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Fiscal Consolidation in The SEACEN Countries: Policy Analysis and Assessment

Ram Prasad Adhikary

in Research Studies from South East Asian Central Banks (SEACEN) Research and Training Centre

Abstract: Up until the first half of 1980s, policy-makers in several countries, including those in the SEACEN region, were reluctant to reduce budget deficit for fear of adversely affecting economic growth through the Keynesian multiplier effect. As a result, high and rising budget deficit was prevalent as government spending was increasing at a much faster rate than government revenue, partly contributing to a sharp reduction in economic growth in some of the SEACEN countries in the mid-1980s. This study aims to assess the fiscal consolidation measures undertaken by the SEACEN countries in response to the above problem. Based on the consolidated central government data of the SEACEN countries (except for Myanmar and Nepal), the study finds that the measures had been generally successful in reducing fiscal deficits without adverse impact on economic growth. In fact, several countries experienced exceptionally high growth for an extended period after this adjustment. The study suggests that bold and decisive fiscal consolidation measures can create favourable environment for higher growth by instilling confidence in the private sector. This supports the view of Giavazzi and Pagano (1990) that sharp reduction in budget deficits may help improve the growth performance of an economy not only in the long run, but also during the fiscal consolidation period. Where success is defined as improving fiscal balance as well as achieving sustainable debt to GDP ratio, the study finds that fiscal consolidation through cutting expenditure is more likely to succeed than by raising revenue. In addition, the bulk of expenditure cutback should come from the current or operating expenditure side. This is also in line with the views of Alesina and Periotti (1996), and McDermott and Wescott (1996) in their studies on fiscal consolidation and its macroeconomic consequences in the OECD countries. Further, the study finds that the budget cuts have also resulted in a substantially reduced capital expenditure, with adverse implications on the investment of necessary infrastructure. This implies that fiscal consolidation through budget cuts alone may not be sustainable in the long run. Further effort would require measures to enhance government revenue. The generally low tax pressure ratio in the SEACEN region suggests that there is scope for increasing tax revenue by tax-reform measures such as broadening the tax base, expanding the tax net by identifying other possible sources, strengthening revenue- collection administration, and reducing concessions and rent-seeking, etc. It may not be advisable for a country to go against the global trend by increasing the tax rates. While the success of fiscal adjustments may to some extent depends on the timing of the implementation, our study finds that the dominating factor is in fact the size and composition of the adjustments. This implies that a country which is having a serious debt/ deficit problem may not need to wait until the difficult time is over before embarking on a fiscal consolidation programme. While data on the consolidated central government operations forms a backbone of the fiscal position of a country, it would have been more accurate to include data on the extra-budgetary operations and other quasi-fiscal activities. It is hoped that as data and information on the latter become available, a follow-up study could be conducted to better assess the fiscal positions of the SEACEN countries.

Date: 1999
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