ISLAMABAD: The World Bank says South Asia’s export opportunity has not gone away, and import demand in the traditional destination markets for South Asian exports – the United States and Europe – will remain robust.

Instead of seizing it by reorienting resources towards foreign markets, especially through fiscal consolidation, countries in the region seem to be drifting towards more traditional protectionist policies, says the World Bank in its report on South Asia.

In the view of experts on South Asia at the South Asia Economic Policy Network, under the office of World Bank’s regional Chief Economist, South Asia could even benefit from the current trade dispute between the US and China through trade diversion.

As the US and China increase their tariffs on each other, the prices of mutual imports increase and the demand for substitutes from other exporting economies — including South Asian countries — grows. To benefit from the opportunities offered by strong import demand in the US and Europe, South Asian countries need to improve logistics, reduce red tape, and enhance competitiveness, the report suggests.

Regulatory duties have been increased in Pakistan; import tariffs on vehicles have been raised in Sri Lanka; and India did the same on 19 products worth $13 billion in imports.

South Asian countries export mainly to the US and Europe, and therefore a key question is how a potential ‘trade war’ may affect import demand in these two markets. Current projections suggest that effects will be quite muted.

Despite increasing tariffs, US imports are growing faster than in the last two years, and the growth of imports by the euro area remains stable.

The report points out that tax revenue in the region is generally lower than could be anticipated given the region’s level of economic development.

South Asian countries are not different from other developing countries in terms of the tax instruments they use, but their tax bases are small, tax exemptions are common, and tax evasion is widespread. Some countries in the region have been making progress on these fronts.

At 4.4 per cent of GDP, South Asia’s fiscal deficit is projected to be the second largest in the world this year. The only region with an even higher deficit is the Middle East and North Africa, which is still suffering from the relatively low oil prices over the last years.

Fiscal deficits in several South Asian countries have been large for quite some time, and average deficit over the last three years has been around 5.5pc in Pakistan and above 6pc in Maldives, India and Sri Lanka.

The level of fiscal deficits is often affected by developments beyond the control of policy makers, including economic shocks. Between 1980 and 2017, South Asian countries experienced over 100 downturns in five key global and domestic variables.

These key variables include global GDP growth, the growth of world trade, the international oil price, the level of remittances, and the country’s terms of trade.

Not surprisingly, fiscal deficits in South Asia are also amplified in times of intense political competition. Between 1990 and 2015, 39 national elections took place in Bangladesh, India, Pakistan, and Sri Lanka.

In the year before elections, the fiscal deficit rose on average by 0.5pc of GDP.

The average fiscal deficit remained high during the election year, to decrease only in subsequent years.

When GDP growth accelerates, most governments in South Asia also tend to spend more. The cyclical components of public spending and GDP move strongly together in Bhutan, Nepal, Bangladesh, and Pakistan.

For the region as a whole, tax revenue increases proportionally with economic activity, but public spending increases more than proportionally. Considering the inverse relationship, from fiscal variables to economic activity, the tax multiplier in South Asia is insignificant but the expenditure multiplier is large, report says.

Published in Dawn, October 9th, 2018