V Fiscal Performance and Reforms
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Mr. Joachim Harnack
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Mr. Sérgio Pereira. Leite
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Ms. Stefania Fabrizio
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Ms. Luisa Zanforlin
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Mr. Girma Begashaw
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Mr. Anthony J. Pellechio
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Abstract

Ghana’s economic performance improved markedly following the adoption in 1983 of the Economic Recovery Program (ERP), which entailed substantial fiscal adjustment and reform along with tight monetary policy and exchange rate reform. Fiscal discipline reduced imbalances in public finance and eased the task of monetary policy. By 1991 the ratio of tax revenue to GDP had more than doubled, from 6 percent in 1983 to 12½ percent (Table 5.1). Company taxes grew steadily as a share of revenue, even though their level and the sectoral differences in rates were substantially reduced. The composition of tax revenue shifted from a heavy reliance on international trade taxes toward taxes on domestic goods and services. In particular, the share of cocoa export taxes declined, and petroleum taxes assumed an increasing role as administered petroleum prices were adjusted more promptly to changes in the price of imported petroleum. Decreases in nominal import tariff rates substantially reduced Ghana’s effective tariff rate. The sales tax was reformed and broadened to become, along with the integration of excises on manufactured goods, the main source of indirect tax revenue.

Ghana’s economic performance improved markedly following the adoption in 1983 of the Economic Recovery Program (ERP), which entailed substantial fiscal adjustment and reform along with tight monetary policy and exchange rate reform. Fiscal discipline reduced imbalances in public finance and eased the task of monetary policy. By 1991 the ratio of tax revenue to GDP had more than doubled, from 6 percent in 1983 to 12½ percent (Table 5.1). Company taxes grew steadily as a share of revenue, even though their level and the sectoral differences in rates were substantially reduced. The composition of tax revenue shifted from a heavy reliance on international trade taxes toward taxes on domestic goods and services. In particular, the share of cocoa export taxes declined, and petroleum taxes assumed an increasing role as administered petroleum prices were adjusted more promptly to changes in the price of imported petroleum. Decreases in nominal import tariff rates substantially reduced Ghana’s effective tariff rate. The sales tax was reformed and broadened to become, along with the integration of excises on manufactured goods, the main source of indirect tax revenue.

Table 5.1.

Central Government Revenue and Grants

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Sources: Ghanaian authorities: IMF staff calculations.

IncludingVAT

Under the ERP, expenditure rose in parallel with revenue as the government shifted current expenditure to the social sectors and reduced interest payments, while raising capital expenditure. Spending on education and health increased relative to GDP from 1983 through 1991, although health spending retreated in absolute terms as a result of the emphasis given to cost recovery charges. The Civil Service Reform Program, launched in 1987, aimed to reduce the civil service work force by 5 percent a year and limit its wage bill to less than 5 percent of GDP. The overall reduction during 1987–90 of approximately 30,000 civil servants, about 10 percent of the civil service, was net of hiring needed skilled staff.

In 1991, the year before the first democratic election under constitutional government, fiscal adjustment contributed to an improvement in the overall savings and investment balance. The overall fiscal deficit, which includes external grants and externally financed capital expenditure, narrowed from 2.2 percent of GDP in 1990 to 1.3 percent in 1991 (upper left panel of Figure 5.1). Meanwhile the primary balance shifted from a deficit of 1 percent of GDP to a surplus of about ⅓ percent of GDP. These developments, along with a tightening of monetary policy, supported strong overall economic performance: real GDP growth increased by 2 percentage points. Inflation (measured as the monthly average over the preceding 12 months) declined from 37 percent at the end of 1990 to 18 percent in 1991 and 10 percent at the end of 1992.

Figure 5.1.
Figure 5.1.

