South Asia Economic Focus | Spring 2019 RTS XPO E 2 © 2019 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 22 21 20 19 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. 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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): 978-1-4648-1407-5 DOI: 10.1596/ 978-1-4648-1407-5 Design: sonideas/alejandro espinosa South Asia Economic Focus | Spring 2019 | Exports wanted 3 Photo: © Shutterstock/ T photography South Asia Economic Focus | Spring 2019 | Exports wanted Photo: © Shutterstock/ CRS PHOTO 4 South Asia Economic Focus | Spring 2019 | Exports wanted 5 T 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 (MTI) Global Practice. Its preparation was led by Robert Beyer (Economist, SARCE) under the oversight of Hans Timmer (Chief Economist, South Asia Region), in close collaboration with Manuela Francisco (Practice Manager, MTI). Substantive contributions were made by Sebastián Franco-Bedoya, Milagros Chocce, Rucheta Singh, Waewnet Sukkasem (all SARCE) and Gonzalo J. Varela (MTI). The report greatly benefitted from inputs from Temel Taskin and other colleagues in the Prospects Group (PG) under the supervision of Ayhan Kose (Director, PG). Useful comments and suggestions were provided by Poonam Gupta, Sebastian Saez, Enrique Blanco Armas, Sanjay Kathuria, Gonzalo J. Varela, Zahid Hussain, Aurélien Kruse, Fernando Gabriel Im, Tae Hyun Lee, Florian Blum, Kene Ezemenari, Rangeet Ghosh, Adnan Ashraf Ghumman, Kishan Abeygunawardana, Nazmus Sadat Khan, Amit Singhi, Thi Thanh Thanh Bui (all MTI) and Rinku Murgai (Lead Economist, Poverty Global Practice), as well as by Christian Eigen-Zucchi (Program Leader, Bangladesh, Bhutan, Nepal CMU) and Tatiana Nenova (Program Leader, Sri Lanka CMU). Colleagues providing information for country briefs include Aurélien Kruse, Tae Hyun Lee, Habiburahman Sahibzada, Zahid Hussain, Yoichiro Ishihara, Tenzin Lhaden, Rangeet Ghosh, Fernando Gabriel Im, Kene Ezemenari, Nayan Krishna Joshi, Enrique Blanco Armas, Zehra Aslam, and Kishan Abeygunawardana under supervision of Manuela Francisco (Practice Manager MTI). Alejandro Espinosa at Sonideas was responsible for the layout, design and typesetting and William Shaw edited the chapters. Alexander Ferguson (Senior Manager) and Yann Doignon (Online Communications Officer) at South Asia External Communications coordinated the dissemination, Gonzalo Alberto Villamizar De La Rosa created accompanying videos, and Neelam Chowdhry and Clydina Luikham Anbiah 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 April 1, 2019. South Asia Chief Economist Office Macroeconomics, Trade and Investment Global Practice South Asia Economic Focus | Spring 2019 | Exports wanted Photo: © Shutterstock/ CRS PHOTO 6 South Asia Economic Focus | Spring 2019 | Exports wanted 7 Table of contents Recent economic developments ···································································································· 9 Global growth moderated············································································································································································10 South Asia grew fast, but the tide turned··································································································································11 External vulnerabilities persisted but may have bottomed out·····································································15 Rising core inflation but low headline inflation··················································································································21 South Asia economic outlook ············································································································· 29 Robust growth forecast····················································································································································································30 Lower import growth and higher export growth ············································································································32 Downside risks to the outlook·································································································································································34 Exports wanted ············································································································································································· 39 Tighter external financing conditions·············································································································································40 A delicate balance··································································································································································································42 Accelerated domestic spending···························································································································································44 Financing risks vary·······························································································································································································49 Underperforming exports·············································································································································································51 Restoring equilibrium ·······················································································································································································57 Active policies are needed··········································································································································································61 South Asia country briefs ·································································································································· 68 South Asia at a glance ··············································································································································· 94 South Asia Economic Focus | Spring 2019 | Exports wanted 8 Photo: © Shutterstock/Radiokafka South Asia Economic Focus | Spring 2019 | Exports wanted 9 Recent economic developments South Asia Economic Focus | Spring 2019 | Exports wanted 10 Recent economic developments S outh Asia remained the fastest growing region in the world last year. However, growth moderated from 7.2 percent in 2017 to 6.9 percent in 2018, along with the deceleration of growth in the rest of the world. Regional growth remained driven by domestic demand – and not exports – which resulted in another year of double-digit volume growth of imports. The value of imports was further pushed up by rising oil prices. The widening current account deficits became more difficult to finance after the Federal Reserve gradually tightened monetary policy. These tensions triggered capital outflows, depreciation pressures, increases in credit default swap spreads, and falling stock prices. In some countries the strong growth of domestic demand or currency depreciation led to rising core inflation, although decelerating food prices kept overall inflation below target levels in most countries. In recent months, the data shows a more positive picture. Oil prices declined again at the end of last year. The pressure on exchange rates and reserves eased and exports rebounded. These recent high-frequency data could signal that the challenging situation has bottomed out, but the risks associated with excessive domestic demand growth remain. Figure 1: Global GDP and trade growth moderated last year. Global GDP growth slowed from 3.3 percent in the fourth quarter of 2017 to 2.7 percent in the fourth quarter of 2018, driven by moderating growth in developing countries and a strong deceleration in advanced countries excluding the United States. Together with global GDP growth, world trade growth decelerated to 3.9 percent in 2018, down from nearly 5 percent a year before. Real GDP growth World trade Percent change, y-o-y Percent change, y-o-y 6 6 5 5 4 4 3 3 2 1 2 0 1 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 2018 Q4 0 World United States Developing countries OECD (excluding United States) 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 Source: World Bank. Source: World Trade Organization. Global growth moderated ing countries slowed from 5.1 percent in the fourth quarter of 2017 to 4.4 percent in the fourth quarter The growth of global GDP slowed gradually from of 2018. In OECD countries excluding the United 3.3 percent in the fourth quarter of 2017 (y-o-y) to States, growth decelerated strongly from 2.7 percent 2.7 percent in the fourth quarter of 2018 (Figure 1). in the fourth quarter of 2017 to only 1.2 percent in The decline was broad-based. Growth in develop- the fourth quarter of last year. Together with global South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 11 Figure 2: Oil price volatility remained high and oil prices declined at the end of last year. The average oil price in 2018 was 72 USD per barrel and hence considerably higher than in 2017. After rising from 66 USD per barrel in January of last year to 85 USD per barrel in October, the price dropped temporarily to a low of 49 USD in January of this year. However, it started rising again and reached 65 USD per barrel at the end of March. Crude oil price: Brent - Europe USD/Bbl 90 85 80 75 70 65 60 55 50 45 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Note: The year 2017 represents the average price in 2017. Source: Haver Analytics. GDP growth, world trade growth decelerated. Glob- South Asia grew fast, but the al trade grew 5.5 percent in the fourth quarter of 2017 but only 4.2 percent in the first quarter of last year tide turned and 3.3 percent in the following two. For all of 2018, Growth in South Asia remained the fastest in the global trade growth is estimated to have been 3.9 world, but it moderated for the second year in a row percent. (Figure 3). The region grew by 7.7 percent in 2016, Oil price volatility remained high and oil was more by 7.2 percent in 2017 and by 6.9 percent last year. expensive in 2018 than in 2017 (Figure 2). After ris- Growth in East Asia and Pacific, the second fastest ing for most of last year, the price of oil reached 85 growing region, was 6.3 percent last year. As in the USD per barrel in October. It then dropped rapidly past, South Asia excluding India grew much slower, at the end of the year and reached a low of 49 USD namely at 5.4 percent last year. Only India and Sri per barrel in January, which was below the average Lanka are reporting quarterly GDP growth rates in price in 2017. However, the price reversed course South Asia. In both countries GDP growth slowed once more and the price reached 65 USD per barrel over the course of 2018. India grew above 8 percent at the end of March. With an average price of 72 (y-o-y) in the first half of 2018, but growth declined USD per barrel in 2018, the price was still much to 7.0 percent in the third and to 6.6 percent in the lower than before the oil price collapse in 2014 – fourth quarter. In Sri Lanka, growth declined from the average price of oil during the first half of 2014 4.0 percent (y-o-y) in the first quarter to 3.5 percent was 109 USD per barrel – but much higher than in in the third and dropped to 1.8 percent in the fourth. 2016 and 2017, when the average price was only 45 Over the last years, growth in South Asia has been USD per barrel and 55 USD per barrel respectively. driven by domestic demand resulting in high import That said, current accounts in South Asia tend to be growth. On average, government consumption in resilient to oil prices in the mid-60 USD range. But South Asia grew 11.1 percent over the last two years since South Asian countries are net importers of oil, and investment by 9.3 percent (Figure 4a). Both the high volatility of international oil prices exerts components hence contributed substantially to the continuously changing pressure on their external high growth over these two years. The strong domes- balances (see Chapter 3). tic demand resulted in very high import growth of South Asia Economic Focus | Spring 2019 | Exports wanted 12 Recent economic developments Figure 3: South Asia remained the fastest growing region in the world, but growth slightly moderated over the last two years. South Asia remained the fastest growing region in the world last year, but its growth moderated slightly from 7.2 percent in 2017 to an estimated 6.9 percent in 2018. Growth in East Asia and Pacific, the second fastest growing region in the world, declined from 6.6 percent to 6.3 percent. Annual real GDP growth in the world, East Asia Paci c and South Asia Regional quarterly real GDP growth Percent change, y-o-y Percent change, y-o-y 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 2016 2017 2018 (e) 2018 Q1 2018 Q2 2018 Q3 2018 Q4 World East Asia and Paci c South Asia South Asia excl. India East Asia and Paci c Europe and Central Asia Sub-Saharan Africa Latin America and Caribbean Middle East and North Africa South Asia Note: Real GDP growth is in calendar years. Notes: Data is for countries that report quarterly data. In South Asia this is only Source: World Bank. India and Sri Lanka. Source: World Bank. Figure 4: Growth last year continued to be driven by domestic demand resulting in high import growth. In the last two years, government consumption and investment grew fast in South Asia. The former averaged 10.3 percent compared to 6.3 percent in 2016 and the latter 9.4 percent compared to 8.0 percent in 2016. The strong domestic demand resulted in very strong import growth of around 15.6 percent in both years, which is nearly twice as high as export growth. a) South Asia b) South Asia excluding India Volume growth of GDP components in South Asia Volume growth of GDP components in South Asia excl. India Percent change, y-o-y Percent change, y-o-y 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 2016 2017 2018 (e) 2016 2017 2018 (e) -2 -2 Private consumption Government consumption Investment Exports Imports Notes: The horizontal line represents the real GDP growth. All variables are in calendar years. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 13 Figure 5: Fewer countries are still growing above their potential and long-run averages. Growth rates differ across South Asian countries and fewer countries grew above their potential last year. Maldives, Bangladesh, and India headed growth in 2018 and Afghanistan continued to lag behind. Real GDP growth in 2018 Percent change, y-o-y 9 8 7 6 5 4 3 2 1 0 Maldives Bangladesh India Nepal Bhutan Pakistan Sri Lanka Afghanistan Average 2012- 2017 Potential Notes: (e)= estimate. Bars represent data from 2018(e); horizontal line, the average growth between 2012 and 2017. Real GDP growth is in calendar years for all countries. For countries reporting growth in fiscal years, we compute weighted averages of annual growth rates and for India calendar years are aggregated using quarterly data. Triangles represent the potential growth. Source: World Bank. 14.9 percent in 2017 and 15.6 percent in 2018. Private eration in exports and a boost in domestic consump- consumption and investment remained robust last tion thanks to a rise in remittances and better agri- year, as a slowdown in Pakistan was offset by solid cultural production. Due to its size, India drives the growth in the rest of the region. The growth com- regional performance and its growth has remained position is similar when India is excluded from the stable. Data for the first three quarters of the fiscal regional aggregate (Figure 4b). Growth was again year 2018-19 suggests that growth has been driven driven by government consumption and investment by an acceleration in industrial growth – owing to and import growth was unusually high. The differ- strong performance of manufacturing, the electric- ence is that in South Asia with India, government ity sector and construction – and a steady perfor- consumption moderated in 2018 while investment mance of agriculture during the first half of the year. accelerated. In the region excluding India, on the However, growth in the third quarter slowed to 6.6 other hand, government consumption accelerated percent, the weakest growth in the past five quarters. while investment moderated. Overall, the growth Consequently, the Central Statistical Office down- in the last years has hence been driven mostly by graded its growth forecast to 7.0 percent for fiscal domestic demand, though export growth picked up year 2018-19 from an earlier projection of 7.2 percent from low levels. at the end of February. In Nepal, growth was still partly driven by reconstruction. In addition, Nepal Regional heterogeneity in growth rates persisted experienced a record level of tourist inflows and the and in 2018 fewer countries than a year ago grew industrial sector expanded capacity, supported by above their long-run average and their potential improved access to electricity. In Bhutan, growth (Figure 5). Over the calendar year 2018, Maldives was was driven by the services sector, especially hotels the fastest growing country in South Asia, owing to and restaurants, retail trade and transportation. the contribution from tourism, wholesale and retail Pakistan’s GDP growth is projected to slow down to trade and construction. Tourist arrivals and bed 3.4 percent in fiscal year 2018-19, from 5.8 percent nights increased, supported by infrastructure invest- a year before, reflecting a broad-based weakening ments on the international airport, opening of new in domestic demand as monetary and fiscal policies resorts, and the expansion of the guest house sector. have been tightened to contain macroeconomic im- In Bangladesh, growth picked up because of an accel- balances. The current macroeconomic challenges in South Asia Economic Focus | Spring 2019 | Exports wanted 14 Recent economic developments Figure 6: Stock prices moved in line with macroeconomic developments. Stock markets have dropped by 14 percent in Pakistan and Sri Lanka, gained 17 percent in India (up 6 percent from October), and returned to the same level in Bangladesh. India, Bombay Stock Exchange SENSEX Pakistan, Karachi Stock Exchange 100 Index Index 40000 48000 Since Mar-18: +17.3 Since Mar-18: -14.4 39000 Since Oct-18: +5.9 Since Oct-18: -5.6 46000 38000 37000 44000 37000 42000 35000 40000 34000 38000 33000 32000 36000 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Sri Lanka, Colombo Stock Exchange ASPI Bangladesh, Dhaka Stock Exchange DSEX Index Index 6800 6400 Since Mar-18: +0.3 6600 Since Mar-18: -13.7 6200 Since Oct-18: +2.5 6400 Since Oct-18: -4.5 6000 6200 5800 6000 5600 5800 5400 5600 5200 5400 5000 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Notes: Growth rates are calculated using daily price data. For the 12-month rate, last observation available of 2019 (Mar-28/Mar-29) was compared against the value of Mar-28/ Mar-29 in 2018. For the 6-month rate, last observation available of 2019 (Mar-28/Mar-29) was compared against the value of Oct-01 of 2018. Sources: Haver Analytics and staff calculations. Pakistan are primarily the result of past policy choic- in Pakistan and in Sri Lanka and in both countries es and there has been some adjustment over the past the decline continued over the course of the last six year. However, further adjustments will be needed. months. In Pakistan, stock prices declined strongly In Sri Lanka, growth dampened significantly in between April and July due to growing concerns 2018, partly due to political tensions which impact- about external imbalances and political uncertainty ed international business confidence. Leading rating ahead of the July elections. After a short recovery, the agencies revised their assessments and Fitch, S&P, Karachi Stock Exchange (KSE) index dropped to its and Moody’s downgraded Sri Lanka’s sovereign rat- lowest level since May 2016 in October, as investors ings. In Afghanistan, output growth slowed because continued to pull out amid economic uncertain- of a severe drought that affected wheat production ty. Yet, prices jumped strongly within the first 10 and livestock pasture. In addition, heightened polit- minutes of trading on October 24, following a USD ical uncertainty and election-related violence nega- 6 billion bailout package from Saudi Arabia that tively affected business confidence and growth. boosted investor confidence. Since then, however, the downward trend continued due to the unresolved In line with broader macroeconomic developments, macroeconomic imbalances. In Sri Lanka, political since March 2018 stock prices have declined in Paki- uncertainty led to foreign selling and stock prices stan and Sri Lanka, increased in India, and returned declined from March until October of last year, when to the same level in Bangladesh (Figure 6). Since a sudden and unexpected change in the country’s March of last year, stock prices declined by 14 percent political climate seems to have led to a temporary South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 15 Figure 7: Current account balances continued to decrease but bottomed out. Current account balances continued to decrease in the first half of last year, but apart from Sri Lanka they bottomed out. In Pakistan and Sri Lanka, the deficit in the fourth quarter has been similar to a year ago and in Bangladesh it has been smaller. In Sri Lanka, however, it continued to decline. Current account balance as percent of GDP y-o-y change, percentage points 2 1 0 -1 -2 -3 -4 -5 2017 2018 Q1 2018 Q2 2018 Q3 2018 Q4 Bangladesh India Pakistan Sri Lanka Notes: Quarterly GDP for Bangladesh, Pakistan and Nepal were derived from annual GDP and assumed to be constant for all four quarters. The year 2017 represents the average of 2017. Sources: Quarterly current account data is from Trading Economics. Quarterly GDP data for India and Sri Lanka is from Haver Analytics. increase. In Bangladesh, stock prices are back at the of GDP) at the end of February 2019, compared to level of March last year. The Dhaka Stock Exchange 11.4 USD billion (3.7 percent of GDP) the year before. (DSE) entered a strategic partnership with a Chinese In Sri Lanka, where remittances remained almost consortium by selling 25 percent of its shares to the flat (Figure 13) and increased dividend and interest Shenzhen Stock Exchange (SZSE) and the Shanghai payments exerted pressure on the current account, Stock Exchange (SSE) in May of last year, which the current account deficit widened during the first strengthened investor confidence. Stock prices rose three quarters of last year. In India, the current ac- strongly after the general election at the end of last count deficit stood at 2.5 percent of GDP in the last year but declined subsequently again. In India, stock three months of 2018. In Bangladesh, accelerated ex- prices are now 17 percent higher than in March of port growth, strong remittances growth, and slower last year and 6 percent higher than in October. The import growth reduced the current account deficit. strong decline of Indian stock prices between Sep- In Nepal, where no quarterly data is available, the tember and October last year can partly be explained current account deficit rose to 8.2 percent of GDP in by a temporary worsening of the external situation. fiscal year 2018, up from 0.4 percent the fiscal year be- But since then the market has bounced back strongly. fore, due to increased imports for the establishment of local government offices, reconstruction activities, and intermediate goods imports for the industrial External vulnerabilities sector. In Maldives, the current account deficit is persisted but may have estimated to have widened to 24 percent of GDP in bottomed out 2018, up from 22 percent a year before. In Bhutan, the other country with a very large current account defi- cit in recent years, the deficit moderated. The import Current account balances continued to decrease in of capital goods for hydropower construction de- the first half of last year, but they bottomed out in clined because of the completion of the Mangdecchu most countries (Figure 7). In Pakistan, the current project and delays in the construction of the other account deficit continued to widen but stabilized two main hydropower projects. In addition, because over the course of last year and it stood at 5.2 percent of elections and a new Five-Year-Plan, no new public of GDP in the fourth quarter of 2018. The current investment programs were undertaken by the gov- account deficit reached 8.8 USD billion (3.3 percent ernment in the first half of the year. South Asia Economic Focus | Spring 2019 | Exports wanted 16 Recent economic developments Figure 8: South Asia experienced portfolio outflows last year but inflows so far this year. Capital inflows to India and Pakistan were positive in 2017 and at the beginning of last year, but negative in 2018. At the end of the year, capital flows turned positive again. There is a strong correlation with flows to other EMDEs, though EMDEs did not suffer from overall outflows last year. Total portfolio ows of India, Pakistan and Emerging Markets USD billion, 3-month moving average 60 6 40 4 20 2 0 0 -20 -2 -40 -4 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Emerging Markets India and Pakistan (rhs) Note: The year 2017 represents the average of 2017. Source: International Institute of Finance. Figure 9: Sovereign credit default swap spreads increased in 2018 but reversed course in 2019. Sovereign credit default swap spreads measure a country’s risk of default and are a useful measure of a country’s economic health. These spreads increased in Pakistan, India and Sri Lanka in the second half of last year, but they have declined in 2019 so far. Sovereign credits default spreads Basis Points Basis Points 575 120 525 110 475 100 425 375 90 325 80 275 70 225 175 60 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Sri Lanka Pakistan India (RHS) Note: The year 2017 represents the average of 2017. Sources: Global Economic Prospect 2019 and Haver Analytics. After capital outflows in 2018, capital is again flow- and developing economies (EMDEs) slowed in 2018. ing to India and Pakistan this year (Figure 8). Due Flows to India and Pakistan even turned negative the to less benign international financing conditions combined outflows amounted to over 12 billion USD related to increasing U.S. interest rates and high over the course of the year. In addition to emerg- policy uncertainty, capital flows to emerging market ing market wide pressures faced by both countries, South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 17 Figure 10: Currencies depreciated against the USD, mostly in the first half of 2018. Nearly all South Asian currencies depreciated strongly against the USD last year, much more than other currencies. The Nepalese rupee lost over 10 percent, the Sri Lankan rupee over 15 percent, and the Pakistani rupee over 20 percent. Over the last six months, the depreciation trends continued in Sri Lanka and Pakistan but weakened in the other countries. a) Over the past 12 months b) Over the past 6 months US Dollar per national currency US Dollar per national currency Percent change, February 2018 to February 2019 Percent change, September 2018 to February 2019 6 6 3 3 0 0 -3 -3 -6 -6 -9 -9 -12 -12 -15 -15 -18 -18 -21 -21 Pakistan Sri Lanka Nepal Bhutan India Afghanistan Bangladesh Maldives China Vietnam Indonesia Thailand Pakistan Sri Lanka Bangladesh Maldives Nepal Afghanistan Bhutan India Vietnam China Thailand Indonesia US base US base Notes: Bars indicate the percent change in nominal exchange rates between February 2018 and February 2019 (September 2018 and February 2019 for the right-hand side graph). Diamonds indicate the percent change in the real exchange rate between February 2018 and February 2019 (September 2018 and February 2019 for the right-hand side graph). The U.S. base shows the appreciation of the USD against all other currencies in the world. Sources: IMF, World Bank and staff calculations. outflows in Pakistan were also partly related to do- South Asian currencies depreciated strongly against mestic imbalances. However, at the end of last year the USD over the last twelve months (Figure 10a), the situation improved and capital flows to EMDEs but some currencies have appreciated slightly over picked up again. In line, capital flows to India and the last six months (Figure 10b). Apart from the Mal- Pakistan started increasing again and have been pos- divian rufiyaa (fixed against the USD), all currencies itive in 2019 so far. in South Asia depreciated against the USD in 2018. The depreciation was around 8 percent in Afghani- Sovereign credit default swap spreads increased in stan, Bhutan and India, 10 percent in Nepal, 14 per- the second half of last year in India, Pakistan, and cent in Sri Lanka, and over 20 percent in Pakistan. In Sri Lanka but declined at the beginning of this 2018, South Asian currencies depreciated against the year (Figure 9). These credit default swaps are an USD by more than the (unweighted) average of all insurance against the debt default of the country currencies (labeled ‘US base’ in Figure 10 and provid- and the price hence reflects the market expectations ing a rough approximation of currency movements of such a default. They are thus a good measure of a explained by developments in the United States, for country’s risks and the health of an economy, even example higher interest rates), while in 2017 South though these spreads are also affected by risk appe- Asian currencies’ depreciation against the dollar was tite of international investors and returns in other less than the average. Over the last six months the countries. While these spreads were mostly stable in depreciation continued in Pakistan and Sri Lanka, South Asia at the beginning of last year, they picked but not in the other countries and in Sri Lanka the up in the second half. From May 2018 to December rupee appreciated from January to March this year. 2018, they rose from an average of 0.8 percent to 1.1 The Indian rupee appreciated 1.9 percent against the percentage point in India, from 3.7 percent to 4.6 USD from September 2018 to February 2019. percentage points in Pakistan, and from 2.8 percent to 4.9 percentage point in Sri Lanka. In the new year, Pakistan’s currency has continued to depreciate they continued to decline in India and Sri Lanka, against its trading partners over the last six months, where they are now back at the levels of August last while India’s has not (Figure 11). Pakistan’s real year. In Pakistan, they decreased from January to effective exchange rate, which is the average of its February, but jumped back in March. currency in relation to an index of other major cur- South Asia Economic Focus | Spring 2019 | Exports wanted 18 Recent economic developments Figure 11: Pakistan’s currency has continued to depreciate against its trading partners over the last six months, while India’s has not. Pakistan’s real effective exchange rate, which is the average of its currency in relation to an index of other major currencies weighted by their relative trade shares, depreciated by nearly 5.5 percent from October last year to March of this year. Real e ective exchange rates Index (July 2018 =100) 106 104 102 100 98 96 94 92 90 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 