Enhancing fiscal frameworks and governance issues

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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

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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 challengesas highlighted in the November
  and April IMF Fiscal Monitors
• Advanced economies, L-T adjustment needs remain
  large
• spending on pensionsand especially, health
  careconstitutes 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

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Fiscal Outlook Advanced Countries-November 2010
IMF Fiscal Monitor (percent of GDP)
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Change in debt-to-GDP Ratios Advanced and
Emerging Economies 2006 - 2016
Source IMF Fiscal Monitor April 2011
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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?

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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 ratepublic 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

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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
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So what will be the impact on public finances?

• Initial post-crisis growth momentum looks to be
  slowing-both 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.

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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?

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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

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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.

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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

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What is medium-term budgeting and why is it
important?
What MTBFs Do How They Do It Who Benefits
1. Reinforce aggregate fiscal discipline presenting deferred effects of todays decisions imposing restrictions on future budgets Finance Ministers Taxpayers Future Generations
2. Facilitate a more strategic allocation of expenditure early reaction to future adverse developments abstracting from annual legal and administrative constraints provide an additional dimension in policy making Prime Ministers Line Ministers Parliamentarians
3. Encourage more efficient inter-temporal planning providing greater transparency and certainty to budget holders about their likely future resources Line Ministries Agencies Local Governments
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Key Pre-requisites in delivering Medium-term
budget Frameworks
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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
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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)

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Examples of Procedural FRLs
Country Fiscal Principles Statement Contents Sample Rules/Objectives
Australia Charter of Budget Honesty (1998) Keep debt at prudent levels Adequate national savings Moderate cyclical fluctuations Ensure stable tax system Regard to future generations LT fiscal objectives ST fiscal targets Budget priorities Stabilization measures Accounting basis Balance on ave over cycle Surpluses over forecast period No increase in tax burden from 1996-7 levels Improve net worth over M-LT
New Zealand Public Finance Act (1989) Keep debt at prudent levels Balance operating budget over reasonable period Maintain adequate net worth Prudently manage fiscal risks Ensure stable tax system LT fiscal objectives ST fiscal intentions S LT fiscal projections Assessment of consistency w/ principles Operating surplus on ave over cycle Keep net debt below 40 of GDP reduce to 30 by early 2020s 20 over the LT Net worth rising by early 2020s
United Kingdom Code for Fiscal Stablity (1998) Transparency Stability Responsibility Fairness Efficiency LT fiscal objectives Fiscal rules for Parliament ST econ fiscal outlook LT fiscal projections Analysis of cyclical impact Golden Rule Balance the current budget over the cycle Sustainable Investment Rule Keep debt below 40 of GDP
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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

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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
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Characteristics of good fiscal objectives/ rules
Characteristic Rationale Good Practice Bad 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
Comprehensive in scope 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