Central Government Finances

(In percent of GDP)

Sources: Ghanaian authorities; IMF staff estimates and projections

Fiscal Impact of the 1992 Election

After a decade of improvement under the ERP, which was rooted in firm control of the budget, fiscal discipline deteriorated significantly in 1992. In the transition to multiparty democracy, the government, concerned about securing the support of public service labor unions, granted substantial wage increases, amounting to 80 percent of the total nominal payroll (Tables 5.2 and 5.3). Tax administration was particularly lax, resulting in a decline in tax revenue from 12.4 percent of GDP in 1991 to less than 11 percent (Table 5.1 and lower left panel of Figure 5.1). The overall fiscal deficit widened by 8 percentage points of GDP (Table 5.4). The domestic primary balance shifted from a surplus of almost 2 percent of GDP to a deficit of almost 5 percent. A nearly identical shift was seen in net domestic financing: repayment of domestic debt equivalent to 2 percent of GDP in 1991 switched to net financing of 5 percent of GDP in 1992. The stock of domestic debt, which had declined steadily since the ERP was implemented, jumped precipitously from 4 percent of GDP in 1991 to almost 16 percent of GDP in 1993 upper right panel of Figure 5.1), just about equal to its level at the end of 1983, the first year of the ERP. This jump was reflected in steep increases in domestic interest payments in subsequent years.

Table 5.2.

Central Government Expenditure

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Sources: Ghanaian authorities; IMF staff calculations.
Table 5.3.

Economic Classification of Central Government Expenditure and Net Lending

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Sources: Ghanaian authorities; IMF staff calculations.
Table 5.4.

Central Government Budgetary Operations and Financing

(In percent of GDP)

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Sources: Ghanaian authorities; IMF staff calculations.

Domestic financing was accomplished by recourse to bank financing. The banking system’s net claims on government rose by 30 percent of the beginning-of-period money stock, even though the program had targeted a 22 percent reduction. Interest rates were raised and sales of Bank of Ghana debt stepped up. but these efforts were not sufficient to absorb the considerable excess liquidity. As a consequence, broad money grew by 53 percent in 1992. Government borrowing from the social security system and other non-financial institutions increased. Because much of this monetary expansion was concentrated in the final quarter of the year, the full inflationary impact was not felt in 1992: inflation at the end of the year was only 13 percent. However, inflation increased sharply to 74 percent at the end of 1993. The treasury bill rate, after declining by 10 percentage points in 1992, rose by 12 percentage points in 1993.

In addition to the substantial domestic financing and monetary expansion, the government undertook considerable new medium-term nonconcessional external borrowing in late 1992, causing external debt ceilings to be exceeded by wide margins. Although the authorities recognized the risks of heavy commercial borrowing, they believed it was necessary to help bridge the shortfall in external assistance that had emerged because of the policy slippages. In addition, a shortfall in cocoa production and a sharp decline in world cocoa prices adversely affected external and fiscal performance.

Although weak tax administration was the main reason for reduced revenue collection, tax reforms contributed as well. The personal income tax brackets and personal credit were adjusted for inflation: these revenue-reducing measures were only partly offset by an increase in the top marginal rate from 25 percent to 35 percent. Corporate tax rates and the withholding tax rate on dividends were reduced.14 These changes, along with weak administration, resulted in company tax collections declining to 1.2 percent of GDP in 1992 from 1.5 percent in 1991.

Indirect taxes decreased from 6.7 percent of GDP in 1991 to 5.9 percent in 1992, Collections of excises and sales tax on both domestically produced goods and imports, despite larger import volume, all declined, by the cumulative amount of 0.5 percent of GDP, as a consequence of weak administration. Rate reductions also contributed to the decline in sales tax collections on imports.15 The largest part of the decline in indirect taxes, however, came from a reduction in petroleum taxes. This reflected the government’s unwillingness in an election year to increase administered prices of domestic petroleum products in response to the depreciation of the cedi, and its willingness to subsidize the operations of the Ghana National Petroleum Corporation (GNPC) by writing off ¢14 billion due as revenue from the petroleum tax.

The fall in international trade taxes was entirely due to a decline in cocoa tax revenue, as tax proceeds that should have accrued to the budget were absorbed by large, unanticipated increases in the operating costs of the Cocoa Board. Although import volume was higher, import duty collections remained constant in relation to GDP as a result of rate reductions.

At the same time that revenue dropped, noninterest recurrent and domestically financed capital expenditure increased, by 40 percent of GDP. This was a result not only of higher wages but also of larger transfer payments to households, more capital spending, and higher interest payments, owing to the need to finance the additional spending (lower right panel of Figure 5.1). Regarding transfer payments, the government agreed toward the end of 1992, in response to pressure from workers in public enterprises and sub-vented agencies, to pay out accumulated retirement and end-of-service gratuities that had been frozen at the end of 1990 when the pension system was changed.16 Capital spending, both domestically and foreign financed, increased by 3 percent of GDP from 1991 to 1992, largely because of outlays on development projects in rural areas before the elections.

