2. Strengthening Fiscal Policy Space

International Monetary Fund. African Dept.
Published Date:
May 2013
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Introduction and Summary

Fiscal balances weakened in most sub-Saharan African countries with the onset of the global economic crisis, with increases in deficits in the early stages of the crisis being partly offset by consolidation efforts as growth rebounded in 2010–12. Concern has been frequently expressed that governments may now be more constrained in their ability to provide fiscal support for economic activity in the event of adverse shocks.1

This chapter examines several aspects of governments’ financial positions to assess whether countries in the region are currently tightly constrained in their capacity to run larger deficits during economic slowdowns, or alternatively have room—what we shall call “fiscal policy space”—to adopt a countercyclical (or, at a minimum, neutral) fiscal policy in the event of a downturn. As used here, the term “fiscal policy space,” is closely linked to the concept of “fiscal buffers,” and is a narrower concept than the more widely used notion of “fiscal space,” which captures the idea of room, in a medium-term context, to undertake desirable policy initiatives, such as expanding social spending or public investment, while maintaining a solid fiscal position.

To establish some quantitative sense of a country’s fiscal policy space, we examine three distinct aspects of a government’s financial position: (i) the level of public sector debt, which, if sufficiently high, limits the government’s ability to accumulate further debt;2 (ii) the ability of the government to finance higher deficit levels at reasonable cost and without imposing undue stress on domestic credit markets; and (iii) the ability of the government to finance higher deficits by drawing on its own financial assets, held at home or abroad. The chapter also examines the scope for improving fiscal positions over the medium term and the trade-offs decision-makers confront in rebuilding fiscal policy space.

One general conclusion of the analysis is that, although the majority of countries in the region are not constrained from borrowing by high debt levels, many could find it difficult to raise sufficient financing for larger deficits in a downturn. In more detail:

  • A combination of strong growth, good macroeconomic management, and debt relief produced a sharp decline in debt burdens for most sub-Saharan African economies in the period prior to the global economic crisis.

  • Fiscal positions came under pressure in the region during the global economic crisis, with significant variation in stress across countries. Oil exporters saw severe, but brief, budgetary shocks, which ended as oil prices recovered in 2010. Middle-income countries suffered significant and lingering growth slowdowns, widening deficits, and sizable debt buildups. In low-income countries, growth slowed modestly, fiscal deficits rose somewhat, and debt accumulation, on average, was limited—but experiences varied markedly across countries.

  • Examination of debt developments in low-income countries indicate that (i) several countries have experienced significant increases in public sector debt levels since 2007; and (ii) forward-looking assessments of debt sustainability suggest that the debt outlook is a concern in a number of countries, partly constraining fiscal policy space. Debt situations have worsened, notably in some middle-income countries, and are now a factor constraining policy decisions.

  • Examination of borrowing capacity across (non-oil) countries shows that there are many countries with thin domestic financial markets that are fundamentally constrained in their ability to finance expanded deficits domestically; in a crisis situation, fiscal policy support for economic activity would require additional donor funding. But there are also several countries with relatively deep financial markets that relied on extra domestic borrowing to finance large deficits during the crisis period and could likely do so again in a downturn, although they might see some impact on their cost of borrowing.

  • There are several countries in the region—typically, but not only, oil exporters—that have accumulated significant financial assets, held either at the central bank or abroad. Such resources can be used to finance larger deficits in the face of a downturn, although the adequacy of these financial assets as a fiscal buffer needs to be assessed against the volatility of budgetary receipts.

  • There is scope in most countries in the region to strengthen fiscal positions, either via revenue augmentation or expenditure rationalization. How this new fiscal room should be used depends on both global conditions and individual country circumstances. Where policy space is seriously eroded, the prudent approach now would be to deploy much of these savings to reduce deficits and debt accumulation; when global recovery is well entrenched, the case for using savings to boost development spending will be more compelling.

