This chapter concludes the analysis in this book with an agenda for moving the region forward, drawing on the discussions of preceding chapters and the accompanying empirical analyses. While a survey of current policies through the Caribbean suggests that there is plenty of work yet to do on the fiscal sustainability agenda, the lack of an economic recovery in the presence of high debt for many countries calls for action. While each country will need to tailor its specific strategy, we outline below some key elements that should be part of any medium-term framework that countries in the region may consider adopting. Already, some countries are responding to the need for action by independently selecting some elements of the menu proposed in this book and putting them in place to meet their debt reduction targets. These include some difficult and complex new institutional arrangements, such as Jamaica’s proposals for implementing a new fiscal rule.
Highly indebted Caribbean countries should generally aim to lower their debt levels in order to reduce vulnerability and create a better platform for growth. The challenge in a low-growth environment is how to achieve the required debt reduction. The analyses in the previous chapters suggest that by consolidating government finances and improving primary balances, countries could signal their determination to address debt overhang, implying that they intend not to default or inflate their debt away. This achievement would help improve their creditworthiness and reduce borrowing costs in the long run.
This book argues, however, that fiscal consolidation may not be enough to bring down the region’s high debt levels, since high primary surpluses need to be run over a long period of time. The region therefore needs a comprehensive and sustained package of reforms to reduce its debt ratios to more manageable levels and to strengthen economic resilience. Reforms should signal a new commitment to credible and sound macroeconomic policies and should include tax policy reforms, public sector rationalization, measures to improve fiscal discipline and credibility, active debt management, the containment of contingent liabilities, active privatization programs or public enterprise reforms, and structural reforms to boost growth and improve competitiveness.
Restarting the Fiscal Consolidation Agenda
Fiscal Consolidation Is Inevitable in the Caribbean
Fiscal consolidation is inevitable in the Caribbean region, so the policy question that Caribbean governments must address is this: What is the most appropriate route to follow in the current environment, given that the need to reduce debt comes in a difficult environment of weak growth? These countries can draw lessons from successful fiscal consolidation efforts in other regions to guide their fiscal consolidation efforts.
Based on a survey of country experiences, expenditure-based consolidations with a focus on reducing current spending tend to be more successful than tax-based consolidations (Alesina and Perotti, 1997). However, for countries with large adjustment needs (such as Caribbean countries), fiscal consolidation may need to be a balanced combination of spending cuts and revenue increases (Baldacci, Gupta, Mulas-Granados, 2010). The composition of spending reductions has also been found to be important. Cuts in the wage bill and in transfer spending address budget categories viewed as politically sensitive and enhance the credibility of the adjustment efforts (Alesina and Ardagna, 2009). On the other hand, cuts in capital spending can have a direct negative impact on growth and carry little credibility if markets perceive them as merely postponing needed outlays. Revenue-based consolidations have been found to be associated with less favorable macroeconomic outcomes, and they bring a higher risk of reversal.
International experience and evidence point to the need to address the Caribbean’s fiscal consolidation needs mainly from the expenditure side. Given the already sizable public sector, most of the fiscal consolidation would have to be done by restraining spending (Egert, 2011). Better control of the wage bill, increased efficiency in the public sector, and reductions in transfer spending are obvious targets to reduce spending. The ratio of wage spending to GDP is higher in the Caribbean than in Latin America, limiting budget flexibility. Reducing the public sector wage bill could be achieved by a freeze on nominal wages. In addition to reducing the public payroll, improving public sector efficiency could help reduce government spending. The Caribbean has one of the largest public sectors among emerging markets. It is essential to introduce performance management in the budgeting process and to systematically review the efficiencies of public policies.
In particular, we propose a reduction in low-priority spending to facilitate fiscal adjustment, because it lowers the pressure on nondiscretionary spending and limits the momentum of public spending growth. Caribbean countries could achieve the benefits of fiscal consolidation with lower social costs by focusing on expenditure reforms within the context of a medium-term fiscal framework. Implementing ambitious expenditure reforms signals strong government commitment to fiscal sustainability. Social expenditures and subsidies also need to be properly targeted.
The Quality of Past Fiscal Consolidations in the Caribbean Is Questionable
Previous fiscal consolidation episodes were characterized mainly by cuts in capital expenditure, which created infrastructure gaps inimical to growth and hence compromising the achievement of debt sustainability. Country experiences show that reducing public spending in a comprehensive reform program by focusing on nonproductive and nonpriority spending, particularly transfers, subsidies, and general goods and services, is likely to ensure success in the Caribbean. The empirical literature finds that in several successful fiscal consolidation episodes in other regions, spending cuts adopted to reduce deficits were associated with economic expansions rather than recessions (Alesina and Perotti, 1997).
