Research & Policy Briefs From the World Bank Malaysia Hub No. 60 December 16, 2022 Drivers of Public Debt in East Asia and Pacific Economies Ergys Islamaj and Agustin Samano Public debt in developing East Asia and Pacific (EAP) economies has increased markedly since the recession in 2020 induced by COVID-19 pandemic. This Brief uses standard debt dynamic accounting decomposition to quantify the main drivers of debt accumulation in developing EAP countries since 2000. In the aftermath of the COVID-19 pandemic, larger primary deficits have been the main drivers of the increase in the ratio of public debt to GDP in most developing EAP economies. While strong GDP growth and, to a certain extent, inflation have helped deflate public-debt-to-GDP ratios during the past two decades, they have, on average, been more muted since the COVID-19 shock. A Surge in Public Debt in Developing East Asia and Pacific This Brief analyzes the drivers of public debt accumulation in Economies developing EAP economies using standard debt dynamic accounting decomposition. Specifically, it quantifies the main drivers of debt The pandemic-induced economic shock in 2020 was accompanied by accumulation in developing EAP economies since 2000. Changes in the largest single-year surge in the public-debt-to-GDP ratio in the debt in any given year can be decomposed into the primary fiscal past 30 years for developing East Asia and Pacific (EAP) economies deficit (defined as revenues minus expenditure net of interest (figure 1). For the region excluding China, the increase in the payments), economic growth, interest payments, inflation, exchange public-debt-to-GDP ratio in 2020 (10.7 percentage points) was more rate depreciations, and a residual. than 2 times larger than during the global financial crisis (GFC) of 2008–09 (4.7 percentage points), and about 1.7 times larger than The sample includes Cambodia, China, Fiji, Indonesia, Lao PDR, during the Asian financial crisis (AFC) of 1997–98 (6.3 percentage Malaysia, Mongolia, the Philippines, Thailand, and Vietnam. The points). As a result, the average public-debt-to-GDP ratio reached 63.9 analysis focuses on the 2000–22 period due to varying data availability percent in 2021 and is estimated to increase to 64.6 percent in 2022 in earlier years. The residual term in the debt accounting for the region excluding China. decomposition is also referred to as the stock-flow reconciliation because it reconciles the deficit, which is a flow variable, with the The COVID-19 shock accelerated the upward trend in the evolution of debt, which is a stock variable. In practice, it covers public-debt-to-GDP ratio observed in most developing EAP economies changes in debt that come from factors such as privatization or the since the global financial crisis. The ratio of public debt to GDP increased realization of contingent liabilities. from about 40 percent in 2008 to about 47 percent in 2019, and close to an estimated 65 percent in 2022: that is, a cumulative increase of 18 The analysis finds that several factors have contributed to the percentage points since 2019. Since the start of the pandemic, the ratio accumulation of public debt in developing EAP economies during the of public debt to GDP has increased by more than 38 percentage points last two decades: in Fiji, more than 33 percentage points in Lao People’s Democratic Republic (PDR), more than 23 percentage points in the Philippines, and 1. High economic growth rates have helped to reduce the more than 21 percentage points in Thailand (figure 2). public-debt-to-GDP ratio, on average, by 2.3 percentage points per Figure 1. The public-debt-to-GDP ratio has been increasing in developing East Asia and Pacific economies during the last decade a. Developing East Asia and Pacific excluding China b. China Public debt Public debt Changes in public debt (right scale) Changes in public debt (right scale) 75 15 75 15 10.7 10.8 10 10 60 60 5 Percent of GDP Percent of GDP Percent of GDP Percent of GDP 5 45 45 0 0 30 30 -5 -5 15 15 -10 -10 0 -15 0 -15 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. Panel a presents unweighted averages. Affiliation: East Asia and Pacific Chief Economist Office, World Bank. Acknowledgements: Aaditya Mattoo offered valuable comments, insights, and suggestions. Enkhzaya Demid provided excellent research assistance. Nancy Morrison provided editorial assistance. Objective and disclaimer: Research & Policy Briefs synthetize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. Drivers of Public Debt in East Asia and Pacific Economies Figure 2. The COVID-19 shock has accelerated the upward Figure 3. Higher primary deficits were the main contributors of trend in the public-debt-to-GDP