The Level of Public Debt as a Constraint on Financing Deficits

The IMF and World Bank regularly conduct joint debt sustainability analyses for low-income member countries based on the Debt Sustainability Framework (DSF).3 The analyses examine the projected trajectories of debt levels and other macroeconomic variables over some twenty years. Debt sustainability analyses (DSAs) were initially focused on the sustainability of external debt, but now give similar weight to assessing public sector debt sustainability (IMF-World Bank, 2012). The IMF also conducts DSAs for “market access” countries—countries that are not eligible for concessional lending. The discussion in this section is based on DSAs for countries in the region.4

Recent Developments

Based on the most recent DSAs, public debt levels in sub-Saharan Africa have fallen sharply since 2000. Average public sector debt in the region fell from more than 100 percent of GDP in 2000–01 to below 40 percent of GDP by 2008 (Figure 2.1), helped by improved fiscal balances, strong economic growth, and some real exchange rate appreciation (see Figure 2.2, left panel). The provision of comprehensive external debt relief by creditors, in the context of the Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI), also made a major contribution to reducing debt levels for low-income countries over this period: the amount of debt relief provided to beneficiaries through these initiatives was, on average, about 47 percent of 2012 GDP.

Figure 2.1.Sub-Saharan Africa: Density of Public Sector Debt, 2000–12

(Percent of GDP)

Sources: IMF, DSA database; and IMF staff calculations.

Note: For any given year, the “box and whiskers” plot (or boxplot) summarizes the distribution—during that year—of debt-to-GDP for 44 countries in sub-Saharan Africa (outliers not shown). Debt-to-GDP ratios pertain to public sector debt as defined in the IMF-World Bank Debt Sustainability Framework.

The steady decline in debt levels was halted by the onset of the global recession, although the dispersion of debt burdens across countries continued to narrow significantly as some heavily indebted countries received sizable debt relief. Although the median debt-to-GDP ratio moved only modestly from 2008 levels, this reflected a number of conflicting trends (Figure 2.2, right panel). Average debt levels rose significantly in middle-income countries, reflecting sluggish growth and widening primary deficits. By contrast, average debt levels in low-income countries showed little movement, with the impact of higher primary deficits being offset by strong growth and negative real interest rates—although the cross-country averages are somewhat misleading in this case. Finally, average debt burdens declined sharply among fragile states, many of whom finally completed the HIPC debt relief process in the last few years (for example, Côte d’Ivoire, Democratic Republic of Congo, Liberia).

Figure 2.2.Sub-Saharan Africa: Public Sector Debt Accumulation Decomposition, 2000–12

Sources: IMF, DSA database; and IMF staff calculations.

Note: The category “Other” comprises debt relief (HIPC and other) as indicated, privatization proceeds, recognition of implicit or contingent liabilities, other country-specific factors (such as bank recapitalization), asset valuation changes, and other unidentified debt-creating flows as defined in the IMF-World Bank Debt Sustainability Framework. Debt-to-GDP ratios pertain to public sector debt as defined in the DSF.

Among countries that did not benefit from debt relief or debt restructuring in recent years, there was some upward drift in debt levels in most cases (Figure 2.3). Public sector debt-to-GDP ratios increased by more than 10 points in nine cases, including Ghana (12 points), Mozambique (19 points), Senegal (21 points), and South Africa (13 points).5 Countries where public debt levels have declined since end-2007 include Ethiopia and Lesotho; many others recorded only modest increases.

Figure 2.3.Sub-Saharan Africa: Change in Public Sector Debt, 2007–12

(Percentage points)

Sources: IMF, DSA database; and IMF staff calculations.

Note: Excludes countries that received debt relief during or after 2007, as well as Eritrea, Gabon, Seychelles, and Zimbabwe (Gabon and Seychelles restructured their debt in 2007–08 and 2009, respectively). Debt-to-GDP ratios pertain to public sector debt as defined in the IMF-World Bank Debt Sustainability Framework. For Equatorial Guinea, the figures correspond to external debt (2012 is projected).

Are Current Debt Levels a Cause for Concern?

Much research effort has been devoted to determining threshold levels of public and public external debt above which the risk of running into debt distress is deemed to be high. We examine here (Figure 2.4) the extent to which public debt levels in sub-Saharan Africa currently exceed these threshold levels. We split the discussion into two parts:

Figure 2.4.Sub-Saharan Africa: Public Sector Debt in 2012 and Sustainability Thresholds

(Percent of GDP)

Sources: IMF, DSA database; and IMF staff calculations.

Note: Excludes Eritrea and Zimbabwe. Debt-to-GDP ratios pertain to public sector debt as defined in the IMF-World Bank Debt Sustainability Framework. For Equatorial Guinea, the figure corresponds to projected external debt as of 2010.