Raising Additional Revenues
To raise revenues, there is significant potential in reducing tax expenditure, eliminating distortions and broadening the tax base. There is scope in many countries to improve the collection of property taxes, which are usually considered the least distorting of major taxes. Broadening the value added tax (VAT) base would also improve the tax structure. In the Caribbean, the average effective rate of VAT, computed as the ratio of VAT revenues to private consumption, is lower than the rate in most advanced economies, indicating the existence of reduced rates and exemptions in the tax system. Tax expenditures (currently estimated at between 4–6 percent of GDP in Barbados and Jamaica) also need to be reduced significantly to make room for phased reductions in the statutory rates of the main taxes. In the fiscal adjustment process, raising taxes should be considered only after careful consideration in order to minimize economic distortions and promote economic efficiency, given that taxes in the region are already high.
Designing and Implementing a Fiscal Consolidation Plan: A Checklist
The IMF’s Fiscal Affairs Department has outlined a number of questions on a checklist to follow when designing and implementing a fiscal adjustment plan:
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Does the proposed adjustment deliver a credible change in debt dynamics?
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Is the size and pace of adjustment appropriate in light of macroeconomic conditions, political considerations, and the need to avoid reform fatigue?
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Are financing constraints taken into consideration?
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Is the operational target for the fiscal consolidation path well defined and well understood? Does it have adequate institutional coverage?
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Does the composition of adjustment take into consideration the size of the public sector?
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Are high-quality measures chosen for the adjustment?
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Are targets met without shifting items off balance sheet?
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Are external factors (if they exist) leveraged to the fullest?
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Are supporting institutional and structural reforms in place?
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Are public enterprises appropriately covered and do subnational levels of government contribute to the adjustment?
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Are distributional effects of the adjustment taken into account?
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Is the adjustment strategy appropriately communicated so as to mobilize broad-based political and public support?
Protection for the Vulnerable
To be credible, any successful consolidation strategy needs to provide a social safety net. In doing so, social safety nets and well-targeted programs need to be enhanced while reducing or eliminating general subsidies. Targeting subsidies and transfers would also help improve the overall efficiency of non-productive spending. International experiences offer a number of key lessons for protecting the poor during the fiscal consolidation process (Braithwaite, Jyotsna, Subbarao, 1995), including these three:
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Social safety nets needs to be designed as an integral part of the overall package of economic reforms rather than as add-ons during the adjustment process;
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The instrument for protecting the poor should build on and complement existing programs; and
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The range of programs and benefits needs to be controlled and the targeting must be effective in order to avoid adverse effects on work incentives and the crowding-out of private transfers.
Credibility Is Key to a Successful Fiscal Consolidation Strategy
Country experiences suggests that support for growth is essential to cope with the contractionary effects of fiscal consolidation, so policies need to stress the removal of underlying structural problems within the economy. Since debt reduction takes time, fiscal consolidation should focus on enduring structural changes. In this regard, strengthening fiscal institutions is essential (IMF, 2012).
Fiscal consolidation in the Caribbean needs to be credible in order to anchor market expectations about fiscal sustainability (Baldacci, Gupta, and Mulas-Granados, 2010). Governments in the region need to demonstrate that the debt burden is manageable and that strong fiscal policies are likely to continue under most situations. Developing this credibility requires not only the implementation of fiscal reforms but also a record of strong implementation of effective reforms in both good and bad times (IMF, 2003). It is essential to strengthen the fiscal framework by adopting fiscal rules and independent fiscal agencies to guide the budget process and improve fiscal transparency.
Fiscal Rules Could Enhance the Credibility of Fiscal Policy in the Caribbean
Mechanisms such as fiscal rules can increase the discipline and credibility of fiscal policy while helping to reduce debt, if appropriately designed and implemented. They are also useful in securing the gains of fiscal consolidation. Empirical evidence (as discussed in Chapter 11) shows that fiscal rules, in particular those that have an expenditure focus, have affected several dimensions of fiscal consolidation. The size of fiscal consolidation has been significantly larger and the consolidation efforts have been sustained longer when such rules were present (Kumar, Leigh, and Plekhanov, 2007).
