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Grading Fiscal Policy in the Last Decade Eduardo Fernández-Arias Research Department Regional Seminar on Fiscal Policy ECLAC Santiago de Chile, March 2013 http://www.iadb.org The opinions expressed in this presentation are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent. The unauthorized commercial use of Bank documents is prohibited and may be punishable under the Bank's policies and/or applicable laws. Copyright © [Type year of first publication] Inter-American Development Bank. All rights reserved; may be freely reproduced for any non-commercial purpose. GRADING FISCAL POLICY OVER THE DECADE OUTLINE I. OVERALL, SATISFACTORY FISCAL REVENUE MANAGEMENT OVER THE DECADE… II. ….BUT HEALTHY FISCAL SPENDING STANCE DETERIORATED AFTER GLOBAL CRISIS III. HOW TO IMPROVE THE CURRENT “B” GRADE TO AN “A” GRADE INSTEAD OF RISKING IT FALLING TO AN “F” GRADE? I. SATISFACTORY FISCAL REVENUE MANAGEMENT OVER THE DECADE Estimation methods for structural and temporary fiscal revenues • Temporary revenue is the sum of temporary: GDP-linked revenue (tax on output gap) and Commodity-linked revenue (temporary price effect) • GDP-linked based on: – Trend or Structural GDP (HP filter, real time) • Commodity-linked based on: – HP-filtered commodity revenues (like Chile) – Trend or Structural Prices (5-year real-time forecast prices) (MORE LATER) Assessing prudent fiscal revenue management (1) • KEY QUESTION FOR CYCLICAL REVENUE: To what extent are temporary revenues saved or spent? • More specifically, to what degree does spending move with temporary revenues: – In good times (TR>0) – In bad times (TR<0) • KEY QUESTION FOR STRUCTURAL REVENUE: To what extent are structural revenues spent? Assessing prudent fiscal revenue management (2) • Prudent/sustainable management of cyclical revenue requires symmetry: spending out of TR equal (or lower) in good times. • Efficient management would further require zero spending out of TR (cyclically stable spending). • Prudent/sustainable management of (increasing) structural revenue requires unitary (or fractional) marginal spending impact. Revenues and Spending over a decade: comovements difficult to assess visually 1) For TR, favorable symmetry and low spending leakage; 2) For SR, some savings margin The special case of commodity exporting countries experiencing massive changes in structural and temporary revenues is also satisfactory Commodity revenues are large and volatile; structural rose by 40% while temporary fell! Commodity Linked Revenues 12 3 11 2.5 10 2 9 1.5 8 7 1 6 0.5 5 0 4 -0.5 3 -1 2 Structural Total Temporary Source: LMW, Author's calculations. 2011q2 2011q1 2010q4 2010q3 2010q2 2010q1 2009q4 2009q3 2009q2 2009q1 2008q4 -2 2008q3 0 2008q2 -1.5 2008q1 1 2007q4 Total and Structural Revenues (% of Structural GDP) Typical LAC Commodity Exporter Spending reaction difficult to assess visually… …but regression confirms overall satisfactory findings for this grouping (LAC-CM) II. HEALTHY FISCAL SPENDING STANCE DETERIORATED AFTER THE GLOBAL CRISIS Prudent/sustainable fiscal policy also depends on prudent autonomous spending policy • Increasing underlying autonomous spending trends (unrelated to revenues) may over time lead to fiscal unsustainability • Even if trends are not dynamically unfavorable, underlying autonomous spending levels may be already too high for fiscal sustainability • Basic measure: level and trend of structural balance (leaving out temporary revenues from observed balance). Split regression suggests a substantial regime change in autonomous spending after 2007 (jump in intercepts) Time series show improving structural balance and then a strong countercylical response to Global Crisis that lingers on Better sustainability measure: Neutral structural balance (adjusting for temporary revenue impact to estimate structural balance at zero TR) Interestingly, commodity exporters exhibit better structural balance trends… …but similarly worrisome neutral structural balance trends Current level of spending may be unsustainable • Fiscal sustainability