Fiscal management has improved in Asia over the past decade. It has become more responsive to economic conditions and thereby helped stabilize growth, especially during the global financial crisis. While these are important achievements, major challenges still lie ahead—as our latest Asia and Pacific Regional Economic Outlook points out.
What are these key challenges? In a nutshell, fiscal policy can, and should do more to make Asia’s growth sustainable and more inclusive.
In the near term, budget consolidation has to proceed as the recovery takes hold to rebuild the fiscal space needed to respond to future output fluctuations.
At the same time several emerging and low income economies need to create room for higher infrastructure and social spending to support long-term growth, reduce income inequality, and fight poverty.
The role of investment
Public investment and the promotion of public-private partnerships can help more fill the significant infrastructure gaps in some economies. For example, government investment remains relatively low in Indonesia, the Philippines, and Sri Lanka, despite substantial infrastructure shortages. At the same time, fiscal risks in some countries, stemming from investment spending conducted outside of the general government budget and from public-private partnerships, need to be countered through enhanced public expenditure management and fiscal transparency.
Public spending on education and health also needs to be scaled up to enhance human capital and living standards in most Asian emerging and low income economies. Indeed, in spite of still relatively poor health conditions, low education levels, and the surge in per capita income of the past decade, government expenditure on health and education has barely increased in Asian emerging and low-income countries since 2001, and remains about 4 percentage points of GDP lower than in peers in other regions.
How can Asian governments make room for higher spending on infrastructure, education and health, while still maintaining or even strengthening fiscal space?
Spending differently and more efficiently
Spending differently and more efficiently can go a long way. In several Asian emerging economies and low-income countries, subsidies—which are often distortive and not well targeted to the poor— take up a higher share of total government expenditure than in peers in other regions. The average annual budget cost—which does not even fully capture the total fiscal burden— of energy and food subsidies is nearly 2 percent of GDP in Asian emerging and low-income countries. In a few cases, such as Bangladesh, Indonesia, and Malaysia, it is even higher. In Indonesia, at more than 4 percent of GDP, the direct fiscal cost of oil and food subsidies is close to total government spending on health and education.
Energy subsidies, which create distortions and other economic costs, are damaging to the environment, and in practice, often benefit higher income groups more than the poor. Furthermore, the effectiveness of subsidy programs in the region is sometimes compromised by implementation problems, such as targeting errors, illegal diversions, and procurement inefficiencies.
Alleviating the impact on the poor
Any subsidy reform should include compensatory measures to alleviate the adverse impact of price increases on the poor, which could be substantial. Targeted cash transfers or vouchers can be effective instruments in this respect, provided data and administrative capacity are adequate. And indeed, some subsidy reforms along those lines are taking place. India, for instance, has initiated a wide-ranging project to shift many subsidy programs away from in‑kind delivery toward direct cash transfers, and in parallel is enhancing the system to identify eligible individuals.
Finally, reforms are needed not just on the spending side but also on the tax side. Reducing complex and poorly targeted tax incentives and enhancing tax administration can create space for social and infrastructure spending. And a number of Asian economies could also consider making their current revenue structure more growth-friendly by making greater use of general consumption taxes and property taxes and reducing their reliance on corporate income taxation.
