Economics is full of fads, and fiscal rules and fiscal councils already fit the profile. Notwithstanding, from a policy perspective we should try to be sure that the recipe will be the right prescription for our idiosyncratic ailments. In the case of Peru, the fundamental problem from a macrofiscal standpoint is the fact that the business cycle and the fiscal revenues are completely dominated by the behavior of export prices (basically, copper and gold prices, see Figure 1). This creates a problem for the fiscal authorities giving that those prices are highly volatile and not easy to predict. If Peru wants to keep a prudent fiscal stance will require to offset this volatility. Indeed, the use of fiscal rules and fiscal councils might be a good recipe.
Fiscal revenues cycles and business cycles depend on mining prices
(annual percentage change in real terms)
Source: Ministry of Economy and Finance.Fiscal revenues cycles and business cycles depend on mining prices
(annual percentage change in real terms)
Source: Ministry of Economy and Finance.Fiscal revenues cycles and business cycles depend on mining prices
(annual percentage change in real terms)
Source: Ministry of Economy and Finance.However, another obstacle for a smoother economic performance in the case of the Peruvian economy is the fact that it has a decentralized government in which only 60% of overall fiscal expenses and one third of the public investment are in the arm length of the central government. This trait renders a less effective fiscal policy if is not fully synchronized within the three government levels (national, regional and municipal), as it happens in the data.
In the last three decades, Peru could be counted as one of the best students in fiscally prudent behavior. However, as it happens in school not every course has the same value. There are many ways to be prudent and what we suggest in this note is that countries should adapt a Maslow-type of approach regarding fiscal prudency needs (see Figure 2).
We identify four levels of fiscal prudency needs: (1) Achieve fiscal stability, (2) Impose prudent behavior, (3) reduce business cycle volatility, and (4) mitigate major fiscal risks.
The most pressing objective of a fiscal framework is achieving fiscal stability. Three main indicators should suffice for this: a low debt-to-GDP ratio, reasonable low fiscal deficits, and an investment grade sovereign rating. Fiscal rules should focus on these indicators. In the case of Peru, the current set of fiscal rules establishes that debt-to-GDP should be lower than 30% unless there is significant external turmoil in which case could go up to 34%. The fiscal performance of Peru in this matter has been outstanding.
The second most pressing objective is to impose—in an automatic way—a fiscal prudent behavior to governments. Giving the fact that fiscal revenues are determined by the behavior of mining prices should be key to have a way to save in a non-discretionary fashion during boom times. A fiscal rule with a focus on structural balance would do this. The first set of fiscal rules did not include such a rule. However, in the 2013 revision it was included, but it was eliminated in the 2016 reform.
The third most pressing target is to reduce business cycle volatility. For that to happen, a decentralized economy will require automatic stabilizing mechanisms and a synchronized response to shocks. In the case of Peru, there are no automatic stabilizers and the decentralization process only worsened the situation as there is not a synchronized fiscal response within the three levels of government (see Figure 3).
Low coordination within government levels1
Source: Ministry of Economy and Finance.Note: Fiscal impulse by nonfinancial expenditures (percentage of potential GDP)Low coordination within government levels1
Source: Ministry of Economy and Finance.Note: Fiscal impulse by nonfinancial expenditures (percentage of potential GDP)Low coordination within government levels1
Source: Ministry of Economy and Finance.Note: Fiscal impulse by nonfinancial expenditures (percentage of potential GDP)Finally, the fiscal framework will be complete if it takes care of the potential fiscal impact of tail risks such as natural disasters. This will enhance sovereign rating and avoid growth interruptions. In the case of Peru, we had managed to increase the toolbox of financial instruments to cover these risks (fiscal stabilization fund, contingent credit lines, and others) but still we are missing an instrument to deal with severe shocks.
The Peruvian fiscal framework is composed by five elements that are built to satisfy these prudency needs. The elements are: (i) a medium-term fiscal framework, (ii) a set of transparency reports, (iii) a set of fiscal rules, (iv) a fiscal stabilization fund, and (v) a fiscal council. All these elements are key ingredients in this fiscal prudency recipe. A quick evaluation suggests that fiscal rules frameworks have been changed too often (three times in 15 years). Fiscal rules should be designed in a way that is preferable to be always observed. In the case of Peru, the recent performance shows that we had strict fiscal rules that had required many transitory limits, waivers and the use of escape clauses (see Figure 4).
The fiscal deficit rule changes
(percentage of GDP and potential GDP)
The fiscal deficit rule changes
(percentage of GDP and potential GDP)
The fiscal deficit rule changes
(percentage of GDP and potential GDP)
We strongly believe that Peru has a strong fiscal prudent stance, and the fiscal council which is the new element added to the fiscal framework could help to maintain this stance. It has an independent voice based on solid data driven research that could help future administrations to navigate turbulent waters satisfying those most pressing fiscal prudence needs.