India Pakistan Note: An increase indicates an appreciation of the economy’s currency against a broad basket of currencies. Source: Haver Analytics/JP Morgan. rencies weighted by their relative trade shares and ports of furnace oil were among the policy responses adjusted for inflation differentials, depreciated by to curb imports in Pakistan (see Box 1 for an update in nearly 5.5 percent from October 2018 to March of recent trade policy developments). However, exports this year. The depreciation against its trading part- grew below 5 percent in the third quarter and not at all ners increases the price competitiveness of Pakistan’s in the fourth. In Bangladesh, both imports and exports exports in international markets and makes imports grew little in 2017, but strongly at the beginning of the more expensive. Over time, such an adjustment of year. Different from before, exports grew stronger than relative prices is needed if policies are put in place to imports in the third quarter of 2018. In Sri Lanka, export mprove the trade balance (see Chapter 3). In India, growth decreased from 7.5 percent in 2017 to 2.1 percent the real effective exchange rate depreciated from in the fourth quarter of last year. At the same time, how- July to October 2018 but then appreciated for two ever, import growth came down from nearly 20 percent months after which it has been hovering around its in 2017 to -5.8 percent in the last quarter of last year. July 2018 level. Because of reconstruction efforts and the establishment of local government offices in Nepal, imports grew over Bucking the trend of the last couple of years, exports 30 percent in fiscal year 2018. In Afghanistan, exports grew faster than imports in the third and fourth quarter declined in 2018, despite an increase in high-value fruit of last year (Figure 12). In 2017, imports grew faster than exports to India via new air corridors. In Maldives goods exports in all countries, in some cases by a very wide exports contracted, while goods imports continued to margin, but the situation changed over the course of grow fast, by over 16 percent. However, services exports 2018. In India, the export performance improved, with grew by more than 10 percent. an acceleration in the growth of exports from 1.5 percent (y-o-y) in the first quarter of last year to 16.6 percent in After growing fast in 2017, remittances continued the fourth. Import growth was a very high 23.2 percent to grow strongly in all countries except Sri Lanka in the third quarter but decreased to 8.0 percent in the last year (Figure 13). Remittances are an important fourth. In Pakistan, import growth came down dramat- source of foreign financing and a key contributor to ically and exports grew faster than imports in all four domestic demand and poverty reduction in several quarters of 2018. Regulatory duties imposed on ‘luxury South Asian countries. Over the last year, the flow items’, combined with the imposition of a ban on im- of remittances increased strongly in India, where South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 19 Box 1: An update on trade policy changes affecting South Asia Several trade policy developments have recently impacted South Asia. On the one hand, import restrictions and tariff increases were put in place in some South Asian countries either to reduce current account vulnerabilities, to protect domestic industries, or as retaliatory actions. On the other hand, countries also achieved some success in restructuring and reducing import tariffs. a) Import tariffs to contain external vulnerabilities or to protect domestic industries In September 2018, India raised import tariffs on 19 non-essential imports such as jewelry, jet fuel, and communications gear. Sri Lanka has raised import duties on vehicles and imposed a temporary non-tariff measure to raise more revenue and to reduce vehicle imports, which doubled in 2018. The cash margin on Letters of Credit for the import of motor vehicles has been increased and the maximum Loan to Value ratio for hybrid vehicles has been reduced. To protect domestic industries from international competition, the 2019 budget in Bangladesh imposed supplementary duties on energy drinks, toiletries, perfumes, body sprays and similar items. In Pakistan, the Supplementary Finance Act 2018, passed in October last year, ad- justed regulatory duties on selected luxury goods to reduce the trade deficit. For example, a flat rate of USD 75 on imported mobile phones valued between USD 350 and USD 500 has been introduced. b) Trade tensions between India and the United States India has again postponed retaliatory tariffs on selected U.S. products by a month (such as walnuts, chickpeas, artemia, lentils, and diagnostic reagents), planned as a response to the new U.S. tariffs on steel and aluminum enacted last year. India benefited greatly from the designation as a beneficiary developing country under the Generalized System of Preferences (GSP) that gave 2,000 products duty-free access to the United States. In 2017, the value of Indian exports covered by GSP was USD 5.7 billion, more than for any other country. However, early in 2019 the United States withdrew these export incentives because of compliance issues related to statutory eligibility criteria. The GSP withdrawal may be an indication of the United States following a market access strategy to open India’s market for U.S. products, for example soybeans. c) Trade tensions between India and Pakistan After the Pulwama incident, India has withdrawn the most favored nation (MFN) status for Pakistan and raised custom duties on all goods imported from Pakistan to 200 percent. This may lead to a significant drop in Pakistani exports to India. However, Pakistan’s exports to India are worth only USD 560 million. Pakistan may still impose retaliatory tariffs on Indian goods or expand its negative list prohibiting specific imports from India. Such retaliatory tariffs could jeopardize Indian exports, which are worth USD 1.8 billion. But since the bilateral trade between the two countries barely reaches USD 2.4 billion, the negative effects from an escalation of trade tensions are limited. However, they would prevent the two countries from moving closer to their high trade potential (see Chapter 3). d) Progressing trade talks between China and the United States Trade negotiations between the United States and China are progressing. New tariffs introduced since the beginning of last year have affected about 12 percent of overall U.S. goods imports, 6.5 percent of China’s total goods imports, and about 2.5 percent of global goods trade. South Asia may have reaped some benefits from trade diversion. In Bangladesh, for example, the tariff escalation has contributed to increased orders from both countries. From July to December 2018, exports to the United States grew by 19 percent and exports to China by 36 percent (see Chapter 4). After the United States government increased duties on textile imports from China, apparel imports from Bangladesh have more than doubled. Despite possibly reduced benefits from trade diversion, however, the weakening tensions between the United States and China are good news for South Asian countries, as they reduce the risk of a global economic slowdown and of a reversal of investor sentiments. e) Some promising developments Recently, Pakistan approved a National Tariff Policy (NTP) to ensure transparency and predictability with the aim of institutional- izing the entire tariff structure. However, the NTP is vague in nature and may postpone the reduction of tariffs on intermediates. In Sri Lanka, most imports, except for some basic goods, are subject to a local levy, i.e. para-tariffs, called Export Development Board Levy (or Cess). In the 2019 Budget, the Cess on imports will be subject to a tariff phase out to increase competition and foster participation in value chains. Some items considered sensitive will be excluded from a complete para-tariff phase out. The Ports and Airports Development levy (PAL), another para-tariff in Sri Lanka affecting high-tech machinery, boilers, and electrical items, will be reduced to 2.5 percent to reduce the upfront costs of investments. Bangladesh is seeking tariff benefits on its exports of garments made from U.S. cotton by requesting re-admittance to the United States Generalized System of Preferences (GSP). Bangladesh was suspended from GSP benefits in June 2013, due to issues related to worker rights and safe- ty. Around 7 percent of the cotton that Bangladesh imports from the United States is used to produce garments that are then exported back to the United States. With a tariff of 16 percent, these apparel exports are subject to the highest tariffs among all exporters. However, at the moment there is no indication that the Unites States is going to give back GSP to Bangladesh. South Asia Economic Focus | Spring 2019 | Exports wanted 20 Recent economic developments Figure 12: Marking a major shift, exports grew faster than imports in the third quarter of last year in Pakistan and Bangladesh. In 2017, imports grew faster than exports in all countries, in some cases by a very wide margin. Over the course of last year, the situation improved and in the third and fourth quarter of last year, exports grew faster than imports. Value growth of merchandise exports and imports Percent change, y-o-y 30 25 2017 20 2017 2018 Q1 15 2018 Q1 2018 Q3 2018 Q1 Growth of imports 2017 10 2018 Q1 5 2018 Q4 0 2017 -5 2018 Q4 2018 Q4 -10 -10 -5 0 5 10 15 20 25 30 Growth of exports Bangladesh India Pakistan Sri Lanka Note: The year 2017 represents the growth of exports from 2016 to 2017. Source: World Bank. Figure 13: Strong remittances growth in most countries provided additional external funding. Apart from Sri Lanka, remittances increased in 2017 and they kept increasing last year. In India, they increased by over 30 percent (y-o-y) in the third quarter of 2018 compared to a year ago, and in Bangladesh and Pakistan they grew over 10 percent. But remittances growth slowed in the fourth quarter. Remittance ows percent change, y-o-y 40 30 20 10 0 -10 2017 2018 Q1 2018 Q2 2018 Q3 2018 Q4 Bangladesh India Pakistan Sri Lanka Nepal Note: The year 2017 represents the percent change between 2016 Q4 and 2017 Q4. Source: National Authorities / Haver Analytics. remittances grew 34 percent (y-o-y) in the third Despite mild declines in Bangladesh and India, their quarter. In Pakistan and Bangladesh, they increased reserve coverage remains comfortable, but the level by around 13 percent in the third quarter, but growth of reserves is more worrisome in the other countries slowed in the fourth quarter. In Sri Lanka, on the (Table 1). Foreign exchange interventions of the Re- other hand, remittances were almost flat. serve Bank of India (RBI) have resulted in losses of South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 21 Table 1: Foreign exchange reserve coverage declined across South Asia, though by very little in most countries. Reserve coverage is a little bit lower than a year ago in Bangladesh and India but remains at comfortable levels there. Sri Lanka’s reserves cover only 2.8 months of imports, and the country faces large repayments soon. In Pakistan, the reserve coverage deteriorated further. Foreign exchange reserves in months of goods imports Bangladesh India Pakistan Sri Lanka Average in 2017 8.4 10.3 4 3.8 18-Jan 7.1 10 3 4 18-Jul 6.6 9.2 2.8 4.5 18-Dec 7.1 9.6 2.5 4.2 19-Jan 6.9 9.5 2.8 3.9 Source: World Bank some reserves. However, with 9.5 months of import sures which made imported final and intermediate coverage as of January the level remains comfortable. goods more expensive. It reached 8.3 percent (y-o-y) In Bangladesh, the reserve coverage declined from over in December of last year, the highest value since Jan- 8.4 months of imports in 2017 to 6.9 months of imports uary 2015. In Bangladesh, strong domestic demand in January 2019. In Sri Lanka, the reserve coverage in- and the disappearance of underutilized capacity, as creased from around 2 months of imports in January well as higher costs from frequent transport disrup- 2018 to 3.9 months of imports in January 2019. A 1 tions, increased core inflation from 3.2 percent in billion Eurobond matured in January of this year and January to 5.5 percent in December. In Sri Lanka, international repayments will remain high over the core inflation was as low as 2.1 percent at the be- coming years. From April of last year to end of Janu- ginning of the year and even continued to decline ary, the reserve coverage declined from USD 9.0 billion slightly until June. However, since then it has in- to only USD 5.2 billion. In Pakistan, external account creased considerably – partly due to higher prices pressure reduced international reserves to USD 6.6 for housing and exchange rate depreciation – and billion (1.3 months of goods and services import cover- it jumped to 5.1 percent in January 2019. In India, age) by mid-January 2019. With short-term financing on the other hand, core inflation is very stable de- from the Kingdom of Saudi Arabia, the United Arab spite high growth, and in 2018 it fluctuated closely Emirates and China, international reserves increased around 5.5 percent. to USD 10.5 billion (2.0 months of goods and services Food price inflation decelerated in nearly all coun- import coverage) at the end of March. Meanwhile, the tries in South Asia in 2018 (Figure 15). Global food government continues to negotiate a support package price growth decelerated as well, but food inflation with the International Monetary Fund. in South Asia seems driven by idiosyncratic and regional factors and not global trends (see Box 2). Food prices fell in Sri Lanka, Bangladesh, and in Rising core inflation but low India, mainly due to good harvests, and food prices headline inflation were lower at the end of last year compared to a year before. Prices were stable in Pakistan and Mal- Core inflation is rising fast in Pakistan and Bangla- dives. While average food inflation was still modest desh and recently picked up in Sri Lanka (Figure 14). at 3.0 percent (y-o-y), Nepal was the only country Core inflation measures consumer prices excluding in which food prices increased faster last year than food and energy. In Pakistan core inflation steadily in 2017, mostly owing to an unfavorable monsoon. rose throughout 2018, mostly due to currency pres- Food price inflation in Bangladesh declined, from South Asia Economic Focus | Spring 2019 | Exports wanted 22 Recent economic developments Figure 14: Core inflation is rising fast in Pakistan and Bangladesh and recently picked up in Sri Lanka. Core inflation, which measures the costs of goods and services excluding food and energy, increased steadily in Pakistan and Bangladesh and picked up recently in Sri Lanka. In India, on the other hand, it is very stable. Core in ation Percent, y-o-y 10 8 6 4 2 0 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 India Pakistan Sri Lanka Bangladesh Note: The year 2017 represents the percent change between Dec-2016 and Dec-2017. Sources: Haver Analytics. Sri Lanka data is from Sri Lanka Department of Census and Statistics. Bangladesh data is from the Central Bank of Bangladesh (non-food inflation). Figure 15: But food price inflation fell, so that … Food price inflation decelerated over the course of last year in nearly all countries in the region. In India, Maldives, Pakistan and Sri Lanka, food prices remained either constant or even declined compared to a year earlier. On average, they declined by 3.0 percent in these countries. Food consumer price in ation Percent, y-o-y 10 8 6 4 2 0 -2 -4 -6 -8 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Afghanistan Bangladesh India Maldives Nepal Pakistan Sri Lanka Note: The year 2017 represents the percent change between Jan-2016 and Jan-2017. Sources: Afghanistan, Bangladesh, India, Pakistan and Sri Lanka National Authorities. Maldives data series from MMA / Haver Analytics. 7.3 percent in February 2018 to 5.4 percent in prices hence tend to foster shared prosperity and February 2019. In South Asia, food constitutes a to benefit the poor most. In South Asia, changes in large part of household expenditure and its budget consumer prices can to a large extent be explained share exceeds 50 percent in Bangladesh, India, and by changes in food prices, which tend to be more Nepal. Across South Asia, the share is higher for volatile (see Box 2). In most countries, lower food the rural population and the poor. For example, in price inflation led also to lower overall inflation. Bangladesh the poor in rural areas spend 67 per- In Pakistan, on the other hand, consumer prices cent of their total spending on food.  Lower food increased despite a strong decline in food prices. South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 23 Table 2: … headline inflation softened in most countries. Consumer price inflation is around or below 3 percent in most countries but 5.5 percent in Bangladesh and 8.2 percent in Pakistan. Inflation decreased strongly in India and Sri Lanka and nearly doubled in Pakistan. Consumer price inflation in percent (y-o-y) Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka 2017 3.0 5.9 0.7 5.2 1.3 4.1 4.6 7.3 Jan-18 4.3 5.9 2.4 5.1 1.1 2.0 4.4 5.4 Jul-18 -0.2 5.6 1.4 4.2 -0.3 4.5 5.9 3.4 Dec-18 0.8 5.4 3.1 2.1 -0.9 6.1 0.4 Last observation 0.4 5.5 3.1 2.6 -1.2 4.2 8.2 2.4 Notes: Data for Afghanistan was completed using national data since September 2018; for Bhutan since December 2017; for India since December 2018; and for Maldives since July 2018. The year 2017 represents the percent change between Dec-2016 and Dec-2017. The last observation for Nepal is October 2018; for Afghanistan and Bhutan is January 2019; and for the rest of the countries it is February 2019. Sources: World Bank, National Statistics and Information Authority (Afghanistan), National Statistics Bureau (Bhutan), Sri Lanka Department of Census and Statistics (Sri Lanka). Figure 16: Inflation is below target in Sri Lanka and India but above in Pakistan. Benchmarking actual inflation against targets reveals how successful central banks are with their stabilization policies and indicates the monetary policy stance. Different from six months ago, inflation is now below target in India and Sri Lanka, and above target in Pakistan. Distance of in ation to policy target Percentage points 3 2 1 0 -1 -2 -3 Sri Lanka India Bangladesh Pakistan In ation - In ation target Trend in ation - In ation target Di erence from in ation target 6 months ago Notes: 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. All countries’ reported inflation is from February 2019. Sources: Inflation target data is from Haver Analytics (National Authorities). Current inflation data is from World Bank. Trend inflation was calculated using the HP filter. SAEF Fall 2018 provides the distance from inflation target 6 months ago. Distance of inflation to target is based on staff calculations. Headline inflation softened in most countries, and Average inflation reached 7.0 percent in the period with inflation rates varying from 0 to over 8 percent between October 2018 and February 2019, compared (y-o-y), strong regional heterogeneity persisted (Ta- to 4.1 percent in the same period last year. On the ble 2). Inflation in Afghanistan picked up during the other hand, inflation has been softening in India second half of last year and left deflationary territory. and Sri Lanka. Inflation came down strongly from The low inflation in Maldives last year was mainly 5.2 percent in 2017 to 2.5 percent in February 2019 due to a decrease in the prices of staple food items in India, and from 7.3 percent in 2017 to 2.4 percent and electricity brought about by policy changes in in February 2019 in Sri Lanka owing to a sustained food subsidies and electricity charges. In Pakistan, decline in food prices since July 2018 (see Figure 15) inflation increased owing to exchange rate depreci- complemented by softening oil prices in the second ation, demand side pressures and higher fuel prices. half of last year (Figure 2). As in the past, inflation in Consumer prices rose by 8.2 percent from February Bangladesh is very flat but it decreased slightly due to 2018 to February 2019, the highest rate in South Asia. declining rice prices. South Asia Economic Focus | Spring 2019 | Exports wanted 24 Recent economic developments Box 2: Consumer price inflation and food inflation in South Asia In South Asia, consumer price inflation and food inflation are highly correlated (Figure 17a). Food inflation can raise aggre- gate inflation substantially when food constitutes a significant share of the consumption basket, as it does in South Asia. In Bangladesh, for example, food has 56 percent weight in the national CPI. Aggregate inflation also increases through knock-on effects on non-food inflation caused by the rise in food inflation. It induces labor to demand higher wages, which raises the cost of production and hence prices of non-food items as well. In addition, an increase in food prices, relative to aggregate prices, raises demand for non-food products via substitution and income effects. In the long-run, however, high food inflation can have a negative impact on non-food inflation when food is a large expenditure item. Persistently high food inflation reduces real income in the long-run, causing proportionately greater decline in consumption of non- food items compared to food and hence negatively impacts on non-food prices. In Afghanistan, India, Maldives, Nepal and Sri Lanka, the correlation between the two from April 2016 to February 2019 was above 0.9. In Bangladesh the cor- relation was at 0.6 somewhat lower, but still high. In Pakistan, on the other hand, the correlation was very low. One reason is the recent currency devaluation that resulted in increasing consumer prices despite slowing food prices (see Figure 15 and Table 2). To understand what proportion of consumer price changes can be explained by changes in food prices, we regress the former on the latter. There are two possible reasons for why changes in overall consumer prices may be strongly related to changes in food prices. First, food prices are of course part of the prices that make up overall consumer prices and since food prices are often volatile, they may be important drivers of overall price changes. The weight of food and non-alcoholic beverages in the consumption basket used to measure consumer prices varies between 35 percent in Pakistan and 48 percent in Afghanistan. Second, there could be a common factor driving both food prices and other consumer prices. The most obvious candidate is the price of oil, as it may increase both agricultural production costs (e.g. through petrol and fertilizers) and other consumer prices. However, we do not find a strong link between the oil price and food prices in South Asia. There is a statistically significant but weak relationship between changes in oil prices and changes in food prices in Nepal and Bangladesh, but no relationship in the other countries. From early 2016 to February of this year, over 80 percent of the variation in consumer price inflation in Afghanistan, India and Sri Lanka can be explained by changes in food prices (Figure 17b). In Pakistan and Maldives, around 70 percent of consumer price changes can be explained by food price changes. But despite the high correlation, only around a third of the variation in consumer prices is explained by food prices in Bangladesh. Figure 17: CPI and food inflation are highly correlated in South Asia. a) Correlation between consumer prices b) Changes in consumer prices explained and food prices in South Asia by changes in food prices Consumer price in ation Changes in consumer price in ation and food price in ation explained by changes in food in ation Percent, y-o-y Proportion 20 1 15 0.8 Food price inflation 10 5 0.6 0 -5 0.4 -10 -4 -2 0 2 4 6 8 10 0.2 Consumer price inflation Afghanistan Bangladesh India Pakistan 0 Nepal Maldives Sri Lanka Afghanistan India Sri Lanka Pakistan Maldives Nepal Bangladesh Notes: Data of CPI and food inflation is from April 2016 to February 2019. Each point represents one month’s data. Sources: World Bank, National Statistics and Information Authority (Afghanistan), National Statistics Bureau (Bhutan), Sri Lanka Department of Census and Statistics (Sri Lanka). …. Continues next page …. South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 25 Figure 18: Food inflation in South Asia is not strongly driven by global prices. a) Food prices are not correlated with global food prices… b)… but co-move within the region. South Asian and global Changes in food in ation food price in ation explained by regional factor Percent, y-o-y Proportion 20 0.3 15 South Asian food price inflation 10 5 0.2 0 -5 -10 0.1 -8 -6 -4 -2 0 2 4 6 8 10 12 Global food price inflation Afghanistan Bangladesh India Maldives 0 Nepal Pakistan Sri Lanka Pakistan Bangladesh Maldives Afghanistan Sri Lanka India Nepal Notes: The regional food inflation factor is derived as the first principal component of food inflation in Bangladesh, India, Maldives, Nepal, Pakistan, and Sri Lanka. The right-hand side graph indicates the percent of variance in food inflation explained by regional factors (squared factor loadings). Sources: World Bank, National Statistics and Information Authority (Afghanistan), National Statistics Bureau (Bhutan), Sri Lanka Department of Census and Statistics (Sri Lanka). Global food prices are often cited as an important determinant of food price developments in South Asia. The theoretical reasons for assuming a strong relationship are obvious: first, some food items are imported and hence directly depend on international prices and, second, if international prices drop, domestic suppliers have less incentive to export their produce, which may lower domestic food prices. However, we find no correlation between global food prices and food prices in South Asia (Figure 18a). Instead, food prices in South Asia seem to follow a regional pattern. We compute the first principle components of food prices in South Asia and then check how much variation this regional factor explains in the different countries (Figure 18b). In Pakistan and Bangladesh, far over 20 percent of domestic food price changes can be explained by regional movements. In Maldives and Afghanistan, the proportion is around 20 percent and in Sri Lanka around 10 percent. One reason for the strong regional co-movement could be the monsoon, and weather more generally. Clearly food prices in South Asia depend strongly on the harvests, which in turn depends on the monsoon. In India and Nepal, however, the regional factor does not explain much, which could be due to strong regulation of food prices. Inflation is now below target in Sri Lanka and India margin and looking at trend inflation widens the but above target in Pakistan. Comparing actual in- gap a little further. In India, the difference between flation to targets reveals whether central banks face consumer price inflation and the target was around unexpected developments and how successful they 1.5 percentage points in February and around 1 per- are with their stabilization policies (Figure 16). Infla- centage point when looking at trend inflation, which tion rates far above target can signal a need to tight- still is within the target band. This gap explains the en interest rates and inflation far below can signal reduction in interest rates in February and further monetary policy leeway. Sri Lanka has not yet moved reduction in early April. In Bangladesh, inflation was to explicit inflation targeting, but its inflation can be nearly at target. The State Bank of Pakistan does not compared against the center point of the Monetary explicitly target inflation, but authorities announce Policy Consultation Clause, which is 4.7 percent. Dif- an inflation target with every budget which it uses as ferent from six months ago, consumer price inflation an indicative target. Different from six months ago, in Sri Lanka was below target in February. With over inflation was with over 2 percentage points consider- two percentage points, it was below by quite some ably above this indicative target. South Asia Economic Focus | Spring 2019 | Exports wanted 26 Recent economic developments Figure 19: Interest rates are reacting in most countries, especially in Pakistan. In Sri Lanka and especially in Pakistan, interest rates were increased last year to contain external pressures. Rates were also raised slightly between May and August in India, but then were reduced in February as inflation was below target. O cial interest rate (policy instrument/base rate) Repo rate (EOP, percent) 12 10 8 6 4 2017 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Bangladesh India Nepal Pakistan Sri Lanka Note: The year 2017 represents the average of 2017. Sources: National Central Banks and IMF / Haver Analytics. In Sri Lanka and especially in Pakistan, interest rates all rupee deposits of commercial banks was reduced to were increased last year to contain external pressures address a liquidity shortage. To neutralize the impact (Figure 19). In Pakistan, policy rates increased from 6.3 of this reduction, the Standing Deposit Facility Rate percent in January to 10.5 percent in February. These (SDFR) was increased to 8.0 percent and the Standing raises were needed to reduce capital outflows, defend Lending Facility Rate (SLFR) to 9.0 percent. In India, the currency and curb domestic demand that resulted rates were raised from 6.0 percent to 6.25 percent in high imports and a large current account deficit. Sri June, and further to 6.5 percent in August. The un- Lanka’s interest rate developments are nuanced. The derperformance of inflation (see Table 2), resulted in upper band of the policy rates was reduced in April of a reduction of interest rates in February and April, to last year, which ended a tightening cycle. Later in the now 6.0 percent. In Nepal, rates were lowered from year, the Statutory Reserve Ratio (SRR) applicable on 7.0 percent to 6.5 percent in May. South Asia Economic Focus | Spring 2019 | Exports wanted Recent economic developments 27 Photo: © Shutterstock/Svitlana Cicorelli South Asia Economic Focus | Spring 2019 | Exports wanted 28 Photo: © Shutterstock/ImagesofIndia South Asia Economic Focus | Spring 2019 | Exports wanted 29 South Asia economic outlook South Asia Economic Focus | Spring 2019 | Exports wanted 30 South Asia Economic Outlook T he growth outlook for South Asia assumes that the recent acceleration of export growth continues and that import growth slows, so that imports and exports grow at similar rates going forward. Under these conditions, GDP growth is expected to accelerate slightly to 7.0 percent this year and to 7.1 percent in 2020 and 2021. GDP growth is forecast to slightly accelerate in Afghanistan, India, and Sri Lanka, but to moderate in Bangladesh, Bhutan, Maldives, Nepal and Pakistan. The further acceleration of export growth will be challenging given global trade weakening. Other downside risks to the forecasts include a re-escalation of political turbulence, fiscal slippages, and deteriorated balance sheets of both banks and corporates. For high GDP growth to be sustained in the long run, the large infrastructure gaps have to be narrowed, and the still weak business climate has to be improved to increase investments from both domestic and foreign sources. Robust growth forecast could disrupt activity in the affected economies and lead to contagion