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II. Strengthening WAEMU Fiscal Rules

Author(s):
Olivier Basdevant, Patrick Imam, Tidiane Kinda, and Aleksandra Zdzienicka
Published Date:
October 2015
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One of the main difficulties with fiscal rules is preserving some room for flexibility without compromising the rules. This is particularly relevant for WAEMU countries, as large and frequent shocks could provide numerous occasions to suspend the application of the rules. This section discusses how the reform approved in early 2015 addresses this issue (Section A). It also provides suggestions on how national authorities could work on making the objectives, as defined at the WAEMU level, more likely to be attained by strengthening, at the national level, both rules (Section B) and incentives for compliance (Section C).

A. The 2014 Reform of WAEMU Fiscal Rules

The 2014 reform sought to address three main issues with existing rules. The WAEMU convergence criteria include fiscal rules (Box 2), which cover, notably, the fiscal balance and the debt-to-GDP ratio. Overall, the experience of WAEMU fiscal rules was mixed, with limited observance of the deficit target, a complex set of rules, and limited incentives for voluntary compliance.

  • First, with the approval of new criteria, the WAEMU needs to reflect on previous experiences with their rules, as lessons can be learned, where the observance of the fiscal balance criterion was limited (Figure 1.A). Limited observance of the deficit criterion is a source of concern. Indeed, fiscal policy in each WAEMU country faces the dilemma of being the main policy tool to respond to shocks while being constrained by the need to preserve fiscal and external stability of each country and of the union. It also reflects that existing rules are more viewed as a constraint to preserve sustainable growth than a desirable goal for each member country. However, empirical findings suggest a strong reason to adhere to the rules, as, empirically, higher deficits in the WAEMU have not been conducive to higher growth performances (Figure 1.C).2 Against this background, the debt criterion is easily met, owing to debt relief (Figure 1.B)3. However, the deficit objective is not linked to the debt criteria, and linking them could help improve compliance—for example, by defining automatic deficit adjustments when debt gets closer to its ceiling.
  • Second, the rules were complex, being numerous and, for some, having an unclear ultimate objective. International best practice suggests that fiscal rules should be simple and their underlying goals easy to understand. This ease is crucial to secure a broad consensus on the rules and the objectives they seek to achieve. Some of the WAEMU convergence criteria achieve this consensus—namely, those on the deficit and debt. However, the total number of rules, six, was relatively large. The rules were also complex (for example, definition of the deficit; see Box 1, footnote 1), and not consistent (a country complying with the deficit objective would not be automatically required to adjust its deficit if it were to breach the debt-level objective). Having too many criteria runs the risk that the authorities do not focus sufficiently on those that are critical for fiscal sustainability; from this perspective, consideration could be given to keeping only two or three criteria. These criteria could relate to the stock of public debt and the flows contributing to debt accumulation (Section B).
  • Third, compliance incentives have been limited and enforcement mechanisms not used. The WAEMU commission is in charge of the surveillance of fiscal rules observance; however, its mission is hampered by the lack of availability of data and also administrative capacity issues (IMF 2013b). Furthermore, the main compliance instrument—financial sanctions—while possible, has not been applied, and therefore lacks credibility.4 Overall, the lack of compliance with rules has led in some WAEMU countries to increasing debt ratios post Multilateral Debt Relief Initiative (MDRI, Figure 1.D). To maintain sustainable debt levels it would be appropriate to observe deficit rules and leave the option to strengthen further regional rules by complementing them with national ones.

Figure 1.Experiences with Fiscal Rules in the WAEMU

Source: Country authorities and IMF staff estimates and computations.

In line with best practices, rules were refocused on fiscal sustainability (Box 1), and enforcement mechanisms at the union level were strengthened. The 2014 reform proposes to address vulnerabilities of current rules, with the aim of making them operational by 2019.

  • In line with international experience, rules were simplified, with a stronger focus on fiscal sustainability. The definition of the deficit has been changed to a more comprehensive overall fiscal balance (instead of the basic fiscal balance), while abolishing the criterion of the non-accumulation of arrears. The secondary criteria are also revised, with the tax-to-GDP ratio floor increased from 17 to 20 percent and the ratio of public investment expenditure to revenue dropped.
  • Enforcement mechanisms were refocused on voluntary compliance. The administrative capacity of the WAEMU Commission will be strengthened and voluntary compliance encouraged through outreach missions in each member state—before finance laws are adopted. Furthermore, there is an overall strategic change in the approach, moving away from the ineffective financial sanctions, to focus on voluntary compliance through communication/peer pressure, as well as support for countries facing difficulties in meeting criteria.

