Asia faces fiscal dilemma

Asia faces fiscal dilemma

By Alan Wheatley

TOKYO (Reuters): The large public debts chalked up tackling Asia's financial crisis have come back to haunt the region's governments as they seek to cushion their economies from a global slowdown.

The debt burden is already so great in some countries, especially Indonesia and the Philippines, that most economists now view a fiscal blow-out as a much larger risk than a re-run of the region's 1997 balance-of-payments crisis.

"The ability of the poorer countries in the region to maintain deficit spending is fast approaching its sustainable limit," Lehman Brothers' Asian economists said in a report.

"Unfortunately, while the parlous state of government finances is of growing concern to markets, political distractions are preventing countries from adequately facing up to the reality of their public debt problems," they said.

Debts ballooned during the crisis as governments took banks' non-performing loans (NPLs) onto their own books.

As a consequence, while private-sector debt has fallen as a percentage of gross domestic product in all five countries worst hit by the crisis, public-sector debt has quadrupled in Indonesia and Thailand.

In the Philippines it has risen further to around 110 percent of GDP, the highest in the region.

What alarms economists and officials is that in most countries the taxpayer's bill for the bank clean-up is still rising.

Goldman Sachs says the official 15 percent figure for NPLs in the Philippines does not include sour loans in the non-bank financial intermediary sector, while ING Barings says the new Thai government's plans for a national asset management company to buy up NPLs could cost 5.1-7.2 percent of gross domestic product.

As William McDonough, president of the Federal Reserve Bank of New York, said in Bangkok on Monday: "Contingent liabilities often remain significant, raising some concern about potential future debt growth."

Not all countries are in a fiscal bind. Economists say Singapore, Hong Kong and Malaysia have plenty of scope for pump- priming if need be.

Taiwan, despite an untackled NPL problem of its own, could afford last week to announce an increase in public infrastructure spending this year of NT$111.5 billion (US$3.5 billion) with the aim of boosting GDP growth by 0.7 of a percentage point.

But Adam Le Mesurier of Goldman Sachs in Singapore said the countries that most need to support growth as exports flag are the ones least able to afford to ease fiscal policy.

"They used their fiscal bullets pretty early on in the game after the crisis in 1997-1998 in terms of socializing the bank liabilities in the system. Once you've shot those bullets, it's difficult to come back and reload," he told Reuters.

Le Mesurier said the case of the Philippines' debt burden was especially sobering. Even on optimistic assumptions for real interest rates and the annual budget, Manila's public-sector debt is sustainable only if growth is strong, he said.

The risk is that a vicious circle will develop.

If the fiscal position deteriorates further, capital flight will increase as taxpayers seek to avoid future tax increases, cutting into investment and making it harder to achieve the growth rates needed to stabilize the debt.

Ultimately under that scenario the government has to resort to the money-printing presses to plug the budget gap. That fuels inflation, driving the currency and real interest rates lower.

Le Mesurier said the next year would be critical in establishing whether the new administration of President Gloria Macapagal Arroyo, which has pledged to improve tax collection, can reverse or stabilize the fiscal position.

"The issue will likely remain the single most important determination of the underlying direction of the Philippine macro risk premium," Le Mesurier said in a report.

The other country debt-watchers are monitoring closely is Thailand. As well as offering plans to manage the country's bad assets, incoming Prime Minister Thaksin Shinawatra ran for election promising to grant each of the country's 70,000 villages one million baht ($23,580) and freeze poor farmers' debt repayments for three years.

For now, economists are not too alarmed. Arthur Woo of HSBC said a strong dose of fiscal expansion was a timely tonic for a slowing economy. John Tsao of JP Morgan Chase said Thailand's public debt, nearing 60 percent, is sustainable provided growth continues and privatization and tax reforms are accelerated.

"For a quarter or two it's not going to kill them, depending on the size of the package," Sailesh Jha of the Asian Development Bank in Manila agreed.

But he said pump-priming for Thailand and other Asian countries could achieve only so much.

"Given the open nature of these economies, it can only be a short-term stabilization measure for a few quarters. That's about it. Then it depends on how quickly the domestic sector reacts both in terms of consumption and investment," Jha said.