amplified in times of intense political competition. Between 1990 and 2015, 39 national elections took place in Bangladesh, India, Pakistan, and Sri Lanka. Of these

contests, 20 were parliamentary elections and 19 were presidential elections. In the year before elections, the fiscal deficit rose on average by 0.5 percent of GDP. The average fiscal deficit remained high during the election year, to decrease only in subsequent years. While the pattern holds both for presidential and parliamentary elections, it is stronger for the latter. Fiscal deficits rose on average from 5.5 percent of GDP two years before a parliamentary election to 6.3 percent one year before and further to 6.4 percent in the year when the election took place. Regional experts are well aware of the influence economic and political cycles have on their countries’

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch

Figure 32: Fiscal deficits increase with adverse economic shocks. Average ﬁscal deﬁcits over downturns Percent of GDP -3.0

-2

-1

Trough of the downturn

-3.5 -4.0 -4.5 -5.0 -5.5

Global and national shocks

Global shocks

Note: The bars show the average fiscal deficit computed from 104 cycles in world GDP growth, world trade, oil prices, countries’ received remittances, and terms of trade. The cycle is defined as follows: the value of the respective variable is smaller than ‘mean - one standard deviation’ in trough, the value which precedes is smaller than the respective mean and the value which follows is bigger than the value in the trough period. The figure shows average five-year periods for all South Asian countries. Sources: Federal Reserve Bank of St. Louis, World Bank, and staff calculations.

Figure 33: Fiscal deficits increase in times of national elections. Average ﬁscal deﬁcit before and after elections Percent of GDP -5.0

-2

Election year

-1

-5.5

-6.0

-6.5

Presidential and parliamentary elections

Parliamentary elections

Note: The bars show the average fiscal deficit computed from 39 national elections between 1990 and 2015 in Bangladesh, India, Pakistan, and Sri Lanka. Of these, 19 were presidential and 20 were parliamentary elections. Sources: World Bank, National Election Commissions, and staff calculations.

Figure 34: Regional experts see deficits increasing with external shocks and national elections. How does the budget deﬁcit in your country react to a negative external shock?

How does the budget deﬁcit in your country evolve when national elections approach?

Number of responses

Increases

Stays the same

Decreases

Source: South Asia Economic Policy Network. Survey conducted for this report.

fiscal stance. In a survey conducted for this report among researchers and practitioners affiliated with the South Asia Economic Policy Network, a strong majority of respondents reported a relationship between

negative external shocks and fiscal deficits in their countries. Similarly, almost 90 percent said that fiscal deficits in their countries increased when national elections approached.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Budget C runch

Figure 35: Tax revenue responds positively to economic growth... Correlation between cyclical components of tax revenues and GDP 0.8

0.6

0.4

0.2

India

Maldives

Nepal

Bhutan

Since Global Financial Crisis

Pakistan

Sri Lanka

Bangladesh

Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations.

Figure 36: â€Ś and so does the level of public expenditures. Correlation between cyclical components of government expenditures and GDP 0.8 0.6 0.4 0.2 0 -0.2 -0.4

Bhutan

Nepal

Bangladesh

Pakistan

India

Maldives

Sri Lanka

Since Global Financial Crisis Note: Based on annual data from 1990 to 2017. Data for Maldives starts in 1995. Cyclical components are calculated as the deviation of the actual data from a trend computed using the Hedrick-Prescott filter with the standard smoothing parameter for annual data (6.25). Filled bars refer to values significant at 10 percent level. Sources: ADB, IMF, World Bank, and staff calculations.

Amplification of boomand-bust cycles From the point of view of macroeconomic stability, it would be desirable if fiscal deficits increased during economic downturns and shrank during growth accelerations. Higher public spending and lower taxes can stimulate economic activity, and therefore can be used to mitigate a downturn. In economic parlance, a countercyclical fiscal policy is desirable, because it can contribute to macroeconomic stability. By contrast, a procyclical fiscal policy may amplify boom-and-bust cycles.

to compare revenue and expenditures when growth is above or below its trend. Fluctuations around a trend are also known as cyclical components. In most countries in the region, the cyclical components of tax revenue and GDP move closely together. In India and the Maldives, for example, the correlation between the two variables is above 0.6. The conclusion is similar when analyzing the growth rates of tax revenue and GDP. The correlation between these two growth rates is statistically significant in India, Maldives, Nepal and Bhutan. The correlation between tax revenue and growth is also positive in Sri Lanka and Pakistan, but at around 0.2 it is not statistically significant.

Across South Asia, faster economic growth leads to higher tax revenue. Studies on the relationship between the fiscal stance and economic growth in advanced economies focus on changes in revenue and expenditures before and after recessions. But in a region where rapid growth is the norm, it makes more sense

When GDP growth accelerates, most governments in South Asia also tend to spend more. The cyclical components of public spending and GDP move strongly together in Bhutan, Nepal, Bangladesh, and Pakistan. Analyzing the correlation between growth rates, rather than cyclical components, yields similar results. But

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 Budget C runch

Box 3: A statistical budget ‘crunch’ Short-term tax buoyancy and spending cyclicality can be assessed by regressing the growth rate of tax revenues or government expenditure on the growth rate of GDP (Lane 2003):

In this expression, ∆ indicates the change between two consecutive years, Xit is the tax revenue or the government expenditure of country i in year t, ai is the change when growth remains on trend, and is the estimated short-term tax buoyancy or spending cyclicality. Rather than estimating this expression for every country separately, we construct a data panel for all South Asian countries and allow for the trend change ai to vary across countries (we do this by using fixed effects in the estimation). Where necessary, the estimated models include a correction for first-order serial correlation in the error term. The simple expression above concerns the short-term, not taking into consideration the possible long-run relationship between the two variables. If a cointegration relationship exists between the change in Xit and the change in GDPit, the estimation of this expression yields distorted results. To address this concern, we also employ an error-correction model, which allows a distinction between the short- and long-term relationships between fiscal variables and output. The panel error-correction model with fixed effects is estimated in the following form (Akitoby et al. 2006; Belinga et al. 2014):

where θ refers to the short-run effect, b to the long-term relationship between the variables, and g represents the rate of adjustment to the gap between the actual level of the fiscal variable considered and the level predicted by the long-term relationship. To estimate fiscal multipliers, we use a three-dimensional panel vector auto-regression (VAR) model with fixed effects. The model includes the first differences of the logarithmic values of real government expenditure (∆git), GDP (∆yit), and tax revenues (∆tit). This specification turns out to be proper, given that all the variables are unit-root processes and the hypothesis of panel cointegration between them is rejected. The estimated model has the following reduced-form: where (∆Zit) and

are matrices of the VAR model parameters.

We estimate the model with the optimal lag length determined in accordance with standard information criteria. After ensuring the stability of the model, structural shocks are identified following broadly the identification approach proposed Blanchard and Perotti (2002). The approach relies on the assumption that governments cannot change expenditures in reaction to changes in economic growth and tax revenue within the same period. Economic growth, on the other hand, is affected by changes in government expenditure and taxes contemporaneously. Originally, this approach was applied to advanced economies with quarterly data. Due to limited data availability, we implement it here with annual data. Stronger assumptions are needed for the results to be valid in this case (Beetsma et al. 2014). But it can be argued that the approach is justified, because lags in implementing fiscal policies are longer in developing countries (Diop and Ben Abdallah 2009). The contemporaneous effect of changes in economic activity on tax revenues (tax elasticity) is not estimated but is instead added exogenously from other empirical estimations. We use a tax elasticity of one, but results are robust to slightly smaller and larger elasticities. The estimation of the structural VAR model provides impulse response functions and consequently the values of fiscal multipliers. We rely mostly on World Bank data for the estimations. This is the case for GDP data for all the countries and for most of the tax revenue data. For some countries, ADB tax data goes back in time longer than World Bank data. When the correlation of the two series is very high, we use ADB tax data to extend the World Bank series backwards. For India, we compute consolidated tax revenue from IMF and Reserve Bank of India data and for Bangladesh we rely on tax revenue information from the ADB. Data on government expenditure is from the IMF. The breakdown for capital and current expenditure is from the ADB.

by this metric Pakistan’s government spending is the most procyclical in the region. A further refinement is to break down public spending into recurrent expenditures and capital expenditures. Results are similar for both components across most countries, but capital spending is much more procyclical than current spending in

Pakistan. Except for Sri Lanka, the procyclicality of public spending has increased since 2008 across South Asia. For the region as a whole, tax revenue increases proportionally with economic activity, but public spending increases more than proportionally. Statistically, a one

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Table 2: Tax buoyancy is around one, but spending is strongly procyclical. South Asia

Observations

Simple regression

Error correction model

Short-term tax buoyancy

162

1.02***

1.06***

Spending cylicality

162

1.16***

1.28**

Note: Panel regression models with fixed effects are estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Three stars mean significant at the 1 percent level, two starts at the five percent level. Sources: ADB, IMF, World Bank, and staff calculations.

Figure 37: The tax multiplier is negative but insignificant … Impulse response to an unexpected one USD increase in tax revenues 1.0

0.5

0.0

-0.5

-1.0

-1.5

Note: Unbalanced panel VAR model with four lags and fixed effects is estimated using the annual data from 1987 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations.

Figure 38: … while the expenditure multiplier is positive and significant. Impulse response to an unexpected one USD increase in government expenditure 1.2

1.0

0.8

0.6

0.4

0.2

0.0

percent increase in GDP growth translates into a one percent increase in tax revenue. In economic parlance, tax buoyancy is around one. However, for every additional percentage point of growth, public spending increases by 1.3 percentage points. Such a more-than-proportionate increase in expenditures is referred to as a voracity effect.

Considering the inverse relationship, from fiscal variables to economic activity, the tax multiplier in South Asia is insignificant but the expenditure multiplier is large. In a panel of six South Asian countries, an additional USD in tax revenue for the government, reduces growth initially by 0.3 USD. The largest negative effect is

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Figure 39: The expenditure multiplier is driven by public investment. Current and capital expenditure multipliers 1.0

0.8

0.6

0.4

0.2

Impact

Current expenditure

Peak

Capital expenditure

Cumulative (4 years)

Note: Both models are balanced panel VAR models with variables current and capital expenditure respectively, instead of the total expenditure. The model with 3 lags is estimated using the annual data from 1990 to 2017 for six South Asian countries - Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Sources: ADB, IMF, World Bank, and staff calculations.

found after four years, before the effect recedes again. After seven years, the cumulative effect on growth is minimal and not significant. The effect of public spending on economic activity, on the other hand, is positive and significant. An additional USD of government spending leads to an immediate increase in GDP of 0.3 USD. Over time, the effect builds-up and each USD of additional spending results in 0.7 USD additional GDP in the third year. In the long-run, the cumulative effect settles at 0.6 USD. The expenditure multiplier is statistically significant at the five percent level in all years. The positive impact of public spending on economic activity comes entirely from capital expenditures. The expenditure multiplier of current government spending is very small and not statistically significant. The expenditure multiplier of public investment, on the other hand, is very large and always statistically significant. On impact, an additional USD of capital expenditure by the government results in an increase of GDP by 0.6 USD. Over time, additional benefits drive up the cumulative effect close to 1 USD. The statistical estimates of the relationship between fiscal variables and growth coincide with the views of regional experts. Among the respondents to the survey conducted for this report, only around 20 percent expect an additional USD of public spending to have a negative impact on economic activity, or no impact at all. Around 40 percent expect a positive impact, but smaller than 0.3 USD. In line with the estimation results, a quarter expects an effect between 0.3 USD and 1 USD and a few expect an even stronger effect. Three

quarters of the respondents expect capital expenditure multipliers to be larger than current account multipliers. Procyclical public spending and a positive expenditure multiplier imply that fiscal policy in South Asia amplifies boom-and-bust cycles. When growth accelerates, both tax revenue and government spending increase, but spending increases more strongly than revenue. The impact of larger tax revenue on subsequent economic activity is not significant but that of larger public spending is, which further accelerates economic growth. And the reverse is true in economic downturns, with the deceleration of economic activity being amplified by fiscal policy. The analyses above, on a country-by-country basis, suggest that the amplification of boom-and-bust cycles may be severe in Pakistan and Bangladesh, and sizeable in Bhutan and Sri Lanka.

A build-up of liabilities Public debt levels are low in some South Asian countries, but remarkably high in others. Public debt in South Asia is projected to be above 55 percent of GDP this year. This average figure masks a strong heterogeneity within the region. With 7 percent of GDP, debt is extremely low in Afghanistan, where the vast majority of foreign aid is provided on grant terms. At the other end, public debt stands at very high 94 percent of GDP in Bhutan, but it is mostly driven by borrowing for commercially viable hydropower projects whose returns will bring the debt level down strongly over the next years. The debt levels of other countries lie somewhere

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Figure 40: Regional experts report that there is both tax buoyancy and procyclical spending … How do the following ﬁscal variables react to a change in economic growth in your country? Distribution of responses Tax revenue

Current public spending

Capital public spending 0

Opposite direction

Stays the same

100

Same direction

Source: South Asia Economic Policy Network. Survey conducted for this report.