  • For countries that are eligible for the Poverty Reduction Growth Trust (PRGT-eligible),6 we employ two sets of threshold estimates. The first is taken from the IMF-World Bank’s DSF; the second is also derived from that framework, but calibrated to embody a more conservative assumption regarding the probability of experiencing debt distress (Box 2.1).

  • For middle-income countries, we use an illustrative debt level of 43 percent of GDP, taken from the IMF’s Fiscal Monitor, as a signal of potential debt concerns.7

Of the 33 PRGT-eligible countries considered, three countries have 2012 debt-to-GDP levels that exceed the DSF thresholds, whereas 10 countries exceed the more conservative limits described in Box 2.1. Among the latter group, countries that exceed the threshold include Cape Verde, The Gambia, Guinea-Bissau, and São Tomé and Príncipe.

Of the nine non-PRGT-eligible countries, Mauritius and Seychelles have debt levels that exceed the indicative threshold level, whereas the South African debt ratio has been gradually approaching the threshold level over the past four years. However, Seychelles’ debt-to-GDP ratio has been declining in recent years, helped by debt-restructuring and vigorous implementation of an economic reform and stabilization program. In Mauritius, the debt-to-GDP ratio has moved only marginally over the past several years; the bulk of public debt is issued domestically. South Africa’s debt is also largely domestic, which reduces the risks associated with public debt, such as currency risk.

Are Projected Debt Trajectories Sustainable over Time?

DSA projections suggest that the medium-term debt outlook for sub-Saharan Africa appears to be generally favorable, given our projected economic outlook for the region. These projections indicate that average debt-to-GDP ratios are expected to edge up only marginally in the next five years relative to end-2012 levels, with limited changes in their dispersion (Figure 2.5). This reflects, for the most part, continued strong growth and favorable financing conditions: the interest rate growth differential—a key driver of debt dynamics—is negative for most sub-Saharan African countries.

Figure 2.5.Sub-Saharan Africa: Density of Public Sector Debt, 2013–17

(Percent of GDP)

Sources: IMF, DSA database; and IMF staff calculations.

Note: Outliers as defined in Figure 2.1 are Eritrea and Zimbabwe (not shown, but included on the distributions depicted). Debt-to-GDP ratios pertain to public sector debt as defined in the IMF-World Bank Debt Sustainability Framework.

There are, however, some important differences in projected debt dynamics across countries. To go beneath the aggregates, and assess the debt outlook for individual countries, it is useful to again split the countries into PRGT-eligible countries (where DSAs yield explicit assessments in regard to external debt) and “other” (middle-income) countries.

Box 2.1.Public Debt Sustainability Threshold

For low-income countries, the country-specific public debt sustainability thresholds used in this chapter are based on IMF and World Bank (2012a), which provides a comprehensive review of the joint IMF-World Bank Debt Sustainability Framework (DSF) for low-income countries. In that paper, country-specific (long-term) public debt sustainability thresholds are calculated for a group of 155 countries between 1971 and 2007 in three steps:

  • Step 1: Episodes of debt distress are identified based on different indicators of debt-servicing difficulties or debt-distress signals.

  • Step 2: A probit model is used to estimate the incidence of debt distress, where the probability of debt distress is a function of the debt-to-GDP ratio and a set of country-specific characteristics that include the World Bank’s Country Policy and Institutional Assessment (CPIA) index.

  • Step 3: The debt sustainability thresholds for each CPIA rating are chosen using the probit estimation results and a specific optimality criterion. Based on the optimality criterion, the framework assigns a 13 percent probability of debt distress to a country whose debt level is at the sustainability threshold for its CPIA rating, and whose characteristics match the average for that grouping. The public debt thresholds thus calculated are 49 percent of GDP, 62 percent of GDP, and 75 percent of GDP for countries with weak, moderate, and strong CPIA scores, respectively (Figure 2.4).

We constructed a second set of debt thresholds for low-income countries, calibrated so that the average country whose debt is at the relevant threshold faces a lower probability of debt distress (10 percent); the associated threshold levels are 34 percent of GDP, 47 percent of GDP, and 60 percent of GDP for countries with weak, moderate, and strong CPIA scores, respectively (Figure 2.4). A more conservative bias is introduced here given our focus in assessing resilience to adverse shocks.