effects. Global growth is projected to moderate from 2.9 percent in 2018 to 2.6 percent in Moderating global activity and heightened risks mean 2019 and is expected to stabilize at 2.8 percent the fol- that global economic prospects are less benign than six lowing two years. The softening of global trade and the months ago. International trade and investment have further tightening of financing conditions is expected softened, trade tensions remain elevated, and some to result in a more challenging external environment large emerging market and developing economies (EM- for EMDEs, whose growth is expected to stall in 2019. DEs) have experienced substantial financial market pressures recently. Downside risks have become more The growth outlook for South Asia has been slightly acute and disorderly financial market developments revised down but remains strong. GDP growth is Figure 20: Growth in South Asia is expected to remain strong. GDP growth in South Asia is estimated to accelerate to 7.0 percent this year and to 7.1 percent in the following two years and South Asia will expand its lead as the fastest growing region in the world. Real GDP growth Percent 8 7 6 5 4 3 2 1 0 South Asia East Asia and Pacific Sub Saharan Africa Europe and Central Asia Middle East and North Africa Latin America and Caribbean 2019 (e) 2020 (f) 2021 (f) Note: (e)= estimate; (f)=forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia Economic Outlook 31 Figure 21: The negative contribution of net exports to growth is expected to shrink. The contribution of government consumption is expected to decline from 1.1 percentage point last year to 0.8 percentage point this year and the following. The contributions of private consumption and investment are expected to soften very little. The largest change is expected from the net exports, whose contribution is expected to improve to -1.0 percentage point from -2.1 percentage points last year. Contributions to real GDP growth in South Asia Percentage points 10 8 6 4 2 0 -2 -4 2018 2019 (e) 2020 (f) 2021 (f) Private consumption Government consumption Gross xed investment Net exports GDP Note: (e)= estimate; (f)=forecast. Source: World Bank. expected to accelerate slightly to 7.0 percent this Table 3: Growth is expected to moderate in year and to increase further to 7.1 percent in 2020 most countries in the region. and 2021 (Figure 20). For this year, this is 0.1 percent-   2018 2019 (e) 2020 (f) 2021 (f) age point below the expectation in January due to a small downward revision for India and a larger one Afghanistan (CY) 1.0 2.5 3.2 3.5 for Pakistan. For India, growth for fiscal year 2018-19 Bangladesh (FY) 7.9 7.3 7.4 7.3 has been revised downward to 7.2 percent to align Bhutan (FY) 5.7 5.4 5.4 5.2 it more with the recent downward revision by the Central Statistical Office to 7.0 percent. Growth es- India (FY) 7.2 7.5 7.5 7.5 timates in India are susceptible to revisions and fur- Maldives (CY) 7.9 5.7 5.2 5.3 ther revisions are likely upcoming in May. East Asia Nepal (FY) 6.3 6.0 6.1 6.2 and Pacific is expected to grow at 6.0 percent this year and next, before it is expected to decelerate to Pakistan (FY, factor 5.8 3.4 2.7 4.0 5.8 percent. South Asia is hence very likely to extend prices) its lead as the fastest growing region in the world. In Sri Lanka (CY) 3.2 3.5 3.6 3.7 2021, South Asia is projected to account for 4.8 per- Notes: (e) = estimate (f) = forecast, CY = calendar year, FY = fiscal year. In Bangladesh, cent of the world economy, up from 4.5 percent last Bhutan, and Pakistan, FY 2018/19 ends June 30, in Nepal it ends July 15 and in India FY 2018/19 ended March 31. year and its contribution to world growth will reach Source: World Bank. 0.33 percentage points. In 2021, over ten percent of the world’s GDP growth is projected to originate in South Asia. following (Figure 21). The contributions of private consumption and investment are expected to soften Growth will continue to be driven by domestic very little, to 4.0 percentage points and 2.8 percent- demand. Domestic demand is expected to remain age points in 2020 respectively. The largest change is strong with support from monetary and fiscal pol- expected from net exports. The net contribution of icies. The contribution of government consumption trade is expected to improve from minus 2.1 percent- is expected to decline from 1.1 percentage points age points last year to minus 1 percentage point this last year to 0.8 percentage point this year and the and the following year. South Asia Economic Focus | Spring 2019 | Exports wanted 32 South Asia Economic Outlook GDP growth is forecast to moderate in most coun- tively more stable external environment is seen to tries - namely in Bangladesh, Bhutan, Maldives, and help a pickup in economic activity starting from Pakistan – but to slightly accelerate in Afghanistan, FY2020/21. India, and Sri Lanka (Table 3). ··  In Sri Lanka, GDP growth is expected to pick up to 3.5 percent in 2019 and to converge towards 4 ··  In Afghanistan, GDP is estimated to recover and percent over the forecast horizon. The recovery converge to 3 percent over the forecast horizon, will be supported by a pickup in services sector with the assumption that drought conditions will and solid infrastructure investment. ease, and political stability will be restored upon presidential elections in September. An improved security situation would support confidence and Lower import growth and economic activity. higher export growth ··  In Bangladesh, GDP is projected to average 7.3 per- cent over the forecast horizon. Activity will be un- In a major shift from the last years, imports and ex- derpinned by strong infrastructure spending and ports are expected to grow at very similar rates this robust investment with expanding credit growth. year and the following (Figure 22). In the last two However, a slowdown in economic activity of years, imports grew much stronger than exports. In trading partners could restrain the contribution 2017, exports grew only 4.6 percent whereas imports of net exports to growth next year. grew by 14.9 percent. Last year, exports grew by 9.7 percent and imports by 15.6 percent. In both years ··  In Bhutan, GDP growth is expected to remain sol- net exports were negative and hence dragged growth. id at 5.4 percent in FY2019/20 and to remain above This year, however, import growth is expected to 5 percent over the forecast horizon, supported by come down to 11.8 percent and export growth to im- tourism and retail trade. prove to 11.1 percent. In the following years, both are ··  In India, GDP is forecast to expand 7.5 percent in expected to grow around 11 percent. As a result, the FY2019/20. Credit growth will benefit from rela- negative net contribution from exports is projected tively more accommodative monetary policy amid to weaken over time. benign inflationary conditions. Support from The projected decline in regional import growth is delayed fiscal consolidation will partially offset consistent with the projected GDP growth compo- the effects of political uncertainty on economic sition going forward. To assess whether the project- activity around elections in May. ed import growth is consistent with developments ··  In Maldives, economic activity is forecast to ex- in the past, we use three simple error correction pand by 5.7 percent in 2019, and to moderate to models. For the first prediction we regress import 5.3 percent over the medium term, as investment growth on the growth rate of the sum of domestic projects converge to historical averages. demand (minus imports) and exports. The advantage of this specification is that we need to estimate few ··  In Nepal, GDP growth is projected to average 6 coefficients. For the second prediction, we consider percent over the medium term. The services sector exports and the three components of domestic de- is forecast to benefit from strong tourism, and mand (private consumption, government consump- manufacturing will be supported by the opening tion, and investments) separately, and for the third of the Nepal’s largest cement factory next year. we include oil prices. All models have a reasonably ··  In Pakistan, GDP growth is expected to further good in sample fit. That said, the models fit the data slow to 2.7 percent in FY2019/20, as domestic better the more information we include (Figure 23). demand remains depressed. Macroeconomic Especially the first model but also the second one imbalances, reflected in large fiscal and current underpredicts import growth in 2016 and 2017, but account deficits, are expected to resolve gradually. the model with oil prices is very close. For last year, Remittances flows are likely to support growth imports grew exactly as much as the second and and the current account balance next year. A rela- third prediction model suggest. The forecast import South Asia Economic Focus | Spring 2019 | Exports wanted South Asia Economic Outlook 33 Figure 22: Imports and exports are forecast to grow at similar rates going forward. In the past years, imports grew much faster than exports in South Asia. This year and the following year, however, imports and exports are forecast to grow at very similar rates. Volume growth of imports and exports (both goods and services) in South Asia Percent / Percentage points 16 14 12 10 8 6 4 2 0 -2 -4 2017 2018 2019 (e) 2020 (f) 2021 (f) Net exports (contribution to GDP growth) Imports (growth in percent) Exports (growth in percent) Note: (e)= estimate; (f)=forecast. Source: World Bank. Figure 23: The expected decline in regional import growth is consistent with the forecast GDP growth composition. The projected decline in imports for this year and the two following is very much consistent with a prediction based on a model considering the projections of the other components of GDP, especially when also taking oil prices into account. Volume import growth (of both goods and services), forecasts, and model predictions Percent 18 16 14 12 10 8 6 4 2 0 2016 2017 2018 2019 (e) 2020 (f) 2021 (f) Growth of imports Model 1 Model 2 Model 3 Note: (e) = estimate; (f)=forecast. Predictions are based on error-correction models explaining import growth given the other components of GDP (1 and 2) plus oil prices (3). Source: World Bank. growth rates, done by different teams for different it is twice as high as the ratio over the last three countries, are below the prediction of the first two years, when it only averaged 0.8 (Figure 24a). It is models, but follow closely the prediction of the third. especially high if one considers the fact that global trade growth is projected to slow this year and the But will export growth pick up? For this year and following (Figure 24b) and that the export growth in the next two, the projected ratio of export growth South Asia is strongly correlated with world trade to GDP growth is 1.6. While this is very much in growth (a correlation coefficient of 0.8 since 2000). line with the long-run average from 2000 to 2018, In Bhutan, exports will increase due to the opera- South Asia Economic Focus | Spring 2019 | Exports wanted 34 South Asia Economic Outlook Figure 24: Export growth is projected to pick up, despite global trade weakening. The projected increase in exports means a doubling of the export growth to GDP growth ratio compared to the average over the last three years, but it is consistent with the long-run average. However, global trade is expected to moderate, which will make achieving high export growth more difficult. a) Ratio of South Asia’s export growth to GDP growth b) Projected global trade growth Ratio of export growth to GDP growth over di erent periods Global trade volume growth Percent 2 6 5 1.5 4 1 3 2 0.5 1 0 0 2002-2018 2016-2018 2019-2021 (f) 2017 2018 2019 (e) 2020 (f) 2021 (f) Note: (e)= estimate; (f)=forecast. Source: World Bank. tionalization of new hydropower plants. Similarly, tor funding issues. The elevated tension between India the Upper Tamakoshi Hydropower Project will in- and Pakistan in mid-February did not have a major crease Nepal’s exports. But while the depreciation of immediate effect on markets, however a re-escalation South Asian currencies may have a positive impact could deteriorate confidence and weigh on investment in the medium run (see Chapter 3), countries may in the region. External risks stem from weakening struggle to increase exports further this year and global growth and rising policy uncertainty. A sharper then even more the next two years. It remains to be than expected deceleration in major economies or a seen whether they will indeed manage to improve recurring escalation of trade-related tensions among their export performance as much as projected. In them could result in unfavorable spillovers to the the past, our trade projections have been too upbeat region. High external debt and low international and we overpredicted export growth and underpre- reserves limit the maneuverability against external dicted import growth (see last edition of this report). shocks in some countries in the region. The new GST If the net contribution of exports does not shrink regime in India is still stabilizing, though GST tax but instead stays at last year’s level, growth in 2021 collection has been improving in February, and fiscal would ceteris paribus only be 6.0 percent rather than deficits exceed official targets in some countries, pos- the projected 7.1 percent. ing a risk for the public finance outlook. And structural bottlenecks persist. Deteriorated Downside risks to the outlook balance sheets of banks and corporates, and supply bottlenecks such as infrastructure gaps and relatively Downside risks to the forecasts are strong. In addition weak business climates continue to depress domes- to uncertainty about the projected pick up in export tic and foreign investment potential in South Asia. growth, there are additional downside risks to the A setback in reforms to address these issues could outlook. The main domestic risks include a re-escala- weigh on activity. In addition, South Asia is vulnera- tion of political turbulence amid an election cycle in ble to natural disasters, and the frequent occurrence some countries, fiscal slippages with expanding public of these events poses a challenge for its economic spending, and a resurgence of non-bank financial sec- development. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia Economic Outlook 35 Box 3: Views from the South Asia Economic Policy Network The South Asia Economic Policy Network, launched by the office of the regional Chief Economist for the South Asia region at the World Bank in 2017, represents an attempt to engage more strongly with thinkers and doers across South Asia. The objective is to be more proactive in nurturing the exchange of ideas and to learn more systematically from colleagues and counterparts in the region. The Network currently focuses broadly on macroeconomics and includes over 380 researchers and practitioners from the region. The network includes researchers from seven South Asian countries, selected based on peer recognition, recent conference presentations, 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 25: We asked over 380 economists from seven countries about their views. Survey among South Asia Policy Network Number of experts 35 30 25 20 15 10 5 0 India Pakistan Bangladesh Nepal Sri Lanka Afghanistan Bhutan Source: World Bank South Asia Economic Policy Network. As for the last three editions of this report, a short opinion survey was conducted among the group for this edition of South Asia Economic Focus. The objective was to take the pulse of informed and influential experts about economic develop- ments in their countries. By the same token, the survey allowed gathering their views on issues related to external stability and the main obstacles to higher exports in their respective countries. With 83 filled-in questionnaires from 7 countries the response rate was 22 percent and all South Asian countries apart from Maldives are represented (Figure 25). Nearly all respondents identified themselves as academics and as macroeconomists. Almost one third of the respondents are involved in policy making and over a half in policy advising. Responses regarding the economic situation are sum¬marized here. The views on external vulnerabilities and exports are reported in the third chapter. 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 any indicator, a value 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. Respondents anticipate GDP growth to develop differently in different countries (Figure 26). In Pakistan and India, a majority expects that the growth rate will come down. In Bangladesh and the other countries, however, the diffusion index signals an acceleration in GDP growth. Network members expect that inflation and interest rates will pick up across all countries, except in India, where interest rates are expected to decrease further. The expected decline in interest rates has already taken shape with the recent reduction in early April. In India, imports are expected to increase, while exports are expected to decrease. In Pakistan, on the other hand, imports are expected to decrease, while exports are expected to increase. In all other countries the volume of imports and exports are both expected to increase. Network members also foresee an increase in the fiscal deficit across all countries, but in Pakistan less strongly than in other countries. Finally, there are very strong views across South Asia that the exchange rate will further depreciate, and that financial sector stress will rise …. Continues next page …. South Asia Economic Focus | Spring 2019 | Exports wanted 36 South Asia Economic Outlook Figure 26: Views on the outlook are mixed. What do you expect to happen in your country whitin the next six months? Di usion index 100 80 Increase 60 Decrease 40 20 0 Real GDP growth Headline inflation Interest rates Volume of imports Volume of exports Fiscal deficit Exchange rate Financial sector stress India Pakistan Bangladesh Others Notes: The index is calculated as follows: Index=(P1*100) + (P2*50) + (P3*0), where P1 is the proportion of responses that report that the indicator will increase, P2 is the proportion of responses that report that the indicator will stay the same, and P3 is the proportion of responses that report that the indicator will decrease. The data points reflect results from the Fall 2017 survey. Sources: World Bank South Asia Economic Policy Network and staff calculations. Different from six months ago, experts expect lower interest rates in India (which has already materialized). But the growth and inflation expectation remain broadly unchanged and so do the expectations about future trade developments as well as the strong views on continued depreciation and rising financial sector stress. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia Economic Outlook 37 Photo: © Shutterstock/Aranya 22 South Asia Economic Focus | Spring 2019 | Exports wanted 38 South Asia Economic Focus | Spring 2019 | Exports wanted 39 Exports wanted South Asia Economic Focus | Spring 2019 | Exports wanted 40 Exports Wanted E xternal financing conditions became less benign, and especially countries relying on portfolio investment from abroad face rising borrowing costs. This is particularly worrisome, as South Asia’s external financing needs have increased. The region’s current account deficit has widened from 0.7 percent of GDP two years ago to 2.9 percent last year. This widening deficit reflects accelerating growth in domestic demand, outpacing income growth. The rebound in oil prices was one of the factors driving it. In response to the mounting financing tensions, interest rate spreads have increased, and currencies have depreciated. However, it is unlikely that such price changes will, by themselves, bring current accounts quickly back into balance. If not accompanied by direct measures to reduce domestic demand, depreciations in fact tend to increase South Asia’s current account deficits, at least in the short run. Fiscal tightening is the most direct way to reduce domestic demand. And indeed, in South Asia there is a strong link between fiscal deficits and current account deficits. Under current circumstances fiscal tightening is appropriate, not only to make government debt more sustainable, but also to bring the economy back into balance, and thus become less vulnerable to deteriorating conditions in international financial markets. Once the reduction in domestic demand has been achieved, real depreciations can bring imports and exports back in line and replace domestic demand with foreign demand. A complication in the latter adjustment is that South Asia’s export volumes are low, so that large real depreciations are needed for a substantial increase in exports. Using a gravity model, we show that South Asian countries export less than a third of their potential. If countries export closer to potential, not only would short-term adjustments be easier, but also the long-term growth potential would be higher. Closing the export gap is an essential step in addressing both short-term and long-term macroeconomic challenges in South Asia. Tighter external financing disruptive for borrowers. Back in 2013, the mere an- conditions nouncement by the Federal Reserve Bank (Fed) of its plan to gradually reduce its quantitative easing pro- As monetary policy tightened in the United States, gram led to strong portfolio outflows from EMDEs, external financing conditions became less benign in currency pressures, and increasing borrowing costs 2018. The rise in U.S. interest rates has led to reduced (World Bank 2018a; World Bank 2018b). That fierce capital flows to emerging markets and developing market reaction might not repeat itself, but the costs economies (EMDEs), making external borrowing of external financing for EMDEs are very likely to more expensive. In South Asia, this was especially increase further, even if the extent of the increase is true for Sri Lanka, Pakistan, and India. All three unpredictable. faced rises in credit default swap spreads, and the And high economic policy uncertainty adds to the latter two experienced net portfolio outflows. Al- risks for a sudden reversal in investor sentiments though the monetary tightening has paused current- (Figure 27). Escalation of trade tensions between ly, the expectation is that U.S. interest rates have not the United States and China or the European Union yet reached their peak (Figure 27), while the quanti- could indirectly affect South Asia in an adverse man- tative easing by the European Central Bank (ECB) ner. Even if South Asia benefits from trade diversion will likely be reversed and European interest rates caused by the trade tensions, it could be hurt by the are expected to increase as well. Even limited further accompanying souring of global investor sentiments. tightening of monetary conditions could become Since capital flows to EMDEs are strongly correlated, South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 41 Figure 27: External financing conditions are becoming less benign. Monetary policy in the United States is expected to tighten further, and global economic policy uncertainty is rising, partly due to the unclear future trade relations between major economies. US federal funds rate Global Economic Policy Uncertainty Percent Index 4 350 300 3 250 2 200 150 1 100 0 0 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Long run Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Median Range Global Economic Policy Uncertainty 12 month rolling average Note: The projections for the federal funds rate are based on the assement of Federal Notes: The solid line shows the GDP weighted global average including Open Market Committee (FOMC) members. 20 countries. Each of the national indeces reflects the relative frequency of Source: Federal Reserve System. newspaper articles that contain a trio of terms economy, policy and uncertainty. For more information refer to www.policyuncertainty.com. Source: Baker, Bloom and Davis (2016). a worsening of investor sentiments would also affect in Maldives. In both countries, the current account South Asian countries, and the impact of changes deficit has started to close somewhat as many of in the risk appetite of international investors tends these investment projects are nearing completion. to outweigh the direct impact of policy changes on The current account deficit indicates that the re- trade flows (Freund et al. 2018). These risks could gion’s expenditure exceeds its income. The current materialize against the backdrop of a slowing glob- account is for a country what the fiscal balance is for al economy, which in itself may negatively affect a government. Adding private income minus private investor sentiment (World Bank 2019a). Moreover, spending to government spending minus govern- geopolitical tensions could put downward pressure ment income gives the current account balance, or: on FDI inflows into the region. All these risks would make financing of the region’s current account defi- cits more difficult. current account balance = private saving – private investment + fiscal balance While financing conditions were deteriorating, South Asia’s financing needs were surging. The re- where private saving is private income minus private gion’s current account deficit increased from 0.7 per- consumption. In South Asia the fiscal balance has cent of GDP in 2016 to 2.9 percent of GDP in 2018. been structurally in deficit. In 2016 that deficit was Except for Afghanistan, all countries in South Asia largely compensated because private sector savings faced a current account deficit last year. Deficits in exceeded private sector investments. But that com- India, Pakistan, and Sri Lanka have widened over pensation weakened over the last two years, resulting the last two years, while current account surpluses in a widening of the current account deficit (Figure in Bangladesh and Nepal turned into deficits (Figure 29). The balance of private savings and private in- 28). The reasons for the deficits vary from country vestments was reduced largely because of a fall in to country. In India, for example, it is mostly driven savings. The widening deficits meant that countries by oil imports, whereas in Sri Lanka also foreign had to borrow more from abroad. A current account exchange financing of short- and medium-term debt deficit is not necessarily undesirable, harmful or plays an important role. The current account deficit risky, and the current account may be in deficit for has been very large for many years in Bhutan and many years. The sustainable equilibrium balance Maldives, due to high investments in hydropower depends on many factors, including demographics, projects in Bhutan and large infrastructure projects credit cycles, and institutions. South Asia Economic Focus | Spring 2019 | Exports wanted 42 Exports Wanted Figure 28: Except for Afghanistan, the current account is in deficit across the region. The current account deficit of Bhutan and Maldives has been large for many years due to high investment, but it is narrowing again. In all other countries, the current account balance decreased from 2016 to 2018 and except for Afghanistan it was in deficit last year. Annual current account balance Annual current account balance Percent of GDP Percent of GDP 8 0 6 -5 4 -10 2 0 -15 -2 -20 -4 -25 -6 -8 -30 -10 -35 2016 2017 2018 2016 2017 2018 Afghanistan Bangladesh India Nepal Pakistan Sri Lanka Bhutan Maldives Source: World Bank. Figure 29: South Asia’s external financing stan were positive during the first quarter of 2018, needs are increasing. capital started flowing out of South Asia afterwards South Asia’s current account deficit rose from 0.7 percent of and overall portfolio flows were negative in 2018 GDP in 2016 to 2.0 percent of GDP in 2017 and to 2.9 percent (Figure 30). The interest rate spread is the difference of GDP in 2018. Over these years, private saving decreased, and investment increased. between the interest a government has to pay on a dollar-denominated bond and the interest rate the Current account balance United States government pays. This spread can be Percent of GDP approximated by sovereign credit default spreads. 