Current account and fiscal deficits: Evidence from five developing economies of Asia

Abstract

The persistent and coinciding fiscal and external trade deficits have been in the economic spotlight largely because of its important policy implications concerning the long-term viability of economic progress. Most studies on the subject have focused attention on the relationship between the two deficits in developed countries such as the United States. The present study, in contrast, uses multi-variate time series analysis to extend the “twin deficits” debate to five developing Southeast Asian economies—namely, India, Indonesia, Korea, Malaysia and the Philippines. The discussion is especially relevant given the backdrop of the current economic crisis that is engulfing many Asian economies, and the plausibility that there could be wide disparities in the macroeconomic dynamics governing fiscal and current deficits between developing and developed economies. Specifically, Granger causality test based on a vector autoregressive ( VAR) model is utilized to underpin the direction of causality between the two deficit series. Contrary to most findings in the literature, this study finds trade deficits to cause fiscal deficits and not vice versa. A case for increased government spending in response to the domestic hardships caused by a worsening of trade balance is made. Furthermore, the study identifies several other macroeconomic variables that jointly influence the twin deficits, thus highlighting some degree of commonality in the twin deficit nexus. A number of policy implications are derived.