Figure 41: ... they believe that the expenditure multiplier is substantial … If public expenditure in your country grows by one USD, by how much do you think output changes? Number of responses 40 30 20 10 0 Output decreases

Output growth is negligible

Output grows but by less than 0.3 USD

Output grows between 0.3 and 1 USD

Output grows by more than 1 USD

Source: South Asia Economic Policy Network. Survey conducted for this report.

Figure 42: ... and they attribute the multiplier effect entirely to capital expenditures. What kind of spending has a larger effect on output? Number of responses 70 60 50 40 30 20 10 0

Capital expenditure

Current expenditure

Both the same

Source: South Asia Economic Policy Network. Survey conducted for this report.

in between these extremes. In Nepal and Bangladesh, debt is relatively low, at 23 percent of GDP and 31 percent of GDP respectively. In the Maldives and India, debt is around 65 percent of GDP. In Pakistan it reaches 74 percent of GDP and in Sri Lanka it is close to 80 percent of GDP. These debt levels are high in international perspective.

Debt sustainability requires prudent borrowing and smaller fiscal deficits. Debt sustainability analysis jointly conducted by the World Bank and the IMF project that the public debt of most South Asian countries – measured as a fraction of GDP – will decline in the coming years. In Sri Lanka, for example, public debt is expected to fall by nearly ten percentage points by 2022. In

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Box 4: Research on spending procyclicality and multiplier effect in South Asia A vast empirical literature suggests that developing countries tend to follow procyclical fiscal policy: they increase spending (or curb taxes) in good times and cut spending (or raise taxes) during periods of recession (Gavin and Perotti 1997; Kaminsky, Reinhart and Végh 2004; Frankel, Végh and Vuletin 2013). Procyclical fiscal policy reinforces business cycles by exacerbating booms and aggravating busts. The procyclical bias in fiscal policy is arguably a reflection of two fundamental challenges faced by developing countries. These are the inability to access external finance timely and weak institutions that cannot contain overspending when growth is high. Hussain and Siddiqi (2013) analyze the cyclicality of government expenditure in six South Asian countries using data from 1980 to 2010. While they find evidence that fiscal policy was procyclical in these countries, they find no evidence that the strength or quality of political systems or institutions affects this outcome. Zakaria and Junyang (2015) discuss the cyclical properties of fiscal policy in seven South Asian economies and explore the factors responsible for fiscal cyclicality. They find strong procyclicality of government expenditure and argue that limited access to domestic and international borrowing, as well as a wider dispersion of political power, are factors contributing to procyclicality. The empirical evidence on the size of multipliers in developing countries is relatively scarce, but it suggests that multipliers are quite small. Using a Panel VAR model and quarterly data for 44 developing countries, Ilzezki, Mendoza and Végh (2012) argue that the government spending multiplier is around 0.3. They find that multipliers tend to be larger in advanced economies, in countries with fixed exchange rates, in more closed economies, and in economies with lower levels of public debt. Similarly, Huidrom et al. (2016), using an Interactive Panel VAR model and a large sample of advanced economies and developing countries, conclude that fiscal multipliers depend on fiscal positions. They find that multipliers tend to be larger when government debt and deficits are low. Using a large sample of developing countries, Kraay (2012, 2014) obtains an average government spending multiplier somewhere between 0.4 and 0.5. Hayat and Qadeer (2016) estimate fiscal multipliers for Bangladesh, India, Pakistan and Sri Lanka over the period 19822014 using a Panel VAR model. They find an initial impact close to 0.4 and a surprisingly large long-run effect. Tax multipliers, on the other hand, are statistically insignificant. Yadav et al. (2012) estimate the impact of fiscal shocks on the Indian economy using quarterly data from 1997 Q1 to 2009 Q2. They find that, on impact, unexpected changes in tax revenue have a much larger effect on GDP than unexpected changes in government spending. Jain and Kumar (2013) estimate the size of the expenditure multiplier in India at the center and state levels using annual data for the period from 1980 to 2011. The size of the multiplier for all categories of expenditure by state governments is estimated to be larger than that of the central government. Furthermore, capital spending has a higher multiplier than current spending. Depending on the model specification, the aggregate tax multiplier is found to be between 0.1 to 0.5, lower than the expenditure multiplier. Finally, Bose and Bhanumurthy (2015) present a structural macroeconomic model for the estimation of fiscal multipliers in India. Based on annual data from 1991 to 2012, they find a large capital expenditure multiplier of 2.5, a transfer payment and current spending multiplier of 1, and a tax multiplier of -1.

India, public debt is expected to decline to 63 percent by 2023. Only in Bangladesh and Maldives is the debt ratio projected to increase, but the anticipated increases are small. And without exception, the primary balance (the fiscal balance without counting interest payments) is projected to be more favorable than it is today. Debt sustainability is thus closely associated with smaller budget deficits. Some countries face substantial repayments of obligations in the coming years, and currency depreciation will increase debt service payments associated with foreign debt. In Maldives, rising debt levels are reflecting the large infrastructure investments of recent years. These investments were aimed at facilitating population consolidation around the main island and at developing the airport. Major creditors of Maldives include

China, Saudi Arabia, Abu Dhabi, and the OPEC Fund. Total external disbursements to service these debts are estimated to be USD 1.4 billion until 2021. In Pakistan, external financing needs reached USD 21.5 billion in FY 2016/17, or 7.1 percent of GDP. They are expected to increase further over the next few years, partly due to loan repayments and profit repatriation related to projects in the China-Pakistan Economic Corridor (CPEC). In Sri Lanka, more than half of the central government’s external debt stock is denominated in USD, making Sri Lanka especially vulnerable. Financing needs are projected to be around 18.6 percent of GDP in 2018 and substantial international bond repayments will fall due over the coming years. In addition to explicit public debt, the growth of hidden liabilities is an important concern. Hidden liabilities are

40 30 20

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10 0

Latin America

Sub-Saharan Africa

Middle East and

South Asia

Figure 43:and Public debt is reaching high levels in some Caribbean North frica countries.

Europe and Central Asia

East Asia and Paciﬁc

Government debt forcasts for 2018 in South Asia Percent of GDP 100 90 80 70 60 50 40 30 20 10 0

Bhutan (FY)

Sri Lanka (CY)

Pakistan (FY)

India (FY)

Maldives (CY)

Bangladesh (FY)

Nepal (FY)

Afghanistan (CY)

Source: World Bank.

Table 3: Debt sustainability requires prudent borrowing. First-year primary balance (percent of GDP)

Last-year primary balance (percent of GDP)

Annual debt space (percent)

5.9

0.1

0.2

35.8

38.5

-2.3

-1.6

4.7

2021

115.0

80.0

0.1

7.6

1.7

2018

2023

69.2

62.8

-1.8

-1.5

8.3

2017

2022

69.4

73.2

-5.7

-0.8

6.9

Nepal

2018

2022

23.2

22.0

-1.8

-1.1

2.5

Pakistan

2017

2022

69.1

60.9

-0.1

0.0

8.6

Sri Lanka

2017

2022

87.0

75.1

-0.2

2.3

6.8

Country

First-year Last-year government debt government debt (percent of GDP) (percent of GDP)

First-year

Last-year

Afghanistan

2017

2022

7.2

Bangladesh

2016

2021

Bhutan

2017

India Maldives

Note: Initial projection years range from fiscal years 2016/17 or 2017/18, depending on available DSAs. Space refers to the annual increase in nominal debt over the next four/five projection years under the baseline scenario as a share of first-year GDP. Sources: World Bank-IMF debt sustainability analysis (DSA) and staff calculations.

obligations that may end up in the government’s books not due to a deliberate borrowing decision, but rather because of a default on debt obligations outside of the government. Important sources of hidden liabilities include borrowing by state-owned enterprises and the failure of infrastructure projects involving the private sector. In South Asia, one of the main sources of hidden liabilities is the “circular debt” of distribution companies in the power sector. Other unplanned government obligations arise from overly optimistic or poorly designed Public-Private-Partnerships. Liabilities can also be hidden in the banking sector in the form of non-performing loans. The recapitalization of banks in India, for example, was already accompanied by considerable capital infusions by the Indian government.

A fiscal “reading” of development challenges The nature of fiscal issues in South Asia is intrinsically linked to the development challenges the countries in the region face. Not all the fiscal patterns described above are present in all countries in the region. Nevertheless, these patterns combine into a distinctive set of fiscal issues in each case. And these fiscal issues are very telling about the constraints each of the countries faces in its quest for greater prosperity.

› Afghanistan. Foreign aid, aimed at increasing se-

curity and fostering development, is very large relative to the size of the economy. Security spending is huge, and despite great efforts a large fraction of

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Figure 44: In Afghanistan, the level of aid-dependence is unsustainable in the long run. External/core budget and domestic revenue in Afghanistan Percent of GDP 70 60 50 40 30 20 10 0

2012

2013

2014

Domestic revenue

Aid on-budget

2015

Aid off-budget

2016

2017

Source: Islamic Republic of Afghanistan National Statistics and Information Authority.

Figure 45: In Bangladesh, the cost of energy is increasing while electricity demand is surging. Wholesale subsidies in Bangladesh Tk/kWh 7

Wholesale purchase costs

2015/16

2014/15

2013/14

2012/13

2011/12

2010/11

2009/10

Price paid by distributors

Source: International Energy Agency.

aid remains off-budget. There is a limit to how much domestic revenue can increase and there is also a limit to how much more aid donors will be willing to provide in the future. Hence, without peace bringing down security spending substantially, the fiscal situation of Afghanistan could become unsustainable.

â€ş Bangladesh. The energy mix is becoming increasing-

ly expensive, at a time when the demand for electricity is surging. Distortions in the natural gas sector are getting on the way of further exploration and

exploitation and are leading to a growing reliance on more expensive fuels. Generation costs are amplified by a dispatch that does not follow merit order and by poorly designed contracts with private electricity generating companies. Passing on the high costs to consumers is politically difficult, which results in a growing subsidy burden for the budget.

â€ş Bhutan. Exports of electricity from large hydropower

projects are an important source of government revenue, but they are lumpy. When Tala, a large dam,

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Figure 46: In Bhutan, revenue from hydropower exports is lumpy and creates instability. Domestic revenue and total expenditure in Bhutan Percent of GDP 45

Percent of GDP 15

Tala

40 10 35 5 30

Rupee crisis

Total expenditure less energy capital spending

2017/18

2016/17

2015/16

2014/15

2013/14

2012/13

2011/12

2010/11

2009/10

2008/09

2007/08

2006/07

0 2005/06

Non-tax revenue (rhs)

Note: Vertical line refers to the Tala hydropower plant getting commissioned. Source: Ministry of Finance of Bhutan.

Figure 47: In India, competitive federalism requires strong discipline in the states. Fiscal deﬁcit and resource transfer in India Percent of total reciepts

Percent of GDP 7

4 30 3 20

10 0

2011/12

2012/13

2013/14

Resource transfer from center to states

2014/15

2015/16

Fiscal deﬁcit of center (rhs)

2016/17

2017/18

Fiscal deﬁcit of states (rhs)

Source: Reserve Bank of India.

became operational in FY 2006/07, non-tax revenue surged, which created strong pressure for larger current public spending. Higher government spending fueled domestic demand and imports of consumer goods, leading to the so-called Rupee crisis a couple of years later. Without a mechanism to smooth out public spending, similar turbulence could arise as other large dams start operation.

› India. In the drive towards competitive federalism, spending decisions by state governments have

become increasingly important. But fiscal discipline is stronger at the center than it is in the states. The fiscal deficit of the center decreased from 3.9 percent of GDP in FY 2015/16 to 3.5 percent in FY 2016/17 and FY 2017/18, while that of the states increased for four consecutive years to 3.5 percent in FY 2016/17 before moderating to 3.1 percent last fiscal year. In addition, states could be a source of contingent liabilities, for example due to borrowing by unreformed utilities and due to waivers of bank debts for specific groups.

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Figure 48: In Maldives, service delivery is costly but bringing it down is expensive too. General government expenditure Percent of GDP 70

Predicted given GDP per capita, population, and being an archipelago

Maldives 30

Predicted given GDP per capita only

GDP per capita (in logs, PPP adjusted)

Note: All data is for 2016. Sources: IMF and World Bank, and staff calculations.

Figure 49: In Nepal, decentralization may make budget execution even more challenging. Actual expenditure relative to budget in Nepal Percent 0 -5 -10 -15 -20 -25 -30 -35

Current expenditure

2016/17

2015/16

2014/15

2013/14

2012/13

2011/12

2010/11

-45

2009/10

-40 2008/09

Capital expenditure

Sources: Ministry of Finance of Nepal, Finance General and Comptroller Office, and staff calculations.