ratio in developing East Asia higher public-debt-to-GDP ratios in developing East Asia and and Pacific economies Pacific economies Growth Inflation-depreciation 12 Interest payments Primary deficits 2019 Residual Change in debt Percent of GDP 2022 forecast 9 Percentage points 120 6 100 80 3 60 0 40 20 -3 0 -6 Mongolia Lao PDR China Malaysia Fiji Vietnam Thailand Philippines Indonesia Cambodia 2000 – 19 2020 – 22 2000 – 19 2020 – 22 EAP excluding China China Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: The figure presents unweighted averages. Public debt refers to general government debt. Standard debt dynamic accounting decomposition is used to express changes in the general-government-debt-to-GDP ratio as a function Source: World Economic Outlook, International Monetary Fund; World Bank of GDP growth, the inflation rate, interest payments, and primary deficits. EAP staff estimates. = developing East Asia and Pacific. year during the 2000–22 period. Economic growth helped reduce Drivers of Debt Accumulation the public-debt-to-GDP ratio by 2.6 percentage points during the 2000–19 period, but that contribution declined to 0.8 percentage Growth points during 2020–22. Historically, economic growth rates in developing EAP economies have been sufficiently high to exceed nominal interest rates, helping to 2. Inflation helped EAP economies reduce the public-debt-to-GDP reduce the public-debt-to-GDP ratio. Economic growth helped EAP ratio, on average, by 1.6 percentage points per year during the economies reduce the public-debt-to-GDP ratio, on average, by 2.3 2000–22 period. During the pandemic-induced recession of 2020, percentage points per year during the 2000–22 period (figure 4). Even among developing EAP economies excluding China, inflation during the global financial crisis of 2008–09 economic growth helped helped reduce the public-debt-to-GDP ratio by only 0.1 percentage reduce the debt burden. However, growth contraction during the points, compared to 2.3 percentage points during the global COVID-19 recession in EAP economies excluding China led to an financial crisis. On average, the reduction in the public-debt-to-GDP average increase in the public-debt-to-GDP ratio of 2.2 percentage ratio due to higher prices dwarfs the increase in the points in 2020. In 2021, growth rates in EAP economies excluding public-debt-to-GDP ratio driven from depreciating currencies. China contributed to reducing the public-debt-to-GDP ratio by only 1.1 percentage points. However, estimates for 2022 suggest that 3. Interest payments helped increase the public-debt-to-GDP ratio, on economic growth will contribute to reducing the public-debt-to-GDP average, by 1.5 percentage points per year during the 2000–22 ratio by 3.0 percentage points. period. The contribution of debt service to debt accumulation did not rise significantly during the COVID-19 shock relative to the GFC The change in the public-debt-to-GDP ratio driven by economic due to low interest rates across the world and strong fundamentals, growth rates consists of two components: (1) the stock of debt; and as reflected in moderate increases in sovereign risk and relatively (2) the growth rate of GDP. Therefore, a large decrease in the low interest rates. Only Lao PDR registered an increase of more public-debt-to-GDP ratio driven by economic growth could be than 1 percentage point in the contribution of interest payments to explained either by large stocks of debt or by high economic growth debt accumulation after the COVID-19 shock. rates. For instance, the decrease in the public-debt-to-GDP ratio due to economic growth in Lao PDR and Mongolia is about 1.6 times larger 4. Primary deficits have contributed to increasing the than in Cambodia, even though the average growth rate in Cambodia public-debt-to-GDP ratio, on average, by 1.1 percentage points per is larger than in Lao PDR and Mongolia (figure 5). In the aftermath of year during the 2000–22 period. The COVID-19 shock has the COVID-19 shock, lower growth rates relative to pre-pandemic accelerated an upward trend in primary deficits that has been rates have led to moderate contributions to reductions in the occurring in most developing EAP economies. Since 2020, primary public-debt-to GDP ratio in most developing economies in EAP. In deficits have added about 3.8 percentage points per year to the contrast, in Fiji, the lack of economic growth contributed to increasing public-debt-to-GDP ratio in developing EAP economies excluding the public-debt-to-GDP ratio by 1.5 percentage points per year during China. In some EAP economies, including Fiji, Indonesia, the the 2020–22 period. Philippines, and Thailand, fiscal surpluses during the 2000–19 period helped