10 the sense of yielding less than its potential. 18 In the East Asian countries, real interest rates were positive and moderately high in the 1980s. (See Table 7) Thus, although investment was not strictly allocated by the market in many instances, private companies using the funds had to pay positive real rates. Credit was not flagrantly subsidized, but it was directed. To some extent, demand for credit had been limited by price, but still credit availability increased s:gnificantly, e.g. from 10.7% of GDP in 1965 to 56.1% in 1987 in Korea, from 14% to 46 % in Thailand and from 13% to 62% in Malaysia. In Indonesia, domestic credit grew at an average 21 % per year between 1973-81, but the inflation trend was much subdued.

The growth of the formal financial sector in these economies is reflae-ed in the extent of "financial deepening' defined as the growth in the share of financial assets in the economy. The ratio of M2 to GDP ( a measure of financial deepening) has risen in all these countries. In Korea it has gone from 11.7% in 1962-65 to 39% in 1985-88; in Thailand from 23.9% to 62.9% and in Malaysia from 27.3% to almost 70% over the same period and in Indonesia from 12.9% to 35% in 1989.

Indeed, maintaining moderately high real interest rates appears to be closely associated with economic performance and financial deepening at the intemational level. Empirical evidence indicates that countries that have maintained relatively high real interest rates have performed better by a considerable margin than those who have favored negative red interest rates. **19**

# _(c) Fiscal Policy_

Expansionary fiscal policies have been the bane of the debt problem in many developing countries. Ninety percent of long term debt of developing countries has either been directly contracted by the Government or guaranteed by it. Therefore, the Government's debt servicing capacity and thus its fiscal position assumes a critical role. The ratio of Government debt to GNP will fall if the non-interest government surplus, as a percent of the debt, exceeds the difference between the interest rate and the growth rate of real GNP. X Since many of the highly indebted countries were unable to meet this condition, they had difficulties in making their debt service obligations. On the other hand, NIEs and Asian countries have had, in general, very responsible fiscal policies (except the Philippines). Public savings have been positive every single year since 1970, and the budget deficit, which includes public investment as an outlay, has never reached worrisome proportions. A moderate fiscal expansion has been used only for very short periods of time, to produce a reactivation when internal and external conditions were not favorable. Moreover, when budget deficits have increased, governments have shown a remarkable ability to bring them down quickly, so that they do not jeopardize macroeconomic stability.

In Thailand, fiscal deficits have been around 4% of GDP for several years during the 1980s. The Bank of Thailand, thjugh, has been careful to avoid monetary financing as much as possible. Malaysia has experienced even higher public deficits but the Government has carefully avoided resorting to monetary financing and deficits have been reduced significantly since 1987. Indonesia has averaged deficits up to 5% of GDP but has contained them to 2% in recent years. The deficits were financed mainly through counterpart funds generated by foreign aid and external project assistance.

le Polak, J. J., Financial Policies and Develooment (Paris: OECD, 1989).

'<sup>9</sup> McKinnon, R. (1989), "Financial Liberalization and Economic Develooment: A Reassessment of Interest Rate Policies in Asia and Latin .metica." International Center for Economic Growth, ICS Press, San Francisco.

) Blanchard et al, The Sustainability of Fiscal Policy: New Answers to Old Questions,' Economic Studies. Vol. 15 (Paris, OECD).