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Enhancing fiscal frameworks and governance issues Brian Olden IMF Regional Public Financial management Advisor “FISCAL CONSOLIDATION, POLICY FRAMEWORK AND GOVERNANCE” POLICY WORKSHOP UMAR/IMAD Fiscal Challenge: Where are we? • Still not out of the woods, but there are some good news • A better appreciation of the size of the problem • More attention to fiscal risks and long-term fiscal challenges—as highlighted in the November and April IMF Fiscal Monitors – Advanced economies, L-T adjustment needs remain large – spending on pensions—and especially, health care—constitutes a key challenge to fiscal sustainability – Challenges to reforms still considerable (i.e. Slovenian pension reform) • With the exception if Ireland, net cost of supporting financial institution less than expected 2 Fiscal Outlook Advanced Countries-November 2010 IMF Fiscal Monitor (percent of GDP) 2 0 -2 -4 -6 -8 Overall Balance -10 2000 2003 2006 2009 2012 2015 2006 2009 2012 2015 2006 2009 2012 2015 4 2 Cyclically Adjusted Primary Balance 0 -2 Primary Balance -4 -6 -8 2000 2003 120 110 Gross Government Debt 100 90 80 70 60 2000 2003 3 Change in debt-to-GDP Ratios: Advanced and Emerging Economies 2006 - 2016 120 100 80 60 40 20 0 2006 2007 2008 2009 2010 Average Source –IMF Fiscal Monitor April 2011 2011 Advanced 4 2012 2013 Emerging 2014 2015 2016 Market Indicators • Government financing needs remain exceptionally high in most advanced economies. • Financing needs remain more “moderate” among emerging economies including SEE but not by any means negligible • Yields and spreads have evolved favorably for emerging economies relative to advanced countries particularly peripheral Eurozone countries – With increased risk appetite and an associated search for yields, demand for emerging economy sovereign debt rose sharply, leading to shrinking emerging market spreads. – The changing perception of sovereign risk is also reflected in a divergence of CDS spreads between advanced and emerging economies • But will it last? Fiscal Risks for SEE economies • A less favorable interest rate-growth differential a key source of risk for emerging economies-including SEE. • Projected declines in debt ratios assumes a negative interest rate-growth differential, which offsets the continued primary deficit. • Less accommodating developments – possibly due to ongoing deterioration in public finances in advanced economies – Could lead to higher global interest rates and a lower growth rate— public debt ratios in emerging economies could start rising again. – Some criticism of over-optimistic forecasts authorities –growth, government revenues-by country has been noticeable (e.g. 2010 EC EFP evaluations) • Increased government guarantees to financial and real sector as response to the fiscal crises Is Living With Higher Debt an Option? • High debt may lead to higher interest rates. It will certainly lead to a higher interest bill • High debt levels are associated with lower investment and slower growth • They are also associated with higher macroeconomic volatility, perhaps because capacity to respond to future shocks is constrained • Implications of having so many high debt countries at once are uncertain, and market response may be sudden and decisive Source IMF Fiscal Monitor –May 2010 7 So what will be the impact on public finances? • Initial post-crisis growth momentum looks to be slowingboth in advanced and SEE countries. • Economic recovery will be gradual when growth resumes • Increased debt levels have reduced fiscal space-even for those with relatively low levels-needs to be restored over the medium-term • Financing options uncertain, both due to domestic banking) and external (competition for capital) factors. • Fiscal risks remain elevated due to continued uncertainty over financial and real sectors of the economy • Downside risks still high-contagion is still a worry if Eurozone sovereign debt crises exacerbates. Medium-Term Fiscal Consolidation Process • Strengthening fiscal institutions will be a key factor – Independent fiscal council-gaining in popularity in the CE and SEE region (Hungary, Slovenia, Romania) – Strengthening existing fiscal institutions • Need for medium-term fiscal consolidation strategy – Existing capacity to produce medium-term fiscal frameworks needs to be strengthened and augmented by realistic medium-term budget frameworks • General consensus that introduction of fiscal rules will help – Fiscal Responsibility Legislation? Strong budget institutions increase the probability of successful consolidation • Enable better understanding of the scale and scope of the fiscal challenge through – comprehensive, timely and credible reporting, – robust medium-term fiscal projections, – quantification of longer-term structural issues that raise sustainability concerns), and – disclosure and management of fiscal risks • Improves capacity to monitor and enforce fiscal discipline Strong budget institutions increase probability of successful fiscal consolidation • Assist with development of credible fiscal consolidation strategy through – Commitment to transparent medium-term fiscal objectives or rules. – Medium-term budget framework setting limits on medium-term spending commitments. • Improves capacity to Implement the consolidation strategy through the budget process. Increasing use of independent fiscal agencies (Fiscal Councils)- including SEE region • Fiscal Council objective to hold government accountable to meeting policy objectives and ensure the realism of underlying assumptions, forecasts and policies. • Role of Fiscal Councils differ -3 main models – Agencies that provide objective analysis of current fiscal developments, and costing of budgetary initiatives- e.g. Netherlands CBP. – Bodies that produce independent projections and forecasts regarding both the budgetary variables as well as the relevant macroeconomic variables -Romania, (Hungary until disbanded) – Institutions that, in addition to the above tasks, have the mandate to provide normative assessments, including on the appropriateness of fiscal