reduce public-debt-to-GDP ratios. Inflation Overall, our results show that the upward trend in the Inflation helped EAP economies reduce the public-debt-to-GDP ratio, public-debt-to-GDP ratio observed in most developing EAP economies is on average, by 1.6 percentage points per year during the 2000–22 mainly driven by larger primary deficits. While strong GDP growth and, period (figure 6). In 2008, the average inflation rate in developing EAP to a certain extent, inflation have helped decrease public-debt-to-GDP excluding China increased to 13.4 percent, which led to an average ratios during the past two decades, their contribution has declined in decrease in the public-debt-to-GDP ratio of 5.1 percentage points. In the aftermath of the COVID-19 shock (figure 3). contrast, during the pandemic-induced recession of 2020, moderate 2 Research & Policy Brief No.60 Figure 4. Economic growth has helped reduce public-debt-to-GDP ratios in developing East Asia and Pacific economies a. Developing East Asia and Pacific excluding China b. China 3 -5 3 -5 Contribution of growth to Contribution of growth to public-debt-to-GDP ratio public-debt-to-GDP ratio GDP growth (right scale ) 0 GDP growth (right scale ) 0 Percentage points Percentage points 0 0 Percent Percent 5 5 -3 -3 10 10 -6 15 -6 15 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. The red (orange) area represents the average annual contribution of growth to changes in the general- government-debt-to-GDP ratio among developing East Asia and Pacific economies (China). Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Panel a presents unweighted averages. Figure 5. The contribution of economic growth to reducing public-debt-to-GDP ratios declined in the aftermath of the COVID-19 shock across developing East Asia and Pacific economies a. 2000–2019 b. 2020–2022 Contribution of growth to Contribution of growth to 2 -6 2 public-debt-to-GDP rati o -6 public-debt-to-GDP rati o 1 -4 1 GDP growth (right scale) -4 GDP growth (right scale) -2 Percentage points Percentage points -2 0 0 0 0 -1 Percent Percent -1 2 2 -2 -2 4 4 -3 -3 6 6 -4 8 -4 8 -5 10 -5 10 Lao PDR Mongolia Lao PDR China Philippines Cambodia Mongolia Vietnam Malaysia China Philippines Cambodia Vietnam Malaysia Indonesia Thailand Fiji Indonesia Thailand Fiji Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. Bars represents the average annual contribution of growth to changes in the general-government-debt-to-GDP ratio for developing East Asia and Pacific economies. Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Figure 6. Inflation has helped decrease the public-debt-to-GDP ratio in developing East Asia and Pacific economies a. Developing East Asia and Pacific excluding China b. China Contribution of inflation to Contribution of inflation to public-debt-to-GDP ratio public-debt-to-GDP ratio 6 Inflation rate (right scale) 15 6 Inflation rate (right scale) 15 10 10 Percentage points Percentage points 3 3 5 5 Percent Percent 0 0 0 0 -5 -5 -3 -3 -10 -10 -6 -15 -6 -15 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. The red (orange) area represents the average annual contribution of inflation to changes in the general- government-debt-to-GDP ratio among developing East Asia and Pacific economies (China). Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Panel a presents unweighted averages. 3 Drivers of Public Debt in East Asia and Pacific Economies inflation, averaging 1.6 percent, contributed to reducing the foreign currency (Cambodia, Lao PDR, and Mongolia), currency public-debt-to-GDP ratio by only 0.1 percentage points in developing depreciation contributes to an increase of 1.5 percentage points in EAP excluding China. Overall, the contribution of inflation in reducing the public-debt-to-GDP ratio. The effect of currency depreciation on debt burdens decreased over time as inflation across developing debt accumulation is negligible among most EAP economies except economies declined, corresponding to the widespread adoption of for Mongolia and Lao PDR, where depreciation has increased the ratio inflation targeting regimes and an increase in central bank credibility. of public debt to GDP by 3.3 percentage points and 0.8 percentage Inflation helped developing EAP economies excluding China reduce points per year, respectively. Overall, inflation has contributed to the public-debt-to-GDP ratio, on average, by 2.2 percentage points reducing public-debt-to-GDP ratios above and beyond the increasing per year during the 2000–07 period (pre-GFC), but only by 1.2 effect due to exchange rate depreciations (figure 8). percentage points per year during the 2010–19 period (post-GFC). The contribution of inflation to the public-debt-to-GDP ratio has Interest