- George Mackenzie, and Peter Stella
- Published Date:
- October 1996
Central banks and other public financial institutions (PFIs) play an important role as agents of fiscal policy in many IMF member countries. Their activities in this guise can affect the overall public sector balance (the balance of both the nonfinancial and the financial public sectors), without affecting the budget deficit as conventionally measured. These activities, which are often referred to as quasi-fiscal operations or activities (QFAs), may also have important allocative effects.1 Moreover, they entail an increase in the effective role and size of the public sector.
Standard measures of the nonfinancial public sector (NFPS) borrowing requirement normally take account of the explicit contribution to the budget of the central bank or other PFIs (typically, their profit transfers).2 In countries where QFAs have been important, however, a more comprehensive definition of the public sector financial balance may be a superior index of the impact of the government’s financial operations on the economy. Thus, the IMF, in its surveillance and program activities, has sometimes relied on a broader measure of the public sector’s financial requirements, in which the NFPS balance is augmented to include the net income (or net losses) of the central bank and sometimes that of other PFIs.
The principal goal of this paper is to analyze the macroeconomic and financial aspects of QFA. There is an important microeconomic dimension to QFA, however, since it effectively introduces taxes, subsidies, or other expenditures outside the framework of the budget. The many forms that QFA takes make it imperative that the analysis address not only the overall impact of QFA on public sector balances, but also the impact of particular QFAs on resource allocation. The paper addresses these allocative concerns. It also deals with the implications of the exclusion of QFA from normal budgetary procedures. Finally, the paper deals with some of the special measurement and accounting issues that QFA entails.3
The rest of the paper presents an analysis of the effects and implications of QFA, and makes recommendations about what should or should not be done about it. Specifically, Section II begins by defining QFAs and explaining why their identification and analysis should be a matter of concern for fiscal policy analysis. It then briefly reviews the factors that give rise to QFAs and some basic problems that arise in quantifying them. Section III provides a more detailed survey of the macroeconomic, financial, and allocative effects of specific QFAs. Section IV then addresses policy toward QFA.
The paper has three appendices. Appendix I analyzes a number of measurement and accounting issues. Appendix II presents some country-specific examples of the practices discussed in Section III of the text, and Appendix III presents five country case studies.
Basic Features of QFAs
The QFAs of central banks and other PFIs are many and varied. In the case of a central bank, most QFAs stem either from its role as regulator of the financial system or from its role as regulator of the exchange system. Subsidized lending, sectoral credit ceilings, and central bank rescue operations fall in the first group; multiple exchange rate (MER) regimes and exchange guarantees fall in the second. Central bank lending to the central government at below-market rates is also a relatively common practice. The QFAs of other PFIs often derive from restrictions on financial markets or from government-mandated special treatment for certain classes of borrowers and lenders. All of these operations may entail implicit or explicit taxation or subsidization of particular groups or activities, but they all fall outside the budget.
QFAs are a matter of concern for several reasons:
- Most important, in many countries, it has become clear that centra bank and PFI losses stemming from QFAs may be large and may be an important factor contributing to financial instability.
- The existence of QFAs means that conventional measures of the government’s financial balance may give a misleading indication of the extent and role of fiscal activity in the economy and of its macroeconomic impact.
- The taxes and subsidies that result from QFAs can be highly distortionary in their impact on resource allocation.
- QFAs may take the form of unfunded or contingent liabilities, which may be potentially sizable, highly uncertain, and especially difficult to control. Certain forms of contingent liabilities—for example, exchange rate guarantees—may have significant macroeconomic effects that precede their impact on the cash flows of the PFIs that extend them.
Three characteristics of QFAs are important in understanding their macroeconomic and financial effects: the size and timing of their impact on the cash income position of the public sector; the feasibility of their quantification (that is, the measurability of the quasi-fiscal taxes or subsidies that they entail); and the extent to which they entail a contingent liability, for which adequate financial provision needs to be made.
Some QFAs are much more difficult to quantify than others. The implicit taxes and subsidies entailed by an appreciated exchange rate applied to particular classes of traded goods can be measured and extracted from the financial accounts of the central bank. In contrast, such practices as credit ceilings, although they clearly have a fiscal component, are in practice impossible to quantify and cannot be incorporated in an alternative measure of the fiscal deficit. Even when it is not possible to quantify fully the impact of specific QFAs, it is nevertheless important that they are at least qualitatively flagged in any analysis of the fiscal situation.
Exchange rate guarantees provide a good example of a potentially very costly contingent liability. Consider a guarantee that ensures the convertibility of the local-currency counterpart of foreign-currency debt at the exchange rate prevailing when the debt was contracted. In a high-inflation country, this can entail a huge subsidy for foreign borrowing, and the stimulatory effect on aggregate demand is likely to take place well before the losses are realized. The potential impact of such contingent liabilities points to the shortcomings of purely cash-flow measures of fiscal activity, even where they extend beyond the NFPS to encompass the QFAs of the central bank and other PFIs.
Policy Toward QFAs
QFAs, if not properly monitored and controlled, can obviously undermine the achievement and maintenance of financial stability. If the central bank is used as a conduit to extend what is really a budgetary subsidy, both the deficit of the NFPS and net bank credit to the NFPS will be understated.4 The subsidy shows up in the form of a reduction in the central bank’s income. The traditional measures of the fiscal stance are thus rendered unreliable by QFA. However, an enlarged measure of the deficit— consisting of the sum of the NFPS and net income of the central bank and any other PFIs engaged in QFA—will capture the aggregate impact of such activity. When QFA is prevalent, it is a superior gauge of the fiscal stance.
To the extent feasible, quasi-fiscal operations should be quantified, extracted from the books of the central bank and PFIs, and included in a measure of the NFPS deficit used for programming or analytical purposes. This procedure will give a truer picture of the size of the public sector and the relative importance of different taxes and expenditures. Even a partial measure of the QFAs of the central bank and other PFIs is superior to concentrating simply on the overall balance. Moreover, such a separate analysis will prove useful even for the purpose of assessing and projecting developments in the accounts of central banks and PFIs for which QFAs are significant.5
Structural measures are likely to be necessary to address the root cause of QFAs. Troubled financial institutions may have to be closed, exchange rate systems unified, or the treasury required to pay a market-related rate of interest on its debt. Similarly, the legal authority of the central bank may need to be revised to limit the extent to which QFAs can be carried out. Such reforms can have major implications for the way a country’s financial system operates.