policy stance US, Korea • But need to be realistic about what is achievable in low capacity environments. – Risk of shifting too many fiscal responsibilities to an independent council, usurping functions that are rightly the responsibility of the executive, and leaving substantial gaps in the MoF What is medium-term budgeting and why is it important? What MTBFs Do 1. Reinforce aggregate fiscal discipline 2. Facilitate a more strategic allocation of expenditure How They Do It presenting deferred effects of today’s decisions imposing restrictions on future budgets early reaction to future adverse developments abstracting from annual legal and administrative constraints provide an additional dimension in policy making Who Benefits Finance Ministers Taxpayers Future Generations Prime Ministers Line Ministers Parliamentarians Line Ministries 3. Encourage more efficient intertemporal planning providing greater transparency and certainty to budget holders about their likely future resources Agencies Local Governments 13 Key Pre-requisites in delivering Mediumterm budget Frameworks Political commitments • Discipline enforced by the minister of finance • Structured budget process • Requirement of ministry of finance approval of fiscal impact of new policies Operational commitments • Multi-annual commitments are necessary for operational efficiency … • … but central control is necessary to enforce discipline Extra-budgetary commitments • Events outside the budget can derail the implementation of the fiscal strategy • Effective discipline within the medium-term budget framework creates incentives to engage in transactions outside the framework • Control of off-budget spending, contingent liabilities and tax expenditure necessary 14 Fiscal Responsibility Legislation • What is an FRL? A law (or part of a law) with organic or “standing” status which aims to improve fiscal discipline by requiring governments to declare and commit to a monitorable fiscal policy strategy • Key features of FRLs – Fiscal Rules – Medium-Term Budget Framework – Top-down Budgeting mechanisms – Requirement for transparency in fiscal policy implementation – Sanctions for non-compliance – Escape clauses-to cater for unexpected macro-fiscal events. 1. Source Fiscal Rules: Anchoring Expectations for Sustainable Public Finance-IMF Board paper 2009 Fiscal Responsibility Legislation • However , in designing FRL need to be sure what weaknesses in fiscal policy-making is an FRL meant to solve? Cookie cutter approach is unlikely to work • Political commitment to implementation is crucial – Many examples of failed efforts. – Need for comprehensive exit strategies from crises may help to focus the effort – Increased usage in SEE countries (Romania, Serbia, Croatia) Examples of Procedural FRLs Country Australia Charter of Budget Honesty (1998) New Zealand Public Finance Act (1989) United Kingdom Code for Fiscal Stablity (1998) Fiscal Principles Statement Contents Sample Rules/Objectives • Keep debt at prudent levels • LT fiscal objectives • Balance on ave over cycle • Adequate national savings • ST fiscal targets • Surpluses over forecast period • Moderate cyclical fluctuations • Budget priorities • Ensure stable tax system • Stabilization measures • No increase in tax burden from 1996-7 levels • Regard to future generations • Accounting basis • Improve net worth over M-LT • LT fiscal objectives • Operating surplus on ave over cycle • Keep debt at prudent levels • Balance operating budget over reasonable period • ST fiscal intentions • Maintain adequate net worth • S & LT fiscal projections • Prudently manage fiscal risks • Assessment of consistency w/ principles • Ensure stable tax system • Transparency • LT fiscal objectives • Stability • Fiscal rules for Parliament • Responsibility • ST econ & fiscal outlook • Fairness • LT fiscal projections • Efficiency • Analysis of cyclical impact • Keep net debt below 40% of GDP & reduce to 30% by early 2020s & 20% over the LT • Net worth rising by early 2020s • Golden Rule: Balance the current budget over the cycle • Sustainable Investment Rule: Keep debt below 40% of GDP Fiscal Rules • Fiscal rules increasingly popular among advanced and emerging markets-By 2009 80 countries had fiscal rules in place1 • Seen as a key element in many countries consolidation strategies • Question as to appropriateness of different fiscal rule options – Procedural vs. Numerical – Revenue, Expenditure, Deficit, Debt • Successful fiscal rules need credibility to help deliver the required adjustment and put debt on a sustainable path. • Need to examine prerequisites needed prior to introduction of fiscal rules. – Important in countries with limited capacity and weak PFM systems Types of numerical Fiscal Rules Objective Type of Rules Country Example Debt Reduction Debt Brake Switzerland Debt Sustainability Debt Ceiling SGP Deficit Reduction Overall Balance SGP Countercyclical Policy Structural Balance Chile Reduce Expenditure Expenditure Ceiling Sweden Reduce Taxes Revenue Ceiling Denmark Protect Investment Golden Rule UK Characteristics of good fiscal objectives/ rules Characteristic Rationale Good Practice Medium-term horizon • Separate fiscal policy and budget decisions in time • Allow flexibility to deal with volatility or shocks • Over the cycle (UK) • Over the Parliament (NL) • Annual deficit ceiling • Debt reduction path • Limit scope for burden shifting or creative accounting • General govt (SGP) • Public sector (UK, NZ) • Budgetary Central Govt • Central Govt Binding on outturn • Reduce optimism bias in forecasts • Ensure deviations are made up in future • “Debt brake” rule (Swiss) • Maintain debt below 40% of GDP (UK) • Aim for balance over the forecast horizon • Real expenditure growth targets Stable over time • Build public support • Raise reputational cost of breaking the rule • Procedural FRLs (Aus, NZ) • Frequent amendments to numerical FRLs in LA Precise & transparent • Provide clear guide for policy-making • Facilitate evaluation of compliance • 1% surplus over the cycle (Sweden) • Increase net worth over time Comprehensive in scope Bad Practice