Chapter

V Key Feature 4: Ensuring Appropriate Flexibility in Fiscal Targets

Author(s):
Benedict Clements, Gabriela Inchauste, Nita Thacker, Thomas Dorsey, Shamsuddin Tareq, Emanuele Baldacci, Sanjeev Gupta, and Mark Plant
Published Date:
September 2002
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This key feature sets out the expectation that fiscal targets in PRGF-supported programs should be designed in a manner that allows greater flexibility in accommodating higher public expenditures and accommodating unexpected changes in revenue or financing.

The flexibility of fiscal targets under PRGF-supported programs can be analyzed from a number of angles. One perspective is to assess whether the fiscal framework in these programs is permitting an increase in public expenditures to accommodate the government’s poverty reduction strategy. To maintain macroeconomic stability, this should be consistent with the program’s targets for external balances, inflation, and credit growth. Another aspect of flexibility in program design is how targets for the budget deficit are adjusted when foreign aid or revenues are different from what is anticipated—for example, are budget deficits allowed to increase when more foreign financing is available? The first section below assesses the design of fiscal targets, and the second examines the adjusters for these targets built into PRGF-supported programs.

Fiscal Targets Under PRGF-Supported Programs

PRGF-supported programs incorporate higher public expenditures. On a commitment basis, primary expenditures (i.e., public expenditures net of interest payments) are targeted to rise by three-fourths of a percentage point of GDP to 22.5 percent of GDP—almost two percentage points higher than envisaged in the last ESAF-supported program (Table 4). On average, almost all of the targeted increase in public outlays relative to the pre-PRGF year will be absorbed by higher capital expenditures, and current outlays in PRGF-supported programs—including programs for wages—will remain roughly constant as a share of GDP (Appendix Table A.1). This pattern of adjustment augurs well for these countries’ growth prospects.27

Table 4.Fiscal Targets in PRGF- and ESAF-Supported Programs1:(Unweighted averages; in percent of GDP unless otherwise indicated)
Under the PRGF2Under the ESAF3
DataPre-Program

Year4
3-Year

Program

Average5
3-Year

Program

Average

Minus

Pre-Program
Pre-Program

Year6
3-Year

Program

Average7
3-Year

Program

Average

Minus

Pre-Program
Total revenue and grants20.321.41.119.420.30.9
Revenue17.117.90.816.317.31.0
Grants3.23.50.33.13.0–0.1
Total expenditure and net lending23.624.40.822.823.20.3
Primary expenditure821.622.50.920.020.60.6
Overall balance (commitment basis)–3.3–3.00.3–3.5–2.90.5
Arrears–0.1–0.5–0.4–0.3–0.4–0.1
Overall balance (cash basis)–3.5–3.6–0.1–3.8–3.40.4
Overall balance (cash basis) excluding grants–6.7–7.0–0.4–6.6–6.20.4
Deficit financing3.53.60.13.83.4–0.5
Domestic0.9–0.2–1.11.0–0.2–1.3
Bank0.1–0.6–0.80.3–0.7–1.0
Non-Bank0.2–0.1–0.40.3–0.1–0.3
Privatization0.40.60.10.20.30.1
External92.63.71.12.83.60.8
Sources: National authorities; and IMF staff estimates.

Excludes Moldova, which did not have an ESAF program; and Guinea-Bissau, Lesotho, and Sierra Leone, where the program data for a number of fiscal variables are three or more standard deviations away from the mean. The components may not sum to the total because of differing sample sizes. The overall balance (cash basis) includes statistical discrepancies.

Refers to program targets set out in the first PRGF program document discussed by the Executive Board after July 1,2000.

Refers to targets set out in the last annual ESAF arrangement.

In most cases, the pre-PRGF year is 1999.

For the sample as a whole, data refer to averages for two years for six countries, and for one year for five countries.

Refers to the year before the last annual ESAF arrangement. In most cases, it refers to 1997.

For the sample as whole, data refer to averages for two years for three countries, and for one year for four countries.

Total expenditure and net lending minus interest payments.

Includes financing not identified at the time documents were submitted to the Board.

Sources: National authorities; and IMF staff estimates.

Excludes Moldova, which did not have an ESAF program; and Guinea-Bissau, Lesotho, and Sierra Leone, where the program data for a number of fiscal variables are three or more standard deviations away from the mean. The components may not sum to the total because of differing sample sizes. The overall balance (cash basis) includes statistical discrepancies.

Refers to program targets set out in the first PRGF program document discussed by the Executive Board after July 1,2000.

Refers to targets set out in the last annual ESAF arrangement.

In most cases, the pre-PRGF year is 1999.

For the sample as a whole, data refer to averages for two years for six countries, and for one year for five countries.

Refers to the year before the last annual ESAF arrangement. In most cases, it refers to 1997.

For the sample as whole, data refer to averages for two years for three countries, and for one year for four countries.