Box 1.Fiscal Rules in WAEMU Convergence Criteria

Old2014 Reform
First-order criteria
• Fiscal balanceBasic fiscal balance1 ≥ 0 percent of GDPOverall fiscal balance2 ≥ −3 percent of GDP
• Debt-to-GDP ratioBelow 70 percent of GDPBelow 70 percent of GDP
• ArrearsChange in arrears ≤ 0Abolished criterion
Second-order criteria
• Ratio of wage bill to revenueBelow 35 percentBelow 35 percent
• Tax-revenue-to-GDP ratioAbove 17 percentAbove 20 percent
• Ratio of domestically financed capital expenditure to tax revenueAbove 20 percentAbolished criteria
Source: WAEMU authorities.

Difference between revenue and expenditure under the direct control of the authorities—that is, tax and non-tax revenue plus budget support grants (including resources from the Heavily Indebted Poor Countries Initiative), less current expenditure, domestically financed capital expenditure, and net lending.

Including grants.

Source: WAEMU authorities.

Difference between revenue and expenditure under the direct control of the authorities—that is, tax and non-tax revenue plus budget support grants (including resources from the Heavily Indebted Poor Countries Initiative), less current expenditure, domestically financed capital expenditure, and net lending.

Including grants.

Continued work by national authorities could help ensure the success of the reform. International experience with fiscal rules suggests that enforcement mechanisms are better designed at the country level, as they tend to be more efficient when relying on increasing the political cost for deviation rather than on introducing financial penalties. Thus, while the 2014 reforms represent a step in the right direction, some options could be considered by national authorities so that they can play their part in the success of the reform. In particular, two areas, discussed further in the next section, could be explored.

  • Fiscal rule designs could be complemented by legal provisions, mostly at the national levels (Section B). For example, a common ceiling for debt-to-GDP ratio is desirable as a long-term goal, but it may not be sufficient to provide guidance in the short and medium terms for countries facing different vulnerability risks. Also, the issue of compliance relates partly to the design of rules, as, for example, escape clauses that could be designed to cope with exceptional circumstances. More generally, redesigning rules at the union level could be enhanced by strengthening the fiscal policy frameworks for each country.
  • Increasing member countries’ ownership could also be strengthened with the introduction at the national level of fiscal councils dedicated to the communication of compliance/noncompliance with WAEMU fiscal rules (Section C).

B. Options to Strengthen Rules at the National Level

This section offers some guidance on how national authorities could rework their own fiscal frameworks to help ensure the success of the 2014 reform. It focuses on the following principles: (1) ensuring the mutual consistency of debt and fiscal objectives, by relying, for example, on debt-sustainability analyses or a debt brake mechanism; (2) defining conditions that would allow temporary suspensions of the rules; and (3) strengthening the budget process, notably by framing fiscal policies within medium-term frameworks.

The rules defined at the WAEMU level could be complemented at the member countries by linking the deficit and debt objectives, and by allowing some tailoring if countries need further constraints on their budgets. The link between debt and deficit objectives should be as clear as possible. For instance, a ceiling on the deficit should not be set at a level so high that it would likely lead in the medium term to a breach of the debt ceiling by most countries. From this perspective, relying on comprehensive Debt Sustainability Analysis (DSA) helps ensure this consistency. Additionally, the consistency could be improved by introducing “debt brakes,” which adjust the deficit ceiling based on past deviations from targets or the distance to the debt ceiling.5 For example, slippages from deficit objectives could be automatically corrected the following year. Similarly, deviations from debt levels (or debt accumulation) could also lead to automatic corrections. The latter would be particularly relevant for countries approaching their debt limits. This type of link between debt and deficit objectives could be designed at the country level so as to provide an operational guidance to each country on how to implement the general rules defined at the WAEMU level. In addition, it would allow each country to adopt a stricter debt limit than the one provided at the union level, which may be particularly relevant for countries facing more vulnerabilities. Also, countries with a high share of revenue coming from natural resources (for example, Burkina Faso, Mali, and Niger) may wish to adopt expenditure rules to cap outlays growth during booms (including investment in public infrastructure) or revenue rules defining savings for future generations (because of the exhaustibility of the resources). Against this background, countries with stronger budgetary processes—including an effective medium-term framework—and with access to market financing may wish to specify the scope for countercyclical policy.

