Article

Public Sector Reform is key to Fiscal Sustainability in Ghana

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 2006
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Although Ghana began liberalizing its economy in the mid-1980s, the government has retained control of some enterprises that engage in quasi-fiscal activities. These are off-budget activities undertaken by the central bank and some public financial and nonfinancial enterprises. How extensive are these activities, and what are their consequences? A new IMF Working Paper by Mali Chivakul and Robert C. York finds that quasi-fiscal activities have caused serious distortions in energy and water consumption and in the investment decisions of the affected enterprises and the private sector.

After Ghana gained independence in 1957, the government assumed control of most of the economy, and, by the early 1980s, the public sector completely dominated production. Publicly owned enterprises were involved in almost all sectors, including finance and banking, with some serving social objectives (for example, nonmarket energy pricing) and other public policy goals (such as transportation). In 1983, the government introduced reforms—including the divestiture of 200 public enterprises—to liberalize and reduce its involvement in the economy. But at the end of 2005, the government still retained full ownership of 35 nonfinancial enterprises, including some of the largest in Ghana, with total assets valued at more than 60 percent of GDP in 2003.

Identifying quasi-fiscal activities

Quasi-fiscal activities entail a net transfer of public resources to the private sector (households and enterprises) through nonbudget channels. In contrast, explicit taxes, subsidies, and direct expenditures are included in the budget and have equivalent effects. If quasi-fiscal activities are pursued, the IMF’s Manual on Fiscal Transparency recommends that they be clearly identified and the implications spelled out in the government’s financial reports.

For public nonfinancial enterprises, quasi-fiscal activities include the pricing of commercial activities below market or cost recovery; the tolerance of payment arrears, unbilled consumption, or low collection rates on services provided; and barter and in-kind transactions.

For public financial institutions, they include subsidized lending and rescue operations or bailouts; the lack of remuneration on commercial banks’ reserve requirements; multiple exchange rates and subsidized exchange rate insurance; and central bank operations to sterilize capital inflows and manage liquidity through open market operations.

Because of their extensive activities, these state-owned enterprises play an important role in Ghana’s economy. Their efficiency can help lower the cost of doing business for the private sector, and, if they are profitable, they can reduce pressure on the budget and influence the amount of infrastructure investment that is needed to support economic development. The government intends to make all of the commercially oriented state-owned enterprises financially self-sustaining and expects them to make an appropriate contribution to the budget. But several are operating at a loss, largely because of their involvement in quasi-fiscal activities (see box).

Where the losses are

Recent data suggest that quasi-fiscal activities are prevalent in the Volta River Authority, the Electricity Company of Ghana, the Ghana Water Company Limited, and the Tema Oil Refinery, as well as in the Bank of Ghana (the central bank). In the state-owned enterprises, quasi-fiscal activities are reflected in mispricing, commercial and excessive technical losses (for example, from unbilled consumption and theft), and the accumulation of new payment arrears. In the Bank of Ghana, they are evident in the relatively high cost of conducting open market operations (although declining interest rates have recently reduced the cost) and sterilizing strong capital inflows, as well as in the absence of remuneration on commercial banks’ deposits held in the central bank to satisfy the primary reserve requirement.

Still too great a presence

Quasi-fiscal activities have declined but still pose a problem.

20002001200220032004
(percent of GDP)
Nonfinancial public enterprises0.50.87.24.22.1
Tema Oil Refinery0.01.80.30.0
Volta River Authority3.32.00.4
Electricity Company of Ghana1.21.11.1
Ghana Water Company Limited0.50.70.90.80.7
Bank of Ghana–0.7–0.7–0.50.00.6
Total–0.20.16.74.22.7
Data: Authors’ calculations.
Data: Authors’ calculations.

Ghana’s combined quasi-fiscal activities reached the equivalent of about 6¾ percent of GDP in 2002 before declining to about 2¾ percent of GDP during 2004 (see table). In 2002, two activities accounted for nearly two-thirds of this amount: the government’s below-cost pricing of petroleum products, which made it impossible for the Tema Oil Refinery to recover its refining costs; and the Volta River Authority’s below-cost pricing of electricity, reflected in a substantial discount to its largest customer. Although quasi-fiscal activities have been reduced, they are still significant enough to dampen the financial prospects of the public sector.