The DSF does not provide sustainability thresholds for non-PRGT-eligible countries. In the discussion here, we employ an illustrative threshold (43 percent of GDP) that signals potential debt concerns in emerging market countries, taken from the IMF’s Fiscal Monitor. This estimate should be viewed as illustrative rather than the result of a statistically rigorous debt sustainability analysis.

Prepared by Tamon Asonuma and Juan Treviño.

Considering first PRGT-eligible countries, we can summarize the conclusions of the most recent DSAs for 33 low-income countries as follows:8

  • 14 countries are deemed to be at low risk of experiencing external debt distress;

  • 14 countries are deemed to be at moderate risk of experiencing such distress, meaning that there are some adverse scenarios in which the risk of debt distress would be high;

  • 5 countries (Burundi, Comoros, Democratic Republic of Congo, The Gambia, and São Tomé and Príncipe) are currently deemed to be at high risk of debt distress.9

To provide some perspective on public debt levels, we consider the projected behavior of public debt-to-GDP levels in the 14 countries under study to be at moderate risk of experiencing external debt distress over the five years 2012–17.10 DSA projections for these countries indicate that public debt levels are expected to decline (or remain unchanged) over the five-year period in virtually all countries, and that the projected 2017 public debt levels lie below even the more conservative threshold levels cited above in all cases (Figure 2.6).

Figure 2.6.Sub-Saharan Africa: Public Sector Debt in 2012, 2017, and Sustainability Thresholds

Sources: IMF, DSA database; and IMF staff calculations.

Notes: The forecasts for Equatorial Guinea and Namibia correspond to 2015 and 2016, given data availability. Debt-to-GDP ratios pertain to public sector debt as defined in the IMF-World Bank Debt Sustainability Framework. For Equatorial Guinea, the figure corresponds to projected external debt as of 2010. The Gambia is expected to change its risk of debt distress from high to moderate, as its CPIA ratings have improved significantly.

To obtain a third perspective, we look at the track record of debt accumulation during the past five years by countries now deemed to be at moderate risk of experiencing external debt distress. Of the 14 countries,11 only Ghana, Malawi, and Mali experienced increases in debt-to-GDP ratios of 10 points of GDP or more since end-2007 (Figure 2.3), indicating that, in these cases, DSA projections for the next five years envisage quite different policies and outcomes from those observed over the past five years.

Pulling these various strands together, one can conclude that current (or projected) debt levels do not constrain temporary financing of expanded budget deficits in most low-income countries. Exceptions to this statement likely include the five countries now classified at high risk of external debt distress, and, to some extent, those countries now classified at moderate risk of debt distress that have experienced a sharp buildup of debt levels in recent years. That debt levels are not a major impediment to borrowing in most low-income countries reflects the combined benefits of debt relief and robust growth.

Turning to middle-income countries, DSA projections through 2017 show mixed results: debt levels are expected to rise sharply (to above 60 percent) in Swaziland; to fall substantially (while remaining elevated) in Seychelles; and to show marginal changes in Mauritius (downward) and South Africa (upward). Viewed through the lens of the ability to finance increased budget deficits over a business cycle, it would appear that Swaziland’s fund-raising capacity will tighten even further, South Africa’s debt levels will continue to be a cause of some concern for markets, while financing capacity should improve in Seychelles.

One important qualification worth recording here is that DSAs provide a forward-looking assessment of debt sustainability: they do not provide any insight into whether debt accumulation in earlier years was or was not beneficial. Assessing this (important) question would require a backward-looking analysis of developments in the relevant country, which lies outside the scope of this paper.12, 13

Availability of Financing as a Constraint on Avoiding Procyclicality

Deficit Financing during the Crisis

The region as a whole was able to finance a large increase in budget deficits during the crisis. As shown in Figure 2.7, the main source of financing when the crisis hit was domestic—with the largest swings in oil exporters and middle-income countries. The main source of domestic financing was credit from the banking sector, including running down deposits at central banks. Reliance on external financing was particularly strong among fragile countries (e.g., Côte d’Ivoire, São Tomé and Príncipe, Togo), typically in the form of concessional loans from international financial institutions. The level of external financing has remained elevated notwithstanding that, for most countries, growth rates have recovered to near pre-crisis levels. With some exceptions (for example, Angola, Cameroon, Eritrea, Swaziland), there was little accumulation of arrears.