â€ş Maldives. Providing universal public services is costly

when the population is scattered among remote islands with a few thousand inhabitants each. From that perspective, consolidating the population around the capital city could reduce public spending in the long run. It could also contribute to job creation and thus increase government revenue. But population consolidation requires huge infrastructure investments, hence large borrowing, in the short term. Managing

this borrowing in a way that does not compromise debt sustainability will be challenging.

â€ş Nepal. Low capacity even at the federal government level prevents full spending of the budget, especially of the capital budget. In 2016/17, for example, current spending was 16 percent lower than budgeted and capital spending was 33 percent lower than budgeted. Capacity is even lower in the provinces and local

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Figure 50: In Pakistan, a procyclical budget deficit reinforces the boom-and-bust. GDP growth and ﬁscal deﬁcit in Pakistan Percent

Percent of GDP

-2

-4

-6

-8

2000/01

2002/03

2004/05

2006/07

Procyclical ﬁscal policy

2008/09

2010/11

2012/13

GDP growth

2014/15

2016/17

-10

Fiscal balance (rhs)

Note: Grey shaded areas indicate years when the fiscal deficit widens as GDP growth accelerates, or narrows down as GDP growth decelerates. Source: World Bank.

Figure 51: In Sri Lanka, population aging will put pressure on public spending. Population 60 years and above and tax revenue in Sri Lanka

Percent of total

Percent of GDP

14 18

12 10

8 14

6 4

2 10

2006

2007

2008

2009

2010

Tax revenue

2011

2012

2013

2014

2015

2016

Population 60 years and above (rhs)

Sources: UN Population Database and World Bank.

governments. The welcome move to fiscal federalism may hence result in even stronger underspending and could end up affecting the delivery of public services in a country that really needs them.

›

Pakistan. The recent economic history of Pakistan is one of slow growth punctuated by recurrent macroeconomic adjustments, often supported by International Monetary Fund programs. Adjustment programs brought in macroeconomic stability, but often at the cost of a temporary (and often substantial) deceleration in economic activity. And once the economy was back on track, fiscal pressures mounted again,

triggering the next boom-and-bust cycle. Fiscal policy has thus amplified macroeconomic fluctuations.

› Sri Lanka. Population aging could make the country’s

generous social programs unaffordable in a not-so-distant future. Sri Lanka is the only aging society in South Asia. With older populations come higher health care costs and larger spending on public pensions. Furthermore, much job creation has been in the public sector, which puts additional pressure on expenditures. Sri Lanka thus needs to keep social programs affordable. It also needs to increase tax revenues, which until recently were steadily declining relative to GDP.

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Table 4: The region’s fiscal patterns affect countries differently.

Summing up The region’s fiscal patterns affect countries differently, but all of them face fiscal challenges. The precise nature of these challenges is related to deeper development issues that are specific to each country. But all of them face at least one of the three fiscal patterns identified, namely limited room for maneuver, the amplification of boom-and-bust cycles and the build-up of liabilities. Some of them face two of these patterns, and all three are present in Pakistan’s case. The most important reason for limited room to maneuver across the region is low revenue generation, but in some countries inadequate spending is a concern too. This challenge is shared among most countries in the region and the only exceptions may be India and Bhutan. The amplification of boom-and-bust cycles is caused by procyclical public spending which is strong in Bangladesh, Bhutan, Nepal, and Pakistan. The build-up of liabilities is a concern across South Asia but especially in India, the Maldives, Pakistan, and Sri Lanka. South Asian experts see limited room for maneuver as the biggest fiscal challenge faced by the region. In the survey conducted for this report, members of the South Asia Economic Policy Network were asked whether the fiscal patterns identified for the region as a whole were relevant in their own countries. More than 60 percent of respondents, and nearly all respondents from Pakistan and Bangladesh, saw low revenue generation as a major issue in their countries. Around a third considered that inadequate spending was a major challenge, and

Fiscal patterns Country

Limited room for maneuver

Afghanistan

√

Bangladesh

√

Amplification of boom-and-bust cycles

A build-up of liabilities

√ √

Bhutan

√

India Maldives

√

Nepal

√

Pakistan

√

Sri Lanka

√

√ √

another third was somewhat concerned about it. A majority saw the procyclicality of spending as somewhat of a challenge, but less than a quarter answered that it matters a lot. Not surprisingly, respondents from Pakistan are the most concerned about the procyclicality of public spending. Responses were similar, if somewhat weaker, for the build-up of liabilities.

Figure 52: Limited room for maneuver is seen as South Asia’s biggest fiscal challenge. Do you think your country faces the following challenges? Distribution of responses

Low revenue generation

Limited room for maneuver Inadequate spending

Ampliﬁcation of boom-and-bust cycles

Procyclicality of public spending

A build-up of liabilities

Liability build up

A lot Source: South Asia Economic Policy Network. Survey conducted for this report.

Somewhat

100

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References Akitoby, B., Clements, B., Gupta, S. and Inchauste, G. (2006). Public spending, voracity, and Wagner’s law in developing countries. European Journal of Political Economy, 22(4), 908-924. Belinga, V., Benedek, M.D., de Mooij, R.A. and Norregaard, M.J. (2014). Tax buoyancy in OECD countries (No. 14-110). International Monetary Fund Working Paper. Beetsma, R., Giuliodori, M. and Klaassen, F. (2008). The effects of public spending shocks on trade balances and budget deficits in the European Union. Journal of the European Economic Association, 6(2-3), 414-423. Blanchard, O. and Perotti, R. (2002). An empirical characterization of the dynamic effects of changes in government spending and taxes on output. Quarterly Journal of Economics, 117(4), 1329-1368. Diop, N., and Ben Abdallah, N. (2009). The dynamic effects of countercyclical fiscal stimulus on output in Tunisia (5087). World Bank Policy Research Working Paper 5087. Lane, P. R. (2003). The cyclical behaviour of fiscal policy: evidence from the OECD. Journal of Public Economics, 87(12), 2661-2675. Bose, S., and Bhanumurthy, N. R. (2015). Fiscal multipliers for India. Margin: The Journal of Applied Economic Research, 9(4), 379-401. Frankel, J. A., Vegh, C. A., and Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32-47. Gavin, M., and Perotti, R. (1997). Fiscal policy in Latin America. NBER Macroeconomics Annual, 12, 11-61. Hayat, M. A., and Qadeer, H. (2016). Size and impact of fiscal multipliers: an analysis of selected South Asian countries. Pakistan Economic and Social Review, 54(2), 205. Huidrom, R., Kose, M. A., Lim, J. J., and Ohnsorge, F. L. (2016). Do fiscal multipliers depend on fiscal positions?. World Bank Policy Research Working Paper 7724. Hussain, T., and Siddiqi, M. W. (2013). Fiscal policy, institutions and governance in selected South Asian countries. Pakistan Journal of Commerce & Social Sciences, 7(2). Ilzetzki, E., Mendoza, E. G., and Végh, C. A. (2013). How big (small?) are fiscal multipliers?. Journal of Monetary Economics, 60(2), 239-254. Jain, R., and Kumar, P. (2013). Size of government expenditure multipliers in India: a structural VAR analysis. Reserve Bank of India Working Paper Series, 7. Kaminsky, G., Reinhart, C., and Végh, C. (2004). When it rains, it pours: procyclical macropolicies and capital flows. NBER Macroeconomics Annual, 2004, 11-53. Kraay, A. (2012). How large is the government spending multiplier? Evidence from World Bank lending. The Quarterly Journal of Economics, 127(2), 829-887. Kraay, A. (2014). Government spending multipliers in developing countries: evidence from lending by official creditors. American Economic Journal: Macroeconomics, 6(4), 170-208. Yadav, S., Upadhyay, V., and Sharma, S. (2012). Impact of fiscal policy shocks on the Indian economy. Margin: The Journal of Applied Economic Research, 6(4), 415-444. Zakaria, M., and Junyang, X. (2015). The cyclicality of fiscal policy in South Asia. Argumenta Oeconomica, (1 (34)), 33-60.

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Box 5 Views from the region on fiscal policy In preparation for a new edition of this report, we convene a technical workshop with experts from the region. This time a two-day Regional Workshop on Fiscal Policy in South Asia was held in Kathmandu, Nepal. Following a broadly disseminated call for papers, this event brought together researchers and practitioners from most countries across the region. Over 60 papers were submitted, and ten of them were selected for discussion at the workshop. The selection process was run by experts from the South Asia Network on Economic Modelling (SANEM, Bangladesh), the National Institute for Public Finance and Policy (NIPFP, India), the Sustainable Development Policy Institute (SDPI, Pakistan), and the Institute of Policy Studies (IPS, Sri Lanka). The discussants of the papers included authors of related papers participating in the workshop, as well as economists from the ADB, IMF, and the World Bank. Prof. Ila Patnaik (NIPFP), a renowned expert on fiscal policy in South Asia, delivered a special lecture on fiscal cyclicality. She discussed the role of business cycles and how to measure them in emerging markets, before analyzing the procyclicality of public spending in South Asia. She argued that the high costs of postponing public spending may potentially be a defensible justification for the procyclicality of fiscal policy in developing countries. Some of the papers focused on the impacts of public spending on economic and social outcomes. Priyatharsiny Selvarasa and Sangaran Vijesandiran (both with the University of Peradeniya, Sri Lanka) analyzed the relationship between fiscal policies and social indicators. They did so by assessing the impact of public spending and taxation on the provision of infrastructure, education, and health services in Sri Lanka. Impacts of public spending on economic activity deserved special attention. Pawan Gopalakrishnan (Reserve Bank of India), Chetan Ghate (Indian Statistical Institute), Chetan Dave (New York University) and Suchismita Tarafdar (Shiv Nadar University, India) evaluated the consequences of fiscal shocks for growth using a real business cycle model of a small open economy calibrated for India. They concluded that when tax rates on capital and labor income are low, a contractionary fiscal shock has an expansionary effect on GDP. Not surprisingly, this finding was intensely debated. In a less controversial way, Iffat Anjum and Selim Raihan (both with SANEM, Bangladesh) concluded that fiscal policy has been effective in stimulating economic growth. In their paper they establish that there is bi-directional causality between economic growth and government consumption in Bangladesh. A similar relationship is found with tax revenue. Other papers dealt with the reasons for low tax revenue generation in South Asia. Vaqar Ahmed and Ahad Nazir (both with SDPI, Pakistan) identified the fragmented structure of revenue mobilization and weak capacity in the provinces as key reasons in Pakistanâ€™s case. They presented a public-private dialogue approach that in their view has helped push tax reform on the countryâ€™s political agenda. In India, the newly adopted GST broadens the tax base, harmonizes tax rates across states, and encourages formalization, but this is not without implementation costs. Bornali Bhandari (National Council of Applied Economic Research, India) and Astha Sen (Sonoma State University, USA) used detailed taxpayer surveys to gauge these costs, finding that they were high in the initial phases but decline later. According to the surveys, GST led to reduced corruption due to the digitization of the reporting system. In some South Asian countries state-owned enterprises and public utilities can indirectly affect fiscal discipline. Priti Dubey and Rishika Shankar (both with University of Delhi, India) point out that the poor performance of Central Public-Sector

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Enterprises in India can lead to a build-up of contingent liabilities and may cause a drain on public resources if they are bailed out at the expense of taxpayers. The discussion centered on the interpretation of aggregate data, and the insights detailed enterprise data can provide. Monzur Hossain, Mahbubur Rahman and Atiqur Rahman (all from Bangladesh Institute for Development Studies) used a large macro-econometric model to analyze the consequences of energy price adjustments in Bangladesh. The results suggest that price increases are inflationary and cause a decline in GDP growth. There was debate on whether a model with microeconomic foundations, with firms and consumers changing their behavior after the adjustment, would yield the same conclusion. Due to their large fiscal deficits over time, many countries in South Asia have high levels of public debt. Sima Rani Dey and Mohammed Tareque (both with the Bangladesh Institute of Governance and Management) argued that the accumulation of external debt has a negative effect on GDP growth, but that better macroeconomic policies can neutralize this effect. Ranjan Kumar Mohanty (NIPFP, India) and Sidheshwar Panda (Indian Institute for Technology) reached a similar conclusion. The workshop concluded with a public session graced by a keynote speech by Nepal’s Finance Minister, Dr. Yuba Raj Khatiwada. Minister Khatiwada offered a thorough review of the challenges posed by the transition to federalism in his Nepal and explained the steps the government is taking to address them. His talk was followed by a panel discussion attended by over one hundred guests, including representatives from think tanks, donors, civil society and the media.