The overall pace of structural reform slowed during 1992, given the government’s concern about its support in the country’s first democratic elections. The state enterprise divestiture program and civil service reform were especially affected. However, the election environment was not completely antithetical to structural reform: licensed private traders were allowed for the first time to compete with the Cocoa Board in the domestic cocoa market toward the end of 1992 (see section IV). This allowed the government to point to some progress on reform in a critical sector that appealed to two constituencies: a small but important entrepreneurial class, and the large group of cocoa suppliers whose livelihood, often at a subsistence level, depended on selling cocoa. The latter was the more important given the predominance of small farms in Ghana’s cocoa sector.

Developments After the 1992 Election

In 1993 the overall budget deficit increased by ½ percent of GDP, as higher expenditure, mainly recurrent, exceeded a rebound in revenue collections. Net domestic financing of the deficit amounted to 1.2 percent of GDP. The domestic primary deficit declined from about 5 percent of GDP in 1992 to 3.2 percent.

Tax collections as a fraction of GDP returned to their level of before 1992–approximately 13 percent–owing mainly to the restoration of administrative effort following the election. In particular, collections of company and personal income tax showed significant increases. Petroleum taxes also increased substantially, but not as much as projected, because retail prices were not adjusted as planned for depreciation of the cedi. Increases in collections of import duties and sales taxes on imports were lower than expected because of problems in customs administration. Cocoa export receipts also suffered as a result of unanticipated outlays related to staff retrenchments by the Cocoa Board.17 Nontax revenue rose because of arrears payments by state enterprises. The pickup in the pace of the divestiture program brought in receipts of 2.1 percent of GDP. which contributed significantly to the decline in net domestic financing of the budget.

The increase in recurrent expenditure in 1993 was about the same as in 1992 as a percentage of GDP, partly reflecting the full-year impact of the civil service salary increase in the election year. The large increases in civil service wages were reflected in the functional composition of expenditures in 1992 and 1993. Outlays for labor-intensive services, such as education, health services, general public services including social security, and defense, increased as a share of GDP. Subventions more than doubled as a result of wage increases in the subvented agencies. On a positive note, the government resisted pressure from public service labor unions for further wage increases and kept the wage bill to its budgeted level.

Overruns in expenditure on goods and services also reflected unbudgeted contributions to regional peacekeeping efforts. Domestic interest payments as a fraction of GDP rose by over 70 percent, which was more than expected, because of the surge in government borrowing during the election period and the consequent rise in interest rates. Although expenditure arrears declined by 0.1 percent of GDP during 1993, contractors in the road sector were contributing more to the problem as a result of poorly written contracts that allowed work to be carried out even without budget appropriation. Capital expenditure, meanwhile, was kept within budgeted limits.

Although the domestic financing requirement declined from its high level of 1992, it remained above 1 percent of GDP. a substantial departure from the target of repaying domestic debt equivalent to 2 percent of GDP. As a result, the banking system’s net credit to government exceeded the program target, as did the quantity of broad money. In addition, liquidity expanded sharply because of lending by the Bank of Ghana to the GNPC to address the squeeze on its operating margins arising from the depreciation of the cedi.

Financing pressures prodded the government to accelerate its divestiture program, especially the sale of shares in its most valuable company, Ashanti Goldfields. The first tranche of the government’s interest was sold in the second half of 1993, but substantial receipts would only be realized the following year.

Reflecting keen awareness that sustained corrective action in the fiscal area was the key to macro-economic stabilization, the government presented a budget for 1994 that simplified the tariff structure. It enacted three ad valorem rates of 0. 10, and 25 percent of the c.i.f. (cost plus insurance and freight) value of imports. However, specific duties were applied to over 100 commodities, including many textiles and garments. This simplification represented an effort to curtail the misclassification of imports and thereby improve the transparency of customs administration. Petroleum taxation was, in effect, increased by raising retail petroleum prices.

The government achieved a domestic primary balance of almost 1 percent of GDP in 1994 with the help of increased revenue from taxes on cocoa exports. The sale of the second tranche of the government’s interest in Ashanti Goldfields and the divestiture of its minority share in seven other companies brought in much higher proceeds than projected: 5 percent of GDP instead of 2 percent. Higher cocoa tax revenue reflected the marked depreciation of the cedi and an increase in export prices. On the other hand, plans to reduce zero-rating and exemptions in the import tariff system were not carried out, leading to shortfalls in import tax revenue.

