Download Fiscal Policy Through the Cycle: The Colombian Experience

XXIV MEETING OF THE LATIN AMERICAN NETWORK OF
CENTRAL BANKS AND FINANCE MINISTRIES
IAB Research Department – Regional Policy Dialogue
FISCAL POLICY THROUGH THE CYCLE: THE COLOMBIAN
EXPERIENCE
Ignacio Lozano and Jorge Toro
Banco de la República, Colombia
October 19/20, Washington, D.C.
CONTENTS
1. Business cycle and public finances in Colombia: An
historical review
2. Trends and Cycles in Colombian Fiscal Accounts
2.1 Methodology
2.2 Results
3. The Colombian fiscal stance through the real cycle
4. Current fiscal stance and prospects
Real Business Cycles (RBC) in Colombia
The Colombian economy has exhibited at least two large RBC during the last thirty years
• The 1st cycle started in 1978 with a boom-phase which lasted about 4 years That
economic expansion was closely related to high external coffee prices
• Subsequently, the economy entered a low-growth-phase between 1982 and 1985
(common for all LAC). It was related to a decline of external commodities prices, the
slowdown of world demand and the debt crises in LAC
• The 2th cycle began at the late 80´s The boom-phase spanned from the late 80´s to the
mid 90´s (more irregular). Capital Inflows stimulated by structural reforms and an
expansionary fiscal policy played a key role.
• The last and deepest crises took place by the end of the 90´s (growth rate of -4,2% in
1999). After a lengthy recovery, the economy is currently expanding again at a rapid rate.
Fiscal balance has been closely related to GDP performance
1. Business cycle in Colombia: 1977-2005
4%
1st Crisis
2th Crisis
2%
20.000
18.000
0%
16.000
-2%
14.000
-4%
12.000
-6%
10.000
8.000
-8%
77
78
79
80
82
83
84
85
87
GAP
88
89
90
92
GDP
93
94
95
97
98
99
Trend GDP
00
02
03
04
05
GDP -GAP
GDP -Billions of Colombian Pesos ( 1994=100)
22.000
The Fiscal balance is closely associated to GDP performance
GAP (Above) and Fiscal Balance (Below)
3%
1st Crisis
2%
2th Crisis
1%
% GDP
0%
-1%
-2%
-3%
-4%
-5%
-6%
77
78
79
80
82
83
84
85
87
88
89
90
92
93
94
95
97
98
99
00
02
03
04
05
0
(% GDP)
-2
-4
-6
NFPS
C-Government
-8
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
And the fiscal balance is directly related to the Debt Ratio
Fiscal Balance (Above) and Debt Ratio (Below)
0
1st Crisis
2th Crisis
(% GDP)
-2
-4
-6
NFPS
C-Government
-8
60
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
96
97
98
99
00
01
02
03
04
05
55
50
45
(% GDP)
40
Government Debt
35
30
25
20
15
10
5
0
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
Comments
• 1st Crisis-Phase: The deficit of the Non-financial public sector (NFPS)
reached 7,6% of GDP in 1982-83. Half of this deficit was explained by the
Central Government. Three years later, the deficit was adjusted thanks to an
effective economic program. By 1986 the public deficit was only 1,2% of GDP
and Government debt reached 18,4% of GDP
• 2th Crisis-Phase: The NFPS reached a deficit of 6,4% of the GDP in 1999,
due entirely to imbalance of the central government. Government debt attained
a critical level of 54% of GDP in 2002. The government is currently facing
additional challenges because of the narrow margins of its expenditure policy.
• Even though the balance of the NFPS improved markedly in the last two
years, the central government fiscal position is still highly imbalanced.
