Date:27/06/2006 URL: http://www.thehindubusinessline.com/2006/06/27/stories/2006062703190600.htm

Back Emerging economies face twin challenges of fiscal, price stability

G. Srinivasan

BIS outlines tasks ahead for monetary authorities, voices concern over debt ratio

One concern is that government revenue ratios are still comparatively low in a number of emerging economies.

New Delhi , June 26

The Bank for International Settlements (BIS) has said a major challenge for the monetary authorities in emerging market economies, including India, is how to avoid policy mistakes that might put macro-economic and financial stability at risk.

In its 76th annual report, released at its annual general meeting today, the BIS has said that external conditions had been unusually favourable to emerging market economies in the current cycle. These included strong global demand, large terms-of-trade improvements for many countries and much easier external financing.

A major question, the BIS said, was "whether the authorities in emerging markets have adequately exploited these favourable circumstances to secure lasting improvements in fiscal positions". A second question concerns imbalances that might raise inflation risks or lead to unsustainable increases in asset prices.

Current account balances

It said that India's GDP growth averaged 6.6 per cent in 2002-04 and it was 8.3 per cent in 2005, with the forecast for 2006 placing GDP growth at 7.5 per cent.

While current account balances of India averaged $2 billion in surplus during 2002-04, this turned negative in 2005 at $16 billion and is likely to be $19 billion in 2006.

It said fixed investment, as a percentage of GDP, in China was 45.2 per cent in 2005, while it was 26 per cent in India.

"In India, strong profits and rising equity prices have also been associated with a revival of investment more generally," the BIS said.

Govt revenue ratios

The report said the fiscal impact of increase in spending has recently been partly alleviated by the higher revenue/GDP ratios that are apparent in all regions. One concern is that, despite recent increases, government revenue ratios are still comparatively low in a number of emerging economies. For instance, revenues are about 18-20 per cent of GDP in India and the Philippines, significantly below the average of 29 per cent in the US, where taxes are low compared to other developed countries.

Even as the emerging market economies have generally experienced declines in public debt ratios in recent years, public debt/GDP ratios still have a median value of around 46 per cent, which is high enough to evoke concerns about debt sustainability. Debt ratios are markedly above that median in India, Argentina, the Philippines, Brazil and Turkey, it said.

Oil subsidies

Stating that sharp increases in commodity prices posed major fiscal challenges, BIS said that a number of oil-importing countries, particularly in Asia, have had to decide what to do about subsidies designed to reduce the cost of energy. Rising oil prices have bloated the cost of such subsidies and have exacerbated the distortions that stem from shielding consumers (and sometimes firms) from price changes. In some cases, subsidy costs have largely been shifted to public oil companies, which are not allowed to raise retail prices. "Such artificially low oil prices have led to shortages, tempted local oil companies to sell abroad and encouraged smuggling", it said adding that countries had responded by lifting these subsidies.

In this regard, it cited the case of Thailand, which ended fuel subsidies in 2005, while India and Indonesia reduced them significantly, causing a jump in fuel prices. "The rising costs of fiscal subsidies and efforts to reduce them have complicated the conduct of monetary policy by sharply increasing headline inflation," it said.

Public debt/GDP ratios

The report said achieving long-run debt sustainability in India also poses challenges, although the risks are "attenuated" by the fact that the Government of India does not borrow in foreign currency and that banks hold a large proportion of the public debt without trading it. While there have been significant reductions in the headline general fiscal deficit in recent years in India, a projected rate of 7.7 per cent of GDP in 2005-06 (from 10 per cent of GDP in 2002-03) remains "too high", the Bank said.