Figure 2.7.Sub-Saharan Africa: Composition of Government Deficit Financing, 2007–12

(Percent of GDP)

Sources: IMF, World Economic Outlook; and IMF, African Department database.

Note: Measures of external financing and deficit levels exclude debt-relief operations.

The manner in which deficits have been financed has varied significantly across countries (Figure 2.8).14 Countries with well-developed government bond markets, such as Ghana, Kenya, and South Africa, relied mainly on domestic bond issuance to finance deficits—with some of the financing coming from nonresident investors. Countries recording more modest deficit levels that have also made significant use of domestic financing include Mauritius, Sierra Leone, and Zambia. By contrast, poorer and/or smaller countries have typically relied heavily on external financing of various forms, whether from international financial institutions loans, bilateral concessional financing, or commercial/project financing. The data do not allow a decomposition of these various financing sources, although poor and fragile states, in particular, benefited from strong support from bilateral and multilateral donors.

Figure 2.8.Sub-Saharan Africa: Composition of Government Deficit Financing, 2008–12

(Average in percent of GDP)

Sources: IMF, World Economic Outlook; and IMF, African Department database.

Note: External financing and the deficit exclude debt-relief operations; excludes Eritrea, Malawi, Togo, Zimbabwe, and oil exporters.

Examination of trends in external budget support to sub-Saharan African countries in recent years supports the view that elevated donor support was key to helping fragile states during the crisis period (Figure 2.9). For non-fragile low-income countries, the increase in budget support from 2008 levels was modest in size and temporary in nature—with the gradual downward trend observed since 2009 consistent with trends in official transfers noted in Chapter 1. For fragile states, the surge in external budget support in 2009 was large (about 2½ points of GDP), reverting to pre-crisis levels by 2011.

Figure 2.9.Sub-Saharan Africa: External Budget Support, 2007–12

(Weighted average across country groups)

Source: IMF, African Department database.

Note: External budget support includes both budget support loans and grants.

Could Countries Borrow in the Event of a New Downturn?

Additional funding for deficit financing can come either from domestic markets or external sources. The ability to attract new external funding from commercial sources to finance increased deficits is likely to be limited for most countries in sub-Saharan Africa, except in the case of specific project finance. Even frontier markets, currently capable of tapping sovereign bond markets, would likely encounter a different environment in the event of a significant global downturn and associated shocks to domestic economies. With the timing of project financing likely to be closely linked to project needs, rather than to budget financing needs, the one reliable source of incremental external financing in a downturn scenario would be multilateral and bilateral donors. Given the budgetary pressures facing many traditional donors, the multilaterals would likely have to play an expanded role in meeting short-term financing needs as compared with 2009.15

The ability of countries to raise additional financing from domestic sources is a function of both the depth of domestic financial systems and the current role of the public sector in the use of domestic credit. In countries characterized by significant financial deepening and the lack of fiscal dominance in access to credit, governments are well positioned to tap credit markets for additional funding in a downturn, especially if private sector credit demand is adversely affected by the shock. The data suggest that there are several countries where tapping additional funds to finance temporary deficits from domestic sources should not be difficult (Figure 2.10):16 examples include Kenya, Mauritius, and South Africa. By contrast, countries with thin financial systems, such as Chad, Niger, and Rwanda, and/or government dominance in the allocation of credit, such as The Gambia or Sierra Leone, would likely cause significant dislocation (for example, via interest rate spikes) were they to attempt to raise significantly larger financing on domestic markets.

Figure 2.10.Sub-Saharan Africa: Composition of Credit, end-2012 or the Most Recent Year Available

(Percent of GDP)

Source: IMF, African Department database.

Note: The sum of two bars represents the total credit-to-GDP ratio. Excludes Liberia. Data is for 2012 or most recent available year.