If the financial performance of the major state-owned enterprises, which is driven largely by quasi-fiscal activities, is combined with that of the central government, the picture of Ghana’s fiscal situation differs from that based on the central government’s finances alone. The overall deficit of the public sector averaged 9 percent of GDP during 2000-04, compared with 6½ percent of GDP for the central government. To finance the large deficits, Ghana borrowed, accumulating domestic debt for the broader public sector amounting to 37 percent of GDP by end-2003, compared with just over 18 percent for the central government alone.

Preliminary data suggest that, despite the additional debt, the government reached its medium-term objective of halving the ratio of domestic debt to GDP by end-2005 from its end-2002 level—mainly by reducing the central government debt. More recently, the strength of fiscal consolidation combined with satisfactory performance of some state-owned enterprises has led to a significant decline of the public sector deficit (see chart).

Implications for economic performance

In general, governments use quasi-fiscal activities to achieve a variety of social, political, and economic objectives. Although some of the objectives are worthwhile, quasi-fiscal activities have broad economic and policy implications:

• They may understate the size of government.

• They can create contingent government liabilities.

• They often escape legislative and public scrutiny.

• They can contribute to monetary expansion and may have the same adverse effects as the financing of government expenditures, such as crowding out.

• Through moral hazard, they may have adverse effects on the financial system, under the presumption of a government bailout.

• They distort resource allocation and generate unwanted and nontransparent redistribution, with implications for equity and economic growth.

Quasi-fiscal activities in Ghana have a number of undesirable effects, which the government needs to address to improve fiscal sustainability and economic performance.

The poor performance of public enterprises imposes both a financial and an economic burden on the country, raising the public sector borrowing requirement and putting upward pressure on interest rates. In turn, higher interest rates impede private sector investment, development, and productivity growth. Without efficient public enterprises, Ghana is unlikely to undertake the investments required to upgrade its public infrastructure—particularly in the energy sector and utilities—which will also have adverse consequences for private investment and economic growth.

Trimming the debt

Fiscal discipline, including a decline in quasi-fiscal activities, is helping to reduce the public sector deficit.

Citation: 35, 6; 10.5089/9781451967951.023.A009

(percent of GDP)

Data: Ghanian authorities and authors’ estimates.

The Bank of Ghana’s failure to remunerate commercial banks’ primary reserve requirements is equivalent to a quasi-fiscal tax, which represents forgone revenue to the budget. However, the relatively high cost of sterilizing capital inflows more than offsets the lack of remuneration, giving rise to quasi-fiscal losses for the Bank of Ghana rather than any transfer of profits and dividends to the budget.

Quasi-fiscal activities have seriously distorted energy and water consumption, as well as the investment decisions of both the affected public enterprises and the private sector. In addition, they have a negative effect on equity and fairness, such as the preferential prices previously offered by the Volta River Authority to its largest customer.

The budget must eventually absorb these quasi-fiscal losses, which suggests the government will have less scope to increase spending on growth-enhancing and poverty-reducing social programs to achieve the Millennium Development Goals. Although improvement will take time, the government recognizes the urgent need to improve the financial and operating performance of the remaining public enterprises. As a first step, it has liberalized the prices of petroleum products, effectively eliminating quasi-fiscal activities from the Tema Oil Refinery, and it is implementing measures to enhance revenue collection and ensure that the prices charged by public utility companies are set to recover costs fully.

Mali Chivakul and Robert C. York

IMF Monetary and Financial Systems and African departments

Copies of IMF Working Paper No. 06/24, “Implications of Quasi-Fiscal Activities in Ghana,” by Mali Chivakul and Robert C. York, are available for $15.00 each from IMF Publication Services. Please see page 96 for ordering details. The full text is also available on the IMF’s website (www.imf.org).

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