8 From January 2018 to January 2019, these spreads in- 6 creased by over 200 basis points in Sri Lanka, by over 4 70 basis points in Pakistan, and by 40 basis points in India. In addition, all South Asian currencies depre- 2 ciated against the U.S. dollar and they depreciated 0 more than currencies in the rest of the world (see -0.7 Chapter 1). The only exception is Maldives, as their -2 -2.0 currency is pegged against the USD. -4 -2.9 A delicate balance -6 -8 2016 2017 2018 (e) Private saving minus Fiscal balance Current account private investment balance The current account balance is the result of many domestic and international factors. As mentioned Note: (e) = estimate. Sources: IMF, World Bank, and staff calculations. above, the current account balance equals domestic income, i.e. domestic production plus remittances and current grants, minus domestic spending. The combination of a less benign external envi- Spending can temporarily deviate from income ronment and larger external financing needs have after short-term shocks to smooth consumption increased sovereign credit default spreads, triggered over time. Spending can also deviate structurally capital outflows, and depreciated the currencies from income. For example, fast growing economies strongly. While portfolio flows to India and Paki- can sustain current account deficits. They need high South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 43 Figure 30: Higher risks already resulted in increasing sovereign spreads, depreciating currencies and capital outflows. While portfolio flows to India and Pakistan were positive during the first quarter of 2018, capital started flowing out of South Asia afterwards. Sovereign credit default spreads increased in 2018 and South Asian currencies depreciated against the U.S. dollar. Sovereign credit default spreads, exchange rates, capital ows, and the current account Percent of GDP / Percent Basis points / Billions 5 50 3 30 1 10 -1 -10 -3 -30 -5 -50 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 2018 Q4 Change in sovereign credit default spreads (basis points, RHS) Current account balance (percent of GDP) Change in exchange rate against USD (percent) Portfolio ows (USD billions, RHS) Notes: Sovereign credit default spreads represent the simple average year-on-year change of India, Pakistan and Sri Lanka of their respective five-year U.S. dollar credit default swap (mid-rate). The current account is in percent of GDP and represents the average of Bangladesh, India, Pakistan, and Sri Lanka. Portfolio flows (billions) include India and Pakistan flows in a 3-month rolling average. Official exchange rate USD per LCU represent the average quarterly growth for Bangladesh, India, Pakistan, and Sri Lanka. Sources: Sovereign credit default spreads are from CMA Datavision (Haver Analytics)/Global Economic Prospects (January 2019). The current account is from Trading Economics. The Official exchange rate is from the International Financial Statistics (IFS) from the IMF. Portfolio flows are from IIF. Figure 31: The Balance of Payments is driven both by domestic and international factors. The Balance of Payments records all economic transactions between the residents of a country and the rest of the world. If imports are higher than exports, the trade deficit needs to be financed by aid, remittances, or external borrowing. Relative prices ensure external balance in equilibrium. Aid and remittances • Growth in remit. orig. countries • Availability of aid Current account de cit • Domestic demand a) HH consumption • Political stability Net external Imports b) Investment rates • Growth prospects nancing • Global nancial cycles c) Fiscal balance • Oil prices • US interest rates Exports • Competitiveness / trade policies • Growth in exports markets I N T E R E S T R A T E investment ratios to support high growth rates and invest in a country, then domestic spending will be debts can be paid back in the future when the econ- forced up. International financing can be of a cycli- omy is larger. Current account deficits also equal cal nature, often through portfolio flows, or can be net capital inflows and are thus also dependent on structural, often through FDI. Therefore, the avail- international factors. If foreign investors are not ability of external financing depends on domestic willing to finance deficits, then domestic spending factors like political stability and growth prospects, will be forced down. If foreign investors are eager to but also on international factors like global finan- South Asia Economic Focus | Spring 2019 | Exports wanted 44 Exports Wanted Figure 32: High remittances and grants are resulting in large trade deficits in some countries. Some South Asian countries benefit from large grants and remittances inflows. The former is close to 20 percent of GDP in Afghanistan, the latter close to 30 percent of GDP in Nepal. These large external inflows allow for high trade deficits. Remittances, aid and trade de cit Percent of GDP 45 40 35 30 25 20 15 10 5 0 Afghanistan Nepal Bhutan Pakistan Sri Lanka Bangladesh India Maldives Remittances O cial development assistance and aid Trade de cit (goods and services) Note: Data is for 2017 as data on official development assistance and aid is not yet available for 2018. Source: World Bank and staff calculations. cial cycles and US interest rates. Finally, the current very low 1.5. Since neither creates a financial obli- account balance also equals the trade balance mi- gation, trade deficits in the region directly linked nus inflows of remittances and official grants. That to inflows of remittances and aid could well be means that current accounts can be influenced, at sustainable. least in the short run, by trade shocks, like changes There is no single policy measure that can keep in tariffs or sudden changes in commodity prices. current accounts in balance or keep deficits sus- Figure 31 depicts all these influences on the current tainable. Because so many factors determine the account. ultimate outcome, the balance is delicate and can In South Asia, there is a major difference between easily be disturbed. What constitutes disequilibri- trade balances and current account balances. In all um is difficult to measure (IMF 2018a) and depends countries in the region, imports exceed exports and on many factors, some of which a country cannot the trade deficits are partly paid with official grants control itself. But once off balance, it can be chal- and remittances inflows. While almost all South lenging to restore equilibrium. Out of equilibrium, Asian countries receive large remittances inflows, pressure builds on interest rates and exchange rates, Nepal is a clear outlier with officially recorded but changes in these prices do not necessarily restore remittance inflows close to 30 percent of GDP. As equilibrium quickly. Before addressing this equi- remittances are inherently difficult to measure and librium process at the end of this chapter, we first not all are accounted for in official statistics, actual discuss consecutively three components of Figure 31: remittances might even be higher (see Box 4). Most domestic demand, external financing, and exports. Nepali migrant workers are in India, Malaysia or the Gulf Cooperation Countries. Remittances increase disposable income and thus imports. But they may Accelerated domestic also reduce exports as a rise in income can reduces spending international competitiveness if it raises domestic prices. Remittances and aid flows are rather stable South Asia’s domestic demand has recently grown sources of external financing. The autocorrelations much faster than exports. In the early 2000s, South of both remittances and grants in South Asia are a Asia’s export grew three times as fast as domestic very high 0.7, and the coefficients of variation are a demand. But since then, exports growth declined, South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 45 Box 4: Measurement and significance of remittances In South Asia, remittances have been increasing since the 1980s, as more workers started to migrate to other countries, especially within South Asia and to Gulf Cooperation Council Countries. For many South Asian economies, remittances now represent a sizable and stable source of external funds, which in many cases exceeds official aid and foreign direct investment by far. South Asian remittances inflows are among the highest in the world compared to output, with a level close to 30 percent of GDP in Nepal, and above 5 percent of GDP in Pakistan, Sri Lanka and Bangladesh. All four of them are among the top 20 remittances receiving countries in the world. And while remittances inflows are only 2.5 percent of GDP, India receives by far the largest amount of remittances in total value in the world. Importantly, personal remittances as recorded in the current account comprise both personal transfers and specific kinds of compensation of employees. Personal transfers are current transfers in cash or in kind received by resident households from nonresident households. In addition, the income of workers employed in an economy where they are not residents and of residents employed by nonresident entities are defined as remittances as well (IMF 2014). For most countries in South Asia, officially recorded personal remittances consist nearly completely of personal transfers, but there are two exceptions: for Afghanistan the compensation of employees matters and for Maldives, compensation of employees is by far the most important component of remittances. Remittances are very difficult to measure precisely and the Balance of Payments (BoP) of course only include officially re- corded ones. Any mismeasurement from imperfections in source data and compilation shows up in the errors and omissions of the BoP. In Nepal, for example, the large current account deficits in previous years did not lead to a significant increase in external debt or decline in reserves. This points towards significant positive net errors and omissions related to informal transactions not captured in workers’ remittances and compensation of employees (IMF 2018b). Remittances help finance trade deficits and, at least for the moment, seem resilient across the countries in the region. As remittances support domestic consumption, they contribute to declining poverty, especially in South Asia (Maimbo et al. 2005). Remittances enable better health care, nutrition, housing, and education and can improve economic growth, especially if used for financing education or health expenses of children (Maimbo and Ratha 2005). Remittances have also been shown to promote financial development (Aggarwal et al 2006). Yet, like for other foreign currency inflows, large remit- tances inflows result in currency appreciation, which affects the competitiveness of exports (Maimbo et al. 2005). In a study on the effect of remittances on current accounts, Lartey (2018) finds a positive effect of remittances contemporaneously, but a negative lagged effect, which indicates the presence of some underlying mechanisms characteristic of the Dutch disease phenomenon. The World Bank regularly reports global trends in remittances flows and highlights developments connected to migra- tion-related Sustainable Development Goal (SDG) indicators for which the World Bank is a custodian: increasing the volume of remittances as a percentage of (GDP), reducing remittance costs, and reducing recruitment costs for migrant workers (World Bank 2018c). and growth of domestic demand increased (Figure dynamics explain the fast growth of imports and 33). For South Asia including India, exports grew the widening current account deficit during the 5.4 percentage points faster than domestic demand last couple of years. The change in the structure of between 2005 and 2009 and still 2.6 percentage growth could have made the growth unsustainable. points faster between 2010 and 2014. For South Asia For that we also need to look at the composition of excluding India, exports and domestic demand grew domestic demand growth. at similar rates between 2005 and 2014.. Over the last four years, however, domestic demand growth During the last two years, a consumption and overtook export growth. In South Asia including investment boom resulted in very strong import India, domestic demand grew by 8.4 percent, while growth. In South Asia, the volume growth of con- exports grew only 3.2 percent. The situation has been sumption and investment was higher over the last similar in the region excluding India, with domestic two years than between 2000 and 2016. Government demand growth of 6.6 percent and export growth of consumption grew on average 11.1 percent in the last 2.2 percent. The recent economic boom was hence two years, compared with a long-run average of 5.7 not driven by exports, but instead by domestic de- percent. For South Asia excluding India, the growth mand (see Chapter 1 and World Bank 2018a). These of private consumption and investment have also South Asia Economic Focus | Spring 2019 | Exports wanted 46 Exports Wanted Figure 33: Over the last years, domestic demand grew much faster than exports. While South Asian exports used to grow faster than domestic demand in the 2000s, the opposite was the case in recent years. Between 2015 and 2018, domestic demand increased on average by 8.4 percent a year, while exports only grew by an average of 3.2 percent. Domestic demand and export growth in South Asia Annual averages in percent 16 14 12 10 8 6 4 2 0 2000-2004 2005-2009 2010-2014 2015-2018 Domestic demand Exports Domestic demand in SAR excl. India Exports in SAR excl. India Note: Domestic demand and export growth are annual averages. Source: World Bank and staff calculations. Figure 34: In many countries, domestic factors translate into high import growth. During the last two years, a consumption and investment boom resulted in very strong import growth. Especially government consumption growth was unusually high. Exports, on the other hand, grew much less than in the past. a) South Asia b) South Asia excluding India Volume growth rates of GDP components Volume growth rates of GDP components Percent Percent 16 16 12 12 8 8 4 4 0 0 Private Government Investment Exports Imports Private Government Investment Exports Imports consumption consumption consumption consumption 2000-2016 2017-2018 2000-2016 2017-2018 Source: World Bank and staff calculations. been considerably above the long-run average. percent. In Sri Lanka, however, they grew by only Whether India is included in the regional aggregate 3.6 percent due to lower government expenditure or not, exports grew much less than in the past and and slow household consumption growth. And in imports much more. South Asia’s imports grew 15.3 Bhutan they even decreased, as investment came percent in the last two years compared to an average down with one hydropower project about to be of 9.3 percent in the long-run (14.4 percent and 7.5 commissioned and two further projects facing con- percent if India is excluded). In Bangladesh, imports struction delays. increased by over 20 percent in 2018, the highest Oil imports are high across countries in South Asia in South Asia. Imports also increased strongly in and the rising oil price increased the oil import bills, Pakistan and Nepal. In India imports still grew 9.5 which in turn worsened trade and current account South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 47 Figure 35: South Asian countries are net importer of oil and the rise in oil prices has raised their import bills. South Asian countries import a lot of oil. After a large drop in 2014, oil prices are increasing again since 2016 and they reached 70 USD per barrel in the last quarter of last year. Rising prices translated into higher oil bills. And the oil trade balance in South Asia is highly correlated with the overall trade balance and the current account balance. a) South Asian countries import a lot of oil. b) The price of oil increased over the last years Share of oil imports in South Asian countries Real oil prices in South Asia Percent Index, 2014 Q1 = 100 30 120 25 100 20 80 15 60 10 40 5 20 0 0 2014 Q1 2014 Q2 2014 Q3 2014 Q4 2015 Q1 2015 Q2 2015 Q3 2015 Q4 2016 Q1 2016 Q2 2016 Q3 2016 Q4 2017 Q1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2 2018 Q3 India Pakistan Afghanistan Maldives Sri Lanka Nepal Bangladesh Note: The bars reflect the average share of fuel imports among all imports from Note: The oil price computed based on BRENT and the price for South Asia is a 2014 to 2017. simple average of all South Asian countries. Source: WTO and staff calculations. Sources: IMF, Federal Reserve Bank of St. Louis, and staff calculations. c) The oil import bills of South Asian d) The oil balance affects the overall trade countries increased balance and the current account Rise in real oil import bills in local currency Correlation of changes in oil balance with changes Percent in trade and current account balance 80 0.8 60 0.6 40 0.4 20 0 0.2 -20 0.0 -40 Sri lanka Pakistan India Pakistan Bangladesh India Sri Lanka 2016-17 2017-18 Current account balance Trade balance Notes: For Sri Lanka, 2016-17 stands for CY 2016; for all other countries we report Note: The correlations are based on annual data in values from 2000 to 2017. fiscal years. For all countries we used oil import information as reported by the Sources: Comtrade and IMF. national statistical offices and petroleum ministries. For Bangladesh we sum the crude oil imports and refined oil imports; for India we use crude oil imports, petroleum product imports and LNG imports; for Sri Lanka we use crude oil imports; and for Pakistan we use petroleum oils import. Sources: BPC for Bangladesh, PNG for India, PBS for Pakistan, DCS for Sri Lanka, and staff calculations. deficits. Fuel imports between 2014 and 2017 consti- International oil prices dropped strongly from over tuted on average around a third of imports in India, 100 USD per barrel in the second quarter of 2014 to a a quarter in Pakistan and a fifth in Afghanistan low of 34 USD per barrel in the first quarter of 2016. (Figure 35a). In Maldives, Sri Lanka, and Nepal, they Since then, prices have increased again, and they constituted around 15 percent of imports, while in reached 69 USD per barrel at the end of 2018, more Bangladesh they accounted for only 8 percent. After than double the level in the first quarter of 2016. For the large drop in 2014, oil prices have risen since 2016. countries in South Asia, the oil price in local curren- South Asia Economic Focus | Spring 2019 | Exports wanted 48 Exports Wanted Box 5: Analyzing the current account balance with Vector Autoregressive (VAR) Models We employ two different VAR models in this chapter. One estimates the effect of oil shocks on the current account; the other estimates the effect of temporary and permanent shocks on the current account and the exchange rate. a) Estimating the effect of oil prices on the current account We estimate the effect of oil price shocks on the current account with a SVAR model with three variables following Qurat-ul- Ain and Tufail (2013): the oil price, the exchange rate and the current account. Shocks to oil prices are identified by assuming that oil prices are independent from exchange rates and current accounts in South Asia in the same period. We hence estimate the following model: where and where ∆oilt and ∆rert are the percentage changes of the oil price and the real exchange rate in each quarter respectively and cat is the current account balance over GDP. Data on oil prices, exchange rates and the current account balance is in USD and available quarterly from 1993Q4 to 2017Q4 from the IMF BoP and International Financial Statistics (IFS) databases for Bangladesh, India, Pakistan, Sri Lanka and Nepal. We use the cur rent account balance as percent of GDP and assume constant nominal GDP growth within each year for countries without quarterly GDP data. Since South Asian countries are net importers of oil, we expect higher oil prices to decrease the current account. We use the Schwartz information criterion (SIC) to select a lag length of one for all countries. The longer lag length suggested by the Akaike information criterion resulted in coefficient estimates with lower statistical significance. b) Estimating the effect of temporary and permanent shocks on the current account Second, we estimate the effect of temporary and permanent effects on the current account and the exchange rate for Bangladesh, India, Nepal, Pakistan, and Sri Lanka using quarterly data from 1993Q4 to 2017Q4. As for the VAR model de- scribed above, we use the current account balance as percent of GDP and assume constant nominal GDP growth within each year for countries without quarterly GDP data. Lee and Chinn (2006) show that for the G7 countries permanent shocks (interpreted as technology innovations) induce a permanent change of the real exchange rate but have no effect on the current account. Temporary shocks (associated with monetary innovations), on the other hand, induce an improvement in the current account that dissipates in the long run. We follow their estimation strategy that uses one key identification assumption consistent with a very broad class of open-macroeconomics models (Obstfeld and Rogoff 1995): temporary shocks have no long-run effect on the real exchange rate. Shocks can hence be identified using long-run restrictions fol- lowing Blanchard and Quah (1989). Following the SIC criteria, we estimate the model with 1 lag for all countries, except for Pakistan for which we use 2 lags. We estimate the model: where and where the variables are defined as above. The identification restriction in this model – that temporary shocks have no long-run effect on the real exchange rate – is imposed with the following long-run restriction: , where is the matrix of lagged coefficients and is a 2x2 identity matrix We use the same data as for the model described above. cies relative to the local CPIs from the first quarter deals or long-term contracts at lower rates. India, of 2016 to the end of 2018 increased nearly as much. for example, faces pressures to reduce its oil imports (Figure 35b). This measure of change in relative oil from Iran and Venezuela, which may increase its oil prices is merely an indication of the relative price price in the near-term. Because of higher oil prices, change that consumers and firms experienced, as do- the oil import bills in South Asia rose on average mestic prices can deviate from international prices by a third in 2017/18 (Figure 35c). The oil balance when governments absorb the changes in interna- strongly impacts the overall trade balance. Changes tional prices through changes in taxes and subsidies. in the oil trade balance are strongly correlated with In that case, a rise in international oil prices does the changes in the overall trade balance and chang- not affect private savings, but it affects the fiscal es in the current account. The correlation between deficit. Moreover, some countries may have special changes in the oil balance and changes in the cur- South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 49 Figure 36: Higher oil prices decrease the current account balance in India, Pakistan, and Sri Lanka. Employing a vector autoregression (VAR) model, we find a significant effect of oil prices on the current account balance in India, Pakistan, and Sri Lanka. The effect is particularly strong for Sri Lanka and somewhat weaker in India. Across South Asia the effect lasts for around two years. India Pakistan Sri Lanka 2 2 4 0 0 0 Current account Current account Current account -2 -2 -4 -4 -4 -8 -6 -6 -12 -8 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 Quarters Quarters Quarters Notes: All estimations are based on a VAR estimated with one lag as described in Box 2. The dotted lines mark the 95 percent confidence bands. Sources: IMF, Federal Reserve Bank of St. Louis, and staff calculations. rent account since 2000 is 0.72 in Sri Lanka, 0.64 in (Ashraf et al. 2018). Concluding, higher oil prices in Pakistan, and 0.55 in India (Figure 35d). In a survey 2017 and 2018 contributed to the high import growth conducted for this report (see Box 3 in Chapter 2), in recent years (Figure 34) and increased external over half of the regional experts say that an USD 10 vulnerabilities. increase of the oil prices affect the current account a lot and another 40 percent say it affects the current account a little. Financing risks vary Rising in oil prices indeed increase current account Over the last three years, portfolio investment has deficits in South Asia, at least in the short run. The been substantial relative to the current account reason is that most oil consumption is imported deficit and GDP in Sri Lanka, India, and Maldives and that it is difficult to substitute away from oil, (Figure 37). All countries in South Asia depend which explains low short-term price elasticities of on external financing, but the composition of the oil demand. In addition, the domestic pass through Balance of Payments varies considerably across is small when highly administered domestic oil pric- countries. Afghanistan and Bhutan, for example, es are rigid. A rising oil bill does not immediately benefit from a large capital account surplus, while trigger cuts in non-oil imports, because also these Nepal receives a lot of remittances. Portfolio flows adjustments take time. For South Asian countries, matter most for Sri Lanka, India, and Maldives. the effect of oil price changes on the current account Over the last three years, portfolio flows in Sri balance lasts for around two years. The effect is Lanka have been on average above 60 percent of the strongest for Sri Lanka, followed by Pakistan and current account deficit and close to 20 percent of India (Figure 36). For the other countries in South GDP; in India, they have been above 40 percent of Asia, we did not find evidence for such a relation- the current account deficit and around 10 percent ship. This might be due to the frequency and quality of GDP; and in Maldives, they have been around of the data in these countries and does not mean 20 percent of the current account deficit and that oil prices are not affecting the current account above 50 percent of GDP. FDI, on the other hand, there. After the first two years the impact vanishes, is very low across the region apart from Maldives, because in the long run more possibilities exist for where the tourism and construction sector attract substitution away from oil and adjustments in non- substantial amounts. Countries in South Asia use oil imports are easier to make. For example, in India, their reserves to a greater or lesser extent as buffers the short-run elasticity of oil demand is between to smooth adjustments and to balance the current zero and -0.1, but the long-run elasticity is close to -1 accounts. South Asia Economic Focus | Spring 2019 | Exports wanted 50 Exports Wanted Figure 37: Portfolio flows are crucial especially in Sri Lanka, India, and Maldives. Over the last three years, portfolio investment flows have been substantial relative to the current account deficit and GDP in Sri Lanka, India, and Maldives. In the latter, they have been on average above 50 percent of GDP. Portfolio investment Percent Percent 70 4 60 3 50 40 2 30 20 1 10 0 0 Sri Lanka India Maldives Bangladesh Pakistan Afghanistan As percent of current account (LHS) As percent of GDP (RHS) Note: Data is the average from 2016 to 2018. Source: IMF BoP Statistics and staff calculations. Portfolio investment is very volatile (Figure 38). Figure 38: Portfolio investment is very Portfolio flows can surge quickly, but they can also volatile. dry up quickly. They can even reverse themselves, as The coefficient of variation measures the variability of the investors pull earlier investments out of countries different financing items. While capital account surpluses and when conditions deteriorate. Moreover, portfolio FDI are rather stable sources of financing, reserves and other investment show some volatility. Unsurprisingly, portfolio flows are highly correlated across countries. Thus, investment flows exhibit the highest volatility. a country dependent on portfolio flows to finance the current account is vulnerable to changes in in- Volatility of BoP items in South Asia vestor confidence. On the other end of the scale, the Average coe cient of variation 4 volatility of inflows on the capital account and of FDI inflows is very low. FDI is thus a relatively stable source of financing. Investors of FDI have long-term 3 commitments and are not inclined to liquidate assets when conditions deteriorate. FDI inflows also bring 2 other advantages, as they often come with technolo- gy transfer and increased exposure to foreign com- 1 petition, while risks are taken by the investor and not the borrower. Nevertheless, there is no certainty 0 Portfolio Other Reserve Direct Capital that FDI flows will continue completely uninter- investment investment assets investment account rupted. Large FDI inflows into small countries are often linked to one-time mega projects, and other Notes: The coefficient of variation is the standard deviation divided by the mean. It is estimated from 2000 to 2017, for all countries except for Afghanistan and Bhutan for FDI flows will likely fall if economic risks increase which the estimation starts in 2006 and 2008 respectively. We show simple averages across countries and exclude observations if their contribution to the overall balance or investors become risk adverse. Reserve assets are is negligible. Source: IMF and staff calculations. more volatile, showing that countries rely on them to balance their payments and smooth out adjustments. Other investments, which are mainly related to debt for the financing of the current account in Sri Lanka, instruments of the Central Bank, the general govern- India, and Maldives and their high volatility, these ment and financial corporations, are as volatile as countries are likely to be most affected by changing reserves. Given the significant role of portfolio flows international financing conditions. South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 51 Figure 39: Export shares in South Asia are below the world average and especially good exports lag behind in South Asia. Exports of services are above the world average in Maldives, Sri Lanka, and India and close to it in Bhutan and Nepal. However, apart from Bhutan, goods exports are far below average in all countries. And apart from Maldives and Bhutan, the combined exports of goods and services are lower than the world average. Services exports Goods exports Percent of GDP Percent of GDP 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Maldives Sri Lanka India Bhutan Nepal Pakistan Bangladesh Afghanistan World Bhutan Sri Lanka Bangladesh India Afghanistan Pakistan Maldives Nepal World Note: Data is for 2018. Sources: IMF, World Bank and staff calculations. Underperforming exports is to compare actual exports with exports predicted by a gravity model (see Box 6). Export shares in South Asia are below the world South Asian countries export only one third of their average. Maldives, Sri Lanka and India export more potential and the gap is widening (Figure 40). The services as percent of GDP than the world average export gap at the start of the estimation period in and in both Bhutan and Nepal the services exports 1996 was 12 percent of GDP. Together with increasing are close to it (Figure 39). In many of these countries, world trade, however, the export potential of South tourism contributes substantially to services exports. Asian countries rose over time. However, South For goods exports, however, all countries apart from Asian countries did not sufficiently take advantage Bhutan (that exports a lot of electricity to India) of the benign global environment, and exports re- arebelow the world average. And in many cases, they mained mostly stable as percent of GDP. Thus, the export less than the world average by a wide margin. export gap widened considerably over time. Exports While the world average is 22 percent, goods exports even declined as share of GDP after 2014, reaching are only around 13 percent in Sri Lanka, Bangladesh, only 11 percent in 2017, resulting in an export gap of 23 and India, around 8 percent in Afghanistan and Pa- percent of GDP in 2017. In other words, South Asia’s kistan and even lower in Maldives and Nepal. Apart export potential is three times its current level of from Maldives and Bhutan, the combined services exports. South Asia also imports less than is expected and goods export are below the world average. How- based on experience in other countries. The import ever, how much South Asian countries are underper- gap is smaller than the export gap, which reflects forming in their good exports cannot be accurately strong domestic demand, partly fueled by inflows of derived from just comparing export to GDP ratios remittances. Nevertheless, also imports fall short of with the world average. There is no reason why all their potential. If South Asia succeeds in closing the countries should have the same export shares. Large export gap, it will likely also close its import gap. Ex- countries naturally have a smaller export share, as ports need imported intermediary inputs and exports firms in those countries have relatively more oppor- generate income that will be partly spent on imports. tunities to sell in the domestic market. Landlocked This link between imports and exports is important countries also have naturally a smaller export share, from a long-term development perspective. The im- as trading costs are higher. One way to more accu- portance of closing the export gap is not that it will rately measure underperformance in goods exports improve the current account balance in the long-run. South Asia Economic Focus | Spring 2019 | Exports wanted 52 Exports Wanted Box 6: A Gravity model to estimate South Asia’s export gaps To benchmark the exports performance of South Asian countries, it is important to understand their export potential, which of course depends on the characteristics of each country. To estimate export potential, we use a common and intuitive econometric analysis, called the gravity model, which is the workhorse model in international trade for this purpose (Head and Mayer 2014). It determines potential goods exports based on the performance of other countries in the world and their characteristics. More precisely, it measures the trade potential of a given country by predicting trade flows with all other countries based on observable variables. Note that the analysis is restricted to goods but excludes services, as reliable data on bilateral service trade flows across a comprehensive number of countries and over a long period of time does not