Dealing with the dilemma of rules versus discretion in the WAEMU. The past experience of WAEMU fiscal rules has shown a dilemma between the rules and discretion faced by each country’s authorities. While rule objectives are desirable, WAEMU member countries are exposed to external shocks, which can warrant countercyclical policies; at times, such policies can go against the rules. Furthermore, the large developmental needs faced by all WAEMU countries require that fiscal policies maintain an adequate level of development spending, which is harder to do during downturns. The key to avoiding recurrent slippages in deficit objectives would be to clarify when countries can suspend the application of fiscal rules, and what to do when rules are breached.

  • Escape clauses can play a useful role, as they allow for the temporary suspension of the fiscal rule in exceptional circumstances. For this to work, a consensus on the process should be agreed to at the union level, and then each member country would need to design an institutional framework to make escape clauses operational. Each parliament would have to approve the government plan for the temporary suspension—ideally, by a super-majority to ensure that the political consensus is solid. Further, government would have to clarify a strategy for reinstating the rule after its suspension.
  • In order to increase the credibility of rules even in case of temporary suspension, countries could build contingency plans and disclose fiscal risks. As shown in Mauro (2011), planning for contingencies is critical when implementing a fiscal strategy. This would be particularly relevant for WAEMU countries that need to preserve development spending approved in budget laws when they get hit by relatively small shocks. However, large shocks may require a temporary suspension of rules. While all shocks are not predictable, some are, because they are related to underlying vulnerabilities, and could therefore be included in fiscal strategies (IMF 2010). A typical issue for WAEMU countries in this regard is the risks pertaining to the energy sector. The budgetary cost of supporting energy sectors not only has tended to be high but also has often been higher than initially budgeted—thus complicating fiscal management and adherence to fiscal rules. This condition has also led to inefficient adjustment, with investment spending bearing the brunt of spending cuts. Contingency planning is, therefore, highly desirable in order to avoid such outcomes.

Rules should be accompanied by a strengthening of the budget processes. The latter are critical to avoid deficit slippages (Milesi-Ferretti 1997) and, therefore, to achieve fiscal sustainability. The WAEMU has a number of recent public financial management (PFM) rules, which are spelled out in directives.6 All WAEMU countries have made progress in transposing these rules into their national laws, and Côte d’Ivoire, Mali, and Senegal have transposed all of them (this step was initially expected to be completed by end-2011). Framing fiscal strategies within a medium-term fiscal framework (MTF) would facilitate compliance with rules without hampering development spending. This would be particularly relevant if automatic adjustments were made to the deficit in case debt gets close to its ceiling, or if deficit slippages were to be observed in previous years. Within MTFs, policymakers could, therefore, gain flexibility in implementing expenditure programs while preserving the fiscal rules’ objectives. MTFs would thereby become a tool to make national numerical rules operational. They not only would help bring budgets in line with medium-term objectives but also would offer a forum for all government agencies to agree jointly on a set of fiscal objectives.

C. Options for Enforcement Mechanisms at the National Level

International experience suggests that incentive mechanisms are more effective at the national level. Adopting binding rules at the country level may help foster ownership and adherence. Financial sanctions have proved ineffective in the WAEMU. Costs, therefore, need to be of a different nature. Typically, these costs can be of two types: either of a legal nature or of a political one, by raising public awareness of deviations and their economic implications. Based on international experience, three avenues could be explored: (1) framing fiscal rules in national laws, (2) introducing fiscal councils at the national level, and (3) improving fiscal transparency.

Transposing WAEMU fiscal rules into domestic laws will increase their binding character for national policymakers. In line with international best practices, legislations could be adopted at the national level to make rules even more binding. These amendments can be complemented with a fiscal responsibility law defining the specific features of the rules, notably the quantitative ceilings. The main advantage of providing a legal basis to fiscal rules is to create incentives for compliance, as they usually imply sanctions if the law is violated. For example, parliaments could be constrained to approve budgets only if they are consistent with fiscal rules.

With commitments to sustainable public finances under close scrutiny since the 2008 crisis, policymakers’ interest in fiscal councils is growing (Figure 2).7 Fiscal councils are independent public institutions that aim to strengthen governments’ commitments to sustainable public finances. They do that through various functions, including public assessments of fiscal plans and performance, and the evaluation or provision of macroeconomic and budgetary forecasts. By fostering transparency and promoting a culture of stability, they can raise the reputational and electoral costs of undesirable policies and broken commitments. The main takeaways from international experience are as follows:

Figure 2.Number of Countries with Fiscal Councils, 1960–2013

Source: IMF Fiscal Councils Database.

