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Capital --- India

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Solvency is an intertemporal concept, relating to the present value of revenues and expenditures, and encompassing both assets and liabilities. But the standard practice among policy makers, financial market participants and international financial institutions is to assess the strength of the fiscal accounts solely on the basis of the cash deficit. Short-term cash flows matter, but a preponderant focus on them can encourage governments to invest too little, especially during episodes of fiscal tightening. This has potentially adverse consequences for growth and, paradoxically, even for fiscal solvency itself. The paper offers an overview of the links between fiscal targets, public investment, and public sector solvency. After reviewing the international experience with public investment under fiscal adjustment, the paper lays out an analytical framework to illustrate the consequences of using the public deficit as a guide to solvency. The paper then discusses some alternatives to conventional cash deficit rules and their implications for investment and fiscal solvency.

Access to Finance --- Cash Flows --- Debt Markets --- Expenditures --- Finance and Financial Sector Development --- Financial Market --- Financial Market Participants --- Financial Markets --- Fiscal Policy --- International Bank --- International Financial Institutions --- Investment and Investment Climate --- Macroeconomics and Economic Growth --- Public Investment --- Public Sector Economics and Finance --- Public Sector Expenditure Analysis and Management --- Solvency

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Serven examines empirically the link between real exchange rate uncertainty and private investment in developing countries using a large cross country-time series data set. He builds a GARCH-based measure of real exchange rate volatility and finds that it has a strong negative impact on investment, after controlling for other standard investment determinants and taking into account their potential endogeneity. The impact of uncertainty is not uniform, however. There is some evidence of threshold effects, so that uncertainty only matters when it exceeds some critical level. In addition, the negative impact of real exchange rate uncertainty on investment is significantly larger in economies that are highly open and in those with less developed financial systems. This paper-a product of the Office of the Chief Economist, Latin America and the Caribbean Region-is part of a larger effort in the region to assess the effects of macroeconomic volatility. The author may be contacted at lserven@worldbank.org.

Capital Stock --- Currencies and Exchange Rates --- Debt Markets --- Developing Countries --- Development Bank --- Economic Stabilization --- Economic Theory and Research --- Emerging Markets --- Exchange --- Finance and Financial Sector Development --- Financial Development --- Financial Literacy --- Financial Systems --- Goods --- Income Level --- Inflation --- Investment and Investment Climate --- Investment Decisions --- Macroeconomic Management --- Macroeconomic Uncertainty --- Macroeconomic Variables --- Macroeconomics and Economic Growth --- Non Bank Financial Institutions --- Poverty Reduction --- Price Uncertainty --- Private Investment --- Private Investors --- Private Sector Development --- Pro-Poor Growth --- Real Exchange Rate --- Real Exchange Rates --- Returns --- Revenue --- Risk Aversion

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Economic infrastructure --- Latin America