Chapter

II Review of Fiscal Developments

Author(s):
Benedict Clements, Liam Ebrill, Sanjeev Gupta, Anthony Pellechio, Jerald Schiff, George Abed, Ronald McMorran, and Marijn Verhoeven
Published Date:
March 1998
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The countries that seek support under the SAF and ESAF programs are typically those experiencing deep-seated macroeconomic and structural problems, often associated with persistent weak growth, high inflation, low rates of national savings, and fragile external positions. For example, during 1981–85, the average annual real per capita GDP growth in countries that later entered into ESAF arrangements was –1.1 percent, in contrast to 0.3 percent in non-ESAF developing countries. In addition, the annual inflation rates for prospective ESAF countries during this period averaged about 95 percent, and most ESAF countries—with the exception of those in the CFA franc zone and some in Asia—experienced significant and disruptive volatility in inflation rates.3

One way the economic imbalances in these countries in pre-program periods manifested themselves was in large and unsustainable fiscal deficits. The overall fiscal deficit for the sample of countries averaged 9.6 percent of GDP in the three years before adoption of a SAF/ESAF-supported adjustment program (Table 1). The primary (noninterest) deficit averaged 6.8 percent of GDP and the current deficit, a measure of public dissaving, averaged 1.6 percent of GDP during the same period. Imbalances were particularly large in the transition countries, where during the three-year pre-program period, the overall deficit averaged 11.1 percent of GDP while the primary and current deficits amounted to 10.2 percent and 3.4 percent of GDP, respectively (Appendix Table 11). Non-CFA franc zone African countries in the sample also experienced relatively large fiscal imbalances.

Table 1.Summary of Fiscal Objectives1(In percent of GDP; averages of SAFIESAF country samples)
(1)

Pre-program Year
(2)

Average of Three Years Prior to Program
(3)

Latest Year Actual2
(4)

Average Program Target
(5)

Average Actual During Program
(6)=(5)–(4)

Average Program Actual Minus Target
Fiscal balances
Overall balance–9.8–9.6–7.6–8.9–8.9
Region
Africa–9.2–9.7–7.6–8.4–8.7–0.3
CFA franc countries–8.7–8.7–7.5–8.0–7.60.4
Other–9.5–10.3–7.6–8.6–9.2–0.7
Asia–8.8–9.1–6.5–7.4–8.1–0.7
Western Hemisphere–5.4–7.0–5.4–5.7–7.5–1.8
Transition economies–14.7–11.1–9.3–13.4–11.22.2
Initial deficit3
High–13.8–13.4–9.5–12.1–11.40.6
Medium–7.8–7.8–6.4–7.0–7.6–0.6
Low–4.3–4.1–5.7–5.5–5.9–0.4
Primary balance–6.8–6.8–4.2–6.0–5.80.2
Current balance–1.9–1.60.50.5–0.1–0.7
Financing9.89.67.68.98.9
Foreign financing6.76.06.89.98.2–1.7
Foreign grants3.02.73.04.13.5–0.6
Net foreign borrowing3.83.43.85.84.7–1.1
Domestic financing (net)3.03.41.0–0.10.91.0
Of which: Financing from banking system1.51.7–0.8–0.10.7
Arrears0.2–0.2–0.8–0.20.7
Sources: Country authorities; and IMF staff estimates.

Averages calculated for total SAF/ESAF country sample excluding Guyana, where major revisions to GDP in the program years rendered comparisons, before and after, virtually meaningless.

Latest year for which data are available.

Countries divided into high, medium, and low initial deficit based on their average deficit for the three years preceding program adoption. High-deficit countries are those with deficits greater than 10 percent of GDP; medium, 5–9.9 percent; and low, less than 5 percent.

Sources: Country authorities; and IMF staff estimates.

Averages calculated for total SAF/ESAF country sample excluding Guyana, where major revisions to GDP in the program years rendered comparisons, before and after, virtually meaningless.