yet exist. In our preferred specification (building on Kathuria 2018), the model includes the distance between trading partners (DISTij), whether countries share a common border (CNTGij), a common language (LANGij), or a colonial legacy (CLYNYij), and whether they participate in Regional Free Trade Agreements (RTA), as well as the exporter and importer GDP (GDPit, GDPjt). In addition, we control for multilateral resistances by including a remoteness indicator (REMit and REMjt) and we include year fixed effects to control for international business cycle fluctuations that affect international trade (gt). We estimate the following model for 196 countries from 1996 to 2017: where stands for the imports of country i from country j or in other words, for the exports of country j from i. We use bilateral trade import data from UN Comtrade and variables related to distance, common border, common language, and common colonial history from the CEPII gravity dataset. The remoteness index is defined as the arithmetically weighted average of the distance of exporter and importer countries from all their trading partners, following Wei (1996). We use bilateral trade flows as reported by the importer but in case of missing information rely on the flows reported by the exporter. We apply a Poisson Pseudo Maximum Likelihood (PPML) estimator to be able to include all zero bilateral trade flows, which is not feasible with a simple ordinary-least-squares estimator, and to overcome all the econometric challenges that have been identified in the literature (Silva and Tenreyro, 2006). Our specification delivers a good data fit (the R-squared is 0.71) and the estimation yields the following very intuitive results in line with the literature (Head and Mayer 2014): distance depresses trade (-0.51), while sharing a language (+0.16), a border (+0.52), colonial ties (+0.69) and a regional trade agreement (+0.48) foster trade. Once bilateral trade is predicted for all country pairs based on these results, we can compare predicted trade to actual trade and compute export and import gaps defined as the difference between the predicted and observed trade flows. We will refer to the predicted exports, which we consider a meaningful benchmark, as potential exports, as the prediction shows the amount of exports you would expect given the above-mentioned characteristics and the experience of 196 countries over 22 years. Our potential exports of course depend strongly on the model specification and abstracts from any factors that are outside the model (and time-varying), such as comparative advantage, economic structure, human capital and many more. But these factors can help explain the observed gaps. Our attempt is certainly not the first to estimate and assess trade patterns in South Asian countries with a gravity model. Most recently, the World Bank used this approach to highlight that the trade between Pakistan and India is much lower than it could be (Kathuria 2018; World Bank 2019b). In our model the predicted trade between Pakistan and India is even higher, since we take the common colonial history of the two countries into account. It is a common approach in academic pub- lications in South Asia as well. For Pakistan, Butt (2008) and Abbas and Waheed (2015) also find a positive export gap. The latter also show that Pakistan’s exports are positively affected by its domestic supply capacity and the demand potential of its partners. Batra (2006) and Kaur and Nanda (2010) show that India’s trade potential is high within the South Asia region and especially with Pakistan. Similarly, exports are generally found to be below potential in Nepal (Thapa 2012; Prasai 2014) and Bangladesh as well. For the latter, rising trade transaction costs are argued to be major cause (Rahman and Ara 2010). Overall, research suggests that South Asian countries are yet to achieve the full benefits of trade (Hassan 2001; Kathuria 2018). The importance is that it exposes a country more to pete with foreign suppliers of imported products. The international competition, in international markets, arising international competition is the driving force where exporters compete with foreign suppliers, and of productivity increases that can fuel the develop- in domestic markets, where domestic producers com- ment process. South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 53 Figure 40: South Asia’s exports are well below potential, and the gap is increasing. Benchmarking South Asia’s export performance against predictions from a gravity model, estimated for 196 countries from 1996 to 2017, unveils a large and increasing export gap. In 2017, the export gap was over 20 percent of GDP. Imports are below the prediction as well, but the gap is much smaller. Export gap in South Asia Import gap in South Asia Percent of GDP Percent of GDP 40 40 30 30 20 20 10 10 0 0 -10 -10 -20 -20 -30 -30 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Export gap Predicted exports Exports Import gap Predicted imports Imports Notes: Predicted trade based on gravity regression described in Box 6. Actual exports and imports from UN Comtrade. Sources: UN Comtrade, WDI, CEPII gravity dataset, and staff calculations. Figure 41: Export and import gaps vary between countries, but exports are below potential with all major export destinations. The export gaps are especially large in Pakistan, Nepal, Afghanistan, and Maldives, but export gaps are substantial in all South Asian countries; apart from Bangladesh’s exports to the EU, exports from all countries to all major destinations are below potential. Predicted versus actual trade in South Asian countries Export gaps by destination Ratio (predicted over actual) Percent of GDP 16 50 14 40 12 30 10 8 20 6 10 4 0 2 0 -10 Nepal Afghanistan Pakistan Maldives South Asia Bhutan India Sri Lanka Bangladesh Pakistan Nepal Afghanistan Maldives Bhutan Sri Lanka Bangladesh India Exports Imports South Asia (excl. India) India China EU USA Rest of world Notes: Predicted trade based on gravity regression described before. Actual exports and imports from UN Comtrade. Sources: UN Comtrade, WDI, CEPII gravity dataset, and staff calculations. For all countries in South Asia, goods exports are ports – due to large remittances inflows – are only below potential, but there are strong differences 1.5 times larger than actual imports. In Afghanistan, between countries. One way to compare predict- predicted exports are 9.8 times larger than actual, ed trade is to contrast it with actual trade (Figure in Pakistan 6.5 times and in Maldives 5.6 times. In 41). In Nepal, predicted goods exports are 15 times all three countries, the predicted imports are much larger than actual exports, whereas predicted im- closer to actual. In Bhutan, India, Sri Lanka, and South Asia Economic Focus | Spring 2019 | Exports wanted 54 Exports Wanted Figure 42: South Asian countries are not integrated into Global Value Chains and attract little FDI. South Asian countries are not well integrated into GVCs and apart from Maldives attract low FDI inflows. Most countries in South Asia are below average in both. Global Value Chain participation and net FDI in ows Percent of GDP 40 35 30 25 20 Net FDI in ows 15 10 MDV 5 BGD LKA IND 0 PAK AFG NPL BTN -5 -10 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Global Value Chain participation Notes: Data is an average from 2013 to 2017. The cross marks the average GVC participation and the average FDI inflow. Sources: WDI, UNCTAD-Eora, and staff calculations. Bangladesh, the predicted exports are between in Nepal and 8 percentage points in Bhutan). The 2.7 times and 2.3 times larger than the actual. In breakdown of the export gaps by destination con- contrast to other countries, the import gaps are firms that a considerable proportion of the two nearly as large as the export gaps in Bhutan and countries’ gaps is explained by low exports to China. Bangladesh. Another way to look at the trade gaps Both countries have only a small gap with the other in percent of GDP (Figure 41). Using this measure, South Asian countries, due to considerable exports Pakistan has the largest export and import gap. Its to India, but considerable gaps with all other major exports are below potential for all major destina- export destinations. Maldives and Afghanistan both tions, especially for India (in line with Kathuria have an export gap of around 40 percent of GDP. 2018 and World Bank 2019b) as well as China (see The model’s prediction for Maldives may be too Box 7 for constraints to export competitiveness in high, given its particular characteristics, like being Pakistan). Nepal, Afghanistan, Maldives and Bhu- an atoll, that are difficult to incorporate in a model tan have large export gaps in percent of GDP as well. estimated for the world. And for Afghanistan the Both Nepal and Bhutan border two large economies gap is no surprise, given the difficult economic and (China and India) and – based on the experience of political situation. Both have much smaller import other small countries – the model suggests that they gaps, since Maldives needs to import goods for its should be trading a lot with these countries. There tourism and construction sector (e.g. oil and food) are mainly two reasons for their low exports: first, and Afghanistan receives large aid flows. The export both countries are mountainous and, second, they gaps are smaller but with around 20 percent of GDP opened their economies very late. When including still substantial in Sri Lanka, Bangladesh, and India. being landlocked in the model, the gaps for both The EU is the most important export destination for countries decline somewhat (9 percentage points Bangladesh, due to essentially tariff-free access, and South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 55 Box 7: Constraints to export competitiveness in Pakistan The last fiscal year showed a record-high trade deficit in Pakistan, at USD 31.1 billion, contributing to a current account defi- cit of 6.1 percent of GDP. The observed trade deficit resulted from the combination of consumption-led growth, that fueled demand for imports, and mounting constraints to export competitiveness. Between 2005 and 2018, Pakistan’s merchandise exports rose from USD 16 billion to USD 23 billion, an increase of only 47 percent compared to an increase of 286 percent in Bangladesh, 563 percent in Vietnam or 193 percent in India. Its exports have been concentrated in a few products with little sophistication like textiles, apparel and rice. Its exporting firms remain small, when compared to those in peer countries, and there is little entry into and exit out of export activities. This box elaborates on the constraints to export competitiveness. Many factors affect competitiveness in Pakistan. These include, among others, high costs of doing business, electricity availability at affordable costs, or access to finance. However, there are three constraints that directly affect exporters. These are the anti-export bias of its trade policy, the inadequate export promotion infrastructure, and an ambiguous regulatory framework around FDI. First, high duties on imports create an anti-export bias, considerably reducing the ability of Pakistan’s firms to integrate into global markets. The structure of Pakistan’s taxes on imports displays two features that prevent firms from leveraging regional and Global Value Chains (GVCs) to sell Pakistan’s goods and services to the world, to increase productivity, and to create more and better jobs. First, Pakistan’s import duties are high – with a marked escalation: the average difference between tariffs on final goods and raw materials was 10.4 percentage points in 2016, and between intermediate goods and for raw material it was of 2.2 percentage points (Figure 43). This creates an incentive for firms to focus on the local market, in which they enjoy higher profit margins due to the tariffs on the final goods, rather than innovating and venturing into competitive global markets. In fact, the policy response to the increasing trade deficit has been to increase import duties, which further increases the anti-export bias. Second, duty suspension schemes for exporters that source intermediates from abroad work imperfectly. It takes 60 days to get the scheme approved – double the time stipulated by law and clearing customs under the scheme takes between 5 to 10 days. In addition, the complexity of securing the scheme approval is such that only 3 percent of textile and apparel exporters use it. Duty rebate schemes, instead, are more widely used – about 50 percent of textiles and apparel exporters use them, although more than half of the firms claim a waiting time of 250 days and more to receive the rebate. Figure 43: Pakistan’s tariffs are higher than Figure 44: Foreign Direct Investment inflows in the region, with escalation showing an anti- have been low export bias Tari rate Foreign direct Investment in ows between 2005 and 2017 Percent Percent of GDP 18 7 16 6 14 12 5 10 4 8 3 6 2 4 2 1 0 0 Pakistan South Asia Vietnam Malaysia East Asia Pakistan South Asia Thailand Vietnam Raw materials Intermediate goods Consumer goods Note: Average tariff by type of good in 2016. Source: UNCTAD. Sources: FBR and UN TRAINS. Second, export promotion infrastructure is not aligned with international good practices. Evidence collected through pri- vate sector consultations in Punjab, Sindh, Islamabad and Khyber Pakhtunkhwa also revealed that exporters lack support in terms of provision of export intelligence, which in other countries has effectively reduced the information frictions that new and small exporters face and that substantially increase their trade costs. This has been validated by a recent assessment of …. Continues next page …. South Asia Economic Focus | Spring 2019 | Exports wanted 56 Exports Wanted the main export promotion agency in Pakistan, the Trade Development Authority (TDAP), conducted by the International Trade Center (ITC). ITC assesses the performance of TDAP at ‘below average’ in its latest benchmarking exercise of 2017, pointing to several challenges, including lack of support to value chain development, lack of client datasets, and client management systems, as well as lack of monitoring and evaluation frameworks for its interventions. Indeed, the existing support focuses on participation in trade fairs for well-established export sectors (textiles and apparel), rather than focusing on connecting new or potential exporters with global buyers, that tend to have been more impactful, according to interna- tional evidence. Inadequate export promotion interventions underlie the little diversification of Pakistan’s export bundle as well as the low entry rates into exporting observed in the data. Third, the policy regime towards foreign direct investment increases the risks perceived by foreign firms. With global trade being structured around Global Value Chains, a country’s success in boosting exports is inextricably linked with its ability in attracting FDI. Pakistan’s record in FDI inflows is lackluster, with inflows averaging 1.5 percent of GDP between 2005 and 2017, compared to 6.1 percent of GDP in Vietnam over the same period (Figure 44). Part of the difficulties lie with the percep- tion of security challenges in Pakistan, which discourages FDI inflows into the economy – indeed, an important challenge has been attracting clients or senior management from abroad to visit premises of multinationals in Pakistan. However, pol- icies have not helped either. The investment regulatory framework shows inconsistencies between the Investment Law of 1976, which is relatively protectionist, and the Investment Policy of 2013, which is relatively more market friendly, although without the rank of a ‘law’. These inconsistencies create uncertainty among foreign investors, reducing their incentives to incur substantial largely irreversible investments, and further constraining the realization of export potentials in Pakistan. receives around 60 percent of its garment exports. termediate inputs. Consequently, closing the export Interestingly, this trade relationship is the only gap may automatically result in a closing of the im- one that the model predicts to be lower than it is, port gap. Closing the trade gaps by integrating more confirming a very close trade relationship between into global markets could also result in larger FDI Bangladesh and the EU. In addition, this result may inflows. Like GVC participation tends to come with imply that the estimated export potentials can be knowledge transfers, FDI often comes with technology reached and are not unrealistic. Bangladesh, Sri transfers that improve productivity. These knowl- Lanka and India are nearly at potential regarding edge and technology transfers are the main reason their exports to the United States and the EU but why integration into global markets is necessary for have considerable gaps with China and the rest of sustained strong growth of the South Asian economies. the world. Due to the large size of India, the ben- The underperformance in exports poses challenges, efits from closing exports gaps within South Asia both in the short and in the long run. In the short are somewhat asymmetric. Most countries would run, low levels of exports make adjusting to shocks naturally benefit more from closing the export gap more difficult. After a rise in oil prices, a fall in with India than India would from closing its export remittances, or a reversal in capital flows, exports gap with them. Finally, the exports gaps have been should increase, through real depreciation or other- rather stable over time in Bangladesh and India, wise increased competitiveness, to restore equilibri- but they increased a lot in Nepal, Pakistan, and Sri um. However, if exports start from a low level, the Lanka. price adjustment needs to be much larger to achieve South Asian countries are not well integrated into the same increase in exports. In the long run, insuffi- Global Value Chains (GVC) and apart from Maldives cient export performance is even more problematic. with its strong tourism sector receive small amounts Through integrating into global markets, countries of FDI (Figure 42). The GVC measure takes both back- gain knowledge and competitive pressures force ef- ward participation (the use of imported intermediary ficiency improvements. This leads to higher growth products) and forward participation (the export of potential that subsequently extends to the non-trad- intermediary products) into account. Therefore, weak able sector (Gould 2018). Such an export-led growth GVC participation can explain both underperform- process also leads to higher quality and better paying ing imports and underperforming exports. To move jobs (Artuc et al. 2019). It is virtually impossible towards a more export driven growth model, it will to sustain high growth rates over a long period by hence be necessary to open further for imported in- merely growing the non-tradable sector. South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 57 Figure 45: Low price elasticities of imports and exports result in slow adjustments. With changes of import and export prices, volumes will adjust. However, the contemporaneous relationship is very weak in South Asia. Export volumes respond only very little to changing export price in the same year and import volumes do not respond to changing import prices at all. Changes in export prices and volumes Changes in import prices and volumes Percent Percent 50 50 25 25 Export unit value growth Export unit value growth 0 0 -25 -25 -50 -50 -20 -10 0 10 20 30 40 -30 -20 -10 0 10 20 30 Export volume growth Import volume growth Note: Data is for all South Asian countries from 1991 to 2017 or as long as available. Source: WDI and staff calculations. Restoring equilibrium further out of equilibrium. If the price elasticity of imports is below one, meaning that an increase of import prices is not offset by a one-to-one reduc- Disequilibrium puts pressure on interest rates and tion of import volumes, the total value of imports exchange rates, but this can put the balance of pay- increases immediately after a depreciation. Since ments even further out of equilibrium. If financing exports are unlikely to adjust enough to offset the of the current account becomes more difficult, after a higher imports bill initially, a depreciation first de- widening of the current account deficit or a reversal creases the trade balance. This is especially true if a of capital inflows, pressure mounts for currencies to large component of imports is oil, which tends not depreciate and interest rates to increase. And this to be very price elastic in the short-run (Ashraf et al. indeed happened during 2018 throughout the region. 2018). Over time, both consumers and producers will Investors demanded higher returns, and increased switch away from some imported goods to domestic demand for foreign currencies eroded the value of the ones. In addition, exports will increase, as they are local currency. However, these price changes will not now more price competitive. In the empirical eco- necessarily restore equilibrium quickly. Depreciation nomics literature, this phenomenon has been labeled and rising interest rate spreads may generate expec- the J-curve effect and it has been confirmed for nu- tations for further depreciations and interest rate merous countries (see Box 8). increases in the future, discouraging investors even In South Asia, the price elasticities of imports and more. Depreciations tend to increase the value of im- exports are low, resulting in slow adjustments to ports as share of GDP, widening the current account relative price changes. Lower export prices have only deficit even more. And if the growing current account a small effect on export volumes in the same year deficit reflects an overheated domestic economy, then (Figure 45). For South Asia, a ten percent reduction a depreciation can put fuel on the fire, as it further of the exports price only results in one percent more boosts demand for domestically produced goods. exports in the same year. For imports the relationship In response to a depreciation, trade deficits in South is even weaker, and the volume of imports does not Asia initially increase, moving current accounts respond at all in the year of import price changes. In South Asia Economic Focus | Spring 2019 | Exports wanted 58 Exports Wanted Figure 46: Views from the region: the price elasticity of exports and imports. 60 percent of experts from South Asia responding to a survey conducted for this report (see Chapter 1) agree that a depreciation affects imports and exports only a little, as their price elasticities are low. Nearly a quarter think that exports react strongly to relative price changes and imports not at all. How does a depreciation a ect the volume of imports and exports in your country? Distribution of responses It changes them a lot, as their price elasticity is high It changes them only a little, as their price elasticity is low It does not a ect them, they are not elastic to price changes 0 10 20 30 40 50 60 70 80 Exports Imports Note: Survey results based on 83 responses from seven South Asian countries (see Box 3 in Chapter 2). Source: South Asia Economic Policy Network. Figure 47: A smaller fiscal deficit results in a smaller current account deficit. There is a statistically significant relationship between the fiscal deficit and the current account deficit in South Asian countries. In a panel estimation, a one percentage point lower fiscal deficit reduces the current account deficit by 0.34 percentage points in the same year and by 0.37 percentage points in the long run. E ect of one percentage point lower scal de cit The current account deficit depends on the fiscal stance Percentage points (1) (2) (3) 0.6 0.65*** 0.37*** 0.37*** Lagged current account (0.06) (0.05) (0.07) 0.22 0.24** 0.34*** 0.4 Fiscal balance (0.13) (0.08) (0.08) Country fixed effects No Yes Yes Year fixed effects No No Yes 0.2 Observations 151 151 151 R-squared 0.61 0.69 0.78 Number of countries 6 6 6 0 0 1 2 3 4 5 Years Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 Response of current account Cumulative response of current account Notes: Data is from 1990 to 2017 for all South Asian countries excluding Bhutan and Afghanistan. We estimate the following model: cait=ai + βcait+δfbit+εit The specification of the regression is inspired by Bluedorn and Leigh (2011) but differs in two important points: first, since we are not interested in effect of deliberate policy decisions but the fiscal deficits in general, we can use the fiscal balance rather than a measure of discretionary changes in fiscal policy. Second, we estimate the model only with one lag due to the smaller sample. Source: World Bank and staff calculations. the second year, on the other hand, there is a larger of experts from South Asia responding to a survey effect on import volumes than on exports. For a price conducted for this report (see Box 3 in Chapter 2) change of 10 percent, the former decrease by 1.6 per- agree that a depreciation affects imports and exports cent, while for the latter the effect is negligible. In only a little, as their price elasticities are low. A fifth the third year, imports decrease by 0.4 percent and thinks that exports react strongly to relative price exports increase by 0.4 percent. Around 70 percent changes and imports not at all (Figure 46). South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 59 Box 8: Research on oil prices, J-curves, and twin deficits in South Asia a) Oil prices and current accounts For oil importers, higher oil prices translate into higher oil bills if the price elasticity is below one. If other imports do not decrease or exports pick up at the same time, the higher oil price increases the current account deficit (or decreases the current account balance). Empirical studies of the relationship between oil prices and current account deficits seem surpris- ingly rare, especially for oil importers. The effect of oil shocks on the trade balance and the current account depends very much on the nature of the shock, its magnitude, and how the nonoil trade balance responds (Marion 1984; Kilian, Rebucci and Spatafora 2009). In Bangladesh, evidence shows that the trade balance deteriorated because of the oil price boom in the early 2000s (Sánchez 2011). Aside from raising import bills, higher oil prices increased the production costs of the export sector. In Pakistan, an increase in global oil prices has a negative effect on the current account and a negative impact on exports (Mohammad 2010). Similarly, in India, oil prices are a leading indicator for the trade balance with an inverse relationship between the two variables: a temporary increase in oil prices negatively affects the trade balance and the current account (Arouri, Tiwari and Teulon 2014; Bhanmurthy, Das and Bose 2012). b) The J Curve The J curve, first identified by Magee (1973), describes the typical pattern of the trade balance in response to exchange rate movements. Currency devaluations initially tend to result in worsening trade deficits before improving them, resulting in a pattern that resembles the letter J, giving the phenomenon its name (Magee 1973; Backus, Kehoe and Kydland 1992; Bahmani-Oskooee and Ratha 2009). Bahmani-Oskooee and Kutan (2004) provide a good review of the empirical literature. Several studies test the J-curve for South Asian countries. There is mixed evidence for the presence of the phenomenon in India and Pakistan. For India, some studies argue that devaluations have no significant long run effect on the trade balance (Buluswar, Thompson and Upadhyaya 1996; Singh 2004; Bahmani-Oskooee and Mitra 2009). However, using disaggregated bilateral data, Arora et al. (2003) find that a rupee depreciation against the currencies of Australia, Germany, Italy and Japan has a positive impact on India’s trade balance with these countries in the long-run. Similarly, Dash (2013) finds a J-curve effect in India’s bilateral trade with Japan and Germany using a different methodology (Dash 2013). For Pakistan, most studies have dismissed the presence of the J-curve effect (Aftab and Khan 2008; Hameed and Kanwal 2009; Atiq-ur-Rehman and Anis 2012). On the other hand, Rehman and Afzal (2003) find some evidence for it. There is also some evidence for the J-curve phenomenon in Nepal and Bangladesh (Chaulagai 2015; Khatoon and Rahman 2009; Rahman and Islam 2006). c) Twin Deficits The evolution of record fiscal and current account deficits in the United States during the 1980s drew increasing attention to what has become popularly known as the “twin deficit” problem. According to the twin-deficit hypothesis, budget deficits increase domestic demand, cause imports to expand, and hence worsen the trade deficit (Ratha 2012). In addition, they cause higher interest rates and domestic currency appreciation, which worsens the trade deficit further (Bartolini and Lahiri 2006; Kulkarni and Erickson 2001; Ratha 2012). Empirical evidence of twin deficits has not been observed as commonly as the identity of total expenditure and total income would suggest. One explanation may be related to the Ricardian Equivalence Hypothesis (REH): since households optimize their consumption inter-temporally and rising budget deficits necessarily imply higher future tax liabilities, they may offset higher government spending by higher savings. In a theoret- ical model, the inter-temporal shift between taxes and budget deficits has hence no impact on real interest rates or trade deficits (Ratha 2012). Additionally, the causality of the relationship is not always observed in a specific direction. The issue of whether the twin-deficits phenomenon holds is very much an empirical question, and it may hold in some countries and not in others. When the volumes of these deficits are large, the probability that a relationship between them exists increases significantly (Ratha 2012). Several studies analyze the link between trade and budget deficits in South Asia. While certain studies provide strong evi- dence for twin deficits in India (Kulkarni and Erickson 2001; Ratha 2012), some show that budget deficits create trade deficits in the short run, but not in the long run (Ratha 2012; Suresh and Gautam 2012). Others, on the other hand, find no evidence for such a phenomenon in India at all (Ravinthirakumaran, Selvanathan, and Selvanathan 2016; Basu and Dutta 2005). In Pakistan, while twin deficits exist, there seems to be a bi-directional causality between the two variables (Mukhtar, Zakaria and Ahmed 2007) and there may even be evidence for a stronger causality in the opposite direction (Aqeel, Nishat and Qayyum 2000; Kulkarni and Erickson 2001; Mukhtar, Zakaria and Ahmed 2007; Ravinthirakumaran, Selvanathan, and Selvanathan 2016). In Sri Lanka, empirical analyses support the conventional view of a long run relationship between current account imbalances and budget deficits (Saleh, Nair and Agalewatte 2005; Ravinthirakumaran, Selvanathan, and Selvanathan, 2016). South Asia Economic Focus | Spring 2019 | Exports wanted 60 Exports Wanted Figure 48: Temporary shocks affect the current account, permanent the exchange rate. Using a VAR model with long-run restrictions, we confirm that in South Asia temporary shocks affect the current account but not the exchange rate and permanent shocks affect the exchange rate but not the current account. a) India Current account Exchange rate Temporary shock Permanent shock a) India Temporary shock