Total expenditure and net lending minus interest payments.

Includes financing not identified at the time documents were submitted to the Board.

PRGF-supported programs have deficit targets that are similar to those under the preceding ESAF-supported programs. PRGF-supported programs target similar deficits on both a commitment and a cash basis, because lower interest burdens and rising revenues and grants have facilitated higher primary outlays. On a cash basis, changes in the deficit (relative to the pre-program year) are higher under PRGF-supported programs, reflecting greater repayment of arrears.

As was the case during ESAF-supported programs, governments are expected to reduce their debt to the banking system on a net basis. PRGF-supported programs, therefore, are designed to be consistent with a further strengthening of public finances and the maintenance of macroeconomic stability—as evidenced by the similarity in macroeconomic targets under PRGF- and ESAF-supported programs (Section III).

The fiscal framework in PRGF-supported programs varies across countries. Not all countries, for example, are able to accommodate higher public spending (even if foreign-financed), because this may not be compatible with macroeconomic stability or a sustainable level of public debt.28 Post-stabilization countries29 incorporate larger increases in expenditure, and the overall fiscal deficit, than other countries with PRGF-supported programs (Appendix Table A.2). Deficits in the post-stabilization countries are targeted to increase by about one-half of a percentage point of GDP, and in other PRGF-supported program countries the fiscal balance will remain roughly unchanged and larger than average.30 Revenue increases targeted under PRGF-supported programs are also less ambitious in the post-stabilization countries, although this could reflect their healthier revenue generation before the start of the PRGF-supported program. These considerations suggest a sizable degree of flexibility in program design, because there is no “one size fits all” approach to fiscal adjustment.

While revenues will rise under PRGF-supported programs, the projected increase is smaller than under ESAF-supported programs. Non-HIPCs anticipate more progress in raising revenues than the HIPCs (Appendix Table A.3); furthermore, HIPCs expect smaller increases in their revenues than under their last ESAF-supported program. This may reflect myriad factors, including more realism in revenue projections and a less pressing need to generate additional fiscal resources in the face of sizable debt relief. Nevertheless, these less ambitious targets suggest the need for continued vigilance on the revenue effort in HIPCs, which will be necessary to secure the resources for higher poverty-reducing spending over the medium term.

Flexibility in Accommodating Changes in Financing or Revenues

One critical aspect of flexibility is how program targets for the government budget accommodate deviations in expected foreign financing, revenues, or privatization proceeds. Of particular interest in this context is (1) whether fiscal targets are sufficiently flexible to allow governments to increase the budget deficit when foreign financing is higher than expected; (2) whether PRGF-supported programs identify contingent expenditures to be expanded or protected in cases where revenues or financing is significantly different from what is expected; and (3) how program targets are adjusted in response to shortfalls in foreign financing, revenues, or privatization receipts.

PRGF-supported programs show greater flexibility than ESAF-supported programs in accommodating higher spending when unanticipated foreign financing (including financing in the form of grants) is available. This is especially true of new PRGFsupported programs, where more than one-third of programs contain such adjusters. Under the ESAFsupported programs, by contrast, these adjusters were present in fewer than 10 percent of countries. Transformed PRGF-supported programs use these adjusters with less frequency than new programs. This may be because the start of a program provides a more ripe opportunity for addressing technical issues of program design, including adjusters.

PRGF program targets accommodate shortfalls in foreign financing, although slightly less than under ESAF programs. About two-thirds of PRGFsupported programs allow for an upward adjustment in targets for domestic financing of the deficit when foreign financing is lower than expected. In most cases, the accommodation is only partial. Adjusters for shortfalls in privatization proceeds, or accommodation for other shocks, are also present in about one-fourth of the programs.

One area where relatively little progress has been made is in the identification of contingent expenditures, especially in transformed PRGF-supported programs. In part, this is because PRSPs have not been identifying the specific expenditures that would be increased/decreased in case of excess/shortfall in foreign financing compared with programmed levels. Only four countries (Cameroon, Guinea-Bissau, Niger, and Rwanda) identify the spending that would be increased if foreign financing were higher than anticipated. In most cases, this spending includes that in the social sectors. If a broader definition of contingency spending is used—one that includes spending that is to be protected in case of financing shortfalls—then about a third of all programs have identified these outlays.

Another way to assess flexibility is to judge whether alternative fiscal adjustment paths were discussed with country authorities, and whether the authorities were able to choose from among several different alternatives. Information on this dialogue, however, is not systematically available in PRGF-supported program documents (see below).

Other assessments generally agree with those of the staff on fiscal flexibility. In the survey of authorities, about two-thirds agree that there is greater fiscal flexibility in accommodating both social spending and increased foreign financing, and fewer than 25 percent disagree on either fiscal flexibility question. Views of NGOs and donors were likewise largely in agreement on the assessment of progress in fiscal flexibility.

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