payments increased slightly in 2021 and 2022 as inflation has increased. On average, interest payments have contributed to increasing the public-debt-to-GDP ratio by 1.5 percentage points in EAP economies In principle, the effect of inflation on the real value of the during the 2000–22 period. Despite an increasing trend since 2012 public-debt-to-GDP ratio depends on the composition of debt. On one which accelerated in the aftermath of the COVID-19 shock, interest hand, inflation helps to lower debt burdens by diluting the real value payments in developing EAP economies remain on average below 2 of public debt. On the other hand, higher inflation rates could percent of GDP. Interest payments contributed to increasing the depreciate the exchange rate and increase the nominal value of debt public-debt-to-GDP ratio in developing EAP economies excluding denominated in foreign currency. Foreign currency debt as a share of China, on average, by 1.7 percentage points per year during the total debt is high in Cambodia (100 percent), Mongolia (96 percent), 2000–07 period (pre-GFC). During the 2010–19 (post-GFC) period and and Lao PDR (83 percent), while in Thailand, China, and Malaysia debt post-COVID period, interest payments contributed to increasing debt denominated in foreign currency represents less than 20 percent of burdens by 1.5 percentage points and 1.8 percentage points per year, total debt (figure 7). Among economies that are highly indebted in respectively (figure 9). Figure 7. While higher inflation has helped lower public-debt-to-GDP ratios in developing East Asia and Pacific economies, exchange rate depreciations have inflated those ratios a. Share of public debt denominated in foreign currency 100 80 Percent 60 40 20 0 Malaysia China Thailand Philippines Indonesia Fiji Lao PDR Mongolia Cambodia b. 2000–2019 c. 2020–2022 Contribution of depreciation to public-debt-to-GDP ratio Contribution of depreciation to public-debt-to-GDP ratio Contribution of inflation to public-debt-to-GDP ratio Contribution of inflation to public-debt-to-GDP ratio Average inflation (right scale) Average inflation (right scale) Average depreciation (right scale) Average depreciation (right scale) 9 9 9 9 6 6 6 6 Percentage points Percentage points 3 3 3 3 Percent Percent 0 0 0 0 -3 -3 -3 -3 -6 -6 -6 -6 -9 -9 -9 -9 Lao PDR Indonesia Lao PDR Vietnam Philippines Indonesia Vietnam Philippines Fiji Cambodia Malaysia Thailand Fiji Cambodia Malaysia China Thailand Mongolia China Mongolia Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: In panel a, data are as of 2021. In panel b bars and diamonds show the average of 2000—2019. In panel c, bars and diamonds show the average of 2020–2022. The red (orange) bars represent the average annual contribution of nominal exchange rate depreciation (inflation) to changes in the general-government-debt-to-GDP ratio among developing East Asia and Pacific economies. Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. 4 Research & Policy Brief No.60 Figure 8. Inflation has helped reduce public-debt-to-GDP ratios more than exchange rate depreciations have increased those ratios in developing East Asia and Pacific economies 0 -1 Net contribution of inflation to public-debt-to-GDP ratio -2 -3 y = -0.1843x - 0.8671 R² = 0.2401 -4 -5 -6 -7 0 5 10 15 20 Inflation rate, percent Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. The Y-axis shows the average annual contribution of inflation plus nominal exchange rate depreciation to changes in the general-government-debt-to-GDP ratio among developing East Asia and Pacific economies. Dots represent averages for each country in four different periods: (1) 2000–07; (2) 2008–09; (3) 2010–19; (4) 2020–22. Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Figure 9. The contribution of interest payments to public-debt-to-GDP has increased slightly, but remains relatively low across developing East Asia and Pacific economies a. Developing East Asia and Pacific excluding China b. China 2.0 2.0 Percentage points Percentage points 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. The red (orange) area represents the average annual contribution of interest payments to changes in the general-government-debt-to-GDP ratio among developing East Asia and Pacific economies (China). Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Panel a presents unweighted averages. The rise on sovereign spreads (defined as the differential between during the same period (figure 11). Even though debt levels in all the interest rate of domestic bonds issued on international markets developing EAP economies have increased due to the COVID-19 and US government bonds) has been relatively muted in the shock, the average contribution of interest payments to debt aftermath of the COVID-19 shock across EAP economies. For instance, accumulation increased only by 0.4 percentage points, reflecting during the global financial crisis of 2008–09, the average sovereign relatively low interest rates. Only in Lao PDR was the increase in the spreads in developing EAP economies excluding China increased, on contribution of interest payments to the debt-to-GDP ratio higher average, by 513 basis points from November 2007 to November 2008. than 1 percentage points per year in the aftermath of the COVID-19 In contrast, during the pandemic-induced recession of 2020, the shock. For instance, in Lao PDR, the contribution of interest payments average sovereign spreads in developing EAP economies excluding to debt accumulation went from an average of 0.7 percent per year, China increased, on average, by 181 basis points from March 2019 to before the pandemic, to an average of 2.2 percent per year after the March 2020, and returned to pre-COVID levels in less than 12 months COVID shock. In contrast to Lao PDR, in the Philippines the average (figure 10). These results likely reflect low interest rates across the contribution of interest payments to debt accumulation after the world and strong fundamentals in EAP economies. COVID shock (1.9 percent) is lower relative to pre-pandemic levels (3.2 Among developing EAP economies in the pre-COVID period, percent), which is surprising because the public-debt-to-GDP ratio in interest payments added the most to the public-debt-to-GDP ratio in the Philippines increased by 23.1 percentage points. This small the Philippines and Fiji: 3.2 percentage points and 2.8 percentage contribution of interest payments to debt accumulation in recent points per year, respectively. In Thailand, Lao PDR, China, and years is driven by the lower interest rates the Philippines is enjoying, Cambodia, interest payments contributed to increasing which is a consequence of strong fundamentals, a high degree of fiscal public-debt-to-GDP ratio by less than 1 percentage point per year prudence, and efforts to develop domestic capital markets. 5 Drivers of Public Debt in East Asia and Pacific Economies Figure 10. The increase on sovereign spreads during the COVID-19 shock has been moderate relative to the global financial crisis in developing East Asia and Pacific economies a. Developing East Asia and Pacific excluding China b. China COVID-19 shock COVID-19 shock 8 Global financial crisis 8 Global financial crisis 6 6 Percent Percent 4 4 2 2 0 0 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 Months since spreads reach the peak (t=0) Months since spreads reach the peak (t=0) Source: JPMorgan Emerging Markets Bond Index (EMBI); World Bank staff estimates Note: The red (orange) area represents the average sovereign spread on government bonds among developing East Asia and Pacific economies (China) during the COVID-19 crisis. The dotted line represents the average sovereign spread on government bonds during the global financial crisis of 2008–09. The event (t=0) is defined as the month in which sovereign spreads reach their peak during a crisis. Developing East Asia and Pacific includes Indonesia, Malaysia, the Philippines, and Vietnam. Panel a presents unweighted averages. Figure 11. The contribution of interest payments to public-debt-to-GDP ratios across developing East Asia and Pacific economies remained moderate after the COVID-19 shock 4 a. 2000–2019 b. 2020–2022 4 3 Percentage points Percentage points 3 2 2 1 1 0 0 Philippi nes Fiji Indonesia Philippi nes Mongolia Malaysia Vietnam Thailand Lao PDR Fiji Indonesia Mongolia Malaysia Vietnam Thailand Lao PDR China Cambodia China Cambodia Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. Bars represents the average annual contribution of interest payments to changes in the general-government-debt-to-GDP ratio for developing East Asia and Pacific economies. Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Primary deficits respectively, during the 2000–19 period (figure 13). However, primary deficits in these economies added to public-debt-to-GDP ratios by 5.0 On average, primary deficits have led to increasing the percentage points, on average, during the 2020–22 period. public-debt-to-GDP ratio by 1.1 percentage points (figure 12). Primary deficits contributed to increasing the public-debt-to-GDP ratio in Policy Implications developing EAP economies excluding China, on average, 0.3 percentage points per year during the 2000–07 period (pre-GFC). This Public debt has been trending upward in EAP economies since the contribution rose to 0.7 percentage points per year during the global financial crisis of 2008–09, and it accelerated