Permanent shock Current account 3 7 rate Exchange 1.6 0.6 Temporary shock Permanent shock Temporary shock 6 Permanent shock 0.4 3 7 1.6 0.6 1.2 0.2 2 5 6 0.4 0 Current acount Current acount Current acount Current acount 1.2 0.2 2 4 5 0.8 -0.2 1 0 3 Current acount Current acount Current acount Current acount 4 -0.4 1 0.8 -0.2 2 0 3 0.4 -0.6 -0.4 1 2 -0.8 0 0.4 -0.6 -1 0 1 0.0 -1.0 -0.8 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 -1 0 0.0 Quarters -1.0 Quarters Quarters Quarters 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 b) South Notes: The model is estimated using quarterly data for India from 1990Q1 to 2017Q4 Asia with one lag. The dotted lines mark the 95 percent confidence interval. and is estimated Quarters Source: IMF and staff calculations. Quarters E ect of temporary shock on current account Quarters Quarters E ect of permanent shock at exchange rate 0.12 b) South Asia 2.5 E ect of temporary shock on current account E ect of permanent shock at exchange rate 0.12 0.10 2.5 2.0 0.10 0.8 acount acount 2.0 rate rate 1.5 Exchange Current Current 0.8 0.6 1.5 Exchange 1.0 0.6 0.4 1.0 0.4 0.5 0.2 0.5 0.2 0.0 0.0 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0.0 Quarters 0.0 Quarters 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 Quarters Quarters Notes: The impulse response functions are an unweighted average of Bangladesh, India, Sri Lanka, Nepal and Pakistan, and the shock size has been standardized to one. All individual country responses are statistically significant at the 5 percent level. Source: IMF and staff calculations. In South Asia, there is a strong relationship be- react to higher government consumption. The causal tween fiscal deficits and current account deficits. relationship between the fiscal deficit and a current An additional percentage point of fiscal deficit does account deficit is often referred to as the “twin defi- not affect the current account deficit one-to-one, cit phenomenon”. There is overwhelming evidence because government spending tends to crowd out that South Asian countries are indeed “twin defi- private spending. Nevertheless, the link between the cit” countries (see Box 8). This empirical evidence two deficits is significant in South Asia. For every is important for the policy discussion above. If a percentage point decline in the fiscal deficit, the cur- sudden increase in current account deficits, caused rent account deficit decreases by a third of a percent- by increased domestic spending, has to be reversed, age point in the same year (Figure 47). Over time, fiscal adjustment is an effective tool. Not all public the effect accumulates to over half of a percentage spending affecting the current account is accounted point. The effect is much smaller than one-to-one for in budgets. In some cases, state-owned enterpris- confirming that private saving and consumption es are responsible for large infrastructure projects South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 61 that worsen the trade balance and can deteriorate pluses. Both measures not only build buffers, they the current account. also prevent a loss in competitiveness. In case of negative external shocks, central banks should be Once domestic demand has adjusted, relative prices cautious in defending the currency through selling also must adjust to restore equilibrium in all mar- of reserves, especially if the shock is not of a short- kets. More specifically, after fiscal adjustment also a term, temporary nature. If current accounts are real depreciation is needed to ensure that not only in deficit and international financing conditions the current account becomes sustainable, but also have deteriorated, it is obviously difficult to build the domestic economy can continue to function at full capacity. These relative price adjustments are up reserves, unless an IMF program or other sup- especially important, and ultimately unavoidable, port can provide the required buffers. after a structural shock. Short-term shocks can of- ·· The root cause of the disequilibrium must be ten be absorbed through buffer mechanisms and do addressed as soon as possible. If, for example, not require major realignments of relative prices. A tensions on the balance of payments are caused by temporary hike of the oil price can be offset by run- excessive domestic spending, then policies should ning down reserves until the oil price is back at the focus on reducing that spending. Fiscal measures old level. For permanent shocks, however, running are likely most effective to achieve this. In most down reserves can sustain the old equilibrium only South Asian countries, increases in the tax base for some time, but eventually relative prices must are more urgent than reductions in government adjust to reach a new sustainable external balance. spending. Empirical evidence confirms that temporary shocks affect the current account and permanent shocks the ·· Once spending is adjusted in response to a per- real exchange rate. Employing a well-established es- manent shock, then relative prices should be al- timation method (see Box 5), we find strong empir- lowed to adjust accordingly. For example, after a ical evidence that it is indeed the case in South Asia moderation of domestic demand to restore equi- that after permanent shocks relative prices change, librium, a real depreciation is needed to bring all while temporary shocks can be absorbed through markets in equilibrium again. The smoothest way fluctuations in current accounts (Figure 48). We find to achieve this relative price change is through these effects for Bangladesh, India, Nepal, Pakistan, flexible nominal exchange rates. However, the and Sri Lanka. advantages of flexible exchange rates apply es- pecially to the larger economies. For Bhutan and Nepal, which trade mainly with India, the peg to Active policies are needed the Indian rupee may serve as an important infla- tion anchor. Policy makers should play an active role to sustain or restore equilibrium on the balance of payments. Of- An even more important challenge for policy mak- ten good things come in threes, and that is probably ers than these three steps to restore equilibrium true also for a successful policy approach in this case: on the balance of payments is the need to increase exports, bringing them much closer to their poten- ·· It is crucial that central banks build up or preserve tial. A range of reforms are needed to unleash the sufficient foreign exchange reserves. That prevents export potentials in the region. Trade liberalization, self-fulfilling expectations of further deprecia- reducing both tariff and non-tariff barriers, is a first tions and further increases in interest rates. It also step. That should include the reduction of import can serve as a buffer to absorb small, temporary barriers. Tariffs on intermediary inputs directly shocks. Also, fiscal buffers, and in general sound increase the costs of exports, and therefore reduce macroeconomic policies, can prevent balance of export competitiveness. But more generally, larger payments to spiral further out of equilibrium. imports tend to trigger also larger exports. When That means that in periods of large capital inflows import prices fall, after a reduction in import tariffs, or large inflows of remittances reserves can be ac- domestic prices will follow, making a country more cumulated and governments could run fiscal sur- competitive and increasing export opportunities. South Asia Economic Focus | Spring 2019 | Exports wanted 62 Exports Wanted Box 9: Policy views among economists in the region Figure 49: Regional economists see a need for short-term measures but are split over which. In a survey conducted for this report, more than three quarters of respondents see a need to adjust policies to contain external risks in the short-run. Many consider a less expansionary fiscal policy appropriate. There is no agreement whether monetary authorities should intervene more or less in foreign exchange markets and regional economists are skeptical about higher interest rates. Is there a need to adjust policies to contain What are appropriate policies to contain external risks in the short run? external risks in the short run? Distribution of responses Distribution of responses Less expansionary fiscal policy More measures to control capital flows Higher import tariffs on selected goods Yes Less foreign exchange interventions of the Central Bank No More foreign exchange interventions of the Central Bank Higher interest rates 0 10 20 30 40 50 60 70 80 90 100 Very appropriate Appropriate Not appropriate Note: Survey results based on 83 responses from seven South Asian countries (see Box 3 in Chapter 2). Source: South Asia Economic Policy Network. Regional economists also see a need to adjust policies to contain external risks in the short-run. Over three quarters of respon- dents agree that adjusting policies is necessary. However, there is much less clarity on the appropriate measures. In line with our assessment, around 70 percent of the respondents consider a less expansionary fiscal policy very appropriate or appropriate. However, nearly as many are in favor of more measures to control capital flows. This chapter has not addressed this issue. Even if such measures would be desirable to limit capital outflows, an open question is how effective the measures could be and what their long-run implication would be. Over 60 percent say that higher import tariffs on selected goods would be appropriate or very appropriate. That seems at odds with what this chapter suggests. In South Asia more and not less trade is needed. Curbing imports would very likely also lead to a reduction in exports, which is the opposite of what this chapter recommends. More generally, re- ducing imports will lead to more demand for domestic products. If the current account deficit was caused by too much domestic demand and an overheating economy, import tariffs would reinforce the root cause of the problem. In addition, the frequent use of import tariff measures increases the uncertainty of investments. Close to 60 percent think that less intervention in foreign ex- change markets is very appropriate or appropriate. At the same time, however, nearly as many experts call for more interventions. Interestingly, there is no clear pattern regarding where the experts are coming from. The split in views on exchange rate man- agement has hence nothing to do with specific country circumstances. Perhaps the views on intervention differ because there is no unanimity on the questions whether South Asian countries currently face temporary or more structural shocks. Somewhat surprisingly, less than half consider higher interest rates necessary, while that could be one way to reduce domestic demand. Figure 50: Regional economists desire higher exports and consider the business environment, logistics and a shortage of skilled labor as main bottlenecks. In a survey conducted for this report, almost all regional experts desire higher exports. They consider a difficult environment for private businesses, difficult logistics and a shortage of skilled workers the most important bottlenecks. Still around 80 percent also see a role of tariffs and nontariff measures, but few think they are very important. And three quarter think the rigidity of the formal labor markets matters, and a third considers it very important. Are higher exports desirable What are the main bottlenecks for higher exports in your country? in your country? Distribution of responses Distribution of responses Difficult environment for private businesses (regulations, property rights) Difficult logistics (roads, ports, storage) Shortage of skilled workers Yes No High tariffs and para tariffs on intermediate inputs Non tariff barriers on intermediate goods Rigidity of formal labor market 0 20 40 60 80 100 Very important Important Not important Note: Survey results based on 83 responses from seven South Asian countries (see Box 3 in Chapter 2). Source: South Asia Economic Policy Network. …. Continues next page …. South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 63 Regional experts desire higher exports, but they see a lot of bottlenecks. First and foremost, they consider a difficult en- vironment for private businesses related to regulations and property rights an obstacle to a better export performance. Nearly as many name difficult logistics related to roads, ports, and storage, as well as a shortage of skilled labor as major bottlenecks. And still over 80 percent see an obstructing role of tariffs and nontariff measures, even though few consider them very important. Interestingly, half of the respondents who name import tariffs on selected goods an appropriate or very appropriate measure to contain risks in the short-run also consider tariffs a bottleneck for the export performance in the long run. Finally, three quarters perceive the rigidity of the formal labor market as an issue, and a third of the respon- dents consider this very important. These views outline the right policy agenda. Implementing this agenda is far from easy, but it should nevertheless be relentlessly pursued. The huge underperformance in trade could very well become one of the main bottlenecks in achieving sustained high growth. A popular view in South Asia is that trade deficits ital markets is needed to support export growth. If can be reduced by raising import tariffs (see Box 9). labor or capital is stuck in non-tradable sectors, then However, the trade deficit is ultimately determined it will be difficult to build up a vibrant export sector, by domestic spending in excess of domestic produc- even if trade barriers have been removed. Finally, the tion, not necessarily by relative trade prices. An in- challenge to increase exports also involves the skills crease in import tariffs would likely lead to a decline agenda. Specific skills are needed to compete in in- in both imports and exports. Apart from trade liber- ternational markets and the right incentives should alization, more flexibility in domestic labor and cap- exist to develop and use these skills. South Asia Economic Focus | Spring 2019 | Exports wanted 64 Exports Wanted Box 10: Views from the region on external vulnerabilities in South Asia In preparation for this report and as part of our engagement with the South Asia Economic Policy Network, we co-organized a regional conference on “External Vulnerabilities in South Asia” with the Central Bank of Sri Lanka (CBSL), the Institute of Policy Studies (IPS), and the University of Colombo. The event was held on February 28 and March 1 at the Central Bank in Colombo, Sri Lanka. During the two-day conference, both scholars and practitioners from six South Asian countries came together to discuss macroeconomic issues and external risks faced by their countries, to understand the sources and to think about solutions in a challenging global environment. The conference featured both more academically-oriented and more policy-oriented sessions. In the academic sessions, 16 papers selected through a highly competitive selection procedure and preliminary findings of this report were presented. Some of the papers focused on the drivers of the current account in the region. Narayan Pradhan and Rajat Malik (both from the Reserve Bank of India) focused on real exchange rate but also discussed growth spillover from advance economies, fiscal policy, and private credit growth. Anita Poudel (Nepal Administrative Staff College) described the situation in Nepal and discussed domestic supply side constraints. Muhammad Ibrahim Shah (University of Dhaka) examined the determinants of current account deficits across South Asian countries and contrary to most of the literature, his findings suggest that an appreciation of the real effective exchange rate leads to a reduction in current account deficit in the long-run. In addition, he argued that financial development, trade openness and population growth widen current account deficits. Muhammad Omer (State Bank of Pakistan) concluded that a depreciation of the real exchange rate decreases imports twice as much as it increases exports and showed that remittances play an important role in the buildup of Pakistan’s foreign exchange reserves. Erandi Liyanage (CBSL) revisited the relationship between exchange rate fluctuations and the trade balance in Sri Lanka for different trade partners and presented a significant negative impact for appreciations, but no significant impact of depreciations. Fayyaz Hussain (State Bank of Pakistan), using data for 40 middle income countries, finds that an exchange rate undervaluation has a positive impact on growth through the trade channel. However, this impact is more than offset by the tightening of the credit supply due to the reduced net worth of the firms. In line, he argued against currency undervaluation as well as against currency overvaluation. Ujjal Protim Dutta (National Institute of Technology, India) assessed the impact of remittances on the real effective exchange rate in a panel for Bangladesh, India, Nepal, Sri Lanka and Pakistan and concluded that remittances put upward pressure on real effective exchange rate, raising similar implications to those of the Dutch Disease. Other papers focused on South Asia’s export performance and monetary policy issues. Pavel Chakraborty (Lancaster University, UK) studied the effect of expansive monetary policy on firm-level performance in India after the global financial crisis. Using a matched firm-bank dataset, he showed that manufacturing firms that borrowed from public banks did not see a drop in their exports because of constrained credit supply, as opposed to firms borrowing from private banks. Public banks have likely benefited from implicit government guarantees. While the presence of public banks hence supported the growth momentum during this period, the long-run implications are less clear. Syed Yusuf Saadat (Centre for Policy Dialogue, Bangladesh) concluded that Bangladesh’s trade integration into the global economy has been driving its economic growth and showed that the minimum wage of readymade garment workers, manufacturing costs, utilities costs, crude oil prices, the exchange rate, foreign exchange reserves, as well as the budget balance all impact the volatility of trade. Tapas Kumar Parida (State Bank of India) estimated the cost of India’s foreign exchange market interventions and concluded that sterilization has overall been successful. Yet, he still sees some operational challenges that could be improved with better communication be- tween the Reserve Bank of India and market participants. Sumila Tharanga Wanaguru and Anil Perera (both CBSL) concluded that monetary policy significantly influences movements of the exchange rate in Sri Lanka, with volatility being persistent and particularly high following negative shocks. With several South Asian countries now running both fiscal and current account deficits, the so-called twin deficit discussion picked up again. John V Guria (RBI) investigated the contribution of fiscal deficits to external vulnerabilities and concluded that the twin deficits phenomenon is indeed present in South Asia. He identified US monetary policy tightening as a factor exacerbating external vulnerabilities and argued that the accumulation of foreign exchange reserves can provide insurance and liquidity buffers. In line, Utsav Kumar (Asian Development Bank) documented that the twin deficits generated volatility in the balance of payments in Sri Lanka and argued that efforts toward a revenue-based fiscal consolidation should be com- plemented with building a buffer stock of foreign exchange reserves. Santosh Kumar PK (Cochin University of Science and Technology, India) used an Error Correction Mechanism with data from 1970 and 2017 and confirmed that there is a positive relationship between trade deficit and budget deficit in India, validating the twin deficits hypothesis both in the short and long run. Conversely, Prasant Kumar Panda (Central University of Tamil Nadu, India), using data for the period from 1970 to 2012 and vector autoregressive and autoregressive distributive lag models, did not find evidence of the twin deficit hypothe- sis in India. He concluded that addressing structural issues and fostering initiatives for export promotion will help reduce the …. Continues next page …. South Asia Economic Focus | Spring 2019 | Exports wanted Exports Wanted 65 current account deficit in India. Muntasir Murshed (Bangladesh Institute of Development Studies) did not find evidence of the twin deficit hypothesis in Bangladesh and attributed this result to the lack of capital mobility. There were three more policy-oriented sessions. In their opening remarks, Yuthika Indraratna (Director of Economic Research, CBSL), Hans Timmer (South Asia Chief Economist at the World Bank), and Dushni Weerakoon (Executive Director, IPS) high- lighted increased external vulnerabilities – such as widening current account deficits and high foreign debt – as risks for South Asia’s long-term growth prospects. They all called for solid financial and fiscal management, while emphasizing coun- try specificities. One session focused specifically on the lessons learned from the experiences in Sri Lanka and Pakistan. The speakers, Nandalal Weerasinghe (Senior Deputy Governor, CBSL), Fernando Im (Senior Economist at the World Bank), Rashid Amjad (Lahore School of Economics), and Sakib Sherani (former PMs Economic Council), very much agreed on the important role of fiscal policy in both countries. A policy expert panel debated the causes, consequences and remedies for the external vulnerabilities in South Asia more broadly. Indrajit Coomaraswamy (Governor, Central Bank of Sri Lanka) pointed to excess demand conditions, fueled by fiscal deficits, as one of the drivers of the current account deficit and generator of external vulnerabilities. He described Sri Lanka as a twin deficit country, financed through concessional terms-loans, that aims at re-entering international capital mar- kets. He emphasized that Sri Lanka needs to identify and address systemic risks like the high level of external commercial borrowing, to commit more firmly to fiscal rules, and to continue the slow process of improving tax administration. Dushni Weerakoon (called the attention to the risks posed by the repayments of maturing short-term debt and worried about the low public support for reforms. She also emphasized the need for higher productivity and higher export competitiveness as part of a comprehensive resilience and growth framework. Hans Timmer underlined that the benefits of foreign exchange reserve buffers are usually underestimated, that public expenditure should follow clear rules to become more predictable to economic agents, and that export competitiveness will require a more dynamic and flexible private sector. Papers presented ·· Anita Poudel (Nepal Administrative Staff College): Drivers of Nepal’s Current Account Deficit and its Policy Remedies. ·· Fayyaz Hussain (State Bank of Pakistan), Muhammad Ishtiaq (State Bank of Pakistan) and M. Ali Choudhary (State Bank of Pakistan): Exchange Rate Undervaluation and Economic Growth: The Trade- versus the Financial Risk Channel. ·· Hemantha Ekanayake (CBSL, Sri Lanka), Erandi Liyanage (CBSL, Sri Lanka): Revisiting the Effect of Exchange Rate Fluctuations on the Trade Balance: Evidence from Sri Lanka. ·· John V Guria (RBI, India): Fiscal Deficit and External Debt Driven External Vulnerabilities in South Asia: A Panel Data Analysis. ·· Muhammad Ibrahim Shah (University of Dhaka): Assessing the Determinants of the Current Account Deficit: Evidence from South Asia. ·· Muhammad Omer (State Bank of Pakistan) and Junaid Kamal (State Bank of Pakistan): Does Exchange Rate Depreciation improve the Balance of Trade? A Pakistan’s Perspective. ·· Muntasir Murshed (Bangladesh Institute of Development Studies): The Twin Deficits Hypothesis, Ricardian Equivalence and Feldstein-Horioka Puzzle: An Empirical Evidence from Bangladesh. ·· Pavel Chakraborty (Lancaster University, UK): Financial Crisis, Monetary Policy and Exports: Evidence from a Matched Firm- Bank Dataset. ·· Rajib Das (RBI, India), Narayan Pradhan (RBI, India) and Rajat Malik (RBI, India): Determinants of Current Account Balance in South Asian Economies – An Empirical Analysis. ·· Santosh Kumar PK (Cochin University of Science and Technology): Twin Deficit Hypothesis: Empirical Evidence from India. ·· Soumya K Ghosh (State Bank of India), Debashis Padhi (State Bank of India) and Tapas Kumar Parida (State Bank of India): Foreign Exchange Market Intervention and Liquidity Management in India: Some Empirical Investigations. ·· Sumila Tharanga Wanaguru (Central Bank of Sri Lanka) and Anil Perera (Central Bank of Sri Lanka): Implications of Exchange Rate Volatility on the Monetary Policy Conduct: An Emerging Market Perspective. ·· Suraj Badaik (Central University of Tamil Nadu) and Prasant Kumar Panda (Central University of Tamil Nadu): Ricardian Equivalence, Feldstein-Horioka Puzzle and Twin Deficit Hypothesis in Indian Context: An Empirical Study. ·· Syed Yusuf Saadat (Centre for Policy Dialogue, Bangladesh): Trade Vulnerability of Bangladesh: An Exploratory Analysis. ·· Ujjal Protim Dutta (National Institute of Technology, India), Partha Pratim Sengupta (National Institute of Technology, India): Do Remittances have a Flip Side? A Panel Cointegration Analysis of Remittances and Real Effective Exchange Rate in South Asian Countries. ·· Utsav Kumar (ADB), Dushni Weerakoon (IPS), Roselle Dime (ADB): Sri Lanka’s Macroeconomic Challenges: A Tale of Two Deficits. All papers and presentations can be downloaded from the conference webpage: www.cbsl.gov.lk/en/regional-workshop-on-external-vulnerabilities-in-south-asia-2019 South Asia Economic Focus | Spring 2019 | Exports wanted 66 Exports Wanted References Abbas, S., and Waheed, A. (2015). Pakistan’s potential export flow: The gravity model approach.  The Journal of Developing Areas,  49(4), 367-378. Aftab, Z., and Khan, S. (2008). Bilateral J-Curves between Pakistan and her trading partners (No. 2008: 45). Pakistan Institute of Development Economics. Aggarwal, R., Demirguc-Kunt, A., and Martinez Peria, M. S. (2006). Do workers’ remittances promote financial development?. The World Bank. Washington, D.C. Arora, S., Bahmani-Oskooee, M., and Goswami, G. (2003). 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National Bureau of Economic Research. World Bank. (2018a). South Asia Economic Focus, Fall 2018: Budget Crunch. The World Bank. Washington, DC.  World Bank. (2018b). Global Economic Prospects. The World Bank. Washington, DC.  World Bank (2018c). Migration and Remittances, April 2018 : Recent Developments and Outlook. Migration and Development Brief, No. 29. World Bank. (2019a). Global Economic Prospects, January 2019: Darkening Skies. The World Bank. Washington, DC. World Bank. (2019b). Pakistan at 100: Shaping the Future. World Bank, Washington, DC. South Asia Economic Focus | Spring 2019 | Exports wanted 68 South Asia country briefs South Asia Economic Focus | Spring 2019 | Exports wanted 69 Photo: © Shutterstock/ T photography South Asia Economic Focus | Spring 2019 | Exports wanted 70 South Asia country briefs Afghanistan Severe drought and political uncertainty have dampened 2018 growth in 2018. While it is expected to moderately recover in 2019, with improving farming conditions, Afghanistan Population, million 36.4 faces downside risks from political instability and violence, GDP, current USD billion 18.2 especially ahead of the upcoming presidential elections. GDP per capita, current USD 502 Ongoing peace talks, however, could boost investment. Over the medium-term, growth and development prospects will Source: World Bank. depend on mobilizing new sources of economic dynamism, in the context of declining aid and high poverty. Contributions to real GDP growth Percent, percentage points 4 3 2 1 0 -1 -2 2016 2017 2018 2019 (e) 2020 (f) 2021 (f) Agriculture Industries Services Real GDP growth (percent) Notes: (e) = estimate; (f) = forecast. Afghanistan’s fiscal year is the calendar year. Source: World Bank. Recent economic only moderately, by 1 percent y-o-y in 2018. Exports developments remain limited at only around 4 percent of GDP, while import volumes are ten times larger. With aid Output growth has slowed to an estimated 1.0 per- inflows almost entirely financing the trade deficit, cent in 2018, down from 2.7 percent in the previous the current account is expected to have recorded a year. The decline was on account of: a severe drought small surplus in 2018. The Afghani depreciated by 9 that affected wheat production and livestock pas- percent against the USD in 2018, largely reflecting ture and, heightened political uncertainty and the strengthening of the USD. On a real effective election-related violence, which dampened business exchange rate basis, the Afghani appreciated against confidence. Despite the lower agriculture output, in- major trading partners. Despite increased USD flation remained moderate at 0.6 percent on average sales by Da Afghanistan Bank to smooth exchange in 2018, due to lower food prices. rate volatility, gross international reserves increased slightly to USD 8.3 billion by the end of 2018, a level The trade deficit is expected to have widened slightly equivalent to over 13 months of merchandise imports. to 35.9 percent of GDP in 2018, from 33.6 percent of GDP in 2017. Exports declined 4 percent (y-o-y) in Fiscal performance improved in 2018, albeit thanks 2018, despite an increase in high-value fruit exports to one-off revenue gains. Domestic revenue collec- to India via new air corridors. Imports increased tion increased by 12 percent, reaching a record of South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 71 13.6 percent of GDP (thanks to tax administration of on-going peace talks will also affect medium-term reforms, large one-time payments of SOE divi- prospects, with a significant upside potential for dends, and clearance of tax arrears). Donor grants improvement in the business environment. also increased, reaching 14.8 percent of GDP (up The current account is expected to remain close from 13 percent in the previous year). Meanwhile to balance, despite a large trade deficit, thanks to expenditure increased to 27.7 percent of GDP (from continued aid financing, with international reserves 26 percent of GDP in 2017), on the backdrop of re- staying at comfortable levels. Fiscal space will be cord-high budget execution (92 percent). The overall under pressures, with limited room for development fiscal balance improved to a 0.7 percent surplus (up expenditures, as revenue collection is expected to from a 0.6 percent deficit in 2017). However, Afghan- remain flat (after significant one-off revenues were istan continued to rely heavily on donor grants, as mobilized in 2018) and aid flows are expected to domestic revenues covered only 49 percent of total decline somewhat. expenditures. Risks and challenges Outlook Afghanistan’s economy will remain significantly Growth is expected to remain modest in 2019, re- vulnerable to political and security risks. In the near covering only slightly. Improved precipitation in the term, these risks will increase in the context of up- 2018-19 winter should be favorable for agriculture. coming presidential elections and uncertainty over However, its translation to welfare and growth re- the outcomes of peace talks. The experience of the mains uncertain, as the 2018 drought led to popu- 