A key policy issue confronting today’s policymakers of vulnerable economies such as Sri Lanka, Nigeria and Pakistan is how to make sustained and inclusive progress in the face of unusual uncertainty and economic imbalances that have plagued them. Whether the situation warrants a pause in the pace of monetary tightening in many economies or consolidation of fiscal positions of governments remains an open question.
On one hand, the room for monetary tightening varies considerably across economies, depending on the magnitude of their domestic overheating pressures and vulnerabilities from their position in the credit cycle. On the other hand, the fiscal consolidation would depend on a host of factors including global oil prices, international financial position, budgetary plans, programmes enhancing social security benefits of citizens, etc.
Given the grim economic scenario of these economies with surmounting uncertainties coming from overheating inflation, rising unemployment, and cyclical output, what is needed of policymakers in these economies is to remain vigilant regarding balance sheet vulnerabilities and maintain ‘accommodative’ financial conditions. On the monetary policy front, macro-prudential measures could be introduced making them complementary to more conventional tools of monetary management with aims at minimising the risks of financial instability, including those resulting from large capital inflows.
Strengthening the ‘regulatory framework’ would therefore play an important role in limiting the adverse spillovers from a potential crisis. Moreover, allowing greater exchange rate appreciation in line with fundamentals would help manage inflationary pressures in addition to helping rebalance economic growth in many such economies. Enhanced upward exchange rate flexibility could be used as a measure to deal with capital inflows likely to be attracted by favourable growth and interest rate differentials. Further, this would mitigate additional pressures for sterilising the impact of greater reserve accumulation on monetary aggregates. Greater regional financial integration could also reduce exposure to external shocks and would also help towards economic rebalancing.
Given the existing difficulties in changing the course of fiscal policy in these economies, the return of fiscal policy to more neutral stances needs to continue. Structural deficit could be a potential threat and appropriate measures should be considered to tackle the issue. A comprehensive and credible fiscal consolidation plan could be a broad set of measures to target the structural deficit. Erosion of fiscal discipline raises the risk of macroeconomic instability. Hence the need to contain overheating and strengthen the economies’ resilience to prevent deterioration in the global environment assumes utmost priority. The possibility of extreme downside of growth in these economies could be avoided by providing or at least non-discontinuation of fiscal stimulus measures.
In the medium term, sustaining growth will require addressing key challenges of rebalancing growth and addressing social imbalances. Income inequality has risen sharply over the last two decades, notwithstanding rapid economic growth and a notable reduction in poverty. Hence, it is implied that continued high growth alone may not be sufficient to address social imbalances and policy measures are needed to make growth more inclusive. For example, investment in public infrastructure can help crowd in private investment, in particular where domestic investment has been relatively low.
Public spending on social areas in vulnerable economies generally falls short of levels in comparable regions at similar levels of development even after accounting for country-specific factors, such as demographics, economic structure, and urbanisation. Therefore, policymakers also need to find room for more social spending in support of inclusive growth, such as greater investment in education and training and social protection schemes. For example, high-quality spending through reforms to enhance teacher performance, establish self-financing unemployment insurance mechanisms, and improve governance can help improve the effectiveness of public spending in reducing social imbalances and would benefit the economy in the long run.
Fiscal pressure from an ageing population is a grave concern for several ‘older’, vulnerable economies such as Sri Lanka. As these economies grow ‘older’, designing mechanisms for old-age income support, which may have to rely in part on public funds, will be important for avoiding old-age poverty. For instance, in Japan, promoting greater old-age labour participation is a key element of the medium-term growth strategy that would reduce income inequality and enhance fiscal sustainability. The composition of spending must be given greater attention. The approach to managing rising and volatile fuel prices entails substantial budgetary costs. Thus, a balance is to be struck between the government’s budgetary position and the loss of economic output owing to fluctuations in international fuel prices.
The benefits of fiscal price-stabilisation strategies are limited as they do little to address underlying supply and demand imbalances and are not targeted at the most vulnerable households. As a result, streamlining fiscal subsidy schemes while adopting carefully targeted social safety nets can go a long way in helping governments in these economies to reprioritize budgets in support of economic rebalancing and inclusive growth.
Revenue measures could also play a role in creating fiscal space. For example, a gradual increase in consumption taxes and a decrease in corporate taxes could be useful to ensure fiscal sustainability. Significant revenue enhancement can be achieved by efforts to strengthen tax administration. Structural reforms are also needed to support economic rebalancing and economic growth or sustain the high growth potential across the region. Further, reforms to social protection schemes, market policies, and health and education investment are key elements of a strategy to reduce the share of vulnerable households in struggling debt economies like Sri Lanka, Nigeria and Pakistan.
Steering through the uncertain times with high and sustainable growth, therefore, would require sound economic policies, backed by measures which would enhance the ability of the vulnerable sections of the society to take part in the success story of growth across countries, thus, making it a path of ‘inclusive growth’.
Surjith Karthikeyan serves as Civil Servant at Indian Ministry of Finance. Views expressed in the above piece are personal and solely those of the author. They do not necessarily reflect News18’s views.
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