Overruns occurred in the wage bill and other labor-related expenditures. Domestic interest payments not only rose relative to GDP as expected but were higher than projected. Significant interest costs were incurred as the Bank of Ghana undertook substantial open market operations toward the end of 1993 to reduce liquidity. This cost weighed against the government’s intention to repay domestic debt with excess divestiture receipts. Also weighing against domestic debt reduction was the recourse to substantial domestic financing of the budget in the first quarter of 1994, owing to delays in external grant disbursements and receipt of cocoa taxes. The increase in domestic debt generated by these delays carries an interest cost that persists even if the expected receipts are realized. In other words, the timing of disbursements of external assistance and other receipts can be as important to the attainment of fiscal objectives as the amounts themselves. As a result, the domestic debt stock climbed by 2½ percentage points of GDP, to 18½ percent at the end of 1994.

The receipt of substantial divestiture proceeds was indeed the overriding fiscal development in 1994, as it resulted in negative net domestic financing and allowed some reduction of domestic debt. However, this reduction was less than the excess of divestiture proceeds over projected amounts because of the high interest payments associated with the Bank of Ghana’s open market operations and delays in the receipt of revenue and external grants. Divestiture receipts helped offset the impact of a major shortfall in long-term concessional assistance in 1994 as a result of difficulties encountered in fulfilling the macroeconomic conditions for disbursement. As the sale of public assets is a nonrecurrent source of funding, substantial fiscal adjustment was needed to tackle high domestic debt and interest.

Monetary policy was severely undermined by large arrears incurred on oil-related credits by the GNPC to the Bank of Ghana. These arrears amounted to 43 percent of beginning-of-period reserve money. As a result, despite a step-up in open market operations by the Bank of Ghana and net repayment of debt to the banking system by the government, broad money grew by 46 percent. Inflationary pressures intensified, resulting in an end-of-period inflation rate of 34 percent, compared with a treasury bill rate of 30 percent and bank lending rates between 29 and 33 percent.

In 1995 the government undertook a medium-term fiscal program geared toward generating the public savings needed to help monetary policy reduce inflation and to strengthen private sector investment. This program was supported by a second Enhanced Structural Adjustment Facility arrangement beginning at the end of June 1995–the first since the program went off track in 1992. Because of the serious fiscal slippages associated with the elections that year, and because of the severe financial difficulties of the GNPC and the resulting excessive monetary growth, the program for 1995 was formulated against a background of intensifying inflationary pressures. A ceiling was placed on the GNPC’s indebtedness to the Bank of Ghana, cutting off further financing as a performance criterion. To achieve the program’s targeted deficit reduction, customs collection was to be substantially strengthened, reflecting the introduction in the budget of an import duty of 10 percent on about half of imports previously zero-rated or exempt from tax. The budget also raised the sales tax rate from 15 percent to 17.5 percent.

The fiscal strategy also called for a restructuring of both revenue and expenditure. The government regarded this restructuring as separate from the measures taken in the budget to reduce the deficit. However, this distinction was not made clearly to the public, whose misunderstanding led to civil disturbance and the consequent reversal of policies discussed below. The overall reason for revenue restructuring was the government’s concern about the distortionary effects of income taxes on private investment, labor supply, and saving. The centerpiece of the government’s intention to shift taxation toward expenditure was the value-added tax (VAT) that was introduced on March 1, 1995; this tax replaced the sales tax and extended its coverage to include retail sales and a range of services. The government also began to consider alternatives to the tax on cocoa exports by exploring ways to tax the cocoa industry, and agriculture more generally, in a manner that would minimize disincentives to production.

As with revenue, the government drew a distinction between spending measures for deficit reduction and the restructuring of expenditure. To reduce the deficit, the budget sought a modest reduction in the civil service wage bill. Other economies were identified in noninterest recurrent expenditure. However, domestic interest was projected to continue to rise as a result of the Bank of Ghana’s open market operations. Regarding expenditure restructuring, the government sought to apply savings from lower outlays on labor and interest to the provision of social services, especially education and health services.