Papers presented Ahad Nazir (SDPI, Pakistan) and Vaqar Ahmed (SDPI, Pakistan): National and Sub-National Tax Reforms in Pakistan: A PublicPrivate Dialogue (PPD) Approach. Astha Sen (Sonoma State University, USA) and Bornali Bhandari (NCAER, India): Lost in Transition? Case Studies Based Approach of Firm’s Compliance cost of India’s GST. Iffat Anjum (SANEM, Bangladesh) and Selim Raihan (SANEM, Bangladesh): The effectiveness of fiscal policy in stimulating private investment and growth: An Empirical Study on Bangladesh. Monzur Hossain (BIDS, Dhaka), Mahbubur Rahman (BIDS, Dhaka) and Atiqur Rahman (BIDS, Dhaka): Impact of energy price adjustments on Bangladesh economy: A macro-econometric modeling approach. Pawan Gopalakrishnan (Reserve Bank of India), Chetan Ghate (ISI, Delhi), Chetan Dave (NYU, Abu Dhabi) and Suchismita Tarafdar (Shiv Nadar University, India): Fiscal austerity in emerging market economies. Ranjan Kumar Mohanty (NIPFP, India) and Sidheswar Panda (IIT, India): How Does Public Debt affect the Indian Macro-economy? A Structural VAR Approach. Rishika Shankar (University of Delhi, India) and Priti Dubey (University of Delhi, India): Loss making public sector undertakings and their impact on fiscal deficit. Sangaran Vijesandiran (University of Peredeniya, Sri Lanka) and Priyatharsiny Selvarasa (University of Peredeniya, Sri Lanka): An Empirical Analysis of the Impact of Fiscal Policy on Human Development in Sri Lanka. Sima Rani Dey (Bangladesh Institute of Governance and Management) and Mohammed Tareque (Bangladesh Institute of Governance and Management): Debt and Growth: Role of Stable Macroeconomic Policy.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8

South Asia country briefs

Afghanistan········································ 54 Bangladesh ·······································56 Bhutan·····························································59

Maldives····················································· 63 Nepal···································································65 Pakistan······················································· 67 Sri Lanka·····················································69

CRS PHOTO / Shutterstock.com

India········································································· 61

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Afghanistan Although economic activity remains subdued, growth has accelerated gradually over 2016 and 2017 reflecting slowly recovering confidence and reform progress. Building momentum now appears to be at some risk, with declining business confidence in the context of upcoming parliamentary and presidential elections (scheduled for October 2018 and April 2019, respectively), worsening drought conditions, and an ongoing displacement crisis. Over the medium-term, Afghanistan needs to mobilize new sources of growth in the context of declining aid and stubbornly-high poverty.

2017 Population, million

35.5

GDP, current USD billion

19.6

GDP per capita, current USD

550

Source: World Bank.

Contributions to real GDP growth Percentage points 4 3 2 1 0 -1 -2

2015

2016

2017

Agriculture

2018 (f)

Industry

2019 (f)

Services

2020 (f)

2021 (f)

Real GDP growth (percent)

Note: (f) = forecast. Afghanistanâ€™s fiscal year is the calendar year. Source: World Bank.

Recent economic developments Afghanistan has experienced a slight recovery in growth since 2015, with growth accelerating slightly to 2.3 percent in 2016 and reaching 2.7 percent in 2017. Growth in 2017 was driven mostly by the services sector, which expanded by 2.6 percent in the context of recovering confidence and investment. The agricultural sector grew by 3.8 percent, with strong growth in fruit and vegetables offsetting declining wheat production in the context of an ongoing drought impacting Northern and Eastern areas. Inflation remained moderate through 2017 and has declined through 2018. Period-average inflation for 2017 was 4.7 percent, with declining domestic food prices (fruit and vegetables) and weakening prices for imported grains offsetting increased energy prices. Low inflation through 2018 (reaching -1 percent y-o-y in June) has been driven by declining food prices, with strong local production of fruit and vegetables, and steady international grain prices.

Exports grew strongly in 2017 and into 2018. In 2017 exports were 28 percent higher than in 2016, while Q1 2018 exports were up nearly 50 percent on Q1 2017 levels. Export growth has been driven by the establishment of new air corridors to India, the resolution of border issues that constrained trade with Pakistan during 2016 and continued gradual depreciation of the Afghani relative to major trading currencies. Imports also increased, however, driven by higher energy prices and increased grain imports in the context of drought-related disruption to domestic wheat production. Consequently, the merchandise trade balance widened further, from 31.6 percent of GDP to 33.6 percent of GDP. The wide trade deficit is financed by aid inflows, and the current account remains in surplus (1.6 percent of GDP at end-2017). Driven by the current account surplus, foreign exchange reserves continued to accumulate (8.2 USD billion at end-2017, more than one year of merchandise import cover). The Afghani depreciated steadily by around 4 percent against the USD during 2017 (end period) and into 2018 (6 percent depreciation against the USD in the first half of 2018), driven mostly by the general strengthening

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

of the USD but possibly reflecting capital flight in the context of election-related uncertainties.

the context of gradually declining aid, the current account surplus is expected to narrow to 0.2 percent of GDP in 2018 before moving into a slight deficit from 2019 (1.2 percent of GDP) onwards. Foreign exchange reserves are expected to remain at comfortable levels, however, at around 11 months of import cover by 2020, reflecting very large current reserves. Inflation is expected to remain moderate, with higher energy prices offset by low domestic fruit and vegetable prices. Drought is not expected to have a major impact on food prices given stable international grain prices. With flattening of recent revenue growth, a fiscal deficit of around 0.4 percent of GDP is expected in 2018.

Revenues continued to grow strongly in 2017, increasing by around 15 percent in nominal terms and exceeding budgeted levels by 5.5 percent, driven by administrative and compliance improvements. However, donor grants fell well short of budgeted levels, leading to a fiscal deficit of around 0.5 percent of GDP, even despite a 2.5 percentage decline in overall expenditure. Revenue growth has ceased in the first half of 2018, reflecting slowing economic activity and potential deterioration in governance around upcoming elections. With the population growing faster than the economy, poverty has increased significantly. A quarter of the labor force is unemployed, and 80 percent of employment is vulnerable and insecure, comprising self- or own-account employment, day labor, or unpaid work. With almost half the population below the age of 15, each year, 483,000 to 600,000 Afghans enter the working age population, most with little education and few productive employment opportunities. The impact of slow growth on poverty and livelihoods is compounded by growing insecurity, internal displacement, refugee repatriation, and declining aid. In the past, there has been little relationship between economic growth and poverty. Economic growth in Afghanistan has translated to changes in welfare to the top 20 percent of the distribution, whose consumption has increased and fallen with GDP per capita.

Risks and challenges Afghanistan faces substantial risks in the short-term arising from the possibility of political instability and violence in the context of upcoming elections. The contested 2014 presidential elections had a negative impact on confidence, investment, and governance, feeding into lower growth and revenues. A similarly disruptive election period could have a major negative impact on revenues, investment, and growth over 2018, 2019, and beyond. On the other hand, progress with a negotiated peace settlement with the Taliban could have a major positive impact on investment confidence, potentially spurring accelerated growth and improved government revenues. Over the medium-term, and in the context of expected declines in aid, economic development progress will depend on mobilizing the sectors with greatest capacity to support increased growth, job creation, exports, and government revenues. This is likely to require a balanced growth strategy, including increased investment in agricultural productivity (including through expanded irrigation), increased investment in human capital, and the realization of Afghanistanâ€™s substantial extractives potential.

Outlook Recent recovery appears increasingly vulnerable. Growth is expected to slow to 2.4 percent in 2018, in the context of election-related uncertainties and weak business confidence. Growth is expected to accelerate gradually to over 3 percent by 2020, as confidence is projected to recover. In Afghanistan macroeconomic outlook

2015

2016

2017

2018 (f)

2019 (f)

2020 (f)

Real GDP growth, at constant market prices

1.5

2.3

2.7

2.4

2.8

3.2

Real GDP growth, at constant factor prices

1.1

2.0

2.3

2.5

2.7

3.2

Agriculture

-5.7

6.0

3.8

2.0

3.0

Industry

4.2

-0.8

0.6

2.5

2.0

2.8

Services

2.1

2.0

2.6

3.3

3.5

Inflation (Consumer Price Index)

4.6

4.3

4.7

3.1

5.0

Current account balance (percent of GDP)

7.5

7.1

1.6

0.2

-1.2

-1.6

Financial and capital account (percent of GDP)

7.9

8.5

6.9

6.7

6.0

5.3

0.0

-0.1

0.0

-0.1

0.1

-0.8

0.0

-0.5

-0.4

-0.2

-0.1

Net foreign direct investment (percent of GDP) Fiscal balance (percent of GDP) Debt (percent of GDP)

9.1

7.9

7.2

6.8

6.2

6.6

Primary balance (percent of GDP)

-0.7

0.2

-0.4

-0.2

0.0

0.1

Note: (f) = forecast. Source: World Bank.

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Bangladesh Strong growth, driven by consumption and public investment, is expected to continue to support poverty reduction. Macroeconomic stability is increasingly stressed by the widening current account deficit because of a surge in imports, and accelerating inflation. Downside risks include fiscal slippages, delays in banking reforms, loss of monetary policy predictability due to diminished central bank independence and weakening reform momentum in the run-up to the elections.

2018 Population, million

166.9

GDP, current USD billion

275.8

GDP per capita, current USD

1653

Source: World Bank.

Contributions to real GDP growth Percentage points 12 10 8 6 4 2 0 -2

2008

2009

2010

Final consumption Statistical discrepancy

2011

2012

2013

2014

Gross ďŹ xed investment Real GDP growth (percent)

2015

2016

2017

2018

Net exports

Note: Bangladeshâ€™s fiscal year runs from July 1st to June 30th. Source: Bangladesh Bureau of Statistics and staff calculations.

Recent economic developments GDP growth in FY18 remained strong, underpinned by private consumption, public investment, and a recovery in ready-made garment exports. Remittances posted 17 percent increase after declining for two consecutive years. Capital machinery imports have been buoyant. Growth in agriculture was limited in the beginning of the year due to above-normal flooding, but harvests recovered subsequently. Real private investment flows increased by 9 percent over its level the previous year, notwithstanding cumbersome business regulations, substantial infrastructure deficits and mounting policy uncertainties. The competitiveness ranking improved marginally, but the Logistics Performance Index ranking slipped 13 places in 2018 relative to 2016. Progress in reducing poverty has been notable. However, recent GDP growth delivered less poverty reduction

than in the past. Close to a million Rohingya people have crossed over into Bangladesh since August 2017. Without aid, 76 percent of these displaced people would be unable to meet basic needs. The localized effects are estimated to have significantly reduced wages. Supply shocks accelerated food inflation from 6 percent in FY17 to 7.1 percent in FY18, pushing headline inflation to 5.8 percent in FY18, from 5.4 percent in FY17. Monetary growth has been below nominal GDP growth, contributing to a decline in non-food inflation. However, non-food inflation increased from its recent low of 3.5 percent in December to 4.9 percent (y-o-y) in June due to spillovers from higher commodity prices and exchange rate depreciation. Interest rates came under pressure as excess liquidity shrank due to credit growth exceeding deposit growth, tightening of the Advance-Deposit Ratio by Bangladesh Bank (BB) and high non-performing loans in the banking

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

system. In March, ceding to pressures from the Bankers Association of Bangladesh, BB reduced the Cash Reserve Ratio from 6.5 percent to 5.5 percent; the repo rate from 6.75 percent to 6.25 percent; and increased the cap on government holding of deposits in private domestic banks from 25 percent to 50 percent. With the administered rates on the National Savings Certificates unchanged at double digit levels, the deposit and lending rates remained downwardly rigid. Subsequently, the government directed commercial banks to cap the deposit rates at 6 percent and the lending rates at 9 percent. The banks are yet to comply. These developments indicate that BB autonomy has substantially eroded. The overall balance of payments swung into the largest deficit in recent memory, driven by a surge in consumer and capital machinery imports. Despite a recovery in exports, the current account deficit jumped from 0.5 percent of GDP in FY17 to 3.5 percent in FY18, driven by 25.2 percent growth in merchandize imports. BB managed the resulting pressure on the exchange rate through a combination of direct sales of foreign exchange and directing foreign exchange dealers to keep their buying and selling rates stable. The nominal taka-US dollar rate depreciated by 1.8 percent in July-August 2018 following 4 percent depreciation in FY18. Fiscal underperformance has continued. The fiscal outcomes in FY18 differed markedly from what was envisaged in the original budget. Underperformance in development spending relative to the original budget offset a revenue shortfall, thus containing the deficit at around 4 percent of GDP. Public debt increased modestly to 31.2 percent of GDP and continues at low risk of debt distress. Excessive reliance on the more expensive nonbank sources of domestic financing has continued. Consequently, interest expenditures remained high.

Outlook Output growth in FY19 is projected at 7 percent, driven by industry and services on the supply side and private consumption and investment on the demand side. Public investment will remain strong as the implementation of mega projects gains further momentum. Private investment growth will remain subdued due to structural constraints. Continued strength in imports is projected to keep net exports negative despite healthy export growth. Increased investment in manufacturing will re-energize job creation and contribute further to poverty reduction.