Latest year for which data are available.

Countries divided into high, medium, and low initial deficit based on their average deficit for the three years preceding program adoption. High-deficit countries are those with deficits greater than 10 percent of GDP; medium, 5–9.9 percent; and low, less than 5 percent.

In the three-year pre-program period, approximately two-thirds of the financing of the overall deficits took the form of foreign grants and net foreign borrowing. This number is an average, however, and masks considerable variation among the countries in the sample. Non-CFA franc zone African as well as Asian and transition countries relied relatively more on domestic financing (Appendix Table 12). Reliance on domestic bank financing depended on the capacity of the individual countries to tap alternative domestic sources without crowding out needed private sector activity. This capacity was quite limited, at least in the African and transition countries in the sample.

An important objective of the SAF/ESAF-supported programs was to bolster domestic savings—during 1981–85, gross national savings in SAF/ESAF countries averaged only 8 percent of GDP. As a practical matter, seeking such an improvement required efforts to increase public savings by reducing the current balance deficit. Consequently, the fiscal adjustment incorporated in SAF/ESAF programs typically envisaged a combination of deficit cutting and medium-term structural reform of government revenue and spending, the latter to place the fiscal accounts on a sounder basis over the long term. Successful fiscal adjustment was to contribute to reductions in inflation, in part, by limiting government recourse to domestic bank financing.

The extent of the fiscal adjustment envisaged in the typical SAF/ESAF program was modest in terms of the overall fiscal balance—the overall fiscal deficit was to decrease by about three-fourths of a percentage point of GDP, on average, from the three-year pre-program period average. Somewhat more ambitious adjustments were sought in the Asian and Western Hemisphere countries than in the African, and in those countries with relatively high initial fiscal deficits. Programs envisaged an average reduction in primary deficits of about 0.8 percent of GDP.4

Besides the deficit reduction targets, programs also set objectives for changing the mix of financing. Specifically, the SAF/ESAF programs envisaged that, in addition to attaining fiscal sustainability, the pattern of financing should shift away from domestic bank financing and the accumulation of arrears. This shift was meant to alleviate pressures on limited domestic financial resources and create room for expansion of private sector activity. Some of the most dramatic reductions in bank financing of the overall fiscal deficits were envisaged for the African countries, with an increasing share for concessional foreign financing. For the CFA franc zone countries, for example, net foreign borrowing was programmed to grow, on average, from 3.1 percent to 7.1 percent of GDP. In the case of the non-CFA franc zone African countries, reliance on bank financing was envisaged, on average, to decline by about 4.5 percentage points of GDP.

Turning to program outcomes, we found countries attained their targets for the overall deficit, on average, but again, outcomes varied considerably among regions. The overall fiscal deficits, on average, exceeded the program targets in both the non-CFA franc zone African and the Western Hemisphere countries. By contrast, the CFA franc zone and the transition countries achieved better-than-programmed fiscal outcomes. Also notable is that the countries with high initial deficits overperformed (Mozambique, Albania, Lao People’s Democratic Republic, and the Kyrgyz Republic), whereas those with low initial deficits failed to meet their overall deficit targets (Figure 1).

Figure 1.Overall Fiscal Balance: Outcomes Relative to Program Targets

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

Over the typical program period, fiscal consolidation progressed significantly in SAF/ESAF countries. The average overall fiscal deficit fell from 9.6 percent of GDP in the three years before the program to 7.6 percent of GDP in the most recent year for which data are available. The reductions were most striking in those countries where the initial deficits were the highest—from an average of 13.4 percent of GDP in the three-year pre-program period to 9.5 percent of GDP in the most recent year. The non-CFA franc zone African countries cut their overall deficit from an average of 10.3 percent of GDP in the three-year pre-program period to 7.6 percent of GDP.

