The paper examines fiscal sustainability in the middle income Arab countries by analysing three sets of information: (1) general government gross debt to GDP; (2) the fiscal balances to GDP and; and (3) the fiscal policy responses to debt, which assesses whether governments take corrective measures in adjusting their primary balances when the debt to GDP ratio starts rising or do they let it grow. A non-linear fiscal reaction function model and fiscal sustainability gap model are analysed to arrive at certain conclusions that are fairly robust. Evidences from the countries show strong fiscal sustainability concerns due to the deteriorating trends in both the debt to GDP ratio and fiscal balances to GDP ratio. The model results indicate to inadequate response of adjusting primary balances to growing debt and the conditions are extended to multiple years, which led to worsening fiscal sustainability situation across the countries.
The analysis of fiscal sustainability gap also shows the laxity of fiscal policy across the countries in addressing debt and fiscal sustainability challenges. However, the paper argues that introduction of fiscal policy reforms by cutting public expenditure from productive sectors and increasing taxes through indirect taxes would not be helpful in rebounding growth and bridging the development deficits and, thus, such measures wouldn’t help improving fiscal sustainability permanently. The governments need to consider alternative solutions through analysis of policy simulations. A well strategized debt-stabilizing public expenditure framework, rather than debt-reducing public expenditure framework, can be growth-enhancing. To this effect, appropriate tools with clear fiscal rules can be worked out to achieve the targets on fiscal balance and debt. Simultaneously, greater efforts should be put to mobilize tax revenues through improving tax compliance and fair taxation.