Inflation is projected to increase as global commodity prices pick up and an expansionary fiscal policy coupled with election-induced rise in private expenditures overheat the economy. Adherence to a tight monetary policy, announced in July, will help contain excess demand. The current account deficit is projected to narrow moderately due to sustained strong imports, owing partly to large import payments associated with foreign debt financed mega projects. The payment obligations will largely be funded by foreign debt accumulation. A large shortfall in government revenue is expected due to reduced taxes on garments and banks and lack of revenue enhancing administrative measures. Also, additional pressures on expenditures are likely due to expanded export subsidies after the budget was announced, as well as inadequate provisions for bank recapitalizations and spending associated with the Rohingya crisis. These together may widen the budget deficit.

Risks and challenges With elections approaching, a major domestic risk is the weakening of ongoing efforts to improve economic governance. Donor fatigue in providing resources to meet the needs of the Rohingya could increase pressure on the budget, while the quasi-fiscal deficit could rise with increasing international oil prices. Unfavorable weather could further slow poverty reduction among households in agriculture. Rising food inflation may dampen gains made through increased investment in industry, while exacerbating the situation for food-deficit households in agriculture. However, export demand and remittances could surprise on the upside. External imbalances and tight liquidity need to be handled urgently. Exchange rate flexibility can help BB maintain sufficient foreign exchange reserves. Timely resolution of external imbalances will also contribute to expanding liquidity in the banking system. However, efforts to reduce interest rates without reducing the NSC rates may be futile. Allowing the BB to function independently, avoiding regulatory forbearance, and strengthening banking supervision is a high priority. The potential for export-led manufacturing growth remains significant as productivity levels lag the global technological frontier. Apart from structural reforms to foster diversification of the economy, this requires putting ever-increasing emphasis on education, skills, and adaptability to rapidly changing technology.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

Bangladesh macroeconomic outlook Real GDP growth, at constant market prices

2015

2016

2017

2018

2019 (f)

2020 (f)

6.6

7.1

7.3

7.9

7.0

6.8

Private consumption

5.8

3.0

7.4

11.0

7.1

7.2

Government consumption

8.8

8.4

7.8

15.4

11.4

10.0

Gross fixed capital investment

7.1

8.9

10.1

10.5

8.9

7.8

Exports, goods and services

-2.8

2.2

-2.3

8.1

4.9

5.1

Imports, goods and services

3.2

-7.1

2.9

27.0

10.1

9.5

Real GDP growth, at constant factor prices

6.5

7.2

7.9

7.0

6.7

Agriculture

3.3

2.8

3.0

4.2

3.1

Industry

9.7

11.1

10.2

12.1

9.5

9.6

Services

5.8

6.2

6.7

6.4

6.5

5.8

Inflation (Consumer Price Index)

6.4

5.9

5.4

5.8

6.7

6.2

Current account balance (percent of GDP)

1.5

1.9

-0.5

-3.5

-3.4

-2.4

Net foreign direct investment (percent of GDP)

0.9

0.6

0.7

0.6

1.0

Fiscal balance (percent of GDP) 1/

-3.7

-3.4

-4.3

-4.6

Debt (percent of GDP)

31.8

31.5

30.6

31.2

32.6

34.2

Primary balance (percent of GDP) 1/

-1.7

-1.8

-2.6

-2.4

-2.6

Note: (f) = forecast; 1/ Including grants Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Bhutan Delays in hydropower construction lowered Bhutan’s growth rate in 2017/18 and the trend is likely to persist over the medium term. The fiscal deficit is projected to decline because of lower public capital expenditures during the initial years of the 12th five-year plan (201823). As hydropower projects contribute little to job creation, the direct impact of growth on poverty reduction is modest.

2017 Population, million

0.8

GDP, current USD billion

2.7

GDP per capita, current USD

3276

Source: World Bank.

Contributions to real GDP growth Percentage points 8 7 6 5 4 3 2 1 0

2015/16

2016/17

Agriculture

2017/18

Industry

2018/19

Services

2019/20

2020/21

Real GDP growth (percent)

Sources: National Statistics Bureau, Royal Monetary Authority, Ministry of Finance, World Bank, and staff calculations.

Recent economic developments GDP growth in 2017/18 is estimated at 5.8 percent. On the supply side, growth was driven by hydropower construction and the services sector (especially financial services, hotels and restaurants, and transportation). On the demand side, gross fixed capital formation, primarily in hydropower and government-financed infrastructure projects, supported output expansion. The Consumer Price Index remained under 3 percent in the first half of 2018, mainly due to stable non-food prices, although the Ngultrum – pegged to the Indian Rupee – depreciated slightly against the USD. The financial sector remained sound with a risk-weighted capital adequacy ratio of 14.5 percent in March 2018, above the minimum requirement of 12.5 percent. However, the gross non-performing loans (NPLs) increased to 14.6 percent in March 2018, up from 12.4 percent a

year earlier. NPLs are especially high in the services sector. To boost financial resources to strategic sectors such as cottage and small industries and agriculture, the central bank introduced the Priority Sector Lending program in early 2018. High imports due to increased government spending as well as construction of hydropower projects kept current account deficit elevated at 21.7 percent of GDP in 2017/18. The deficit was almost fully financed by loans from India. As a result, as of May 2018, gross international reserves remained comfortable at 1.1 USD billion, equivalent to 11 months of imports of goods and services. To support the last year of implementation of the 11th FYP, government spending increased. The fiscal deficit was at 4.1 percent of GDP despite an increase in tax collections to 14.3 percent of GDP in 2017/18 from 13.6 percent a year before. Public debt, including hydropower debt, remained at about 100 percent of GDP in 2017/18.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

Outlook

farming into more productive jobs will likely happen at a slow pace.

Economic growth is projected to average 6 percent a year over the medium term, largely supported by on-going hydropower projects and the services sector, especially tourism. However, downside risks to growth remain, particularly from the delay in the completion of two mega hydropower projects. With the completion of the Mangdechhu hydro project in late 2018, exports are likely to increase while imports will decline because of lower public capital spending. This will help narrow the current account deficit to 12 percent of GDP by 2020/21 and reduce external debt to 87 percent. Lower capital spending during the first few years of the new 12th FYP is expected to bring the fiscal deficit to below 3 percent of GDP during the forecast period. As the hydropower projects contribute little to direct job creation, the impact of growth on poverty reduction is expected to be modest. Low-productivity agricultural activities still account for nearly 60 percent of employment and with limited private sector development, the transition out of Bhutan macroeconomic outlook Real GDP growth, at constant market prices Private consumption

2015

Risks and challenges There are four key risks facing the Bhutanese economy: (a) given the size of hydropower projects relative to the size of the economy, any further delays in hydropower construction will negatively affect the economy through lower exports and revenues; (b) donor financing in Bhutan is getting scarce while domestic debt markets are not yet developed (limited financing sources could constrain government spending and negatively affect future growth and development); (c) the ongoing 2018 general election could lead to policy uncertainty which could impact growth and investment; and (d) adverse weather events could negatively impact the economy through lower electricity generation from existing hydropower plants and lower tourist traffic. Longer-term challenges center on boosting dynamism and job creation in the private sector. 2016

2017

2018 (e)

2019 (f)

2020 (f)

7.3

7.4

5.8

4.6

7.6

6.4

3.4

3.7

-2.0

0.8

10.8

9.6

Government consumption

7.3

4.6

8.5

6.1

6.0

4.9

Gross fixed capital investment

14.1

7.2

1.8

-1.3

4.2

-0.1

Exports, goods and services

-2.7

-2.0

-1.4

-2.0

0.2

4.4

Imports, goods and services

3.4

-2.4

-10.3

-10.5

1.7

0.4

Real GDP growth, at constant factor prices

7.8

7.5

5.9

5.0

7.4

6.2

Agriculture

4.3

3.9

4.5

3.7

2.7

Industry

7.5

5.7

5.4

5.1

4.4

2.1

Services

9.2

10.7

6.7

5.1

11.9

11.0

Inflation (Consumer Price Index) Current account balance (percent of GDP)

3.3

4.3

5.0

-29.3

-24.7

-21.7

-17.8

-13.3

-12.2

Net foreign direct investment (percent of GDP)

0.4

-0.6

1.0

1.1

1.5

1.6

Fiscal balance (percent of GDP)

-1.1

-1.2

-4.1

-3.0

-1.9

-2.6

Debt (percent of GDP)

90.6

104.2

97.9

93.6

87.9

87.5

Primary balance (percent of GDP)

0.5

0.3

-2.9

-1.6

-0.4

-0.8

Note: (e) = estimate; (f) = forecast. Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

India The economy appears to have recovered from the temporary disruptions caused by demonetization and the introduction of the GST: growth reached 6.7 percent in FY17/18, with a significant acceleration in recent months. However, domestic risks and a less benign external environment impact the macroeconomic outlook.

2017 Population, million

13417.0

GDP, current USD billion

2600.8

GDP per capita, current USD

1938

Source: World Bank.

Contributions to real GDP growth Percentage points 10 8 6 4 2 0 -2 -4

2011

2012

2013

2014

2015

Final consumption

Gross ﬁxed capital formation

Other

Real GDP growth (percent)

2016

2017

2018 (e)

Net exports

Note: (e) = estimate; India’s fiscal year runs from April 1st to March 31st. Source: Indian Central Statistics office and staff calculations.

Recent economic developments The economy has recovered from the ‘twin shocks’ of demonetization and GST introduction. GDP growth is estimated at 6.7 for FY17/18, with an acceleration to 7.4 percent in the second half. On the production side, the turnaround in the second half was led by manufacturing (that grew at 8.8 percent vs. 2.7 percent in the first half). Agriculture growth improved, and services growth held steady at 7.7 percent. On the demand side, the pick-up in growth was reflected in a sharp acceleration in gross fixed capital formation to 11.7 percent in the second half, from 3.4 percent in the first. Consumption, growing at 7 percent in the second half, remained the major driver of growth. Meanwhile, some inflationary pressures have emerged due to the convergence of price effects (higher oil prices and exchange rate depreciation) and growth dynamics (closing output gap). Inflation reached 4.2 percent in July 2018, exceeding the central parity of 4 percent, though remaining within the policy band. As a result, RBI

has raised policy rates twice by a cumulative 50 basis points since April 2018 (from 6.0 percent to 6.5 percent). The external situation has become less favorable and the current account balance has deteriorated. A worsening trade deficit has led the current account deficit to widen (on the back of strong import demand, higher oil prices and exchange rate depreciation) from a benign 0.7 percent of GDP in FY16/17 to 1.9 percent in FY17/18. External headwinds - monetary policy ‘normalization’ in the US coupled with recent stress in some EMDEs - have triggered portfolio outflows from April 2018 onwards. As a result, the nominal exchange rate depreciated by about 12 percent from January to September 2018, and foreign reserves declined by over 5 percent since March, while remaining comfortable at about 9 months of imports. Public finances have broadly remained on a gradual consolidation path. In FY17/18 the fiscal deficit of the central government remained at 3.5 percent (unchanged from FY16/17). At the sub-national level, the gross fiscal

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

Risks and challenges

deficit of states declined from 3.5 to 3.1 percent of GDP (y-o-y), mostly on account of lower capital outlays (as a share of GDP). General government debt remained stable and sustainable at around 67 percent of GDP; however, questions remain as to the magnitude of contingent liabilities at the state level.

The higher degree of uncertainty in the global environment and remaining sources of domestic fragility imply that the risks to the outlook are tilted to the down side. This puts a premium on prudent macroeconomic management, including in containing spending pressures ahead of elections and continuing to address the â€œtwin balance sheetâ€? problems of banks and corporates. With little room for fiscal and monetary levers to support aggregate demand, structural reforms will determine the prospects of economic growth in the medium term; namely addressing bottlenecks to private credit growth and wider issues related to the banking sector, alleviating supply side bottlenecks, and adopting other competitiveness enhancing measures. Policies to improve competitiveness will also be needed to support export growth and address external imbalances. While the recent real depreciation of the Rupee helps ceteris paribus tightening global financing conditions can bring challenges in financing the current account deficit. Preventing fiscal slippage will be key to signal commitment to macroeconomic stability.