Assessing the extent to which additional domestic deficit financing would crowd out private sector access to credit requires a careful examination of country-specific factors and the impact of downturns on private sector credit demand. Based on an empirical assessment of the situation in sub-Saharan African economies, Berg and others (2009) argued that crowding out of private sector activity by expanded government borrowing was unlikely to have been significant during the crisis period, given the fall-off of investment and private credit demand. Recent assessments by IMF country teams also suggested that little evidence exists that deficit domestic financing has crowded out private credit in the past few years, albeit with some exceptions, including Burundi and Sierra Leone. Although the significance of “crowding out” in a downturn may be relatively modest, this is unlikely to be the case as economies recover and resume trend growth rates.

One constraint facing most countries in financing deficits is the nascent stage of development of government bond markets in most of sub-Saharan Africa. The size of these markets in the region averaged about 15 percent of GDP in 2010—a level significantly lower than observed in developing countries in other regions (Mu and others, 2013). Further development of domestic bond markets would enhance the capacity to finance countercyclical fiscal policies.

Pulling together the discussion above, there are many economies in sub-Saharan Africa that, though not burdened by significant debt levels—are constrained in their ability to finance temporary increases in budget deficits by the shallowness of domestic financial markets. For such countries, “fiscal policy space” is dependent on their ability to tap into increased external funding from multilateral and bilateral donors—or to accumulate domestic arrears (with potentially significant adverse effects on suppliers). Countries with deeper financial markets, by contrast, can finance larger deficits in a downturn by domestic borrowing—as we have seen has been the case for many countries. Of course, continued recourse to higher borrowing levels, absent rapid growth and/or negative real interest rates, will over time yield a rising debt burden—that will eventually constraint borrowing capacity.

Availability of Government Deposits

Government deposits, held either in foreign or domestic financial institutions, provide governments with an additional fiscal buffer in responding to shocks.17 During the peak of the crisis, countries—notably oil exporters and middle-income economies—did run down government deposits, and have been rebuilding them over the past two years (Figure 2.11); the scale of rebuilding is, to date, more modest than the initial run down.

Figure 2.11.Sub-Saharan Africa: Changes in Government Deposits, 2007–12

Source: IMF, African Department database.

Note: Includes the changes in government deposits in the domestic monetary sector, and in government deposits abroad for a few resource-rich countries.

The significance of domestically held government deposits in sub-Saharan Africa varies markedly across countries (Figure 2.12). Among the CFA currency zone countries of CEMAC and WAEMU, the oil-rich Republic of Congo and Equatorial Guinea appear to have large fiscal buffers in the form of government deposits that can be drawn down to finance an expanded budget deficit; among other countries with currency pegs, Lesotho stands out as a country with sizable domestic deposits that are more-than-backed by foreign currency reserves.18 Among countries without an exchange rate peg, Angola and Botswana have sizable government deposits with the banking system, backed by strong levels of foreign reserves—an important buffer for countries where exports and budgetary receipts are highly volatile.19 Comparable data on foreign financial assets held directly by governments (as distinct from via central banks) are not easy to construct: some oil producers have already accumulated significant overseas assets that can provide an important fiscal buffer, whereas others (such as Angola and Nigeria) are gradually accumulating external financial wealth in sovereign wealth funds, although the amounts involved in some cases are still modest.

Figure 2.12.Sub-Saharan Africa: Government Deposits in Banking System and Foreign Reserves, end–2012 or the Most Recent Year Available

Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; and IMF, African Department database.

Note: Countries “without peg” include all sub-Saharan African countries whose exchange rate regimes are not classified as a conventional peg or a currency board, ranging from de facto crawling pegs to fully floating regimes, according to the IMF’s 2012 Annual Report on Exchange Arrangements and Exchange Restrictions.

Some Conclusions on the Availability of Fiscal Policy Space

The discussions above have examined the extent to which economies in sub-Saharan Africa have adequate fiscal policy space (or buffers)—meaning the capacity to finance temporary increases in budget deficits to support economic activity in the event of adverse economic shocks. One conclusion was that elevated public debt levels are a constraint on fiscal policy space in several cases, but most countries now have relatively modest levels of public debt, with IMF-World Bank debt sustain-ability assessments pointing to significant concerns in a minority of cases. A second conclusion was that, even with modest debt levels, the ability to finance larger deficits domestically was quite limited in countries with shallow financial systems and/or large government shares in the existing stock of credit—implying that fiscal policy space would be available only with financial support from multilateral and bilateral donors and in some cases with increased rollover risks. There are also several countries—with deeper financial markets—that were able to borrow domestically to fund enlarged deficits during the crisis period; a brief review of the current supply of credit across countries suggests that, abstracting from debt-level concerns, there is scope to increase domestic financing from current levels in these countries on a temporary basis. Finally, several natural resource producers have built up sizable government financial asset holdings that (if liquid) can provide a buffer in the event of adverse shocks: whether these buffers are adequate given the volatility of external/budgetary receipts needs to be evaluated on a case-by-case basis.