in the aftermath 2010–19 period (post-GFC). However, during the period following the of the COVID-19 shock. High GDP growth rates and, to a certain COVID-19 shock, primary deficits contributed to increasing extent, inflation, have contributed to reducing public-debt-to-GDP public-debt-to-GDP ratios by 3.8 percentage points per year, on ratios for the region’s economies during the past two decades. average, in developing EAP economies excluding China. However, the contribution of inflation in reducing debt burdens has decreased over time as inflation across EAP economies has declined. The Philippines, Indonesia, Fiji, and Thailand lowered At the same time, most economies in the region have run primary public-debt-to-GDP ratios through primary surpluses during the deficits since the global financial crisis. Only the Philippines and 2000–19 period. For instance, primary surplus helped the Philippines, Thailand have consistently run surpluses in the last decade. However, Indonesia, Fiji, and Thailand reduce the public-debt-to-GDP ratio, on low global interest rates have made it possible for interest payments average, by 1.9, 0.7, 0.7, and 0.5 percentage points per year, to add to existing public-debt-to-GDP ratios only marginally. 6 Research & Policy Brief No.60 Figure 12. Primary deficits have led to increasing the public-debt-to-GDP ratio in developing East Asia and Pacific economies a. Developing East Asia and Pacific excluding China b. China 10 10 Percentage points Percentage points 5 5 0 0 -5 -5 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. The red (orange) area represents the average annual contribution of primary deficits to changes in the general- government-debt-to-GDP ratio among developing East Asia and Pacific economies (China). Standard debt dynamic accounting decomposition is used to express changes in the general-government-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Panel a presents unweighted averages. Figure 13. The contribution of primary deficit to the public-debt-to-GDP ratio across developing East Asia and Pacific economies has increased in the aftermath of the COVID-19 shock a. 2000–2019 b. 2020–2022 8 8 6 6 Percentage points Percentage points 4 4 2 2 0 0 -2 -2 Philippines Indonesia Philippines Fiji Thailand Indonesia China Vietnam Fiji Thailand Mongolia Cambodia Malaysia China Vietnam Lao PDR Mongolia Cambodia Malaysia Lao PDR Source: World Economic Outlook, International Monetary Fund; World Bank staff estimates. Note: Public debt refers to general government debt. Bars represents the average annual contribution of primary deficits to changes in the general-government-debt-to-GDP ratio for developing East Asia and Pacific economies. Standard debt dynamic accounting decomposition is used to express changes in the public-debt-to-GDP ratio as a function of GDP growth, the inflation rate, interest payments, and primary deficits. Starting in 2020, fiscal deficits have been the main driver of the While policy makers in developing EAP economies deal with the increase in public-debt-to-GDP ratios for the region’s economies. aftermath of COVID-19, the war in Ukraine, and global financial Going forward, fiscal deficits may continue because output gaps are tightening, they should commit to curbing their increased deficits in a still negative, and economies need to deal with the ongoing external timely manner. Economies that have relaxed fiscal rules should pressures from the war in Ukraine and financial tightening by central provide clear guidance as to when they plan to return to the banks in advanced economies. Less fiscal space, combined with preexisting rule (World Bank 2022a). More efficient and targeted financial tightening, is likely to translate to higher costs of refinancing support to households and firms would limit pain from the cumulative debt, which will further increase interest payments in the future. shocks and create space for investment in the infrastructure of trade, Other potential risks include lower growth rates, contingent liabilities energy, and technology diffusion (World Bank 2022b). Committing to as the veil of regulatory forbearance is lifted, and exchange rate fiscal rules and future reforms of revenue and expenditure would help depreciation pressures for economies that have a high share of debt reconcile spending needs with tightening budget constraints amidst in foreign currency, such as Cambodia, Lao PDR, and Mongolia. growing debt. References World Bank. 2022a. “Braving the Storms.” World Bank East Asia and Pacific Economic Update (April), World World Bank. 2022b. “Reforms for Recovery.” World Bank East Asia and Pacific Economic Update (October), Bank, Washington, DC. World Bank, Washington, DC. 7