analysis based on observed and required structural primary balance presented last year indicated that: • Current sustainability uniformly lower than prior to Global Crisis • Many countries with measurable unsustainability risk (required structural adjustment gap above 1 % of GDP) III. HOW TO IMPROVE THE CURRENT “B” GRADE TO AN “A” GRADE INSTEAD OF RISKING IT FALLING TO AN “F” GRADE Spending expansion holds and continues today Primary Expenditure (% of Potential GDP) 31.00% 29.00% 27.00% 25.00% 23.00% 21.00% Typical LAC Typical Commodity Exporter Source: LMW, IMF (WEO), Ministries of Finance and Authors' Calculations. Incomplete retirement of successful countercyclical package in Global Recession as recovery took hold may lead to an “F” grade • Low sustainability assessment based on current SB is optimistic in that it implicitly assumes that negative regime change is a one-off shock • It may be more realistic for markets to infer that recent SB deterioration reveals a pattern of ratcheting up expansion, dynamically unsustainable • Extraordinary low levels of world interest rates and consequently low spreads and yields may be hiding it for now. For commodity exporters, current trends and future uncertainties entail special risks: • Commodity prices are highly volatile and fiscal revenues are dependent on them; no room for error • Commodity prices expected to fall over the next 5 years according to WEO (20% real terms) • Decade average is some 25% below current price (prudent structural forecast in the spirit of Chile’s) • Estimation of structural prices is unreliable, a strong reason for caution • Non-renewability is another reason for structural revenue risk 2002-Dec 2003-Mar 2003-Jun 2003-Sep 2003-Dec 2004-Mar 2004-Jun 2004-Sep 2004-Dec 2005-Mar 2005-Jun 2005-Sep 2005-Dec 2006-Mar 2006-Jun 2006-Sep 2006-Dec 2007-Mar 2007-Jun 2007-Sep 2007-Dec 2008-Mar 2008-Jun 2008-Sep 2008-Dec 2009-Mar 2009-Jun 2009-Sep 2009-Dec 2010-Mar 2010-Jun 2010-Sep 2010-Dec 2011-Mar 2011-Jun 2011-Sep 2011-Dec 2012-Mar 2012-Jun 2012-Sep 2012-Dec Comm Price Index (2005=100) 150 29.00% 130 27.00% 110 25.00% 90 23.00% 70 50 21.00% Comm Price Index Source: LMW, IMF (WEO), Ministries of Finance and Authors' Calculations. Fiscal Revenues Fiscal Revenues (% of Potential GDP) Real Commodity Prices and Fiscal Revenues Typical Commodity Exporter 190 31.00% 170 Real Commodity Price Index (2005=100) For Typical Commodity Exporter 180 170 160 150 140 130 120 2012 2013 Source: IMF (WEO Projections) and Authors' Calculations. 2014 2015 2016 2017 2000-Mar 2000-Jun 2000-Sep 2000-Dec 2001-Mar 2001-Jun 2001-Sep 2001-Dec 2002-Mar 2002-Jun 2002-Sep 2002-Dec 2003-Mar 2003-Jun 2003-Sep 2003-Dec 2004-Mar 2004-Jun 2004-Sep 2004-Dec 2005-Mar 2005-Jun 2005-Sep 2005-Dec 2006-Mar 2006-Jun 2006-Sep 2006-Dec 2007-Mar 2007-Jun 2007-Sep 2007-Dec 2008-Mar 2008-Jun 2008-Sep 2008-Dec 2009-Mar 2009-Jun 2009-Sep 2009-Dec 2010-Mar 2010-Jun 2010-Sep 2010-Dec 2011-Mar 2011-Jun 2011-Sep 2011-Dec 2012-Mar 2012-Jun 2012-Sep 2012-Dec Real Commodity Prices Index (2005=100) - Fiscal Shares For Typical Commodity Exporter 190 170 150 130 110 90 70 50 30 Comm Price Index Source: IMF and Author's Calculations 10-year MA Estimated Impact in Total Revenues as % of Potential GDP as result of a 25% decline in Real Commodity Prices Ecuador Bolivia Trinidad and Tobago Venezuela Mexico Chile Peru Argentina Colombia -4.50% -4.00% -3.50% -3.00% -2.50% Source: Ministries of Finance and Authors' Calculations. -2.00% -1.50% -1.00% -0.50% 0.00% A fiscal agenda towards an “A” grade (while preparing for action given low growth prospects and global downside risks): • First and foremost, normalize fiscal structural balance where needed as soon as practical • Credibly establish fiscal framework under principles of sound structural budget objectives and the use of (self-reversed) automatic stabilizers • Prepare fiscal measures and projects that are fast to launch, have high multiplier effect, are temporary or easily reversible, economize in fiscal space. Infrastructure maintenance and investment may fill these requirements.