  • There is suggestive evidence that, all else being equal, fiscal councils contribute to fiscal discipline. Part of their effectiveness comes from the provision of unbiased budgetary execution assessments as well as active participation in public debate, including in the monitoring of fiscal policy rules. Although the evidence is subject to the usual caveats regarding the existence of a causal link between institutions and policy outcomes, case studies broadly support these conclusions.
  • Clear guarantees of independence from politics are essential. They can notably entail secured financing, and open and transparent hiring processes. These guarantees would typically be complemented by adequate transparency and accountability requirements from the fiscal council.
  • The remit, tasks, and institutional models can vary greatly across countries, reflecting available human and financial capacities, political traditions, and causes for excessive deficits and debts.

In line with the definition proposed above, fiscal councils generally carry out the following functions:

  • The basic functions of fiscal councils are independent analysis, review, and monitoring of a government’s fiscal policies, plans, and performance. This includes reviews of the government’s annual or medium-term budget proposals, generally with respect to compliance with official objectives—such as those enshrined in fiscal policy rules. Fiscal councils also provide ex post assessments of macroeconomic and fiscal performance against official aggregate objectives and targets.
  • Three advanced functions can be performed by fiscal councils.8 First, councils can be mandated to prepare the macroeconomic forecasts used for budget preparation or to set key assumptions and parameters. These could cover, for example, a prudent price level for certain commodities with a large budgetary impact (either because the country is a large commodity producer or because of extensive subsidy schemes). Second, councils can also be tasked to produce unbiased estimates related to specific spending programs or policy measures. Third and finally, councils can also advise policymakers on policy options. This function can be general—a right to comment and issue recommendations on any policy issue of its choosing—or specific—limited to a particularly contentious issue that must be solved by consensus. A general function is better suited to countries with an already rich public debate and a relatively consensual approach to policymaking. A specific function can be useful in such issues as the sharing of certain revenues across unequal regions, where a consensus must be found but interests among decision makers diverge strongly.

Recent fiscal councils are often explicitly tasked to monitor compliance with fiscal policy rules. While the vast majority of fiscal councils continue to perform positive analyses, evaluate long-term sustainability issues, and prepare or assess macroeconomic forecasts, newly created ones have broader remits. The majority (more than three-quarters) of the new generation monitor compliance with fiscal rules, more than the double compared with veteran institutions. This trend is associated with the increasing use of numerical fiscal rules (Schaechter and others 2012) and is likely to continue given the requirements of Treaty on Stability, Coordination and Governance, which mandates such independent monitoring for European Union signatories.

When establishing fiscal councils in WAEMU countries, it would be desirable to take into consideration administrative setup and capacity of those countries. For WAEMU countries, the case could be made to: (1) find synergies when building fiscal councils, for example by attaching the council to parliament (for example, Kenya and South Africa), or by using an existing institution, as France did when deciding to attach its new fiscal council to the existing external audit court (Cours des Comptes); and (2) require the councils to focus solely on reporting and alerting the public on compliance/noncompliance. Such councils would complement the regional surveillance exercised by the WAEMU Commission, and, in time, could also build from their experience to assess budget projections.

Fiscal transparency and communication must be central to the strategy of improving voluntary compliance. To be effective, the objectives of the fiscal rules must be widely understood and accepted by the public so that a political and social consensus can be reached. Communication campaigns could, therefore, be organized to inform the public about the scale of the fiscal challenges and explain what can be reasonably achieved through reforms without overburdening taxpayers or unduly curtailing necessary public services. Similarly, communication of the adverse consequences of not adjusting would also be essential, particularly in cases of fiscal adjustments. The publication of annual reports on implementation could provide incentives for member countries to enact the directives. Applying international best practices in terms of fiscal transparency would imply, among other things, publishing accounts and budget execution reports, and having external assessments (overseen by parliaments) and external audits of public accounts performed and made public.9 With the disclosure of budget documents, budget execution, and fiscal risks, governments could then have the tool to provide convincing arguments about the implications of fiscal adjustment (or lack thereof) as well as their efforts to protect the most vulnerable. By helping the public and key stakeholders to understand fiscal policy and fiscal trends, the authorities could facilitate the emergence of strong support, both domestically and externally, for their fiscal strategy. The credibility of the authorities would also be enhanced if their policies were supported by an independent assessment provided by the fiscal council.

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