In mid-May 1995, civil disturbance broke out over the introduction of the VAT, which forced the government to rescind the tax and return to the previous sales tax at a rate of 15 percent. As offsetting measures, a withholding tax on interest income was reactivated and recurrent expenditure was reduced. The civil unrest over the VAT was the result of several problems associated with its introduction. First, a low threshold for taxpayer registration forced small businesses to register and apply the tax, even though aggregate revenue from these businesses was very low. Second, inflation was high, and many small business operators used the introduction of the tax as a scapegoat for higher prices. Third, as noted, the sales tax rate had already been raised from 15 percent to 17½ percent as a deficit reduction measure shortly before the VAT became effective. Although the government considered that rate increase separate from its structural tax reform, the public did not. Finally, the government did not pursue an adequate public information program in advance of the VAT’s introduction so that the public would recognize its objectives and impact.

The overall deficit declined by 2½ percentage points of GDP in 1995 but was nonetheless above target because of overspending on roads amounting to more than 2 percent of GDP. This overspending reflected the initiation of several large projects and a bunching of work contracted in previous years, which was indicative of weak expenditure control. Large arrears to domestic contractors were incurred.

Tax revenue collections in 1995 generally fell short of program expectations. Petroleum taxes were lower because of reduced consumption and the failure to pass through increases in the price of oil imports. Import duty collections were adversely affected by a real appreciation of the cedi and delays in implementing import tariff adjustments early in the year. The large cocoa crop harvested toward the end of 1995 was not reflected in higher tax receipts until early 1996. Despite these shortfalls in tax receipts, however, government revenue was above target because of very large dividend payments from state enterprises and royalties from the mining sector. As a result, nontax revenue relative to GDP more than doubled over the previous year, from 2.6 percent of GDP in 1994 to 5.8 percent in 1995. This accounted for a decline of nearly 3 percent of GDP in the stock of domestic debt in 1995—a significant reversal of the sharp rise in domestic debt since 1992.

Fiscal Impact of the 1996 Election

Entering 1996, the government was facing the consequences of the economy’s uneven performance in 1995, in particular the rising inflation rate. In early 1996 the government took a number of measures to address problems encountered the previous year. Monetary policy was tightened, and road contracts were renegotiated to remain within budget limits. Petroleum pricing and marketing reforms were implemented.

However, large fiscal slippages occurred during the second half of 1996 in the run-up to the elections. These slippages, as in 1992. reflected the government’s effort to shore up its support among the electorate. For example, the mechanism introduced in June 1996 for automatically adjusting retail petroleum prices for changes in the price of imported oil and the exchange rate was suspended when its application called for an increase in prices. This caused a shortfall in petroleum tax collections. Import duty and sales tax collections were also down, evidence of a growing problem of exemptions.

Serious slippages occurred on the expenditure side because of overruns in capital spending in rural areas, where the government sought to maintain the support it had received in the 1992 elections. Unbudgeted capital spending on roads amounted to 0.5 percent of GDP. The construction of two hospitals in rural areas was undertaken with external loans on commercial terms, adding almost 1 percent of GDP of unbudgeted spending. The wage bill and wage-related payments to subvented agencies exceeded the budgeted amount by 0.5 percent of GDP, largely because of the inclusion of local government employees on the central payroll.

The reduction in domestic debt in 1995 and the heavy reliance on external financing in 1996 resulted in a further decline of domestic debt in 1996. However, domestic debt was rising rapidly at the end of the year, with the domestic financing requirement of the government running high near the elections in December. High domestic debt and high interest rates, and the inclusion in the budget of the cost of the Bank of Ghana’s liquidity operations, combined to raise domestic interest payments to nearly 4 percent of GDP. Net domestic financing amounted to 4.7 percent of GDP for all of 1996, almost the same as in the first election year of 1992. The overall deficit of 9½ percent of GDP was virtually the same in both election years.

Facing a much-deteriorated fiscal situation, the government presented to parliament a budget for 1997 that signaled a significant tightening of financial policies. However, the budget was not passed into law until the end of the first quarter, delaying the issuance of updated tax assessments, which was an important element of more effective tax administration following the elections. Even though expenditures were uniformly restrained, the domestic primary balance was weak, and net domestic financing continued to run high in the first half of 1997. Financing was met without recourse to the central bank but at the cost of higher interest rates. The stock of domestic debt continued its rise from the latter part of 1996, finishing the year 4 percentage points of GDP higher than at the end of 1996.