2014 elections also suggests there could be significant lation displacements away from rural areas and has revenue losses and weaker expenditure discipline. The likely led to reduced or sub-optimally timed plant- humanitarian crisis will remain unabated, with large ing. In addition, with limited instruments to man- internal displacements from drought and conflicts, age the flow of snowmelt into rivers and irrigation further compounded by growing food insecurity due channels, flood risks and unpredictable access to to the recent drought. Over the medium-term, a de- water for cultivation may threaten farm production cline in foreign aid would pose significant challenges and rural welfare. Over the medium-term, growth is to pursuing growth and development with severely expected to gradually accelerate to around 3 percent limited fiscal space, warranting a balanced growth in 2021, assuming a stable political transition in the strategy to support the sectors with good potential aftermath of the presidential election. The outcome to generate growth, jobs, exports and revenue. South Asia Economic Focus | Spring 2019 | Exports wanted 72 South Asia country briefs Afghanistan macroeconomic outlook 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 2.4 2.7 1.0 2.5 3.2 3.5 Real GDP growth, at constant factor prices 2.1 2.2 0.8 2.4 3.2 3.6 Agriculture 6.0 3.8 -5.0 4.0 2.7 4.5 Industry -0.8 0.4 1.5 2.0 3.0 3.0 Services 2.2 2.5 2.5 2.0 3.5 3.5 Inflation (consumer price index) 4.3 4.7 0.6 3.1 5.0 5.0 Current account balance (percent of GDP) 5.6 1.0 0.3 -1.4 -2.5 -3.8 Net foreign direct investment (percent of GDP) -0.1 -0.1 0.1 0.1 0.1 0.1 Fiscal balance (percent of GDP) 0.1 -0.5 0.7 -0.7 -0.7 -0.5 Debt (percent of GDP) 6.1 5.9 6.9 7.0 7.0 7.3 Primary balance (percent of GDP) 0.2 -0.4 0.8 -0.6 -0.5 -0.3 Note: (e) = estimate, (f)= forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 73 Bangladesh Economic growth was robust in the first half of FY19, thanks to 2018 strong exports and consumption-driven domestic demand. As a result, core inflation increased. While the current account deficit Population, million 166.9 has narrowed, the overall Balance of Payments deteriorated. GDP, current USD billion 274.1 The fiscal deficit widened due to weak revenue mobilization. GDP per capita, current USD 1642 Going forward, both growth and poverty reduction are expected to continue at a healthy pace. Risks to the outlook Source: World Bank. stem mainly from financial sector weaknesses and adverse private investment dynamics. Contributions to real GDP growth Percent, percentage points 10 8 6 4 2 0 -2 2008 2009 2010 201 2012 2013 2014 2015 2016 2017 2018 2019 (e) Final consumption Gross xed investment Net export Statistical discrepancy Real GDP growth (percent) Notes: (e)= estimate. Bangladesh’s fiscal year runs from July 1st to June 30th. Sources: Bangladesh Bureau of Statistics and staff calculations. Recent economic growth in the stock of private sector credit deceler- developments ated to 13.3 percent (y-o-y) through December 2018. Core inflation is rising. Inflation decelerated to 5.3 Economic expansion is continuing. Growth in FY19 percent (y-o-y) in December 2018, due to the decline benefited from an acceleration in exports, and a in the price of rice. However, core inflation increased boost in domestic consumption thanks to a rise in to 5.4 percent, compared with 3.8 percent a year ago. remittances and bumper agricultural production. Cost pushes from frequent transport disruptions, Exports grew by 14.4 percent in the first 6 months exchange rate depreciation and the expanding output of FY19, driven by readymade garments. Tariff esca- gap were the main contributors to the rise. Growth lation between the United States and China has led (y-o-y) in the stock of broad money through December to increased orders from both countries. Exports to 2018 has been weak at 9.4 percent, driven by a decline the United States grew by 19 percent and to China in net foreign assets and slower private credit growth. by 35.8 percent. However, private investment growth remained confined within already established activ- Rising non-performing loans (NPLs) have con- ities, such as garments and pharmaceuticals. Let- strained financing for private investment. NPLs rose ter-of-Credit settlements for the import of capital to 11.5 percent of total loans at end-September 2018, machinery declined by 27.5 percent in July-Novem- up from 10.4 percent at the end of June 2018, despite ber 2018 relative to the same period last year, and significantly increased rescheduling of toxic loans. South Asia Economic Focus | Spring 2019 | Exports wanted 74 South Asia country briefs Efforts to improve the NPL recovery rate are con- Inflation is likely to remain high in the 6.0 to 6.5 strained by lengthy legal processes and the inability percent range due to increased global inflation, a wid- to take action against large defaulters. This increased ening output gap and expansionary fiscal policy. Re- risk aversion among lenders and led to downward strained monetary expansion, announced in January, rigidity in lending rates, which declined only 40 will help contain excess demand. The current account basis points since April 2018 when both the Cash deficit is projected to narrow moderately with expect- Reserve Ratio and the repo rate were reduced. Ac- ed declines in food and capital machinery imports. cess to finance continued to feature among the top A large shortfall in government revenue is expected four constraints on private investment in the World due to reductions in several taxes in the absence of Economic Forum 2018 business perception survey. administrative measures to enhance collection. Ad- The current account deficit is narrowing. Accelerated ditional pressure on expenditures are likely, due to export growth and slower imports reduced the cur- expanded export subsidies, inadequate provisions rent account deficit significantly. Still, the deficit in for bank recapitalizations, and spending associated the overall balance of payments widened to USD 513 with the Rohingyas. Together, these may widen the million from USD 354 million during the same peri- budget deficit to 4.2 percent in FY19. od last year due to a decline in the financial account surplus. The Central Bank sold USD 1.5 billion in the Emerging spatial inequalities warrant greater at- foreign exchange market in the first half of FY19, un- tention. As poverty continues to decline across the derpinning taka-dollar rate stability, but the taka-euro board, poverty rates between east and west are di- and the taka-pound rates appreciated 3.9 percent and verging. Faster progress in educational attainment, 5.3 percent respectively by the end of December 2018 reduction of fertility rates, and structural transfor- relative to their levels at the end of June. Gross foreign mation creates much more rapid poverty reduction exchange reserves declined from USD 32.9 billion at in the east than in the (north) west of the country. the end of June 2018 to USD 31.9 billion in mid-Feb- ruary 2019, equivalent to about 5.2 months of imports. Risks and challenges The fiscal deficit is widening. The overall fiscal deficit re- mained below 4 percent of GDP in FY18, despite a large Downside external risks deepened, while domestic shortfall in revenues. Weak tax revenue collection con- risks are balanced. Expansion in major export markets tinued in FY19, with only 6.4 percent growth in the first may slow. The conclusion of the national elections dis- half of the fiscal year, well below nominal GDP growth. sipated political uncertainty. Increasing NPLs could The government has started borrowing from the bank- limit banks’ ability to finance growth and undermine ing system, a significant departure from the recent trend fiscal discipline. Recent stress in the foreign exchange of relying exclusively on non-bank borrowing. market highlights the need to strengthen buffers against unfavorable external trade and financial con- ditions. Donor fatigue in responding to the Rohingya Outlook crisis could add to fiscal pressures. Bangladesh’s growth outlook remains strong due to Moving forward, the challenge is to ensure macro- sound macroeconomic fundamentals and resilient economic stability, accelerate structural reforms and domestic demand. Output growth is projected at 7.3 address partial inequalities. Deepening fiscal reforms, percent for FY19, driven by industry and services on resolving fragile banks, and addressing balance of the supply side, and private consumption and ex- payments challenges are immediate priorities. In the ports on the demand side. The dissipation of political longer term, steps to enhance human capital, improve uncertainties should unlock private investment, and urban management, raise rural productivity and accelerated implementation of mega public projects lower barriers to investment would boost potential will boost public investment, leading to sustained 7 growth and help tackle informality challenges in em- percent plus growth in the medium-term. Increased ployment. Infrastructure construction activity is set investment will also re-energize job creation. to rise, but structural challenges need to be addressed. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 75 Bangladesh macroeconomic outlook 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 7.1 7.3 7.9 7.3 7.4 7.3 Private consumption 3.0 7.4 11.0 6.8 6.9 6.9 Government consumption 8.4 7.8 15.4 8.0 9.5 10.7 Gross fixed capital investment 8.9 10.1 10.5 11.2 11.2 10.3 Exports, goods and services 2.2 -2.3 8.1 5.2 5.4 4.8 Imports, goods and services -7.1 2.9 27.0 10.5 11.1 10.4 Real GDP growth, at constant factor prices 7.2 7.2 7.9 7.3 7.4 7.3 Agriculture 2.8 3.0 4.2 4.1 3.5 3.1 Industry 11.1 10.2 12.1 9.9 10.0 9.9 Services 6.2 6.7 6.4 6.6 6.7 6.5 Inflation (consumer price index) 5.9 5.4 5.8 6.0 6.3 6.1 Current account balance (percent of GDP) 1.9 -0.5 -3.5 -3.2 -2.8 -2.9 Net foreign direct investment (percent of GDP) 0.6 0.7 0.6 0.6 0.5 0.5 Fiscal balance (percent of GDP) -3.7 -3.4 -3.9 -4.2 -4.4 -4.6 Debt (percent of GDP) 31.5 31.0 31.1 32.8 34.7 35.1 Primary balance (percent of GDP) -1.8 -1.6 -2.1 -2.2 -2.2 -2.3 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted 76 South Asia country briefs Bhutan Growth is projected to moderate to 5.4 percent in 2018/19, 2018 primarily because of lower investment. Going forward, Bhutan’s economy is expected to grow by 5 to 6 percent per Population, million 0.8 annum, supported by a robust services sector and higher net GDP, current USD billion 2.7 exports. Risks stem mostly from delays in the completion of GDP per capita, current USD 3321 two major hydropower projects. Source: World Bank. Contributions to real GDP growth Percent, percentage points 8 6 4 2 0 2016 2017 2018 2019 (e) 2020 (f) 2021 (f) Agriculture Industries Services Real GDP growth (percent) Note: (e)= estimate, (f)= forecast. Sources: National Statistics Bureau, Royal Monetary Authority, Ministry of Finance, World Bank, and staff calculations. Recent economic trade with India accounts for more than 80 percent developments of Bhutan’s international trade. As the inflation rates between the countries are strongly correlated, the real effective exchange rate remained stable. In the GDP growth in 2018/19 is expected to decelerate financial sector, gross non-performing loans at 12.4 slightly to 5.4 percent compared to 5.8 percent in percent of total loans warrants continued attention, the previous year. On the supply side, growth will despite high capital adequacy and sufficient provi- be driven by the services sector, especially hotels and sioning. restaurants, retail trade and transportation. On the demand side, the main contribution will come from The import of capital goods for hydropower con- the pickup in net exports, as the Mangdechhu hy- struction declined so far this year because of the dropower plant begins production (720 MW). At the completion of the Mangdechhu project and delays in same time, imports are likely to decline because of the construction of the other two mega hydropower weaker construction activity associated with further projects owing to unexpected geological challenges. delays in PunatsangchhuI and II. The contribution of In addition, no new public investment programs net exports to growth will be partly offset by lower were initiated by the government in the first half investment. Inflation slowed to about 3 percent in the of the year, also reducing imports. With continued first half of 2018/19, mainly due to stable non-food export growth, the current account deficit is likely prices. The Ngultrum depreciated slightly against to narrow to 17.2 percent of GDP in 2018/19. As of the USD. It is fully pegged to the Indian rupee and November 2018, gross international reserves stood at South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 77 USD 1 billion, equivalent to 11 months of imports jected to decline. This is because large amortization of goods and services. In the first half of 2018/19, payments associated with hydropower investments capital spending fell, as no new capital projects begin with the operationalization of the plants and were implemented due to the elections. In addition, are the main determinants of the debt trajectory. The higher revenues from royalties and corporate income transition out of agricultural jobs will continue to be taxes are expected to contribute to a narrowing of slow, due to challenges in accelerating private sector the fiscal deficit to 0.7 percent of GDP in 2018/19. development. The tourism sector has expanded sig- Public debt as a share of GDP is broadly unchanged nificantly in recent years, with the number of visitor at about 107.5 percent of GDP in 2018/19. arrivals increasing by 21.5 percent between 2016 and 2017. Utilizing the growth potential of the tourism sector could help accelerate poverty reduction, as Outlook tourism-related jobs tend to have low entry barriers and require low skills. Improving internal connec- Economic growth may average 5 to 6 percent per tivity and further investing in tourism promotion annum over the medium term, supported by the and development could help create jobs and increase services sector and higher net exports. In the services earnings in the sector. sector, the key drivers are likely to be hotels and restaurants, retail trade and transportation, under- pinned by tourism. With the operationalization of Risks and challenges the Mangdechhu hydropower project in 2019, exports are projected to increase strongly, while imports are Risks to the outlook stem mainly from: further delays projected to moderate due to further delays in the in hydropower project implementation/completion, construction of Punatsangchhu I and II. As a result, which would also delay the large expected export the current account deficit may narrow further, and and revenue payoffs; managing financing of the help reduce external debt as a share of GDP. The budget at higher costs in a context of under-devel- fiscal deficit is projected to be around 3 percent of oped domestic debt markets, which could constrain GDP over the medium term. Revenue growth will public investment and; natural calamities, which be supported by royalties from Mangdechhu, cor- could lower electricity generation from existing porate income taxes, and the introduction of GST hydropower plants and reduce agriculture output. in 2020/21. Spending is also likely to increase over A short-term challenge will be to ensure prudent the medium term as the government undertakes new fiscal management, including in years when there public investment programs in line with the Twelfth are jumps in hydropower revenues. Longer-term Five Year Plan. Current expenditures are projected challenges include the need for diversification of the to increase with higher spending on the mainte- country’s asset base through investments in physical nance of hydropower plants and a possible increase capital, human capital and institutions. This would in public sector wages. In spite of the continuing help lower the barriers for investment and facilitate fiscal deficit, public debt as a share of GDP is pro- private sector development. South Asia Economic Focus | Spring 2019 | Exports wanted 78 South Asia country briefs Bhutan macroeconomic outlook 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 7.4 6.3 5.7 5.4 5.4 5.2 Private consumption 3.0 -0.4 1.0 7.0 5.0 4.4 Government consumption 7.3 4.3 6.0 6.0 6.0 5.0 Gross fixed capital investment 14.1 5.6 2.5 -2.0 -7.0 1.1 Exports, goods and services -6.3 0.8 -2.1 7.6 9.3 0.5 Imports, goods and services 0.8 -4.9 -7.2 0.0 -6.9 -4.4 Real GDP growth, at constant factor prices 7.8 6.0 5.5 5.5 5.6 5.4 Agriculture 4.4 3.6 5.2 4.0 3.0 3.0 Industry 7.6 4.6 4.2 4.5 3.9 3.3 Services 9.2 8.2 7.0 7.0 8.0 8.2 Inflation (consumer price index) 4.4 4.1 3.9 5.0 5.0 5.0 Current account balance (percent of GDP) -30.5 -22.8 -18.4 -17.2 -12.4 -9.1 Net foreign direct investment (percent of GDP) 0.7 -0.5 0.4 0.9 0.7 0.4 Fiscal balance (percent of GDP) -1.3 -4.6 -2.4 -0.7 -2.7 -3.2 Debt (percent of GDP) 114.2 108.5 106.8 107.5 105.9 99.4 Primary balance (percent of GDP) 0.2 -3.4 -1.2 0.0 -0.9 -1.6 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 79 India India continued to enjoy robust growth in FY18/19, with 2018 indications of a revival in investment and exports. Going forward, growth should stabilize around the potential level Population, million 1356.6 of 7.5 percent. Main risks to the outlook include possible GDP, current USD billion 2723.9 exogenous shocks and fiscal slippages. However, declining GDP per capita, current USD 2008 wages of rural construction workers, divergent trends in food Source: World Bank. and core inflation, and an increased compliance burden on informal sector firms, may have moderated the pace of poverty reduction. Contributions to real GDP growth Percent, percentage points 10 8 6 4 2 0 -2 -4 2011 2012 2013 2014 2015 2016 2017 2018 (e) Final Consumption Gross Fixed Capital Formation Net exports Other Real GDP growth (percent) Notes: (e) = estimate. India’s fiscal year runs from April 1st to March 31st. Sources: Indian Central Statistics office and staff calculations. Recent economic 2018, subsequently complemented by the softening developments of oil prices and concomitant appreciation of the rupee, has led to a steady decline in inflation. Head- Real GDP growth is expected to remain at 7.2 percent line inflation stood at 2.6 percent in February 2019, in FY18/19, unchanged from the (revised) figure for and the average for FY18/19 so far at 3.5 percent, well the previous year. Data for the first three quarters below the RBI’s target-midpoint of 4 percent. As a suggest that growth has been broad-based. Industrial result, the RBI reduced the policy rate by 25 basis growth accelerated to 7.9 percent, making up for a de- points (to 6.25 percent) in February 2019. celeration in services. Meanwhile, agriculture growth The current account deficit widened in FY18/19. In- was robust at 4 percent. On the demand side, domes- dia’s external position worsened significantly in the tic consumption remained the primary growth driv- first half of FY18/19, as large portfolio outflows were er, but gross fixed capital formation and exports both triggered by US monetary policy and fears of conta- made growing contributions. Over the last quarter, gion from stress in some emerging market economies. growth is expected to remain balanced across sectors. The nominal exchange rate depreciated, and foreign Inflation dynamics have been subdued over most of reserves declined by over 8 percent over January to FY18/19. A sustained decline in food prices since July October 2018. However, since then, the decline in oil South Asia Economic Focus | Spring 2019 | Exports wanted 80 South Asia country briefs prices and the United States Fed signaling a slower and vulnerability for extremely poor households. pace of normalization than initially anticipated led For non-agricultural households, a muted growth to a partial reversal. Portfolio outflows have reversed, in real rural wages in construction, since 2015, may and the rupee has appreciated by about 4 percent have moderated the pace of poverty reduction as the vis-à-vis the USD since October 2018. For the full sector employs most of the poor and vulnerable. For fiscal year, the current account deficit is expected to the urban poor, there may be second-round poverty reach 2.6 percent of GDP (from 1.8 percent of GDP effects of GST, due to the increased burden of com- the previous year). Foreign reserves stood at USD pliance on small and informal firms. 401.8 billion in early March 2019 (equivalent to over 9 months of imports). Fiscal consolidation was put on hold. The fiscal deficit Risks and challenges of the central government was revised at 3.4 percent of GDP, 0.1 percentage point above the initial budget External risks have moderated significantly. With the target, on account of a new income transfer scheme pause in US monetary policy normalization, risks to for farmers. With the aggregate gross fiscal deficit of the growth outlook have declined relative to the first states believed to be in the range of 2.9 percent of half of the year. Nonetheless, India remains vulnera- GDP, the deficit of the general government is expect- ble to changes in international financing conditions ed to be 6.3 percent, and public debt to remain stable and to increases in oil prices. at 67.2 percent of GDP (a level that remains manage- However, the outlook on public finances remains able since debt is mostly domestic and long-term). challenging. The GST regime is still stabilizing and remaining below expectations on the revenue side, while pre-electoral promises, in addition to commit- Outlook ments already made in the Budget for FY19/20, may translate in significant expenditure outlays at the The economic outlook is strong, with growth expect- center and state levels going forward. This implies ed to converge to potential in coming years. GDP that meeting budget targets will require significant growth is expected to accelerate moderately to 7.5 effort and discipline, including on maximizing reve- percent in FY19/20, driven by continued investment nue potential from the GST. strengthening—particularly private— improved ex- port performance, and resilient consumption. With Important structural challenges remain, particularly robust growth, and food prices poised to recover, to investment. These structural challenges include inflation is expected to converge toward 4 percent. the “twin balance sheet” problem (impaired balance sheets of public sector banks and corporates) and Both the current account and the fiscal deficit are supply bottlenecks, which preclude the significant expected to narrow. On the external front, improve- increase in credit and investment that would be re- ments in India’s export performance and low oil quired to put the economy on a higher growth tra- prices should bring about a reduction in the current jectory. Broad-based poverty reduction remains a big account deficit to 1.9 percent of GDP. On the inter- challenge. India must accelerate the responsiveness of nal front, the consolidated fiscal deficit is projected poverty reduction to growth, including for presently to decline, albeit slowly (to 6.2 and 6.0 percent of excluded groups, and extend gains to a broader range GDP in FY19/20 and FY20/21 respectively). As the of human development outcomes related to health, center’s deficit is budgeted to remain unchanged at nutrition, education and gender, where it ranks poor- 3.4 percent of GDP in FY19/20, the burden of adjust- ly. The persistent negative impact of uneven monsoons ment will rest on the states. on agriculture, amplified by low uptake of crop in- The divergent trend between falling food-inflation surance, underlines the medium-term risk of climate and rising core inflation has reduced the real pur- change for the rural poor. Furthermore, outdated in- chasing power for agricultural households. Sharply formation on indicators of poverty and employment rising inflation in the rural health and education pose serious challenges in reliably correlating growth may also result in greater out-of-pocket expenditure forecasts with projected rates of poverty. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 81 India macroeconomic outlook 2016 2017 2018 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 8.2 7.2 7.2 7.5 7.5 7.5 Private consumption 8.2 7.4 7.5 7.9 7.6 7.9 Government consumption 5.8 15.0 8.6 7.8 7.5 7.5 Gross fixed capital investment 8.3 9.3 9.9 8.1 8.7 7.7 Exports, goods and services 5.1 4.7 12.5 12.3 12.5 13.2 Imports, goods and services 4.4 17.6 16.8 13.2 13.5 14.5 Real GDP growth, at constant factor prices 7.9 6.9 7.1 7.4 7.5 7.5 Agriculture 6.3 5.0 3.5 3.6 3.8 3.8 Industry 7.7 5.9 7.6 7.8 7.9 7.9 Services 8.4 8.1 7.7 8.2 8.3 8.2 Inflation (consumer price index) 4.5 3.6 3.7 4.0 4.0 4.0 Current account balance (percent of GDP) -0.6 -1.8 -2.6 -1.9 -1.7 -1.2 Net foreign direct investment (percent of GDP) 1.6 1.1 1.2 1.4 1.6 1.6 Fiscal balance (percent of GDP) -6.9 -6.4 -6.3 -6.2 -6.0 -5.8 Debt (percent of GDP) 67.7 67.6 67.2 66.1 65.2 64.1 Primary balance (percent of GDP) -2.2 -1.6 -1.4 -1.3 -1.1 -0.9 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted 82 South Asia country briefs Maldives Real GDP growth is expected to reach 7.9 percent in 2018, 2018 driven by construction and tourism, supported by recent infrastructure investment and expansion in the guest houses’ Population, million 0.4 sector. It is projected to gradually decline to 5.3 percent over GDP, current USD billion 5.4 the forecast period. Efforts to rationalize recurrent spending GDP per capita, current USD 12108 are needed, especially related to subsidies and health spending. Poverty is low, but labor market challenges for Source: World Bank. the youth persist. Public debt is projected to rise further, and international reserves are low. Tourist arrivals Growth of tourist arrivals and bed nights Thousands Percent 1,600 20 1,400 15 1,200 1,000 10 800 600 5 400 0 200 0 -5 2013 2014 2015 2016 2017 2018 Tourist arrivals Change in tourist arrivals (RHS) Change in bed nights (RHS) Note: Maldives fiscal year is the calendar year. Source: National Bureau of Statistics. Recent economic The overall consumer price index marginally declined developments by 0.1 percent in 2018, compared to an increase of 2.8 percent in 2017. This was driven mainly by a decrease in prices of staple food items and electricity, due Real GDP growth is expected at 7.9 percent for 2018, to policy changes in food subsidies and electricity on the back of strong performance of tourism and charges. The decline in prices was more pronounced construction, as well as trade. Preliminary estimates in the atolls, averaging -1.4 percent for the year. Two indicate that growth accelerated to 9.1 percent y-o-y major contributors were food and non-alcoholic over the first three quarters of 2018, compared to 6.6 beverages (-0.9 percent) and housing and utilities percent over the same period in 2017. Tourism contrib- (-9.4 percent). uted 2.1 percentage points, followed by wholesale and retail trade (1.8pp) and construction (1.3pp). Tourist The current account deficit is estimated to have arrivals and bed nights increased by 6.8 percent and widened to 24.2 percent for 2018, up from 22 percent 10.2 percent respectively (y-o-y), supported by infra- in 2017. The trade deficit increased on the backdrop structure investments on the international airport, of subdued performance of goods exports (a con- the opening of new resorts, and expansion in the guest traction of 1.6 percent) and rapid growth of goods houses’ sector. However, the tourism and construction imports (16.1 percent) linked to investment projects. sectors are not generating employment opportunities On the services side, exports performed strongly that Maldivians are able or willing to take up. (10.7 percent) thanks to strong tourism receipts. The South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 83 current account deficit was financed mainly through The outlook assumes an increase in recurrent spend- debt flows and direct investment. Gross official ing related to the new administration’s campaign reserves increased to USD 758 million in December pledges, including an extension of Aasandha cov- 2018, up from USD 586 million a year before (USD erage for Maldivians living in Sri Lanka, Malaysia 281 million after netting out short-term foreign cur- and India, additional subsidies, and an expansion rency liabilities to domestic banks, representing 1.3 of the university scholarship program. Interest months of goods imports). costs are also expected to gradually rise over the medium-term, reflecting the country’s increased Preliminary fiscal outcomes suggest a deterioration uptake of non-concessional borrowing. The overall in 2018. The fiscal deficit is expected to have widened fiscal deficit is projected to increase initially, before to 4.9 percent of GDP in 2018, from 3.0 percent in stabilizing over the forecast period. Public debt is 2017. Total spending grew by 13.3 percent between projected to rise over the forecast period and peak 2017 and 2018, whereas revenues and grants increased soon after. by only 6.9 percent. Increases in expenditures were driven by spending on subsidies (3.6pp of total spending), the health program Aasandha (2.5pp), allowances to employees (1.9pp), and interest costs Risks and challenges (1.5pp), and training expenses (1.2pp). On the reve- nue side, the full-year collection of the airport devel- Risks to the outlook are tilted to the downside. A opment fee helped increase receipts. Strong growth downturn in the global economy could impact Mal- contributed positively to debt dynamics. Public debt dives’ tourism industry. Increase in oil prices could is estimated to have reached 57 percent of GDP in affect the external account, given the country’s heavy 2018. reliance on diesel imports. Legislative elections due in April could result in additional fiscal slippages There is no strong link between employment and and delay of key reforms. poverty status, and there is a general lack of pro- ductive employment opportunities for Maldivians. One key challenge for Maldives is to strike an ap- Youth unemployment is high at 15.3 percent, with propriate balance between making large investments young males being 1.5 times more likely to be unem- needed to close existing infrastructure gaps – poten- ployed than young females, and 6 times more likely tially allowing to boost tourism, increase resilience to be unemployed than their adult counterparts. to climate change and ease constraints in service Almost one in four Maldivian youth were not in delivery — and managing the rapid accumulation education, employment or training. of public debt. Containing recurrent spending and improving the efficiency of social spending are key areas that require attention. The overall level of Outlook indebtedness is high and reserves coverage is low. Large volume of external loans and guarantees on non-concessional terms to finance infrastructure Real GDP growth is expected to decline gradually projects represent significant risks. to 5.2 percent by 2020, as tourism sector activity converges back to historical levels, and capital in- Public sector jobs account for 40 percent of total vestment projects gradually taper-off. Tourism is ex- employment. Large wage premiums and other bene- pected to continue to be the main driver of growth, fits associated with public employment disincentiv- with recent infrastructure investment helping relieve ize young jobseekers from taking up private sector supply bottlenecks in the sector. The current account opportunities. Still the projected expansion in the deficit is projected to narrow over the forecast peri- young labor force means that private sector alterna- od, as investment-related imports gradually subside. tives will be required. South Asia Economic Focus | Spring 2019 | Exports wanted 84 South Asia country briefs Maldives macroeconomic outlook 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 7.3 6.9 7.9 5.7 5.2 5.3 Real GDP growth, at constant factor prices 7.0 6.0 7.9 5.7 5.2 5.3 Agriculture 1.5 8.3 7.8 5.9 3.4 3.1 Industry 12.3 10.9 13.4 10.2 9.9 8.1 Services 6.7 5.2 7.1 4.9 4.6 5.0 Inflation (consumer price index) 0.5 2.8 -0.1 1.2 1.5 2.0 Current account balance (percent of GDP) -23.4 -22.0 -24.2 -22.1 -17.2 -14.8 Fiscal balance (percent of GDP) -9.9 -3.0 -4.9 -5.2 -4.8 -4.5 Debt (percent of GDP) 56.3 58.6 57.2 60.5 62.0 63.1 Primary balance (percent of GDP) -8.1 -1.5 -3.2 -3.5 -3.0 -2.7 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 85 Nepal Growth reached 6.3 percent in FY2018, driven by investment. 