The bulk of the adjustment occurred on the revenue side, with the average revenue-to-GDP ratio increasing from under 15 percent in 1983 to about 18 percent in 1995 (Figure 2). Significant reductions in the overall and primary deficits of SAF/ESAF countries were achieved in the most recent years, when many adjustment programs were reinvigorated (as in the CFA franc zone following the 1994 currency devaluation) and when the policy and institutional reforms began to take hold (as in the transition countries).5

Figure 2.Revenue, Expenditure, and Deficit1

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

1 Unweighted average of sample excluding Guyana; see Box 2 for countries.

Although overall deficit targets were achieved on average, financing objectives were missed by a considerable margin as countries failed to reduce their reliance on domestic financing—partly because of shortfalls in foreign financing. Net foreign borrowing and foreign grants were both below target by the equivalent of 1.1 and 0.6 percentage points of GDP, respectively, while net domestic financing was about 1 percentage point of GDP above target. As pointed out in subsequent sections, the failure to mobilize as much foreign financing as anticipated may have been a factor in the shortfall in meeting capital expenditure targets in SAF/ESAF countries.

There are differences in the regional patterns of financing outcomes. Although all regions experienced shortfalls in foreign financing, including in foreign grants, the CFA franc zone countries and the transition countries, in particular, experienced larger shortfalls in net foreign borrowing. However, for both of these groups, the shortfalls were not accompanied by a corresponding increase in domestic financing, indicating a likely buildup of arrears or incomplete fiscal accounting.6 In contrast, in the non-CFA franc zone African countries the shortfall in foreign financing had its counterpart in greater-than-anticipated domestic financing. This differential response between the CFA and non-CFA franc zone African countries likely reflected the disciplining effect of a common central bank on domestic borrowing in the CFA franc zone, a role enhanced by the relatively less developed financial intermediation in the region. The combination of limited external financing and a regional central bank that pursued a tight monetary policy to support a fixed exchange rate meant that government expenditures could be financed only by tax revenue or the accumulation of arrears (central bank financing of the budget deficit is by statute limited to 20 percent of revenue). Indeed, the lack of domestic financing in the CFA franc zone countries also likely contributed to their above-mentioned modest overperformance on fiscal consolidation.

Although the pattern of financing did not shift as much as anticipated during program periods, there was broad movement away from domestic bank financing. This shift occurred in all regions, although relatively steeper declines occurred in the non-CFA franc zone African and the Western Hemisphere countries (Figure 3). Comparing the average from the most recent year for which data were available with the average of the three-year pre-program period shows that total domestic financing declined by 2.4 percentage points of GDP, the entire decline being traceable to lower domestic bank financing. The decline was 4.1 percentage points of GDP for countries with high initial fiscal deficits, of which 3.1 percentage points were attributable to reduced bank borrowing. On average, the SAF/ESAF countries reduced their payment arrears by 0.2 percent of GDP; however, this performance fell short of the targeted reduction of 0.8 percent of GDP per year. The slippage was particularly large in CFA franc zone countries—amounting to 2 percent of GDP.

Figure 3.SAF/ESAF Countries: Financing of the Overall Deficit

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

1 Sample average excluding Guyana; see Box 2 for countries.

2 Average of three years prior to program.

3 Latest year for which data are available.

As noted above, sustainable fiscal consolidation cannot be measured simply by the behavior of macroeconomic aggregates such as the fiscal deficit; systemic structural reforms must seek sustainable revenue mobilization and improved expenditure policy and management. The following sections discuss the structural reforms in the tax and expenditure systems in SAF/ESAF countries and assess their implications for improved economic performance.

3The data in this paragraph are drawn from International Monetary Fund (forthcoming).
4Note the sample of countries for which primary balance targets were available was smaller than the sample for the overall balance targets.
5This improvement was also aided by the extension of SAF/ESAF programs to new countries that happened to have lower deficits relative to the current group mean at that time.
6The arrears data in Appendix Table 12 refer only to annual flows; the absence of adequate data on the stocks of arrears before and during programs precludes an accurate assessment of their role in fiscal consolidation.

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