Developments After the 1996 Election

The 1997 budget marked a transition to a policy of generating domestic primary surpluses in order to reduce domestic debt and support a reduction in monetary growth to rates consistent with single-digit inflation. Lower domestic debt and financing, along with lower inflation, were expected to lower interest rates, which would, in turn, further reduce domestic financing and the debt.

The 1997 budget also served to signal the government’s renewed commitment to tax and expenditure reforms. The government’s broad objective in seeking tax reform was to increase the efficiency and buoyancy of the tax system by shifting the tax structure toward taxation of consumption. An ad valorem excise duty on petroleum products was introduced with parliamentary approval, so that changes in international oil prices and the exchange rate would be more closely reflected in retail prices.

The cornerstone of Ghana’s tax reform, however, was the replacement of the sales tax with a VAT. The tax was proposed to parliament with a single positive rate equal to the current sales tax rate, a zero rate for exports (with an effective refund system), and a high threshold that would not require small businesses to register and impose the tax. The government also launched an intensive public information campaign to avoid repetition of the public confusion associated with the short-lived introduction of the VAT in 1995.

The government also planned to strengthen and modernize tax administration as part of its revenue mobilization effort. In the 1997 budget the government announced its plan to introduce a single, unique taxpayer identification number. The budget also stated the government’s intention to consider the establishment of a central revenue authority that would integrate the information systems and enforcement procedures of the separate tax agencies–the Internal Revenue Service and the Customs, Excise, and Preventative Services–which were functioning as separate subvented agencies.

Total expenditure declined by over 3/4 percentage point of GDP in 1997, with most of the reduction occurring in the domestic capital budget, where expenditure overruns had been concentrated in 1996. In the recurrent budget, wages declined slightly, as they had in 1996, as a result of the government’s strict adherence to a wage policy of providing cost-of-living, but not real, wage increases. This adherence was facilitated by the Trade Union Congress’ understanding of the wage-price link from the 1992 election experience. On the other hand, expenditure did not decline as much as projected, because domestic interest outlays continued to increase more rapidly than expected, rising above 4½ percent of GDP for the year. To gain better control of expenditure in the context of a medium-term development program that is fully costed and consistent with macroeconomic policies, the government took steps to improve the sectoral allocation of spending and strengthen budget management.

In 1997 as in 1993 (that is, in both the years immediately following recent elections), the overall deficit rose by about ½ percentage point of GDP to around 10 percent. This occurred despite postelection fiscal tightening, in large part, because of surges in domestic interest and foreign-financed capital expenditure, reflecting the government’s recourse to domestic and external financing in support of election-related spending. Nonetheless, fiscal discipline contributed to a decline in the inflation rate from 33 percent to 21 percent during 1997. As intended, this discipline resulted in the domestic primary balance showing a surplus of 3.2 percent of GDP, the highest since the ERP was launched in 1983. This was achieved entirely by reducing domestically financed capital expenditure. In August 1997 the GNPC began to repay its debt to the Bank of Ghana.

The government intensified its structural reform efforts in 1997, taking a more participatory approach in order to enhance public understanding of the reforms and the prospects for implementing them. For example, the government suspended a substantial increase in electricity tariffs, and in September 1997 it created an independent commission with representation from the public, utilities, and government. After extensive public hearings, the commission recommended a two-step increase scheduled for February and September 1998.

The 1998 budget sought to build on the adoption and implementation of appropriate financial policies in 1997. The overall budget deficit declined by over 2 percentage points of GDP. The domestic primary surplus was 3.6 percent of GDP, less than targeted but an improvement over 1997. However, total expenditure was higher than expected, as domestic interest payments exceeded the projected amount by 1.4 percent of GDP. The government, confronted with large arrears in the road sector, reduced them beyond the amount provided in the budget. Consequently, net domestic financing exceeded its projected level by almost 2 percentage points of GDP. As a result, the stock of domestic debt rose by almost the same amount, which was more than projected but less than half the increase in 1997 relative to GDP.

The government followed through on several important fiscal reforms that comprised its shift to financial discipline and structural reform as articulated in the 1997 budget. The separate governing boards of the tax agencies were replaced by a central revenue board to better coordinate activities and facilitate tax administration. Tariff measures were implemented in March 1998 to reduce the number of zero-rated goods and exemptions.