Multiple Rules Are Helpful in Stabilizing Debt
The adoption of a spending rule on top of a budget balance rule helps in the achievement and maintenance of a primary balance that is sufficient to stabilize the debt-to-GDP ratio. Caribbean countries could create a stable general fiscal rule to strengthen current fiscal frameworks by defining the rule in terms of primary deficit for the general government, which could take the form of expenditure ceilings and revenue floors. It is also essential to support the fiscal rule by creating an independent fiscal council to assess macroeconomic projections underlying the budgeting process and assess the compatibility of the fiscal framework with fiscal rules and general government policies.
It is important to stress that fiscal rules do not solve fiscal problems such as determining the appropriate level of expenditure or taxes. A comprehensive fiscal strategy needs to focus on the short- and medium-term evolution of fiscal policy as well as the longer-term development strategies (Carenas and Tessada, 2011). Policies and initiatives aimed at reducing tax evasion and improving the efficiency of the public sector should remain essential components of a comprehensive strategy to improve fiscal capacity and performance.
Fiscal Consolidation Is Necessary But Not Sufficient for Debt Reduction
Fiscal consolidation is necessary, but it may not be sufficient to bring down debt levels, since high primary surpluses would have to be maintained over a relatively long period to have a lasting impact on debt. The very highly indebted Caribbean countries would also need to reduce the net present value of their outstanding debt stock to levels that provide fiscal space and room for countries to resume their growth. Past episodes of large debt reductions in Caribbean countries were largely associated with debt relief (Box 12.2). Further initiatives to secure additional debt relief would need to take into account the size and structure of public debt. Accordingly, a menu approach is proposed, one in which different options to reduce the existing debt stock or debt service payments can be chosen by individual countries depending on their circumstances. Among the options to be considered should be debt conversion for climate adaptation and debt restructuring.
Debt Relief Received by Caribbean Economies Since 2000
Since 2000, a number of Caribbean countries have received debt relief. These have involved a combination of debt write-offs, debt restructuring, debt swaps, and debt buy-backs. These operations have taken place at different times and have benefited different countries.
Debt write-offs. Three countries have benefitted from debt write-offs during the 2000s. In particular, in the early 2000s, Guyana received additional debt relief under the enhanced Heavily Indebted Poor Countries Initiative and the Multilateral Debt Relief Initiative, including from the IMF. In 2004, Jamaica received some debt relief from the United Kingdom under the Commonwealth Debt Initiative. In 2007, both Antigua and Barbuda and St. Vincent and the Grenadines (US$56 million) benefited from an Italian debt write-off initiative.
Debt restructuring. Debt restructuring has been the most frequently used form of debt relief in the Caribbean. Five countries restructured their debts in the 2000s. In the early 2000s, Suriname successfully restructured a number of its external loans. In 2004, Dominica restructured its public debt, in the context of an IMF program, reducing its interest rates to 3.5 percent from 8 percent. Grenada also restructured its debts in 2004–05, amid extensive infrastructure destruction caused by hurricane Ivan. In 2007, Belize restructured its external debts, which provided front-loaded interest payment relief, and postponed amortization payments until 2019. In 2010, Antigua and Barbuda also received debt relief from its Paris Club creditors, which agreed (under the baseline accord) to suspend accumulating penalties and interest charges and postponed amortization until 2017. Also in 2010, Jamaica launched a comprehensive debt exchange to address its looming debt problem. The objective of the debt exchange was to enable the government to reduce its interest bill and expand the maturity profile of the debt stock. Jamaica repeated its domestic debt restructuring in 2013, achieving a reduction in its public-debt-to GDP ratio by about 8½ by 2020.
Debt swaps and buy-backs. Debt swaps and debt buy-backs have been used by Belize and Antigua and Barbuda. Belize benefitted from a debt swap arrangement (US$8 million) with the U.S. government. In 2005, Antigua and Barbuda engaged in a debt buy-back operation with private creditors, which lowered its external debt by approximately US$500 million.
Other Elements of a Comprehensive Debt Reduction Strategy
Reforms should signal a new commitment to credible and sound macroeconomic policies and should include tax policy reforms, public sector rationalization, measures to improve fiscal discipline and credibility, active debt management, containing contingent liabilities, active privatization programs, and structural reforms to boost growth and improve competitiveness.
Tax Policy Reform
There is some scope for raising revenues and retiring debt through tax policy reforms. Tax policy reforms need to focus on broadening the tax base while reducing rates, ensuring sufficiency of revenues, and supporting growth and competitiveness. Simplifying the tax system (including introduction and/or strengthening of VAT) by reducing excessive tax rates, broadening the tax base, and reducing discretionary waivers and differential rates could help improve revenue collection while shifting the burden of taxes away from the productive sectors.