Outlook Growth is projected to firm-up gradually over 2018-21. It is projected to rise to 7.3 percent in FY18/19, on the back of a recovery in investment and continued support from consumption. On the production side, industry is projected to make a more significant contribution. From FY19-20 onwards, growth is projected to rise further to 7.5 percent and possibly higher, in line with potential growth. India faces continued internal and external risks. High oil prices and an uncertain global trade environment may pose challenges for the current account. A widening trade deficit is likely to lead to a current account deficit of around 2.6 percent of GDP in FY18/19, and tighter global financing conditions will put added emphasis on Indiaâ€™s ability to attract FDI. Fiscal consolidation is expected to resume in FY18/19, but slippages could happen on both the revenue side (as the GST is still stabilizing) and the expenditure side (ahead of state and federal elections). Elevated oil prices, a recent hike in agricultural support prices, and further exchange rate depreciation, could keep the inflation outlook challenging, possibly resulting in further monetary policy actions. India macroeconomic outlook

2016

2017

2018 (e)

8.2

7.1

6.7

7.4

7.3

6.6

Government consumption

6.8

12.2

Gross fixed capital investment

5.2

10.1

Exports, goods and services

-5.6

Imports, goods and services

-5.9

Real GDP growth, at constant market prices Private consumption

Real GDP growth, at constant factor prices

2015

Broad-based poverty reduction remains a big challenge. India needs to accelerate the responsiveness of poverty reduction to growth, including for presently excluded groups (such as women and scheduled tribes), and to extend gains to a broader range of human development outcomes, where it continues to rank poorly. The persistent negative impact of uneven monsoons on agricultural growth, amplified by low uptake of crop insurance, underlines the medium-term risk of climate change on the rural poor. 2019 (f)

2020 (f)

7.3

7.5

6.2

8.2

7.7

10.9

11.2

9.5

9.0

7.6

10.2

7.3

7.5

5.0

5.6

7.9

7.1

7.7

4.0

12.4

9.5

8.0

7.5

8.1

7.1

6.5

7.2

7.4

Agriculture

0.6

6.3

3.4

3.2

Industry

9.8

6.8

5.5

7.1

7.2

Services

9.6

7.5

7.9

8.3

8.7

8.6

Inflation (Consumer Price Index)

4.9

4.5

3.6

5.0

4.0

Current account balance (percent of GDP)

-1.0

-0.7

-1.9

-2.6

-2.4

-1.3

Net foreign direct investment (percent of GDP)

1.7

1.6

1.2

1.4

1.6

1.8

Fiscal balance (percent of GDP)

-6.9

-7.0

-6.6

-6.1

-5.9

-5.6

Debt (percent of GDP)

70.0

69.5

68.8

67.2

66.1

63.9

Primary balance (percent of GDP)

-2.2

-1.7

-1.8

Note: (e) = estimate; (f) = forecast. Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Maldives Growth is expected to continue to be driven by construction and tourism, supported by the opening of 13 new resorts in 2017. Real GDP growth is expected at 8.0 percent in 2018, and to gradually decline to 5.6 percent over the forecast period. Efforts to contain recurrent spending to accommodate the increase in capital spending have been effective, yet the level of public debt is projected to rise further, and foreign exchange reserves are low.

2017 Population, million

0.4

GDP, current USD billion

4.7

GDP per capita, current USD

10675

Source: World Bank.

Contributions to real GDP growth Percentage points 8 6 4 2 0 -2

2012

2013

Taxes less subsidies Transport

2014

Construction Transport

2015

2016

Tourism Other

2017

Real GDP growth (percent)

Note: Maldives fiscal year is the calendar year. Source: National Bureau of Statistics.

Recent economic developments Real GDP grew by 7.1 percent in 2017, on the back of strong performance of the tourism sector, an acceleration of construction, transportation and communication, and fisheries. These sectors contributed about 5 percentage points to headline growth (or over 70 percent). Preliminary estimates for 2018 indicate that GDP growth accelerated to 12 percent (y-o-y) in the first quarter of 2018 against 6 percent in Q1 2017, driven by strong outings from tourism (4.1 percentage points), the construction sector (2.1 percentage points), trade (1.1 percentage points), and the transportation and communication (1.1 percentage points) sectors. Headline inflation averaged 2.8 percent in 2017, driven by the increases in prices of food and housing and utilities, reflecting the partial removal of food subsidies and the pass-through of rising electricity prices. Over the first half of 2018, major components of the CPI basket receded, with the overall consumer price index falling by 0.4 percent. This decline in prices was more pronounced in the atolls, given the relatively higher weight of food items compared

to MalĂŠ. Limited uptake of the cash transfer to compensate for the partial removal of food subsidies may have impacted on the poor householdsâ€™ purchasing power. Growth in goods exports outpaced that of imports, narrowing the trade deficit by 2.7 percentage points of GDP in 2017. Strong performance of services exports against the backdrop of strong tourism receipts was more than offset by growing services imports, rendering the balance of goods and services virtually unchanged. The current account deficit is estimated to have narrowed to 18.8 percent of GDP in 2017 (from 24.4 percent in 2016), mainly supported by significant improvements in the secondary income account balance. The financing of the current account was mainly through direct investment and, to a lesser extent, portfolio flows. Gross official reserves recovered from 467 USD million at end-2016 to 586 USD million at end-2017 (206 USD million after netting out short-term foreign currency liabilities to domestic banks, representing 1.1 month of goods imports). The government made progress in rebalancing fiscal expenditure to accommodate increased capital expenditure.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

Risks and challenges

The fiscal deficit narrowed from a 10.6 percent of GDP in 2016 to a 2.5 percent in 2017, driven mainly by a reduction in public investment from 10.9 percent of GDP in 2016 to 8.2 percent in 2017, and a reduction in spending on food subsidies and on the Aasandha unlimited health care system. Excluding the Public Sector Investment Program, the underlying current fiscal balance went from a deficit of 2.0 percent of GDP in 2015 to an estimated surplus of 5.7 percent of GDP in 2017, reflecting revenue increases and current expenditure reforms. Public debt is estimated to have reached 61.2 percent of GDP in 2017, an increase from 59.7 percent of GDP in 2016, driven by external project-related borrowing and the 200 USD million Eurobond issuance, while domestic T-bills were redeemed.

Risks to the outlook are tilted to the downside. A downturn in the global economy could impact Maldives’ tourism industry. Increases in global commodity prices could impact external sector performance given the heavy reliance on diesel imports. In the domestic front, the challenging political environment along with major elections due in the coming months could adversely impact the reform momentum, including measures to improve budget credibility. One key challenge for the Maldives is to find the appropriate balancing act between, on the one hand, the ongoing large infrastructure projects to close some of the existing infrastructure gaps that potentially would allow to boost tourism, reduce the impact of climate change and ease constraints in the delivery of key public services, and on the other, the rapid accumulation of public debt, the widening current account deficits and the limited fiscal space available. Vulnerability of the overall debt portfolio, with indebtedness levels at over 60 percent of GDP, is heightened by the short maturity of domestic debt and low reserve coverage. Large volume of external loans and guarantees on non-concessional terms to finance infrastructure projects represent significant risks to the downside.

The construction and tourism sectors, the main drivers of recent growth, have not generated sufficient jobs for Maldivians since they rely mostly on foreign labor and male employment. Youth and female unemployment are high. More than a quarter of women are either unemployed or not looking for a job. Almost a quarter of Maldivian youth are not employed, in education, or training (NEET). The driver for the high NEET rate among females is inactivity, whereas for males it is unemployment.

Outlook Real GDP growth is expected at 8.0 percent in 2018, and to gradually fall to 5.6 percent at the end of the forecast period, as growth in the tourism sector returns to historical levels and capital investment projects are gradually tapering off. The current account is projected to narrow over the forecast period, as investment-related imports gradually subside.

The government is still the top employer among Maldivians, and about two thirds of Maldivians are employed in jobs not related to tourism, suggesting a misalignment between the drivers of growth and aspirations of jobseekers. Measures that foster private sector job creation can help reduce pressure on the public sector to create jobs for an expanding working age population. The consolidation of population from vulnerable islands and atolls into Greater Malé, while also reducing pressure on Malé, may eventually allow for new forms of economic activity, create employment, improve quality of public service delivery, and increase resilience to climate change.

The outlook assumes no major fiscal slippages related to current expenditure or the realization of contingent liabilities through guarantees. The overall fiscal deficit is projected to narrow over the forecast period. Public debt is projected to rise to 2020 and peak soon after. Maldives’ risk of external debt distress is assessed as high. Maldives macroeconomic outlook Real GDP growth, at constant market prices Real GDP growth, at constant factor prices

2015

2016

2017

2018 (e)

2019 (f)

2020 (f)

2.2

6.2

7.1

6.3

5.6

2.8

7.2

7.9

6.3

5.6

Agriculture

-0.5

1.4

12.8

0.8

2.8

Industry

16.5

15.1

19.4

14.4

12.5

12.1

Services

1.4

5.2

5.1

7.3

5.5

4.6

Inflation (Consumer Price Index)

0.5

2.8

1.4

1.2

-7.5

-24.4

-18.8

-18

-17.8

-17.7

Fiscal balance (percent of GDP)

-7.1

-10.6

-2.5

-5.3

-5

-4.8

Debt (percent of GDP)

54.4

59.7

61.2

61.7

62.6

63.5

Primary balance (percent of GDP)

-4.9

-8.8

-0.8

-3

-2.6

-2

Current account balance (percent of GDP)

Notes: (e) = estimate; (f) = forecast. Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Nepal At 6.3 percent, economic growth remained strong in FY2018, driven mainly by investment in earthquake reconstruction. To sustain investment and maintain high levels of growth, additional private sector resources and engagement - including foreign direct investment (FDI) - are needed. This necessitates timely implementation of reforms to support an enabling environment for the private sector and to increase foreign investment. As Federalism proceeds, it will be particularly important to enhance implementation capacity and revenue potential at subnational levels of government.

2017 Population, million GDP, current USD billion

29.3 249.0

GDP per capita, current USD

849

Source: World Bank

Contributions to real GDP growth Percentage points 14 12 10 8 6 4 2 0 -2 -4

2010

2011

2012

Note: Nepalâ€™s fiscal year runs from Private July 16th to July 15th. consumption Source: Central Bureau of Statistics and staff calculations.

2013

2014

Investment

Recent economic developments Growth in FY2018 remained strong at 6.3 percent despite less favorable monsoons and the easing of rapid growth that ensued following the 2015 earthquake. Services were the main driver contributing 3.6 percentage points, over 60 percent of which came from trade and hotels. For industry, over 90 percent of growth came from construction and manufacturing. On the demand side, investment and private consumption were the main drivers of growth. Inflation was 4 percent driven by non-food items whose prices grew at 5.5 percent, compared to food prices which grew at 3.1 percent. Consumption fueled by remittances continued to drive private sector credit growth which contributed 17.2 percentage points to money (M2) growth of 19.4 percent. Saving deposits growth increased to 18.8 percent in July but credit grew faster at 22.5 percent, causing the weighted average lending rates of commercial banks to remain high at 12.5 percent in July. All banks met the minimum capital

2015

2016

2017

2018

Real GDP growth (percent)

adequacy ratio of 10 percent with an NPL ratio of 1.7 percent in Q3 FY2018. A higher trade deficit and slower remittances growth widened the current account deficit, which was offset by errors and omissions, government borrowing, and trade credit. The trade deficit surged to 37.7 percent of GDP (from 33.9 percent in FY2017), primarily from imports to build government subnational offices, construction and reconstruction materials, as well as higher fuel prices. Remittances grew by 10 percent, but as a share of GDP declined from 26.3 percent in FY2017 to 25.1 percent in FY2018. In addition, the USD-Rupee exchange rate depreciated 6.2 percent. Gross official reserves declined slightly but remained adequate to cover 8.3 months of imports (compared to 9 months in FY2017). Poor execution of the budget continued with overall execution of 82.4 percent (71.2 percent for capital expenditure). In FY2018, 37.5 percent of total spending (or 54.6 percent of capital expenditure) was spent in the last

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

quarter of the fiscal year. Revenue growth was strong due to higher taxes from high imports (which constitute just under half of all revenue) coupled with collection rates that were close to planned targets. The fiscal deficit increased in FY2018, primarily driven by higher spending to establish sub-national governments and to finance the transition to Federalism. This was financed by government deposits and higher public debt.

The government is shifting from consumption to investment-based growth, with emphasis on engaging the private sector and raising the very low levels of FDI. In addition to infrastructure investments, key reforms will include establishing public private partnerships (PPPs), one-stop investor services, and e-government services for citizens. Consolidated spending of government is expected to reach 34 percent of GDP over the medium term (versus 28 percent in FY2017), with 3 to 4 percent of the increase from Federalism alone. Transfers to sub-nationals are expected to increase by 4 percentage points to reach 6 percent of GDP by 2021. Raising revenue potential of subnational governments will be critical as will be their capacity to implement their projects and programs. Overall, taxes on rising imports, luxury items and incomes of wealthier households, including a broadening of the tax base, will help increase revenue to 29 percent of GDP over the medium term. Public debt as a share of GDP will increase but remain sustainable.