The most significant fiscal reform in 1998 was the reintroduction of the VAT at the end of the year. This successful reintroduction of a tax that had had to be rescinded more than three years before because of public unrest can be attributed to several factors. The intensive public information campaign that had begun over a year before the tax became effective succeeded in conveying to a wide audience the government’s message about the rationale for the tax and its expected impact. As already noted, small businesses were excluded from charging the tax by a high threshold for registration. The tax became effective in an economic environment in which inflation was declining. Perhaps most important, the reintroduction of the VAT had been a major topic at the National Economic Forum in September 1997. the most important consensus-building exercise leading to the Ghana—Vision 2020 strategy. At this forum, agreement was reached that the VAT would be reintroduced at a 10 percent rate, substantially below the sales tax rate of 15 percent proposed by the government. The lower rate and the public consensus behind it were critical to the successful reintroduction of the VAT.

On the expenditure side, the medium-term expenditure framework, a comprehensive approach to budget preparation that integrates investment and recurrent expenditure into a unified, three-year, roiling budget, was implemented ahead of schedule (Box 5.1). This represented a major step in the full costing of expenditure programs based on clear specification of the expected outcomes of budget spending.

Structural reforms continued in 1998, building on the progress achieved in 1997. The commission on public utilities raised electricity tariffs by 90 percent in February and again by 100 percent in October, and this eliminated the operating losses of the utility companies. These substantial increases were made possible by the participatory nature of the commission and a shift in public sentiment caused by the drought-related energy crisis in the first half of the year. The shortage of electricity made the public aware of the cost of its generation and instilled a willingness to pay. The public utilities commission was also able to raise water tariffs to eliminate operating losses. The automatic formula for adjusting the prices of petroleum products to changes in the exchange rate and the world oil price, which had been rescinded in the 1996 election environment, was reintroduced.

The Medium-Term Expenditure Framework

The medium-term expenditure framework (MTEF) is a comprehensive approach to budget preparation that integrates investment and recurrent expenditure into a unified, three-year rolling budget. The MTEF is based on a planning exercise that combines top-down funding discipline and a decision-making process in which all government agencies participate. It clarifies the procedures, costs, and potential outcomes of resource allocation, thus requiring policymakers to base their choices on comparisons of costs and benefits.

The MTEF process in Ghana started formally in June 1998 with cabinet approval for issuing the 1999 budget circular with preliminary ceilings for 1999–2001 derived from the policy framework paper. This was followed by a review of the responsibilities and objectives of the various ministries, departments, and agencies (MDAs), the outputs to be produced to achieve these objectives, and the activities required to produce the outputs. MTEF workshops spanning the months of July and August provided senior managers and personnel from 11 MDAs and selected statutory institutions hands-on experience in applying the MTEF methodology. The process entailed the preparation of a strategic plan by each MDA to form the basis of budget estimates. At both the aggregate and the sectoral levels, an attempt was made to capture all expenditures, including those financed by MDAs’ internally generated funds and those financed by external sources. Although the MTEF was to be implemented initially in the priority sectors of education, health, and roads, the authorities realized that its success depended on including all MDAs, rather than trying to pursue a dual budget process, and therefore decided to implement it for the entire budget.

Experience with implementing the MTEF approach to budgeting in Ghana has been encouraging. In addition to the early expansion of its budget coverage, other developments include the preparation of mission statements for all MDAs, the basing of budget estimates on an explicit costing of the activities required to meet the MDAs’ objectives, and the withdrawal of the Ministry of Finance from involvement in the details associated with incremental budgeting by MDAs.

By the end of 1998 the government had made progress in several difficult areas, as a result in part of wider adoption of a participatory and consensus-building approach. Nevertheless, fiscal targets, in particular net domestic financing, were missed because of higher-than-expected domestically financed capital expenditure and interest payments, which continued the cycle of high domestic interest expense and debt accumulation.

External Shock Ahead of the 2000 Elections

Ghana suffered a major terms-of-trade shock in 1999 as world prices for its two principal exports declined and the price of oil increased. Cocoa prices fell by over 40 percent and remained low at the beginning of 2000, gold prices dropped by 13 percent before recovering in October 1999, and the world price of crude oil doubled from the end of 1998 to the end of 1999. Because a significant portion of Ghana’s cocoa and gold exports are sold under forward contracts, the brunt of this shock was felt in the latter part of 1999 and, in particular, in 2000, when the deterioration in the fiscal and balance of payments accounts would be substantial.