It is useful to look at the overlap between countries deemed to be highly vulnerable to growth shocks and those deemed to have significant fiscal policy space to handle shocks. A simple exercise (Box 2.2) suggests that countries most vulnerable to growth shocks are likely to have limited fiscal policy space—and hence more likely to need donor support (bilateral and multilateral) in the event of a significant downturn.

Strengthening Fiscal Positions Over the Medium Term—to What End?

To assess the viability of enhancing fiscal policy space in the region, we examine the scope for raising the government’s revenue take and/or containing expenditure levels in the period through 2015. To simplify this task, we make use of the assessments provided by IMF country teams, based on their understanding of individual country circumstances.

The conclusion is that about two-thirds of the countries in the region have the capacity to raise revenue collection by 2015. Even absent policy actions, many middle-income countries are likely to see revenues rebound significantly as economic activity recovers from below-capacity levels. Abstracting from cyclical factors, natural resource-rich countries (not just oil producers) are seen as being among those best positioned to raise revenue-to-GDP ratios—but a combination of improved tax policies and enhanced tax administration can deliver significant revenue gains over this period in many non-resource rich economies as well. Fragile countries face serious barriers in building effective revenue collection administrations within a relatively short time—providing a strong case for relying on measures such as higher excise and fuel taxes, if politically feasible.

On the expenditure side, the assessment is that, again, there is scope for sizable consolidation in the majority of countries in the region by 2015, most notably in those countries with already large public sectors. Areas for consolidation in many countries include the public sector wage bill and generalized (rather than selective, well-targeted) subsidies—areas where savings can be sizable, but political opposition can be particularly vigorous. Containing spending in fragile states may be more difficult, given the pressing need to rebuild state institutions and capacity, along with publically provided state infrastructure and services, while balancing the interests and incomes of different groupings in socially fractured states. As has often been emphasized, it is in fragile states—where governments face multiple overlapping constraints—that foreign aid can produce especially high economic returns.

Box 2.2.Do Vulnerable Low-Income Countries Have Fiscal Policy Space?

We measure growth vulnerability using the “Growth Decline Vulnerability Index” (GDVI), developed semi-annually by the IMF as part of its Vulnerability Exercise for Low Income Countries (see IMF 2012b); and construct a simple composite index of fiscal policy space, based on the factors considered in the preceding sections.1

The results, summarized in Table 1, show that countries more vulnerable to adverse growth shocks typically have limited fiscal policy space, whereas countries less vulnerable to adverse growth shocks typically have significant fiscal policy space—a result that, though perhaps unsurprising, is less than ideal.

Table 1.Growth Vulnerability and Fiscal Policy Space: Low-Income Countries(Number of LICs)
Vulnerability (VE-LIC)
Sources: IMF (2012); and IMF staff estimates.
Sources: IMF (2012); and IMF staff estimates.
1 A synthetic measure of policy space is created by aggregating assessments of the individual component explored above, with higher weight given to current DSA assessments.

Given that most sub-Saharan African countries have the capacity to create fiscal space over time, should such hard-won fiscal space be devoted to strengthening fiscal buffers (“fiscal policy space”) or to addressing development needs? The appropriate trade-off between these two competing priorities clearly depends on country-specific circumstances and conditions.20 Where debt dynamics are a serious cause for concern, the case for using fiscal savings to contain debt accumulation and rebuild fiscal buffers is clearly strong; where infrastructure gaps are impeding growth and public investment management capacity is high, the case for using the created fiscal space for development purposes would be strong. The global context, including the severity of external risks, also influences the terms of this trade-off.

There is no “off-the-shelf” answer to choosing the optimal trade-off, but some general points can be made:

  • Moving into debt distress is usually an exceptionally costly experience that can halt development for extended periods; monitoring debt trends closely and taking the requisite fiscal actions to contain debt accumulation are essential.