Outlook GDP growth is projected to average 6 percent over the medium term, driven primarily by total investment. The FY2019 budget includes investments to promote improved inputs and storage facilities for farmers, including for irrigation. These investments focus on modernization, commercialization, mechanization and the expansion of value chains. As these programs ramp up, the agriculture sector growth is expected to increase from 2.8 to 4.5 in FY2020. Also, the Visit Nepal 2020 program aims to bring in two million foreign tourists annually by 2020. This will be supported by key infrastructure projects and includes linking completed hydro projects to the transmission grid. A new large private cement factory is expected to boost construction activities, while the agreement to build a second cement factory with Chinese investment will likely enhance FDI in the next fiscal year. Growth in industry and services is projected to average 8 and 6 percent respectively, as infrastructure constraints are eased, and capacity utilization expanded. Â Inflation is projected to reach 5 percent over the medium term, assuming oil prices increase, and the exchange rate depreciates. The current account deficit will gradually improve as import growth moderates. Nepal macroeconomic outlook Real GDP growth, at constant market prices Private consumption

2015

Risks and challenges Risks to the outlook include: (i) slow implementation of reforms needed to increase private investment, particularly foreign investment; (ii) low implementation capacity at decentralized levels that worsens budget execution and the quality of expenditure; (iii) external shocks to outmigration and remittances leading to deterioration of the balance of payments, a reduction in growth of financial deposits, a shortage of loanable funds and credit, lower consumption and increased poverty; and (vi) natural disasters. Each of the above factors individually would seriously undermine growth. A combined occurrence could lead to growth below the average 4.4 percent per annum that was observed in previous decades.

2016

2017

2018 (e)

2019 (f)

2020 (f)

3.3

0.6

7.9

6.3

5.9

6.0

2.9

-0.7

2.6

2.5

4.7

Government consumption

7.4

-0.4

10.4

9.4

30.2

7.0

Gross fixed capital investment

19.6

-12.3

44.2

15.7

13.2

7.7

Exports, goods and services

6.8

-13.7

13.7

4.4

7.6

9.5

Imports, goods and services

9.6

2.8

30.3

14.8

12.7

6.2

Real GDP growth, at constant factor prices

3.0

0.2

7.4

5.9

6.0

Agriculture

1.1

0.2

5.2

2.8

4.0

4.5

Industry

1.4

-6.4

12.4

8.8

8.0

Services

4.8

2.3

7.4

7.1

6.2

6.3

Inflation (Consumer Price Index)

7.2

9.9

4.4

4.0

4.7

Current account balance (percent of GDP)

5.1

6.2

-0.4

-8.2

-7.8

-6.8

Fiscal balance (percent of GDP)

1.0

1.4

-3.1

-5.8

-5.5

Debt (percent of GDP)

25.6

27.9

26.6

30.5

32.7

35.2

Primary balance (percent of GDP)

1.5

1.8

-2.8

-4.9

-4.8

-4.2

Note: (e) = estimate; (f) = forecast. Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Pakistan Pakistan’s macroeconomic situation remains fragile. Consumption led growth is expected to slow down due to fiscal and possibly monetary tightening. However, short term measures for fiscal consolidation and export growth need to be complemented with implementation of medium term structural reforms to uplift the economy out of frequent boom-and-bust cycles.

2018 Population, million

200.4

GDP, current USD billion

312.6

GDP per capita, current USD

1560

Source: World Bank.

Trade deﬁcit and import coverage Percent

Months of imports

-3

-6

-6 2012

2013

2014

2015

Current account balance

2016

2017

2018

Import coverage (rhs)

Note: Pakistan’s fiscal year runs from July 1st to June 30th. Sources: Ministry of Finance and State Bank of Pakistan.

Recent economic developments Pakistan’s macroeconomic imbalances are increasing. Economic growth reached 5.8 percent in FY18, 0.4 percentage points higher than in FY17. On the demand side, growth was driven by consumption which contributed seven percentage points towards GDP growth. On the supply side, recovery in the agricultural and industrial sectors and consistent acceleration in the services sector contributed to the GDP growth. Although headline inflation remained benign and was recorded at 3.9 percent in FY18, core inflation rose indicating underlying inflationary pressures. Therefore, the State Bank of Pakistan increased the policy interest rate by 175 bps to 7.5 percent between January 2018 and July 2018. The current account deficit increased to 5.8 percent of GDP in FY18, up from 4.1 percent in FY17. The widening current account deficit reflects the growing trade deficit as exports are not growing as fast as imports. Imports are growing fast due to high domestic demand and import-intensive investments related to the China Pakistan Economic Corridor (CPEC). The State Bank of Pakistan

intervened heavily in the foreign exchange market in the first half of FY18 to maintain the value of the Pakistani Rupee, resulting in a large decline in international reserves from 16.1 USD billion (2.9 months of imports) at end-June 2017 to 10.2 USD billion (or 1.7 months of imports) by August 24th, 2018. Under intense market pressure, the currency depreciated by almost 18 percent between 1st December 2017 and 25th of July 2018. Post-election, with emerging political certainty, the Pakistani Rupee recovered 3 percentage points against the USD and was trading at 124.3 Pakistani Rupees per USD on 7th September 2018. The fiscal deficit has widened over the past two years – reversing fiscal consolidation efforts in previous years and raising public debt levels. The FY18 fiscal deficit (including grants) reached 6.5 percent of GDP—a slippage of 2.5 percentage points compared to the budget target. This was due to limited revenue growth and large increases in recurrent spending at both the federal and provincial levels. Consequently, Pakistan’s public debt reached 73.5 percent of GDP by end-June 2018, significantly raising debt-related risks. The newly elected

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

government recognizes the need for macroeconomic adjustments to overcome these challenges and has already announced its plans to cut expenditures, improve the management of State Owned Enterprises, and undertake revenue mobilization reforms.

It is expected that there will be some scaling down of public investment spending at the federal and provincial levels, and increase in revenue collection through tax base expansion and other administrative measures. Fiscal consolidation would improve debt dynamics, but the public debt to GDP ratio is expected to stay around 70 percent of GDP during FY19 and FY20 - the debt burden benchmark for high-risk in case of Emerging Markets (as per the IMF Market-Access Countries public debt sustainability analysis). Growth deceleration and higher inflation are expected to slow-down poverty reduction in FY19 though overall poverty decline is projected to continue reflecting GDP growth. The presence of safety net programs will mitigate the negative impact of inflation on poverty.

Outlook GDP growth is projected to decelerate to 4.8 percent in FY19 as authorities are expected to tighten fiscal policy to correct imbalances. However, growth is expected to recover in FY20 and reach 5.2 percent as macroeconomic conditions improve. This recovery is conditional upon the restoration of macroeconomic stability, a supportive external environment, including relatively stable international oil prices, and a strong recovery in exports.

Risks and challenges

Inflation is expected to rise to 8 percent (average) in FY19 and remain high in FY20, driven by exchange rate pass through to domestic prices and a moderate increase in international oil prices.

Immediate macroeconomic adjustments are required to correct the large twin deficits. Rising global interest rates and tighter liquidity situation will pose challenges to Pakistan given the high gross external financing requirements. With declining reserves and elevated debt ratios, Pakistanâ€™s ability to withstand external shocks is diminished and risks will remain predominantly on the downside. Appropriate policy responses to correct these imbalances and increased buffers to absorb future shocks will reduce these risks and support a positive growth outlook. Such responses would entail increased flexibility of the exchange rate, strengthening the fiscal position through renewed efforts to improve revenue collection and better coordination between federal and provincial governments to reduce public spending.

The pressure on the current account is expected to persist and the trade deficit is projected to remain elevated during FY19 and FY20. Remittances will continue to partly finance the current account deficit, although slower growth in the Gulf Cooperation Council (GCC) countries will affect remittances. FDI, multilateral, bilateral, and private debt-creating flows are expected to be the main financing sources in the near to medium term. The fiscal deficit is projected to narrow in FY19 due to post-election adjustments and some fiscal measures. Pakistan macroeconomic outlook Real GDP growth, at constant market prices

2015

2016

2017

2018 (e)

2019 (f)

2020 (f)

4.7

5.5

5.7

5.4

4.8

5.2

Private consumption

2.9

7.6

8.7

6.3

4.6

2.8

Government consumption

8.1

8.2

5.3

14.2

1.6

4.2

Gross fixed capital investment

15.8

7.5

10.0

5.7

-0.8

13.5

Exports, goods and services

-6.3

-1.6

-0.8

9.9

13.4

10.1

Imports, goods and services

-1.6

16.0

21.0

17.5

1.9

3.5

4.1

4.6

5.4

5.8

4.8

5.2

Agriculture

2.1

0.2

2.1

3.8

3.5

3.4

Industry

5.2

5.7

5.4

5.8

5.0

5.7

Services

Real GDP growth, at constant factor prices

4.4

5.7

6.5

6.4

5.1

5.5

Inflation (consumer price index)

4.5

2.9

4.2

3.9

8.0

7.5

Current account balance (% of GDP)

-1.0

-1.7

-4.1

-5.8

-5.2

-4.2

Net Foreign Direct Investment (% of GDP)

0.3

0.8

0.9

1.7

2.0

Fiscal balance (% of GDP)

-5.2

-4.5

-5.8

-6.5

-5.0

-4.6

Debt (% of GDP)

64.3

68.7

67.9

73.5

72.6

69.6

Primary balance (% of GDP)

-0.5

-0.2

-1.5

-2.1

0.2

0.0

Notes: e = estimate; f = forecast. Source: World Bank.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Sri Lanka The recent fiscal and monetary policy measures have broadly contributed to stability amid continued natural calamities. Growth is projected to be around 4.0 percent in the medium-term and the outlook remains stable. Poverty is projected to further decline as growth recovers. However, risks are downward tilted. The country is vulnerable to global financial conditions due to large external refinancing requirements starting from 2019. Although some vital reforms were carried out, the process has slowed down in a challenging political environment. The impending election cycle elevates the uncertainty.

2017 Population, million

21.4

GDP, current USD billion

87.3

GDP per capita, current USD

4073

Source: World Bank.

Real GDP growth Percent 10 8 6 4 2 0

2010

2011

2012

2013

Average Real GDP growth

2014

2015

2016

2017

Average of the period

Note: Sri Lankaâ€™s fiscal year is the calendar year. Source: Department of Census and Statistics and staff calculations.

Recent economic developments The country-wide drought conditions continue to take a toll on macroeconomic performance. The economy is estimated to have grown by 3.6 percent in the first half of 2018, following a 16-year low growth of 3.3 percent in 2017. Agriculture and related industry sectors are expected to have recovered in the first half of 2018 with relatively benign weather. However, the ongoing episode of drought, which has been more pronounced from the beginning of the third quarter of 2018, has already impacted more than 900,000 people in 18 districts. Increased agriculture output led to benign inflation in the first quarter of 2018. Favorable inflation outlook prompted the central bank to marginally relax policy rates in April, as the growth in monetary aggregates decelerated in response to a tight monetary policy. However, subsequent currency depreciation and spill-over

effects of increasing fuel prices increased inflation to 5.6 percent by August 2018. On the external front, exports rebounded thanks to the reinstatement of GSP+ preferential access to the European Union. Nevertheless, the gradually rising fuel bill and increased imports of vehicles and gold widened the trade deficit. External liquidity received a boost from the proceeds of sovereign bonds and increased FDI compared to the previous year. While reserve cover of imports has improved from 2017, external vulnerability remains elevated with relatively high short-term liabilities. Amid tightening global financial conditions, the Sri Lankan Rupee depreciated by 5.6 percent against the USD by end-August 2018. Albeit lower than expected, the government recorded a primary surplus for the first quarter of 2018; however, the higher than budgeted interest costs masked the

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 C ountry briefs

improvement. The debt portfolio of the central government is subject to important risks with over 50 percent being denominated in foreign currencies, of which around 30 percent is expected to mature in the next five years. While implementation of the cost-reflective fuel pricing will enhance fiscal sustainability, the flip side will be the need for targeted measures to protect the poor and vulnerable who may be affected more. The gradual rebound of growth from last yearâ€™s record-low rate is expected to have helped improve the incomes of the poor. However, droughts continue to disrupt livelihoods and agricultural activities, and may have contributed to the recent notable drop in employment, especially among women in rural areas. In addition, inflation reached 6.5 percent in 2017, its highest levels since 2014, which likely offset some of the gains.

Outlook The outlook remains stable, conditional on reforms to improve competitiveness, governance and public financial management. Together with the IMF program, these reforms will add to confidence and lead to sustained growth and development. Growth is projected to rebound in 2018 from a low base and continue to be marginally above 4.0 percent in the medium term, driven by private consumption and investment. Inflation will hover around mid-single digit level, although currency depreciation and rising oil prices may exert some upward pressure. Despite global uncertainties, exports will benefit from spill-over effects of the reinstatement of GSP+, while tourism and remittances support the external balances. With improved hydropower generation, the growth in imports will normalize in the medium-term. External reserves are expected to improve, thanks to debt inflows to the government, providing a buffer for debt redemptions. The Liability Management Act, passed in early 2018, will provide the flexibility for managing some important risks of the debt portfolio. The overall fiscal deficit is projected to fall in

the medium term, supported by the implementation of revenue measures.