Real GDP grew as projected under the program during the first half of 1999, but it fell short of projected growth for the year in large part because of the external shock. Given a shortfall in external assistance of 1½ percent of GDP, domestic financing of the budget exceeded its projected level by about the same amount.

Broad money grew faster than projected because of heavy government borrowing from the banking system. The Bank of Ghana conducted aggressive open market operations near the end of the year to bring reserve money down to its projected level by the end of the year. As a result, the rediscount rate rose sharply, and the treasury bill rate increased to 34 percent at year’s end. Given the end-of-year inflation rate, this implies a real interest rate of close to 20 percent.

The current account deficit for 1999 was $385 million higher than originally projected because of lower export earnings and lower investment income from foreign reserves. This resulted from the decline in the terms of trade, which also contributed to a substantial depreciation of the cedi, by 50 percent against the dollar, during 1999. This depreciation also reflects a change in the method of calculating the exchange rate adopted by the Bank of Ghana in October 1999: from the average in the interbank market to an average of rates reported by banks in their transactions with customers.

The government tried to address the Fiscal implications of the external shock by substantially cutting back on domestically financed capital expenditure, but shortfalls in tax and nontax revenue collections and in divestiture receipts weighed against this effort. Poor performance in import tax collections reflected inadequate customs procedures and a shake-up at the top levels of the customs administration. A delay in the adjustment of petroleum prices for higher world oil prices and the depreciation of the cedi reduced petroleum tax collections below their projected amount. Cocoa export tax revenue fell short of its originally projected level for 1999 because of the sharp decline in the world price of cocoa during the year and the government’s decision to maintain the nominal price paid to domestic producers.

On the structural front, after the extensive consultation with stakeholders, the cabinet approved a medium-term cocoa development strategy designed to improve incentives for producers, foster competition, and end the government’s monopoly in exports (see section IV). The government decided in June 1999 to maintain the price paid to cocoa producers, raising their share of the export price substantially above the minimum established. In October 1999 two large enterprises were divested, and in December over 50 percent of the government’s domestic cocoa purchasing enterprise, the Produce Buying Company, was offered for sale on the Ghana Stock Exchange. The government also carried out a financial restructuring of the Tema Oil Refinery to prepare it for sale in 2000. A new public sector wage structure was put in place in mid-1999 and applied retroactively to the beginning of the year. The cabinet approved the legal framework for the reform of subvented agencies and established committees to address the reform of central management agencies.

At the end of 1999 the government planned to implement important measures to address the problems for 2000 posed by the adverse external developments during the year. The most significant revenue measure, an increase in the VAT rate from 10 to 12.5 percent, was implemented with a June 1, 2000 effective date.

Conclusion

The shift in political rule in Ghana to constitutional democracy in 1992 was a singularly important event. The longer process of adjusting to a democratic environment disrupted Ghana’s progress in reforming and improving its economy. The looming 1992 elections encouraged breaches in financial discipline, which carried heavy costs in terms of inflation, interest payments, and debt. The importance of public support in a democratic environment slowed structural reform. These disruptions were not caused solely by the adjustment to democracy, as this adjustment coincided with the more difficult stage of reform that follows achievement of macro-economic stability. However, the financial taxity associated with the new democratic environment jeopardized macroeconomic stability and made further reform more difficult.

Several salient macroeconomic features of the fiscal problems during the eight years following the 1992 election can be identified. These included budget deficits in the 9–10 percent of GDP range in almost all these years, a ten-fold rise in the domestic debt burden relative to GDP, a fivefold rise in domestic interest payments relative to GDP, and real interest rates in the 20 percent range. Rather than supporting tight monetary policies as had been the case in the predemocratic period of reform, fiscal performance was tax, putting pressure on the financial sector.

In the area of structural reform, Ghana’s experience with the introduction of the VAT provides a striking example of the difficulties that can attend reforms in a democratic environment. Although the government relaxed its fiscal position to enhance public support in election years, its failure to attend to public opinion between these years on this key reform led to its dramatic reversal. The lessons of this setback were not lost, however: the government undertook an intensive, year-long campaign to educate the public about the VAT before its successful reintroduction in 1998. But this success was not without its cost, in the form of revenue forgone from having to accept the much lower rate that came out of the consensus-building exercise for the VAT. However, once the VAT was in place and accepted as an efficient instrument for raising revenue, the government was able to raise its rate to address the severe external shock that developed in 1999.

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Economic Development in a Democratic Environment
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