  • Building strong domestic bond markets provides governments with an important additional policy option to handle adverse shocks; bond market development warrants high priority, including at the sub-regional level where countries are small/poor.

  • For aid-eligible countries, obtaining exceptional support from multilateral and bilateral donors provides an important additional degree of freedom, although the availability of emergency bilateral support may now be more constrained in light of fiscal constraints in the advanced economies. Multilateral agencies, notably the IMF, can respond speedily to assist in handling adverse external shocks.

  • In situations where the global outlook is cloudy and risks of adverse developments are elevated, more weight needs to be given to building fiscal policy space (or “buffers”) to handle a downturn—just as less weight can be given to this concern when the global environment is more settled and downside risks are muted.

Providing fiscal support includes both: (i) a neutral fiscal stance, allowing deficits to widen as revenues (in particular) decline and (ii) a countercyclical fiscal stance, taking active measures to stimulate domestic demand.

The government may be unable or reluctant to push debt levels higher because of its own concern about maintaining debt at manageable levels or, alternatively, because lenders, fearing solvency risk, demand elevated/unsustainable interest rates on new debt or simply refuse to increase their exposure.

The joint World Bank–International Monetary Fund (IMF) Debt Sustainability Framework (DSF) was introduced in April 2005 to help guide countries and donors in mobilizing the financing of low-income countries’ development needs, while reducing the chances of an excessive buildup of debt in the future. The most recent review of the DSF was discussed by the Executive Boards of the International Development Association and the IMF in February 2012 (see

Public debt-to-GDP data used throughout this chapter correspond to the last available DSA on file, which may not necessarily reflect the most recent debt position of any given country.

Caution is needed in evaluating these numbers, as the increase in the net present value (NPV) of debt can be much more modest than the headline debt level in countries receiving sizable amounts of concessional external loans.

PRGT-eligible countries are those countries eligible to access concessional loans (currently interest-free) from the IMF under the various facilities available to low-income countries.

The debt threshold for emerging market economies is, in many cases, lower than for low-income countries because the actual burden of debt is typically much lower than its face value in low-income countries, which often borrow on subsidized (“concessional”) terms.

Eritrea and Zimbabwe are excluded from this analysis.

The Gambia is expected to change its risk of debt distress from high to moderate as its CPIA ratings have improved significantly. Comoros moved from “in debt distress” to “high-risk” after HIPC completion.

We focus on a medium-term (five-year) perspective, where the information content of the projections is strongest; the confidence intervals around longer-term projections are large.

Some of the 14 countries benefited from HIPC/MDRI debt relief during 2008–12, and hence recorded sizable declines in debt-to-GDP ratios.

For some discussion of this topic, in the context of sovereign bond issues, see Chapter 3.

A related issue pertains to the possibility of rollover risk in the event of a global liquidity squeeze.

This figure excludes oil producers, who recorded marked recoveries in their finances as the world price of oil rebounded in 2010. Nigeria had financed its large 2009 fiscal deficit by drawing on the balances in its oil stabilization fund; Angola had financed the adverse fiscal shock in good part via arrears to suppliers.

Incremental financing from donors, however, cannot be taken for granted, especially in the context of a global down-turn scenario.

Lack of comparable data precludes adjusting the stock of credit to include provision of credit from non-bank financial institutions—a significant phenomenon only in the few sub-Saharan African countries where pension, insurance, and other financial services are well developed.

Drawing down on bank deposits at central banks will have expansionary monetary effects (analogous to direct government borrowing fron the central bank) unless there are sufficient foreign reserves to allow sterilization of the monetary expansion through foreign exchange sales without impairing confidence in the domestic currency. In this chapter, we discuss reserves only in this respect. Chapter 1 discusses the adequacy of external reserves as buffers in their own right.

Although deposits are large in both cases, the volatility of external receipts (oil revenue for Republic of Congo, Southern African Customs Union (SACU) receipts for Lesotho) is also high.

Botswana’s Pula Fund was established for transferring wealth across generations while also serving as a revenue stabilization fund.

Intuitively, the trade-offs are a variation on those involved in determining an appropriate target for foreign reserves—quantifying the confidence and shock-absorbing benefits of holding extra reserves versus the adverse carry-cost of investing in low-return assets rather than potentially high-yielding domestic investments.

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