VUCA and revenue sensitivity

In Vietnam, customs revenue represents a large share of total revenue, a depreciation of the local currency may generate a considerable amount of revenue.

>> Can current fiscal structures hold up?

The VUCA – “volatility, uncertainty, complexity and ambiguity” – of today’s macroeconomic environment remains high on the agenda due to US Fed rate hikes, geopolitical tensions, rising inflation and higher oil prices. And uncertainty in today’s macroeconomic environment means uncertainty about a country’s revenue base. That is why the majority of ASEAN governments are forecasting revenue growth in 2023 to fall below trend.

“The impact will be uneven and the three countries with the highest tax revenue-to-GDP ratio – the Philippines, Vietnam, and Singapore – are likely to be more resilient. We have done a stress test to see how changes in growth, inflation and FX rates can affect government revenues”, said HSBC.

As for the growth, lower real GDP will mean lower tax revenues as there is less economic activity to tax, people are buying less goods and are earning less wages. All else equal, the correlation between GDP and revenue growth is usually high. For simplicity, HSBC assumes that the correlation is almost one to one – a 1% reduction in economic activity may lead to a 1% loss in revenues.

>> Is it time for fiscal tapering?

Concerning the inflation, revenues can go either way when it comes to inflation. For instance, inflation can lead to more government revenue as higher prices of goods means a bigger tax base for VAT or sales tax. However, if people begin to buy fewer items, then revenues can go in the other direction. Therefore, in HSBC’ view, it is important to see how sensitive revenue is to inflation.

It matters how much more non-customs tax revenue (taxes on wages, corporations, sales, excise, etc.) can grow with a 1ppt increase in the inflation rate. For all ASEAN economies, it seems this relationship is also one to one, except for outliers, such as Malaysia and Thailand. This means that, from a fiscal perspective, the high-inflationary environment could theoretically help support a government’s revenue base and make up for slower growth.

As far as the FX is concerned, the same relationship doesn’t hold when it comes to the local currency versus the USD. For the Philippines and Vietnam, two economies where customs revenue represents a large share of total revenue, a depreciation of the local currency may generate a considerable amount of revenue. Meanwhile, for Singapore, Indonesia, and Malaysia, the relationship is actually negative. However, this isn’t necessarily significant, given the fact that customs revenues only represent a very small share of their revenue base.