"In Asia, the substantially weaker revenue outlook together with concerns about the quality of additional spending and about debt sustainability would indicate that there is little scope for further fiscal stimulus by governments," the IMF said in a regional economic outlook published this week.
"In most cases, a reprioritization of spending toward strengthening the social safety net is the most viable response."
IMF said Sri Lanka, Bangladesh, Nepal and Laos had problems with debt sustainability.
In 2007 and 2008 Sri Lanka has had deficits of 7.7 percent of gross domestic product (GDP). IMF is projecting a deficit in excess 9.0 percent of GDP for 2009.
A 6.5 percent deficit target was projected in the original budget for 2009.
Inflation Effect
Official projections for inflation are also low in 2009, which can increase the budget deficit number as a proportion of GDP, as nominal growth in the economy will be low.
When inflation is high, nominal economic growth is also high, dwarfing the budget deficit as a proportion of GDP. Last year Sri Lanka's economy expansion was 23 percent when inflation was included.
Deficit spending is only effective in 'stimulating' an economy if money can be printed or borrowed from abroad. Otherwise rising interest rates will land the country back in square one or worse by crowding out activities of non-state players.
Countries with exchange rate pegs will also have macro-economic instability in the form of high inflation, or a breaking exchange rate pegs.
"In Asia, the limited scope for countercyclical easing is also because of dollarization, weak financial institutions, and exchange rate pegs," the IMF report said.
"High vulnerability together with weak public expenditure management, ineffective monetary transmission mechanisms, and other policy constraints may reduce the scope and effectiveness of countercyclical policies."
In a country that runs a peg, only foreign borrowing can really push up economic growth.
Pegged countries that deficit spent and printed money also risked losing their foreign reserves.
"In the absence of additional sources of finance, domestically financed public investment programs are coming under pressure—in cases where adjustment is not being made, the pressure risks spilling over onto international reserves," IMF warned.
Sri Lanka is already in a balance of payments crisis with almost 200 billion rupees being printed in the seven months to March.
Coupled
The report said high income Asian countries had suffered growth reversals greater than the countries in which the crisis originated
"The spillovers from the global crisis have impacted Asia with unexpected speed and force," the IMF report said.
"The intensity of the downswing has outstripped what could have been anticipated based on the historical correlation between business cycles in the G-2 (the euro area and the United States) and Asia.
"Indeed, the downswing has been even larger than in other regions, and sharper than at the epicenter of the global crisis.
"In the fourth quarter of 2008, GDP in Asia excluding China and India plummeted by close to 15 percent on a seasonally adjusted annualized basis."
Low income Asian countries have been hit by collapsing export commodity prices, especially Laos, Mongolia and Papua New Guinea. Lower demand for garments and aggressive price cuts had hurt countries like Bangladesh and Sri Lanka.
Falling agricultural prices were also hurting rural incomes.
High income countries have suffered from a collapse in demand for advanced manufactured goods. Hong Kong and Taiwan which were exporting goods for final assembly in China have been hit by a double whammy.
Suppliers to Japan of products such as auto parts also suffered the same fate, resulting in a downturn in intra-regional trade as well.
Recovery
Analysts say the only way to de-couple is to break exchange rate pegs and boost domestic consumption, by floating exchange rates up. Appreciating exchange rates, backed by a domestic anchor allows domestic consumption to go up.
"Although exchange rate appreciation may not be a realistic strategy at present as most Asian currencies are under pressure to depreciate, it may become so over the longer term," the IMF report said.
IMF research has shown that recovering from a downturn in which the banking sector is hurt is protracted and more painful.
"Minimizing the depth and duration of the current recession means essentially two things for Asia: preserving the stability of core banking systems, and putting less emphasis on an export recovery," IMF said.
"History suggests that cracks in the banking sector could worsen an already painful recession."
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