2018 The current account and fiscal deficits widened sharply, calling for improved spending efficiency related to the Population, million 29.6 implementation of federalism, strengthened revenue efforts, GDP, current USD billion 28.8 and enhanced medium-term planning at the subnational GDP per capita, current USD 973 level. Over the medium-term, growth is expected to remain strong at around 6 percent and to continue to drive significant Source: World Bank. poverty reduction. Risks to the outlook arise from reform implementation constraints and vulnerability to natural disasters. Contributions to real GDP growth Percent, percentage points 25 20 15 10 5 0 -5 -10 2013 2014 2015 2016 2017 (e) 2018 (e) 2019 (e) Private Consumption Government Consumption Investment Statistical Discrepancy Net Exports Real GDP growth (percent) Note: Nepal’s fiscal year runs from July 16th to July 15th. Sources: Central Bureau of Statistics and staff calculations. Recent economic tightening of liquidity, increase in interest rates, and developments a rise in the banking sector’s credit-to-core capital plus deposits (CCD) ratio. GDP grew robustly at 6.3 percent in FY2018, despite The current account deficit rose sharply to 8.2 per- less favorable monsoons. On the supply side, growth cent of GDP in FY2018 (from 0.4 percent of GDP in services contributed 3.6 percentage points to in FY2017), due to increased imports for establishing GDP growth due to record tourist inflows, and the local government offices, reconstruction activities, industrial sector contributed an additional 1.4 per- and intermediate goods for the industrial sector. centage points, due to expanded capacity supported The depreciation of the Nepali Rupee against the by improved access to electricity. On the demand USD, and the increased use of formal channels for side, investment was the main driver, contributing remittances contributed to an increase in officially 4.4 percentage points to growth. recorded remittance inflows in the first six months As of January 2019, the inflation rate stood at 4.6 of FY2019 (30.2 percent). With imports growing by percent (y-o-y), driven by increases in non-food 30.6 percent and a persistently low export-import prices. Credit growth reached 23.9 percent, exceed- ratio of only 6.3 percent, even buoyant remittances ing deposit growth of 21.0 percent, and leading to a growth was insufficient to offset a widening trade South Asia Economic Focus | Spring 2019 | Exports wanted 86 South Asia country briefs deficit, leading to an increase in the current account ery is devolved to provincial and local governments. deficit. A part of this deficit was financed through Meanwhile revenues are expected to reach 30 percent international reserves which declined to USD 9.4 of GDP over the medium term, from increased taxes billion (7.8 months of imports). on luxury items and incomes of wealthy households. Also, VAT exemptions have been abolished, leaving The fiscal deficit (including grants) increased over allowance only for standard VAT refunds. An inte- FY2018 (driven by federalism-related expenses) to grated customs system has also been rolled out to reach 5.7 percent of GDP, up from 3.1 percent of GDP in FY2017. Federal revenue targets were achieved in reduce underreporting of taxes. The fiscal deficit is FY2018; but spending rose by 29 percent, despite expected to moderate as reforms are implemented to budget execution of just 82.4 percent. Debt to GDP raise revenues at the federal and subnational levels, remained close to 30.5 percent in FY2018, a level at spending levels stabilize and expenditure efficiency which risk of debt distress remains low. increases. Over the medium term, the debt to GDP ratio is projected to reach around 36 percent. Outlook Risks and challenges Growth is projected to average 6 percent over the medium term. On the supply side, it will be driven The capacity to sustain service delivery and establish by strong growth in paddy production (estimated to fiscal discipline, particularly at the local levels, re- reach 10 percent in FY2019), services stemming from mains a challenge. The transfer of financial manage- higher international tourist arrivals, and manufac- ment staff over a year ago made it possible for local turing as the largest cement factory in Nepal comes governments to prepare budgets and receive fiscal into operation. On the demand side, the main transfers of 8 percent of GDP in FY2018. However, driver will be gross investment as ongoing reforms underspending of the budget persists. Although to crowd-in the private sector and maximize finance the 2018 Civil Service Readjustment Act governs begin to pay-off. Inflation is expected to remain be- the transfer of federal staff to the local levels, there low 5 percent, assuming stable oil prices, and strong remains uncertainty about staff already recruited by agricultural production. With prudent macroeco- local governments. The latter do not have authori- nomic management, the current account deficit is ty to determine which federal staff are assigned to expected to peak over the next year or two, before them. In addition, capacity building and systems improving gradually, as imports associated with strengthening are needed to improve the planning establishing local government offices slow down, and budget preparation and execution process, and and investments and reforms to stimulate exports, track resources and results. particularly in the energy sector, begin to take effect. Key risks to the outlook include (i) slow implemen- Further improvements in access to electricity (pos- tation of reforms to increase private investment, sibly through the Upper Tamakoshi Hydropower especially foreign investment; (ii) limited resources Project) should help expand industrial capacity and and capacity to support federalism and local service exports. delivery; (iii) constraints on credit as banks limit Consolidated government spending could reach 35 lending to meet the CCD ratio regulatory limit; (iv) percent of GDP by FY2021 up from 31 percent of adverse effects of natural disasters; and (v) shocks to GDP in FY2018, with fiscal transfers (to both local remittance inflow. The poverty outlook is especially and provincial governments) projected to reach 12 sensitive to remittance inflows, natural disasters and percent of GDP. Federal spending is projected to be local level implementation capacity constraints that around 23 percent of GDP by FY2021, as service deliv- may hamper service delivery. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 87 Nepal macroeconomic outlook 2016 2017 (e) 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 0.6 7.9 6.3 6.0 6.1 6.2 Private consumption -0.7 2.6 2.5 4.8 4.8 4.8 Government consumption -0.4 10.4 9.4 13.0 11.9 14.9 Gross fixed capital investment -12.3 44.2 15.7 16.5 15.9 14.6 Exports, goods and services -13.7 13.7 4.4 9.5 11.0 11.0 Imports, goods and services 2.8 30.3 14.8 11.6 11.5 11.5 Real GDP growth, at constant factor prices 0.2 7.4 5.9 6.0 6.1 6.2 Agriculture 0.2 5.2 2.8 4.2 4.5 4.5 Industry -6.4 12.4 8.8 8.6 8.8 8.8 Services 2.3 7.4 7.1 6.3 6.3 6.4 Inflation (consumer price index) 9.9 4.4 4.0 4.7 4.7 5.0 Current account balance (percent of GDP) 6.2 -0.4 -8.2 -7.8 -6.8 -5.4 Fiscal balance (percent of GDP) 1.4 -3.1 -5.7 -5.7 -5.5 -5.4 Debt (percent of GDP) 27.9 26.6 30.5 32.5 35.1 36.4 Primary balance (percent of GDP) 1.8 -2.8 -4.8 -4.7 -4.7 -4.6 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted 88 South Asia country briefs Pakistan After peaking at 5.8 percent in FY18, growth is expected 2018 to slow over the next two years as measures are taken to correct macroeconomic imbalances. Tighter monetary and Population, million 200.4 fiscal policies are expected to curb domestic demand. Large GDP, current USD billion 312.6 external financing requirements and an elevated public debt GDP per capita, current USD 1560 to GDP ratio are sources of risk requiring remedial action. In this context poverty reduction is expected to continue but at a Source: World Bank. slower pace. Real GDP growth and twin de cits Percent of GDP 6 3 0 -3 -6 -9 2012 2013 2014 2015 2016 2017 2018 Real GDP growth (at factor cost) Current account balance Fiscal balance Note: Pakistan’s fiscal year runs from July 1st to June 30th. Sources: Ministry of Finance and State Bank of Pakistan Recent economic depreciation, demand side pressures and higher developments fuel prices, inflationary pressures have increased and average headline inflation reached 6.5 percent While growth reached 5.8 percent in FY18—the in the period between July 2018 and February 2019 highest in 11 years—twin deficits widened. The cur- (as compared to 3.9 percent in the same period last rent account and the fiscal deficits rose to 6.1 and year). The real effective exchange rate depreciated by 6.5 (including grants) percent respectively. The new 12.6 percent during July and January FY19 compared government took steps to address these imbalances, to a 2.5 percent depreciation in the same period last but outcomes by mid-year suggest that further ad- year. In response to higher inflationary pressures, justments will be necessary. Leading indicators for the State Bank of Pakistan has increased the policy real sector activity suggest a contraction in demand. rate by a cumulative 375 bps to 10.25 percent since Large scale manufacturing, which accounts for 65 July 2018. On the external front, the current account percent of overall industrial output, contracted deficit reached USD 8.8 billion (3.3 percent of GDP) by 2.3 percent between July and January FY19. In at end February 2019, compared to USD 11.4 billion agriculture, four of the five major crops have wit- (3.7 percent of GDP) the year before. Overall im- nessed a y-o-y decline in production, due to water ports contracted by 1.6 percent (y-o-y) but exports shortages and a decline in production area. The also declined by 0.1 percent (y-o-y) in spite of the exchange rate has continued to depreciate, with a exchange rate depreciation. Over the same period, cumulative depreciation of 12 percent between July remittances experienced healthy growth, but foreign 2018 and February 2019. As a result of exchange rate direct investment declined. By mid-January inter- South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 89 national reserves had fallen to US$6.6 billion (or deficit. FDI, multilateral and bilateral debt-creating 1.3 months of imports). With short term financing flows as well as financing from international mar- from the Kingdom of Saudi Arabia and the United kets are expected to be the main financing sources of Arab Emirates reserves increased to USD 8.1 billion the current account in the near to medium term. The (or 1.6 months of imports) by March 8th, 2019, and fiscal deficit is projected to increase to 6.9 percent further financing from these countries is expected. in FY19 and to remain high during FY20-21, a result Meanwhile, the government continues to negotiate of large interest payments and a slow increase in do- a support package with the International Monetary mestic revenues. Public debt to GDP is expected to Fund. cross 80 percent in FY19 and to remain elevated in the next two years, increasing Pakistan’s exposure to The fiscal deficit reached 2.7 percent of GDP in the debt-related shocks. The pace of poverty reduction first half of FY19 (compared to 2.2 percent in the first is expected to continue to slow-down in FY19 and half of FY18). Efforts to curb development spending FY20, following the projected growth deceleration were insufficient to offset the limited growth in and higher inflation rates. revenues and large increases in debt servicing and defense expenditures. Pakistan’s public debt reached 73.2 of GDP by the end of December 2018. Risks and challenges Together with the macroeconomic adjustment ex- Outlook pected over the next two years, there is an urgent need to implement structural reforms to support Growth is projected to decelerate to 3.4 percent in the growth rebound from FY21 onwards. Economic FY19 and to 2.7 percent in FY20, as the government uncertainty has increased due to protracted nego- tightens fiscal and monetary policies. While domestic tiations with the IMF. In addition, recent regional demand growth will slow down immediately, net ex- tensions have had an impact on risk perceptions. The ports will only increase gradually. As macroeconom- low reserves position and high debt-ratios limit the ic conditions improve, and a package of structural buffers that Pakistan could use to absorb external reforms in fiscal management and competitiveness shocks (such as an increase in US interest rates) and is implemented, growth is expected to recover to may negatively impact the government’s ability to 4.0 percent in FY21. This baseline scenario assumes access international markets. Reforms to put the stable international oil prices and reduced political country on a stable growth path include increased and security risks. Inflation is expected to rise to 7.1 exchange rate flexibility, improved competitiveness percent (average) in FY19 and projected to reach 13.5 and lower cost of doing business. On the revenue percent in FY20 as a result of further exchange rate front, reforms to improve tax administration, widen depreciation pass-through. The trade deficit is pro- the tax base and facilitate tax compliance are critical. jected to remain elevated during FY19, but to narrow Higher inflation rates may jeopardize recent gains in in FY20 and FY21 as the impacts of currency depreci- poverty reduction, since poor households in urban ation, domestic demand compression, and other reg- areas are particularly affected by increases in prices, ulatory measures to curb imports set in. Remittances as shown by the most recent inflation hike during are projected to finance over 70 percent of the trade the 2007-08 food price crisis. South Asia Economic Focus | Spring 2019 | Exports wanted 90 South Asia country briefs Pakistan macroeconomic outlook 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 5.5 5.7 5.4 3.4 2.7 4.0 Private consumption 7.6 8.7 6.3 2.9 1.8 3.1 Government consumption 8.2 5.3 14.2 10.0 -0.7 1.8 Gross fixed capital investment 7.5 10.0 5.7 -4.1 2.7 6.0 Exports, goods and services -1.6 -0.8 9.9 5.4 7.0 7.0 Imports, goods and services 16.0 21.0 17.5 1.0 -1.0 2.0 Real GDP growth, at constant factor prices 4.6 5.4 5.8 3.4 2.7 4.0 Agriculture 0.2 2.1 3.8 1.4 1.6 2.3 Industry 5.7 5.4 5.8 2.3 1.3 4.3 Services 5.7 6.5 6.4 4.4 3.5 4.5 Inflation (consumer price index) 2.9 4.2 3.9 7.1 13.5 11.0 Current account balance (percent of GDP) -1.7 -4.1 -6.1 -5.6 -2.9 -2.4 Net foreign direct investment (percent of GDP) 0.8 0.9 1.0 0.9 1.2 1.3 Fiscal balance (percent of GDP) -4.5 -5.8 -6.5 -6.9 -6.3 -5.3 Debt (percent of GDP) 68.7 67.9 73.5 82.3 79.3 75.7 Primary balance (percent of GDP) -0.2 -1.5 -2.1 -1.6 -0.3 0.4 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 91 Sri Lanka Sri Lanka is facing a challenging macroeconomic situation. 2018 Growth declined to 3.2 percent in 2018, and the fiscal deficit was 5.2 percent of GDP. External sector performance Population, million 21.5 remained weak with a widened current account deficit and GDP, current USD billion 86.3 low reserves.  Going forward, growth is expected to converge GDP per capita, current USD 4007 towards 4 percent. Large refinancing requirements make the country vulnerable to global financing conditions. Poverty has Source: World Bank. remained on a downward trajectory, with the headcount ratio estimated at 8.7 percent in 2018. Eurobond repayments USD million 2,500 2,000 1,500 1,000 500 0 2019 2020 2021 2022 2023 2024 2025 2026 2026 2028 Note: Sri Lanka’s fiscal year is the calendar year. Sources: Department of Census and Statistics and, staff calculations. Recent economic tinued to grow fast, high oil prices in the first half developments of 2018 and increased imports of vehicles drove overall import growth. Meanwhile, worker remit- Growth is expected to have declined to 3.2 percent in tances remained almost flat, and increased divi- 2018, down from 3.3 percent in 2017. While agricul- dend and interest outflows exerted pressure on the ture made a positive contribution, thanks to clement current account deficit, which is expected to have weather, a deceleration in construction depressed the widened to 3.0 percent of GDP in 2018 (from 2.6 in contribution from industry, and services expanded at 2017). Debt-creating flows dominated the financial a modest rate. Inflation declined to 4.3 percent by end account with issuance of Eurobonds, project loans 2018, with the moderation brought about by lower and term-financing. Nevertheless, FDI is expected food prices, despite currency depreciation and high to have reached an all-time high at around USD 2.0 oil prices in the first half of the year. Monetary policy, billion in 2018, thanks to the long-term leasing of the which remained broadly tight in response to external Hambantota port. pressures, also helped maintain inflation low. A political controversy in the fourth quarter affected External sector performance was mixed. The trade external sector performance. Fitch, S&P and Moody’s deficit widened. While earnings from tourism con- cut Sri Lanka’s sovereign credit rating by one notch, South Asia Economic Focus | Spring 2019 | Exports wanted 92 South Asia country briefs and currency pressures were elevated amid capital fiscal deficit and public debt on a downward path. outflows. Keeping up with debt repayment, capital The current account deficit is projected to remain outflows, and market intervention by the Central at around 2.4 percent of GDP between 2019-2021, as Bank, gross official reserves decreased to USD 6.9 bil- tourism receipts help counterbalance the effect of lion in December (from an all-time-high of USD 9.9 sluggish remittance flows and high external interest billion in April 2018). Thus, reserve adequacy metrics payments. Foreign capital inflows to government se- remained weak, with foreign exchange obligations curities and FDI should help meet external financing for 2019 estimated at USD 5.9 billion. The Govern- requirements. The recovery of domestic demand and ment announced plans to issue Eurobonds, and to improvements in the labor market, aided by low in- borrow from Chinese banks, while entering into flation, should boost real incomes and lead to a fur- SWAP arrangements. The IMF reached a staff-level ther reduction in poverty. Sri Lanka is a fast-growing agreement on the fifth review of Sri Lanka’s Extend- tourist destination and the tourism sector could help ed Fund Facility program in February 2019, which accelerate poverty reduction as it is labor-intensive, was delayed earlier due to the political controversy. requires relatively low investment, and thus holds After the announcement of the staff-level agreement great potential to create jobs for youth and women. with IMF, the Government raised USD 2.4 billion in More generally, the recovery of domestic demand Eurobonds. and improvements in the labor market, aided by low Fiscal policy remained conservative. A primary sur- inflation, should boost real incomes and lead to a plus of 0.5 percent of GDP is expected to have been further reduction in poverty. realized in 2018, thanks to a combination of increased tax revenues and tight control over expenditures. However, a sharp increase in interest expenditure is Risks and challenges expected to have overshadowed these improvements and contributed to keep the overall deficit at 5.2 per- The challenging political environment remains a cent of GDP (only marginally down from 5.5 percent key source of risk. Given recent developments, and in 2017). Central government debt is estimated to have the impending election cycle, the window for re- reached 83 percent of GDP, more than half of which is forms is narrowing. On fiscal and debt management denominated in foreign currency. Recent commercial fronts, risks include a delay or reversals in efforts to borrowings have increased the cost and risk of the strengthen revenue collection, improve tax adminis- portfolio. While the implementation of cost-reflective tration, and implement liability management oper- pricing of fuel is an important step, further reforms ations. On the external front, tighter than expected are needed to reduce fiscal risks of SOEs. global financial conditions would increase the cost of debt and complicate endeavors to roll-over maturing A rebound in the agricultural sector and modest Eurobonds. The increasing occurrence and impact of inflation helped incomes of the rural poor. The polit- natural disasters could also have an adverse impact ical turmoil, however, put a temporary brake on the on growth and poverty reduction. rapid growth in tourism towards the end of the year, on the eve of the peak holiday season. A rebound in Priority reforms to sustain economic growth, create this sector could help move labor out of agriculture more and better jobs, and reduce poverty include: (a) and improve the earnings of the poor. fiscal consolidation to make space for investments in health, education, social protection and public infrastructure; (b) improving competitiveness and Outlook promoting trade and FDI to facilitate a shift in the growth model driven more by private investment The economy is expected to rebound, and growth to and exports; (c) mainstreaming governance reforms, converge gradually toward 4 percent in the medium particularly with respect to public finance man- term, driven by domestic demand. Inflation is pro- agement (PFM) and state owned enterprise (SOE) jected to stabilize around 5 percent. Continued fiscal reforms; and (d) reducing vulnerability stemming consolidation, albeit slow, should bring the overall from refinancing risks and natural disasters risks. South Asia Economic Focus | Spring 2019 | Exports wanted South Asia country briefs 93 Sri Lanka macroeconomic update 2016 2017 2018 (e) 2019 (e) 2020 (f) 2021 (f) Real GDP growth, at constant market prices 4.5 3.3 3.2 3.5 3.6 3.7 Private consumption -3.9 1.3 3.2 3.5 3.6 3.8 Government consumption 2.3 -5.2 3.3 3.6 3.6 3.6 Gross fixed capital investment 7.8 5.0 5.8 5.5 5.5 5.4 Exports, goods and services -0.7 7.5 3.6 3.4 3.4 3.3 Imports, goods and services 7.9 19.3 3.8 3.0 3.0 3.0 Real GDP growth, at constant factor prices 4.3 3.3 3.6 3.5 3.6 3.7 Agriculture -3.8 -0.8 4.8 3.4 3.4 3.4 Industry 5.8 4.6 0.9 4.0 4.1 4.2 Services 4.7 3.2 4.7 3.3 3.4 3.5 Inflation (consumer price index) 4.0 6.6 4.3 5.0 5.0 5.0 Current account balance (percent of GDP) -2.1 -2.6 -3.0 -2.4 -2.4 -2.5 Net foreign direct investment (percent of GDP) 0.8 1.5 2.2 1.4 1.1 1.1 Fiscal balance (percent of GDP) -5.4 -5.5 -5.2 -4.8 -4.8 -4.7 Debt (percent of GDP) 78.8 77.4 83.0 81.4 80.2 79.2 Primary balance (percent of GDP) -0.3 0.0 0.5 1.0 1.1 1.3 Note: (e) = estimate, (f) = forecast. Source: World Bank. South Asia Economic Focus | Spring 2019 | Exports wanted 94 South Asia at a glance South Asia at a glance Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South Asia (CY) Real GDP 2015 1.3 6.8 6.2 7.8 2.9 2.0 5.1 5.0 7.4 growth 2016 2.4 7.1 7.4 8.2 7.3 0.6 5.5 4.5 7.7 2017 2.7 7.3 6.3 7.2 6.9 7.9 5.7 3.3 7.2 2018 (e) 1.0 7.9 5.7 7.2 7.9 6.3 5.4 3.2 6.9 2018 Q3 .. .. .. 6.9 .. .. .. 3.4 .. (CY) 2018 Q4 .. .. .. 6.5 .. .. .. 1.7 .. (CY) Inflation 2015 4.6 6.4 6.3 4.9 0.9 7.2 4.5 0.9 2.8 (Consumer 2016 4.3 5.9 4.4 4.5 0.5 9.9 2.9 4.0 4.3 OUTPUT and PRICES Price Index) 2017 4.7 5.4 4.1 3.6 2.8 4.4 4.2 6.6 5.1 2018 (e) 0.6 5.8 3.9 3.7 -0.1 4.0 3.9 4.3 4.0 2019 1.9 5.4 3.1 2.0 0.0 .. 7.2 1.2 .. January 2019 .. 5.5 .. 2.5 .. .. 8.2 2.4 .. February REER 2015 .. .. .. 103.7 .. .. 110.3 .. 104.3 (CY) 2016 .. .. .. 105.0 .. .. 109.6 .. 105.4 2017 .. .. .. 109.7 .. .. 106.4 .. 109.4 2018 (e) .. .. .. 104.8 .. .. 102.4 .. 104.6 2019 .. .. .. 103.5 .. .. 101.9 .. 103.3 January 2019 .. .. .. 102.2 .. .. 101.3 .. 102.1 February Current 2015 12.6 1.5 -27.4 -1.0 -7.3 5.1 -1.0 -2.4 -0.8 account 2016 5.6 1.9 -30.5 -0.6 -23.4 6.2 -1.7 -2.1 -0.7 balance (percent of 2017 1.0 -0.5 -22.8 -1.8 -22.0 -0.4 -4.1 -2.6 -2.0 GDP) 2018 (e) 0.3 -3.5 -18.4 -2.6 -24.2 -8.2 -6.1 -3.0 -2.9 Trade balance 2015 -21.6 -6.5 -24.3 -1.0 9.1 -33.1 -5.3 -10.9 -5.4 (percent of 2016 -29.2 -4.1 -24.9 -0.8 -1.1 -35.6 -7.5 -12.8 -5.0 BALANCE of PAYMENTS GDP) 2017 -30.8 -4.8 -20.8 -3.2 -1.1 -44.4 -10.6 -16.8 -6.9 2018 (e) -31.5 -8.3 -17.0 -4.2 .. -49.0 -12.4 -17.0 -8.9 Import 2015 4.6 3.2 6.3 -5.9 .. 9.6 -1.6 10.6 -2.3 growth 2016 25.8 -7.1 0.8 4.4 .. 2.8 16.0 7.9 3.2 (percent, y-o-y) 2017 8.0 2.9 -4.9 17.6 .. 30.3 21.0 19.3 14.9 2018 (e) 1.2 27.0 -7.2 16.8 .. 14.8 17.5 3.8 15.6 Export 2015 2.4 -2.8 -4.7 -5.6 .. 6.8 -6.3 4.7 -3.3 growth 2016 -0.3 2.2 -6.3 5.1 .. -13.7 -1.6 -0.7 1.8 (percent, y-o-y) 2017 7.0 -2.3 0.8 4.7 .. 13.7 -0.8 7.5 4.7 2018 (e) -4.0 8.1 -2.1 12.5 .. 4.4 9.9 3.6 9.7 South Asia Economic Focus | Spring 2019 | Exports wanted South Asia at a glance 95 Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South Asia (CY) Foreign 2015 .. 7.6 .. 10.7 4.1 .. 4.6 4.5 9.8 reserves 2016 .. 8.8 .. 12.1 3.4 .. 5.4 3.8 11.0 (months of goods import 2017 .. 8.4 .. 10.4 2.8 .. 4.0 3.8 9.5 cover, CY) 2018 (e) .. 7.1 .. 9.5 3.2 .. 2.8 4.4 8.7 2019 .. .. .. 9.5 .. .. 2.8 3.9 8.7 BALANCE of PAYMENTS January 2019 .. .. .. 10.2 .. .. .. .. 9.3 February Personal 2015 341 15,296 20 68,910 3.6 6,730 19,306 7,000 117,606 remittances 2016 368 13,544 34 62,744 3.8 6,612 19,808 7,262 110,376 received (USD million, CY) 2017 378 13,498 43 68,967 4.0 6,928 19,689 7,190 116,698 2018 (e) .. 15,545 .. 47,321 .. .. 20,909 7,015 .. 2018 Q3 .. 3,869 .. 13,477 .. .. 5,558 1,652 .. 2018 Q4 .. 3,626 .. 11,602 .. .. 5,473 1,739 .. Fiscal balance 2015 -0.8 -3.7 -1.1 -6.9 -6.4 1.0 -5.2 -7.7 -6.4 (percent of 2016 0.1 -3.7 -1.3 -6.9 -9.9 1.4 -4.5 -5.4 -6.4 GDP) 2017 -0.5 -3.4 -4.6 -6.4 -3.0 -3.1 -5.8 -5.5 -6.2 GOVERNMENT FINANCES 2018 (e) 0.7 -3.9 -2.4 -6.3 -4.9 -5.7 -6.5 -5.2 -6.2 2019 (e) -0.7 -4.2 -0.7 -6.2 -5.2 -5.7 -6.9 -4.8 -6.1 Public debt 2015 6.8 31.8 95.9 68.5 52.8 25.6 64.3 78.5 .. (percent of 2016 6.1 31.5 114.2 67.7 56.3 27.9 68.7 78.8 .. GDP) 2017 5.9 31.0 108.5 67.6 58.6 26.6 67.9 77.4 .. 2018 (e) 6.9 31.1 106.8 67.2 57.2 30.5 73.5 83.0 .. 2019 (e) 7.0 32.8 107.5 66.1 60.5 32.5 82.3 81.4 .. Private 2015 6.8 5.8 2.8 7.9 .. 2.9 2.9 7.5 6.9 consumption 2016 -0.2 3.0 3.0 8.2 .. -0.7 7.6 -3.9 7.4 growth (percent, 2017 4.3 7.4 -0.4 7.4 .. 2.6 8.7 1.3 7.5 y-o-y) 2018 (e) 0.5 11.0 1.0 7.5 .. 2.5 6.3 3.2 7.0 2019 (e) 1.3 6.8 7.0 7.9 .. 4.8 2.9 3.5 6.9 Gross fixed 2015 4.8 7.1 20.0 6.5 .. 19.6 15.8 2.5 5.8 capital 2016 -6.0 8.9 14.1 8.3 .. -12.3 7.5 7.8 8.0 investment CONSUMPTION and INVESTMENT growth 2017 6.4 10.1 5.6 9.3 .. 44.2 10.0 5.0 9.2 (percent, 2018 (e) 3.1 10.5 2.5 9.9 .. 15.7 5.7 5.8 9.4 y-o-y) 2019 (e) 5.1 11.2 -2.0 8.1 .. 16.5 -4.1 5.5 8.4 Net foreign 2015 0.0 0.9 0.4 1.7 7.4 0.2 0.3 0.8 .. direct 2016 -0.1 0.6 0.7 1.6 10.3 0.5 0.8 0.8 .. investment (percent of 2017 -0.1 0.7 -0.5 1.1 10.6 0.8 0.9 1.5 .. GDP) 2018 (e) 0.1 0.6 0.4 1.2 .. .. 1.0 2.2 .. 2019 (e) 0.1 0.6 0.9 1.4 .. .. 0.9 1.4 .. Net foreign 2015 82 -203 .. -9,487 -123 .. -916 -686 .. portfolio 2016 99 -42 .. 4,725 132 .. -153 -993 .. investment (USD million, 2017 -29 367 .. -30,638 -279 .. -1,200 -1,772 .. CY) 2018 (e) .. .. .. .. .. .. 291 .. .. 2018 Q2 .. 372 .. 8,145 .. .. -1 .. .. 2018 Q3 .. 89 .. 1,618 .. .. 140 .. .. South Asia Economic Focus | Spring 2019 | Exports wanted 96 Notes Notes (e) Estimate CY Series for calendar year FY 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 Note: Real GDP growth rates (percent change, y-o-y) at Market Prices; Pakistan is in factor costs. Sources: Central Statistics Office of India, Department of Census and Statistics - Sri Lanka, World Bank and World Bank MTI. Inflation (Consumer Price Note: Period average percent change in CPI inflation. Index) Sources: National Statistics and Information Authority (Afghanistan), National Statistics Bureau (Bhutan), Sri Lanka Department of Census and Statistics (Sri Lanka), World Bank DEC GEM, and World Bank MTI. REER (CY) Note: 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 Note: Does not include grants unless otherwise stated. (percent of GDP) Source: World Bank MTI. Trade balance (percent of GDP) Note: Trade balance in goods and services is derived by offsetting imports of goods and services against exports of goods and services as ratio to GDP. Sources: World Bank MTI for all countries except Maldives, World Bank WDI for Maldives, and staff calculations. Import growth (percent, y-o-y) Notes: For each country, annual trade change is in fiscal year and covers goods and services imports in volume. Sources: World Bank MTI and staff calculations. South Asia Economic Focus | Spring 2019 | Exports wanted Notes 97 Export growth (percent, y-o-y) Notes: For each country, annual trade change is in fiscal year and covers goods and services exports in volume. Sources: World Bank MTI and staff calculations. Foreign reserves, months of Source: World Bank DEC GEM. import cover (CY) Remittances (USD million, CY) Note: Personal remittances including personal transfers and compensation of employees in current USD. Sources: Haver Analytics, World Bank WDI, and staff calculations. Fiscal balance (percent of GDP) Notes: Does not include grants unless otherwise stated. Source: World Bank MTI. Public debt (percent of GDP) Note: Gross public debt stock including domestic and foreign liabilities, end of Period. Source: World Bank MTI. Private consumption growth Notes: Annual (respective) fiscal year percent change in gross real consumption expenditure. (percent, y-o-y) Source: World Bank MTI. Gross fixed capital investment Notes: Annual (respective) fiscal year percent change in gross real fixed capital expenditure. growth (percent, y-o-y) Source: World Bank MTI. Net foreign direct investment Note: Net balance of Foreign Direct Investment assets and liabilities as ratio to GDP. (percent of GDP) Sources: World Bank for all countries except Maldives and Nepal and World Bank WDI for Maldives and Nepal. Portfolio investment (USD Notes: Portfolio investment covers transactions in equity securities and debt securities. Balances are million) calculated as net assets minus net liabilities. Data is in current USD. Sources: Haver Analytics, IMF Balance of Payments Statistics, and staff calculations. South Asia Economic Focus | Spring 2019 | Exports wanted