Debt Management
Active debt management could help lengthen the maturity structure of debt and reduce debt servicing costs. A number of countries are already involved in active debt management. Where possible, countries should continue to lengthen maturities and reduce the average interest costs by substituting high-interest, short-term debt with lower-interest, long-term debt. In parallel, many countries must significantly improve institutional debt management capabilities.
Public Sector Rationalization
There is scope in the region to further reduce spending through the rationalization of the public sector. The Fiscal Affairs Department of the IMF estimates that expenditure rationalization could reduce public spending on a cumulative basis by 3 to 5 percent of GDP over the medium term in the Eastern Caribbean Currency Union. Savings could be gained from consolidating administrative services and personnel through mergers or the closing of agencies. This should be accompanied by implementing a broad-based public expenditure reform to rationalize the public sector wage structure and employment. Some countries are already moving in this direction. Similarly, it would be important to review the functions and rationale of existing public enterprises with the objective of rationalizing them. The oversight of public enterprises could be strengthened by enforcing existing legislation on governance and reporting requirements.
Active Privatization Programs
An active privatization program, which reduces debt and develops the private sector, should also form part of a debt reduction strategy. There is scope in some Caribbean countries to raise revenues and reduce public debt through privatization and debt swaps. The problem with privatization is that it does not change the net worth of the government and it cannot be relied upon to bring durable improvement in the net worth of the government. The scope for privatization varies across countries, but this method cannot be relied upon to produce large reductions in public debt.
A number of lessons could be learned from previous privatization experiences in the region (Sahay, 2006). Privatization receipts have generally been low in the region, ranging from between 4 and 6 percent of GDP in a year. Privatization schemes need to be carefully planned, and distress sales should be avoided to maximize revenues.
The privatization process needs to be transparent to ensure that deals are conducted in a fair manner. In cases where full privatization is not feasible, corporatization of public enterprises could be useful in improving financial viability and limiting the risk to the budget.
Containing Contingency Liabilities
Measures to contain fiscal risks posed by contingent liabilities should remain an integral part of any debt reduction strategy. Contingent liabilities present significant fiscal risks in many Caribbean countries. The experience of many countries in the Caribbean in recent times has shown that the recognition of contingent liabilities can significantly increase public debt and raise issues of debt sustainability. As a result, Caribbean policymakers need to be fully aware of these risks and the alternative fiscal strategies that may be needed to contain them. Budgets in the region need to provide a detailed discussion of the risks of explicit contingent liabilities and their implications for fiscal and debt sustainability. A better understanding of fiscal risks and greater public awareness would encourage governments to adopt prudent fiscal policies, including stronger fiscal positions in the short to medium term (IMF, 2003). Containing contingent liabilities will require improving the regulation and supervision of the financial system, implementing pension reforms, and clarifying rules for issuing public guarantees.
Growth-Enhancing Structural Reforms
The analyses in Chapter 4 of this book suggest that it is very difficult to reduce public debt without improving growth prospects. In this direction, implementing growth-enhancing structural reforms will complement the region’s fiscal consolidation efforts and help improve the debt outlook in the region. Improved growth prospects would require greater emphasis on competitiveness and private sector development. Measures to make labor and product markets more competitive would help boost productivity with direct feedback on the speed and credibility of fiscal consolidation (IMF, 2003).
Key areas for reforms include increasing labor market flexibility, achieving greater regional cooperation, creating an enabling environment for private sector development, and reducing the size of the public sector, including the high levels of public employment. Addressing weaknesses in the private sector (both financial and the nonfinancial corporate sector) will also be crucial, while further steps to promote foreign investments will bring lasting growth benefits (IMF, 2003).
Reducing Public Debt in the Caribbean
Credible fiscal consolidation
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Focus fiscal consolidation on expenditure reforms within the context of a medium-term fiscal framework to signal government commitment to fiscal sustainability.
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Begin fiscal consolidation with a large up-front adjustment to restore market confidence and deliver a credible change in debt dynamics.
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Some front-loading of fiscal consolidation can help avoid reform fatigue and present political economy benefits, especially if the adjustment is initiated by a new government.
Fiscal rules and a medium-term fiscal framework
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Create a stable general fiscal rule to strengthen the current fiscal framework. Define the rule in terms of the primary deficit for general government, which could take the form of expenditure ceilings and revenue floors.