2. Trends and Cycles in Fiscal Accounts:
Methodology (Traditional Approach)
Tax Revenue: For t, the actual-tax-revenue (Ta ) has two components: structural (Ts) and
cyclical (Tc). Hence,
Tt c  Tt a  Tt s
The structural-component could be estimated using actual (Ya) and Potential output (Yp)
Tt s
 Yt p
a
 Tt *  a
 Yt
T , Y



 T Y represents output-tax-elasticity. According to Blanchard & Perotti (1999), the output-taxi i
elasticity could be calculated as:
n
T ,Y  Ti , Bi * Bi ,Y *
i 1
Ti
T
where  Ti Bi = elasticity of taxes of type i to their tax base; TiY= elasticity of the tax base to
GDP, and T   T.i Trade taxes are adjusted for an exchange factor.
i
Oil Revenue: Profits obtained by Ecopetrol in t are transferred in t+1 to central government. One
fraction of actual profits arise from domestic sales of gasoline ( DPt a ), and the other one from
a
external sales of petroleum ( EPt ).

p


Y
s
a
t 1
DPt  DPt *  a 
 Yt 1 
P
EPt  EPt * 
P
s
a
S
LT
t 1
a
t 1




Structural component DPt is achieved using potential output while EPt S is attained with a
long term external price of oil.
Expenditures (two items are adjusted):
• Regional Transfers (Between 1994-2001, Law 60/93)
• Interests Payments ( Domestic and External)
Outcomes-Elasticities
Tax-Revenue to Base
Base to Output
Total
…
…
1,47
Income Tax
1,11
(0,27)
1,06
(0,06)
1,18
Value Added Tax
2,26
(0,23)
0,91
(0,02)
2,06
Trade Tax
1,00
(0,10)
1,46
(0,07)
1,46
Other Taxes*
…
…
1,00
Oil Revenue
…
…
1,68
Domestic
…
…
1,85
(0,85)
Foreign
…
…
1,43
(0,39)
…
1,47
Revenues
Total Tax Revenue
Primary Expenditures
Transfers
…
Estimates were computed using GLS. Standard Errors appear in parentheses. All estimated elasticities are
significative at the 5 percent level.
Data: 1970-2005
Comments
• Relatively high responses of tax revenues to output. In a range from 1,18 for
income-tax to 2,06 for value added-tax.
• The aggregate tax elasticity with respect to output amounts to 1,47
• The parameters are similar to those found in international evidence: The
income tax to GDP elasticity is, on average, 1,3 for OECD; 1,5 for the Euro
area and 1,1 for new EU members (Girouard and André 2005).
• For domestic tax components: tax-revenues response to their bases are
more sensitive than its corresponding tax-base response to GDP, and
conversely for external taxes.
• Using these elasticities, we find the cyclical and structural components of
revenues and expenditures. Subsequently, we also find the cyclically adjusted
balance.
Cyclical and Structural Components of Revenues
(Percentage of GDP)
(c) Income Tax
(d) Value Added Tax
7
1,0
6
0,8
5
1,0
0,8
4
5
0,6
4
0,4
3
0,2
2
0,0
0,6
3
0,4
0,2
2
0,0
1
1
-0,2
0
-0,4
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
-0,2
0
05
-0,4
90
91
92
93
94
95
(e) Trade Taxes
96
97
98
99
00
01
02
03
04
05
(f) Oil Revenues
4
2,0
0,6
1,5
0,5
3
1,0
2
0,2
0,2
0,4
0,3
0,1
0,2
0,1
0,5
0,0
0,1
1
-0,5
0
-1,0
90
91
92
93
94
95
96
97
98
99
00
01
Actually
02
03
04
0,0
0,0
-0,1
05
-0,1
90
Structural
91
92
93
94
95
96
97
Cyclical
98
99
00
01
02
03
04
05
Cyclical and Structural Components of the Expenditures
(Percentage of GDP)
(c) Regional Transfers
(d) Total Interest Payments
6
1,0
0,8
5
6
2,0
5
1,5
0,6
4
0,4
1,0
4
0,5
3
0,2
3
0,0
0,0
2
2
-0,5
-0,2
1
-0,4
0
-0,6
90
91
92
93
94
95
96
97
98
99
00
1
-1,0
0
01
-1,5
90
91
92
93
(e) Domestic Interest Payments
94
95
96
97
98
99
00
01
02
03
04
05
(f) External Interest Payments
4
1,0
2,5
0,5
2,0
1,0
0,8
3
0,6
0,0
0,4
1,5
2
0,2
-0,5
1,0
0,0
1
-1,0
-0,2
0,5
-0,4
0
-1,5
90
91
92
93
94
95
96
97
98
99
00
01
Actually
02
03
04
0,0
05
-0,6
90
Structural
91
92
93
94
95
96
97
Cyclical
98
99
00
01
02
03
04
05
Cyclically-adjusted budget balance
Central Government –Percentage of GDP
2
Cyclical Component
1
0
(a) Total
Balance
-1
-2
-3
-4
Current Balance
-5
-6
-7
Structural Balance
-8
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
2
1
Cyclical Component
(b) Primary
Balance
0
-1
-2
Current Balance
-3
Structural Balance
-4
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
Comments
• The evidence shows that the deficit of the central government in Colombia
basically has a structural character.
