Fiscal sustainability in developing Asia - New evidence from panel correlated common effect model

Abstract

Purpose - This study aims to investigate the problem of fiscal sustainability for a panel of developing Asian economies. Design/methodology /approach - In this study, we control for crosssection dependence and heterogeneity while estimating the fiscal reaction function, which shows how governments react to the accumulation of public debt. Findings - We show that the fiscal sustainability issue in the region is not so benign as in previous studies. Overall, fiscal policy is unsustainable, even for the nonlinear fiscal rule. Country-specific long-run coefficients are also examined in the study. Research limitations/implications - The findings show that many developing economies in the region could not satisfy the IBC, which raises concerns about debt sustainability in the region, especially for the post-crisis period. Originality /value - This study investigates whether governments can maintain the sustainability of public finances in the long run, if the ratios of public debt over GDP and primary deficit over GDP continue their recent problematic trends. Another novelty is controlling for heterogeneous effects among the countries in the region to give a more precise picture of debt sustainability. The empirical evidence also supports that insolvency risk can occur at low levels of public debt.