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Support the fiscal rule by creating an independent fiscal council to assess macroeconomic projections underlying the budgeting process and assess the compatibility of the fiscal framework with fiscal rules and general government policies.
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Implement multiyear or medium-term budgeting, supported by political institutions and consistent with the fiscal rule.
Public sector efficiency and rationalization
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Introduce an incentive element into central government grants by setting efficiency targets and rewarding ministries that outperform the targets.
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Review the role of government and identify government agencies that could be streamlined, closed, or divested.
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Enhance the oversight of public enterprises by strengthening and enforcing existing regulations on governance and reporting requirements.
Tax policy reforms
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Focus tax policy reform needs on broadening the tax base while reducing excessive tax rates and ensuring sufficiency of revenues. Simplify the tax system through a reduction in discretionary waivers and differential rates.
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Assess the effectiveness of new or existing tax expenditures on a systematic and regular basis. Handle higher taxes carefully to minimize economic distortions and promote economic efficiency.
Expenditure reforms
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Reduce public spending, with a focus on nonproductive and nonpriority spending, particularly transfers, subsidies, and general goods and services in a comprehensive reform program.
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Safeguard social safety nets by targeting and enhancing social programs while reducing or eliminating general subsidies.
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Improve the efficiency of nonproductive spending by improving the targeting of transfers and subsidies.
Debt management
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Lengthen maturities and reduce the average interest cost by substituting high-interest, short-term debt with lower-interest, long-term debt. Improve debt management capabilities.
Growth-enhancing reforms
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Continue with key reforms to increase labor market flexibility, achieve greater regional cooperation, and create an enabling environment for private sector development.
Summary and Conclusion
This chapter has discussed policy options for reducing the high debt levels in the Caribbean. It has argued that significant fiscal consolidation is inevitable in the region and that by consolidating government finances and improving primary balances, countries could signal their determination to implement prudent fiscal policies. Country experiences suggest that support for growth is essential to cope with the contractionary effects of fiscal consolidation, and therefore policies need to stress the removal of underlying structural problems within the economy. Since debt reduction takes time, fiscal consolidation should focus on enduring structural change. In this direction, strengthening fiscal institutions would be very helpful. It is essential to strengthen the fiscal framework by adopting fiscal rules and independent fiscal agencies to guide the budget process and improve fiscal transparency.
Fiscal consolidation may not enough to bring down the high debt levels, since high primary surpluses need to be run over a long period of time. The region therefore needs a comprehensive and sustained package of reforms to reduce debt ratios to more manageable levels and strengthen economic resilience. Reforms should signal a new commitment to credible and sound macroeconomic policies and should include tax policy reforms, public sector rationalization, measures to improve fiscal discipline and credibility, active debt management, the containment of contingent liabilities, active privatization programs, and structural reforms to boost growth and improve competitiveness.
To conclude, this book is intended to be a useful tool for policymakers and policy advisors in addressing the complex challenges that face the Caribbean in the years ahead. The Caribbean can benefit by learning from successful fiscal strategies around the world, including those distilled here. A new agenda is waiting to be adopted and implemented.
References
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Alesina, Alberto, and Roberto Perotti, 1997, “Fiscal Adjustments in OECD: Composition and Macroeconomic Effects,” IMF Staff Papers, Vol. 44, No. 2, pp. 210–48.
Baldacci, Emanuele, Sanjeev Gupta, and Carlos Mulas-Granados, 2010, “Getting Debt under Control,” Finance and Development, Vol. 47, No. 4, December (Washington: International Monetary Fund).
Braithwaite, Jeanine, Jyotsna Jalan, and K. Subbarao, 1995 “Strategies for Protecting the Poor During Adjustment and Transitions,” Human Capital Development and Operations Policy Working Paper No. 58 (Washington: World Bank).
Carenas, Mauricio, and Tessada, Jose, 2011, “Fiscal Policy Rules and Latin America: Lessons from the Crisis,” http://www.brookings.edu/opinions/2009/1123_fiscal_policy_latin_america_cardenas.aspx.
Egert, Balazs, 2011, “Bring French Public Debt Down: The Options for Fiscal Consolidation,” OECD Economics Department Working Paper No. 858 (Paris: Organization for Economic Co-operation and Development).
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Sahay, Ratna, 2006, “Stabilization, Debt, and Fiscal Policy in the Caribbean,” in The Caribbean: From Vulnerability to Sustained Growth, ed. by Ratna Sahay, David Robinson and Paul Cashin (Washington: International Monetary Fund).