South Asia’s reliance on state-led development is concealing vulnerabilities to growing levels of unsustainable debt that could lead to financial crises, the World Bank warned.
Governments in the region, including India and Pakistan, are exposed to the risk of “hidden debt” via funding guarantees by state-owned banks and enterprises, as well as public-private partnerships, the World Bank said in a report Tuesday, which also included policy reforms to help alleviate the risks.
“While the government must lead in reform, it takes a concerted effort by society to ensure that the off–balance sheet operations of government serve the right socioeconomic purpose and responsibly leverage public capital,” the bank said in the report. “Falling short of this task, South Asian countries face the threat of possible financial crises soon.”
The World Bank’s recommendations include clearly defining the purpose of the state-backed entities, as well as ensuring transparency and data collection on explicit and implicit debt obligations. In terms of debt funding for state-owned enterprises, it recommended deeper and more liquid corporate bond markets.
India, the region’s biggest economy, is particularly vulnerable to sovereign debt and funding risks, especially after the pandemic shuttered businesses and left millions jobless.
A key danger for India is the government’s guarantee for debt raised by state-owned entities for public-private infrastructure projects. The coronavirus pandemic is likely to lead to the cancellation of many of those projects, strain partnerships and hit their viability, adding to the government’s debt obligation, the World Bank said.
The country accounts for 85% of the $328 billion invested in public-private partnership projects in South Asia, and their early termination poses a fiscal cost to India as high as $18.5 billion, the most in the region, for the remainder of their contractual periods, the World Bank said in the report.
Across South Asia, a systemic crisis that triggers public-private partnership failures could cost governments more than 4% of revenues.
As well, governments are threatened by the liabilities of loss-making state-owned enterprises, which totaled 3.3%, 4.9% and 14.7% of gross domestic product in, respectively, India, Sri Lanka and Pakistan during 2017, according to the report.
“As governments rebuild from the shock of the Covid-19 pandemic and strive to avert future financial crises, they should clearly separate the social and commercial objectives of these enterprises in order to reduce inefficiencies, while maintaining socially beneficial investments,” Hans Timmer, chief economist for South Asia, said in a statement.