• In times of the deepest recession (1998-1999), the cyclical deficit amounted
to -1% of the GDP, equivalent to 15% of the actual deficit (-6,7% of the GDP).
• Recently (2005), when the economy returned to historical growth rates (5%),
the cyclical component amounted to +0,8% of the GDP, which corresponds to
15% of the actual fiscal disequilibrium (- 5,3% of the GDP).
• The structural nature of the government fiscal deficit had been widely
recognized by analysts and policymakers. This feature of the government
finances has motivated a set of fiscal reforms, in particular since the end of the
nineties: tax-reforms; regional-transfers-reform; pension-reforms; Statereforms; etc
3. Colombia´s fiscal stance through the cycle:
Methodology
Estimating Fiscal Policy Reaction in Colombia (Traditional approach: Manesse,
IMFWP- 2006; Alesina & Tabellini BU-WP 2005; Alfonso ECB-WP-2005, etc)
S t  a0  a1Gapt 1  a2 Debt t 1  a3 S t 1  ut
S = Primary (or total) surplus, in percent of GDP
Gap = output gap
Debt = debt-GDP ratio
a1<0 is evidence of pro-cyclical policy. Primary balance-to-GDP ratio falls when
the output increases relatively to potential output
If a2 > 0, government tries to increase its primary balance as a reaction to the
existing stock of public debt and then comply with the budget constraint. It could
be seen as a sign of a Ricardian-fiscal-regime
Estimating Fiscal Policy Reaction, 1960-2005
Dependent Variable
Primary Balance
Total Balance
Estimated Coefficients
Constant
0.42 **
(0.23)
0.50 **
(0.25)
GAP
t-1
-0.20 *
(0.06)
-0.10 **
(0.05)
Debt
t-1
-0.02 *
(0.01)
-0.05 *
(0.02)
Primary Balance
Total Balance
t-1
t-1
R-squared
Adjusted R-squared
0.64 *
(0.09)
…
…
0.77
0.73
…
…
0.65 *
(0.09)
0.94
0.93
Note: Estimates were computed using OLS. Standard errors appear in parentheses. * = significance at 5%
and ** = significance at 10%
Comments
• The coefficient a1, is significant and negative implying that fiscal policy in
Colombia has been pro-cyclical for the last 45 years or so, with the primary
surplus falling (and the deficit rising) by approximately 1/5th of a percentage
point when the output gap improved by one percentage point
•Coefficient a1 falls from 1/5 (for primary balance equation) to 1/10 (for total
balance equation), which means that interest payment “smooth out” or
“compensate” the pro-cyclicality policy stance.
• The interest payments role is not surprising because in bad times, when
financial markets are more restricted, the indebtedness cost rise increasing
public spending (via higher spreads on public bonds, depreciation of
exchange-rate and so on). In good times, the opposite takes place.
Comments
• Regarding a2, they are significant and negative in both cases. When a2 >0,
government tries to increase its primary balance in order to react to the
existing stock of public debt and comply with the budget constraint. We don´t
find evidence to support this behavior for C-Government in Colombia.