Risks and challenges A further slowdown in reform implementation, in a challenging political environment, remains the key domestic risk to the baseline. Impending election cycle exacerbates this risk. External risks include steeper than expected global financial conditions that would increase the cost of debt and make rolling over the maturing Eurobonds from 2019 more difficult; disappointing growth in key countries that generate foreign exchange inflows to Sri Lanka through exports, tourism, remittances, FDI, and other financing flows; faster than expected rises in commodity prices that would increase pressure on the balance of payments; and capital outflows that would further increase currency pressure. On the fiscal and debt management front, risks include the delay in implementing revenue measures, and slower than expected improvement in tax administration. The increasing occurrence and impact of natural disasters could have an adverse impact on growth, the fiscal budget, the external sector and poverty reduction. Sri Lanka needs to address several challenges that increasingly put its economic growth and stability at risk, through macroeconomic and structural reforms: (1) continue fiscal consolidation by broadening the tax base and aligning spending with priorities: this is important given high public debt, contingent liabilities and large gross financing needs; (2) shift towards a private investment-tradable sector-led growth model by improving trade, investment, innovation and the business environment; (3) improve governance and accountability and improve SOE performance; and (4) reduce vulnerability and risks by enhancing disaster preparedness and mitigating the impact of reforms on the poor and vulnerable with well-targeted spending. The government recently announced plans to expand coverage of the main social protection program (Samurdhi), but details remain unclear.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 Country briefs

Sri Lanka macroeconomic outlook Real GDP growth, at constant market prices

2015

2016

2017

2018 (e)

2019 (f)

2020 (f)

5.0

4.5

3.3

3.9

4.0

4.1

Private consumption

7.5

-3.9

1.3

4.0

4.1

Government consumption

10.2

2.3

-5.2

3.7

4.6

Gross fixed capital investment

2.5

7.8

5.0

5.9

6.0

Exports, goods and services

4.7

-0.7

7.5

4.0

4.7

3.3

Imports, goods and services

10.6

7.9

19.3

3.6

3.8

3.4

Real GDP growth, at constant factor prices

4.8

4.3

3.3

3.9

4.1

Agriculture

4.7

-3.8

-0.8

4.0

3.4

Industry

2.2

5.8

4.6

3.9

4.1

4.2

Services

6.0

4.7

3.2

3.9

4.1

4.2

Inflation (Consumer Price Index)

0.9

4.0

6.6

5.0

Current account balance (percent of GDP)

-2.3

-2.1

-2.6

-2.9

-3.0

-3.1

Net foreign direct investment (percent of GDP)

0.8

1.5

2.0

1.2

0.9

Fiscal balance (percent of GDP)

-7.6

-5.4

-5.5

-5.2

-4.6

-4.4

Debt (percent of GDP)

77.7

78.8

77.4

77.8

77.1

76.3

Primary balance (percent of GDP)

-2.8

-0.3

0.0

0.5

1.2

1.3

Note: (e) = estimate; (f) = forecast. Source: World Bank.

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 South Asia at a glance

South Asia at a glance Afghanistan Bangladesh

OUTPUT and PRICES

Real GDP growth

Inflation (Consumer Price Index)

REER (CY)

Current account balance (percent of GDP) Trade balance (percent of GDP)

BALANCE of PAYMENTS

Import growth (percent, y-o-y)

Export growth (percent, y-o-y)

Foreign reserves (months of goods import cover, CY)

Bhutan

India

Maldives

Nepal

Pakistan

Sri Lanka South Asia

2015

1.5

6.6

7.3

8.2

2.2

3.3

4.1

5.0

7.1

2016

2.3

7.1

7.4

7.1

6.2

0.6

4.6

4.5

7.5

2017

2.7

7.3

5.8

6.7

7.1

7.9

5.4

3.3

6.6

2018 (f)

2.4

7.9

4.6

7.3

8.0

6.3

5.8

3.9

6.9

2018 Q1 (CY)

7.7

8.9

2018 Q2 (CY)

8.2

7.1

2015

4.6

6.4

3.3

4.9

1.0

7.2

4.5

0.9

4.5

2016

4.3

5.9

4.3

4.5

0.5

9.9

2.9

4.0

4.4

2017

4.7

5.4

5.0

3.6

2.8

4.4

4.2

6.6

3.8

2018 (f)

3.1

5.8

5.0

1.0

4.0

3.9

5.0

3.5

2018 July

5.6

4.2

5.9

5.4

2018 August

5.5

3.7

5.9

2015

103.7

110.3

104.3

2016

105.0

109.6

105.5

2017

109.8

106.4

109.4

2018 (f)

105.5

102.0

105.2

2018 August

106.2

104.1

106.0

2018 September

102.7

104.4

102.9

2015

7.5

1.5

-29.3

-7.5

5.1

-2.3

-3.4

2016

7.1

1.9

-24.7

-0.7

-24.4

6.2

-1.7

-2.1

-4.8

2017

1.6

-0.5

-21.7

-1.9

-18.8

-0.4

-4.1

-2.6

-6.1

2018 (f)

0.2

-3.5

-17.8

-2.6

-18.0

-8.2

-5.8

-2.9

-7.3

2015

-41.8

-7.4

-28.5

-2.3

9.4

-29.9

-6.4

-7.5

-3.6

2016

-42.1

-4.7

-23.4

-1.7

-1.2

-29.9

-7.0

-7.3

-3.1

2017

-5.2

-22.0

-2.9

-4.8

-32.3

-9.3

-7.2

-4.0

2015

4.6

3.2

3.4

-5.9

9.6

-1.6

10.6

-3.8

2016

25.8

-7.1

-2.4

4.0

2.8

16.0

7.9

0.3

2017

8.0

2.9

-10.3

12.4

30.3

21.0

19.3

6.2

2018 (f)

4.1

20.6

-10.5

9.5

14.8

17.5

3.6

-2.3

2018 May

36.8

14.5

14.3

7.7

2018 June

17.0

20.5

26.3

17.9

2015

2.4

-2.8

-2.7

-5.6

6.8

-6.3

4.7

-5.0

2016

-0.3

2.2

-2.0

5.0

-13.7

-1.6

-0.7

0.9

2017

7.0

-2.3

-1.4

5.6

13.7

-0.8

7.5

4.5

2018 (f)

8.0

7.5

-2.0

7.9

4.4

9.9

4.0

1.1

2018 April

8.0

6.1

18.5

-0.3

2018 May

14.1

26.8

31.9

10.2

2015

7.6

10.7

4.1

4.6

4.5

9.8

2016

8.8

12.1

3.4

5.4

3.8

11.0

2017

8.4

10.3

2.8

4.0

3.8

9.5

2018 January

7.2

10.0

2.7

3.0

4.0

9.0

2018 February

7.2

10.4

2.9

3.1

3.7

9.3

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 S outh Asia at a glance

GOVERNMENT FINANCES

BALANCE of PAYMENTS

Afghanistan Bangladesh

Personal remittances received (USD million, CY)

Fiscal balance (percent of GDP)

Public debt (percent of GDP)

CONSUMPTION and INVESTMENT

Private consumption growth (percent, y-o-y) Gross fixed capital investment growth (percent, y-o-y) Net foreign direct investment (percent of GDP) Net foreign portfolio investment (USD million, CY)

Bhutan

India

Maldives

Nepal

Pakistan

Sri Lanka South Asia

2015

341

15,296

68,910

6,730

19,306

7,000

117,606

2016

368

13,544

62,744

6,612

19,808

7,262

110,376

2017

378

13,498

68,967

6,928

19,689

7,190

116,698

2018 Q1

3,829

10,744

4,862

1,979

2018 Q2

4,221

11,498

5,016

1,645

2015

-0.8

-3.7

-1.1

-6.9

-7.1

1.0

-5.2

-7.6

-3.8

2016

0.0

-3.7

-1.2

-7.0

-10.6

1.4

-4.5

-5.4

-3.6

2017

-0.5

-3.0

-4.1

-6.6

-2.5

-3.1

-5.8

-5.5

-4.3

2018 (f)

-0.4

-4.3

-3.0

-6.1

-5.3

-5.8

-6.5

-5.2

-4.4

2015

9.1

31.8

90.6

70.0

54.4

25.6

64.3

77.7

53.7

2016

7.9

31.5

104.2

69.5

59.7

27.9

68.7

78.8

57.4

2017

7.2

30.6

97.9

68.8

61.2

26.6

67.9

77.4

56.8

2018 (f)

6.8

31.2

93.6

67.2

61.7

30.5

73.5

77.8

56.5

2015

6.8

5.8

3.4

7.4

2.9

7.5

5.5

2016

-0.2

3.0

3.7

7.3

-0.7

7.6

-3.9

8.4

2017

4.3

7.4

-2.0

6.6

2.6

8.7

1.3

7.6

2018 (f)

3.1

11.0

0.8

6.2

2.5

6.3

4.0

4.2

2015

4.8

7.1

14.1

5.2

19.6

15.8

2.5

5.5

2016

-6.0

8.9

7.2

10.1

-12.3

7.5

7.8

4.7

2017

6.4

10.1

1.8

7.6

44.2

10.0

5.0

10.3

2018 (f)

2.5

10.5

-1.3

10.2

15.7

5.7

6.3

2.5

2015

0.0

0.9

0.4

1.7

7.4

0.2

0.3

0.8

1.5

2016

-0.1

0.6

-0.6

1.6

10.8

0.5

0.8

1.4

2017

-0.1

0.7

1.0

1.2

0.8

0.9

1.5

1.1

2018 (f)

0.0

0.6

1.1

1.4

0.9

2.0

2015

-203

-9,487

-123

-916

-686

2016

-42

4,725

132

-153

-993

2017

-29

367

-30,638

-279

-1,200

-1,772

2018 Q1

-2,276

-42

SO U T H ASI A ECO N O MIC FO CUS | FA L L 2 0 1 8 South Asia at a glance

Notes (f)

Forecast

Series for calendar year

Series for fiscal year Afghanistan’s fiscal year is the calendar year. Bangladesh’s fiscal year runs from July 1st to June 30th. Bhutan’s fiscal year runs from July 1st to June 30th. India’s fiscal year runs from April 1st to March 31st. Maldives’s fiscal year is the calendar year. Nepal’s fiscal year runs from July 16th to July 15th. Pakistan’s fiscal year runs from July 1st to June 30th. Sri Lanka’s fiscal year is the calendar year.

Real GDP growth

Real GDP growth rates (percent change, y-o-y) at market prices; Pakistan is in factor costs. Source: Central Statistics Office of India, Sri Lanka Department of Census and Survey, World Bank DEC GEP, and World Bank MTI.

Inflation (Consumer Price Index)

Period average percent change in CPI inflation. Source: World Bank DEC GEM and World Bank MTI.

REER (CY)

Real effective exchange rate is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. An increase in REER implies that exports become more expensive and imports become cheaper. Source: World Bank DEC GEM.

Current account balance (percent of GDP)

Does not include grants unless otherwise stated. Source: World Bank MTI.

Trade balance (percent of GDP)

Trade balance in goods and services is derived by substracting imports of goods and services from exports of goods and services as ratio to GDP. Source: World Bank WDI.

Import growth (percent, y-o-y)

Annual trade change is in (respective) fiscal year and covers goods and non-factor services (GNFS) imports. Monthly trade change is in calender year and covers only merchandise. Source: World Bank DEC GEM, World Bank DEC GEP, World Bank MTI, and staff calculations.

S OU TH AS IA ECONOMIC FOCU S | FA LL 2 0 18 S outh Asia at a glance

Export growth (percent, y-o-y)

Annual trade change is in (respective) fiscal year and covers goods and non-factor services (GNFS) exports. Monthly trade change is in calender year and covers only merchandise. Source: World Bank DEC GEM, World Bank DEC GEP, World Bank MTI, and staff calculations.

Foreign reserves, months of import cover Source: World Bank DEC GEM. (CY) Remittances (USD million, CY)

Personal remittances including personal transfers and compensation of employees in current USD. Source: Haver Analytics, World Bank WDI, and staff calculations.

Fiscal balance (percent of GDP)

Does not include grants unless otherwise stated. Source: IMF, World Bank MTI, and staff calculations.

Public debt (percent of GDP)

Gross public debt stock including domestic and foreign liabilities, end of Period. Source: IMF, World Bank MTI, and staff calculations.

Private consumption growth (percent, y-o-y) Annual (respective) fiscal year percent change in gross consumption expenditure. Source: World Bank DEC GEP and World Bank MTI. Gross fixed capital investment growth Annual (respective) fiscal year percent change in gross fixed capital expenditure. (percent, y-o-y) Source: World Bank DEC GEP and World Bank MTI. Net foreign direct investment (percent of Net balance of Foreign Direct Investment assets and liabilities as ratio to GDP. GDP) Source: Haver Analytics and World Bank MTI. Portfolio investment (USD million)

Portfolio investment covers transactions in equity securities and debt securities. Balances are calculated as net assets minus net liabilities. Data is in current USD. Source: Haver Analytics and staff calculations.

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SO U T H ASI A ECO N O MIC FO CUS | FA L L 20 1 8