Asean can afford larger budget deficits, public debt levels without causing instability

SOUTH-EAST Asia's external position is solid enough to sustain a prolonged expansionary fiscal stance, which also means policymakers can continue to run larger budget deficits and debt levels over the next few years, without causing any macroeconomic instability, a report by ANZ Research suggested on Monday.

While large fiscal stimulus programmes have provided a critical backstop to falling growth this year, these demands on policy could naturally weaken the region's fiscal positions, it said.

However, ANZ economists believe the region can afford larger budget deficits and public debt levels for a prolonged period without causing macroeconomic instability.

At first glance, fiscal metrics including budget balances and public indebtedness have indeed deteriorated, with the unprecedented large stimuli needed to combat the economic fallout of the COVID-19 pandemic, ANZ said.

Restoring public debt ratios to pre-pandemic levels is likely to be "an exceptionally tall order", as it will require governments to run primary surpluses on a scale that will severely hurt growth, the economosts said.

However, there is a case for moving the old goalposts, they said.

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"The evolving fiscal situation is obviously beyond the pale of traditional conservatism in most economies in the region. At the same time, it does not present any risks to macroeconomic stability. Governments can afford to maintain expansionary fiscal policies and some are doing so," they wrote.

As an example, Souh Korean policymakers previously strived to keep the debt ratio below 40 per cent of gross domestic product, but the 2021 budget proposal has outlined a significantly looser medium-term fiscal policy stance that will see the debt ratio rise meaningfully in the coming years. Malaysia has also abandoned its pre-pandemic objective of balancing its budget by end-2023.

"Steeper budget deficits or levels of public debt are in fact, part of a global trend. Benchmarks beyond the headline debt level are needed to assess debt sustainability," ANZ economists said.

"Indicators such as the debt profile and market perception of sovereign risk suggest there is now more scope for fiscal policy to remain expansionary for most of these economies as compared to the past."

For example, the share of short-term government debt has generally been on a decline, suggesting lower rollover risk, as has the dependence on foreign funding, and sovereign credit default swap spreads have also been on a downtrend despite larger imbalances, they pointed out.

Monetary easing by G3 central banks and domestic policy accommodation have also helped the region pursue an expansionary fiscal policy, the economists said, adding that this has been instrumental to absorbing enhanced levels of government funding at stable costs.

Meanwhile, low and stable funding costs will have a more positive impact on debt sustainability in 2021, ANZ said. As nominal GDP growth turns positive it will result in a more favourable growth-interest rate differential, a key determinant of the change in public debt.

At the same time, Asia's external situation is also in "solid shape" - current accounts are in surplus in all economies except Indonesia and FX reserves have grown.

"Our view is further corroborated by the performance of Asian currencies, most of which have appreciated in recent months and volatility has been low," the economists said.

They also noted that real policy rates are higher in all economies except India, the Philippines and South Korea.

"The evolving macro backdrop, much of which has been precipitated by the Covid-19 pandemic, calls for a new and more liberal assessment of fiscal policy. Larger deficits and public debt ratios are justifiable not just in light of negative output gaps but also external metrics and the ability to continue with supportive monetary policies," said the economists.