• Our fiscal pro-cyclicality results confirm the findings of other studies in
Colombia. Using various fiscal impulses definitions, Lozano and Aristizabal
(2003) found that fiscal policy was pro-cyclical between1991 and 2002. For a
longer period (1881-2005) and using also fiscal impulses technique, Cárdenas
et. al. (2006) found the same pro-cyclical results
4. Current fiscal stance and prospects
6,0
4,7
Decentralized Sector
Forecast
3,6
4,0
3,3
3,1
2,2
2,0
0,0
-0,4
-2,0
-2,0
-2,1
-2,3
NFPS
-3,6
-4,0
-6,0
-5,7
-5,1
-5,3
-5,3
-5,7
Central Government
-8,0
2003
2004
2005
2006
2007
Comments
• As a result of economic recovery, high international oil prices, tax reforms and fiscal
tightening at local and regional levels, the NFPS deficit narrowed to 0,4% of GDP in
2005 (0% including quasi-fiscal operations)
• This fiscal outcome in 2005 was much better than expected and than the results in
2004 and 2003 ( 2,1% and 3,6%, respectively). The C-Government deficit widened
to 5.1% of GDP and this was offset by a surplus in the decentralized sector
•The current administration has made progress on structural reforms and fiscal
adjustment. However, 2005 fiscal outcome was influenced by exceptional factors
• The government has made a preliminary commitment to narrow the fiscal deficit to
2% of GDP in 2006 (for NFPS). However, for 2007, the budget includes an spending
plan of Col$117,6 billons, a 7% increase in real terms compared to 2006, and targets
a NFPS deficit of up to 2,3% of GDP.
Understanding Fiscal Balance in 2005:
Initial
Projection
Consolidated Fiscal Balance
(Including quasi-fiscal balance
Percentage of GDP)
-2,4
Outcome Difference
0,0
2,4
Explaining better fiscal balance in 2005
Item
Initial
Projection
Outcome Effect (as percentage of GDP) :
Real GDP Growth
4,0
5,1
Growth of Imports
18,4
26,8
Exchange Rate -Nominal Appreciation
Yield Bonds - TES*
0,4
12,1
Higher Government Tax Revenue
0,7
11,7 Lower external interest payment
0,1
Lower domestic interest payments -By Placement9,2 Bond-Primium
Portfolio Valorization - Social Security Funds
WTI Price (US$/b)
* Average yield rate in 2004 vs. 2005
37,0
56,3 Higher Ecopetrol Surplus
0,6
0,3
0,5
Comments
• Official preliminary predictions pointed out to a consolidated fiscal deficit of
2,4% of GDP in 2005 (including quasi-fiscal operations). The actual result was
a fiscal equilibrium.
• This outcome was influenced by exceptional factors, such as higher than
expected world oil prices and the accounting treatment of interest government
expenses
• In addition, economic growth –above expectations– together with favorable
external conditions also helped to obtain a fiscal equilibrium.
•We quantify each of these factors. Notice that better than expected GDP
growth rate increased tax revenue in 0,7% of GDP. This outcome is roughly
consistent with what we showed in section 2 (cyclical budget in 2005)
Conclusions
• Like in other economies, fiscal balance in Colombia has been closely related
to GDP performance
• We found relatively high responses of tax revenues to output. The aggregate-taxelasticity with respect to output is 1,47 (similar value to those found in international
evidence)
• The evidence shows that the deficit of the central government in Colombia basically
has a structural character (the cyclical component amounted 15% of the actual deficit)
• Fiscal policy in Colombia has been pro-cyclical in the last four decades, with the
primary surplus falling (and the deficit rising) by approximately 1/5th of a percentage
point when the output gap improved by one percentage point.
• The fiscal outcome in 2005 was much better than expected and the outcomes in
2004 and 2003 ( 2,1% and 3,6%, respectively). However, that was influenced by
exceptional factors
Conclusions
• The higher than expected world oil prices; the accounting treatment of interest
government expenses; economic performance –which surpassed expectations– as
well as a favorable macroeconomic environment; helped to obtain equilibrium in public
finances
• The government has made a preliminary commitment to narrow the fiscal deficit to
2% of GDP in 2006 (for NFPS). Nonetheless, for 2007, the budget entails spending
plans of Col$117,6 billons, a 7% real rise compared to the 2006 budget, and targets a
NFPS deficit of 2,3% of GDP