Sub-Saharan African countries emerged from the 1970s with large and unsustainable fiscal deficits, stemming from the increase in government spending following the two oil shocks. The commodity price boom, associated with these shocks, increased government revenues and fueled government spending in a broad range of activities, including investment in public enterprises and marketing boards. Because such spending entailed a large expansion in government employment and other recurrent expenditures that are difficult to reverse, it resulted in a structural imbalance between revenue and expenditure, which has persisted in most African countries throughout the 1980s. This internal imbalance was exacerbated by a sharp deterioration in the external environment, characterized by a protracted decline in terms of trade, an increase in real interest rates, and a sharp decline in the availability of external bank credit.
To alleviate both the internal and external imbalances, sub-Saharan African countries pursued two different strategies. Countries in the western and central African monetary unions (the CFA franc zone, in which CFA stands for Communaute Financiere Africaine), retained the “internal” adjustment path predicated on maintaining a fixed exchange rate parity with the French franc to ensure fiscal discipline and low inflation.1 Most other sub-Saharan countries addressed the decline in the terms of trade using a variable exchange rate strategy.2 This “external” adjustment strategy allowed the current account to adjust directly, although at the price of substantially higher inflation.
With a pegged exchange rate, a real devaluation can be achieved through deflationary policies, provided price and wage flexibility prevail. On the other hand, when the tax base is highly dependent on international trade, an overvaluation of the real exchange rate would tend to undermine tax revenue and the attainment of fiscal balance (Tanzi (1989)). With a floating or a managed exchange rate, it could be argued that the inflation generated by the lack of fiscal and monetary discipline would also undermine government revenue—owing to lags in tax collection and adjustments of public utility prices—causing growing fiscal deficits, an unfavorable investment environment, and slow growth (Tanzi (1977)).
This paper argues that for economies in which the tax base is highly dependent on imports and import substitutes, an exchange rate that is adjusted toward its equilibrium level is a critical element in improving fiscal performance. To the extent that an overvaluation of the exchange rate undermines the tax base, internal adjustment may result in a widening of the fiscal deficit, when its very purpose is to restore the real exchange rate to its equilibrium level through fiscal contraction. Hence, presenting the internal and external adjustment strategies as policy alternatives is not meaningful. Rather, these two strategies should be complementary.
Having established a fiscal data base for 28 sub-Saharan countries for the 1980–91 period, the paper assesses the implementation of the two alternative strategies by comparing the fiscal performance of the two groups of countries during the 1980–91 period.
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The 11 fixed-rate countries in the sample are all members of the CFA franc zone: Benin, Burkina Faso, Cameroon, Central African Republic, Congo, Côte d’Ivoire, Gabon, Mali, Niger, Senegal, and Togo.
The 17 variable-rate countries are Botswana, Burundi, The Gambia, Ghana, Kenya, Madagascar, Malawi, Mauritania, Mauritius, Nigeria, Rwanda, Sierra Leone, Tanzania, Uganda, Zaire, Zambia, and Zimbabwe.
In terms of GDP, the average investment rate in the 1970s was 20.6 percent in sub-Saharan Africa and 21.6 percent in south Asia.
This dependence is defined as taxes on imports and exports, nontax revenue on imports and exports, plus excise taxes, sales taxes, and fees levied on imports as a percentage of total tax receipts.
If terms of trade are weighted by each country’s share of trade, the figures are 23 percent for the variable-rate countries and 37 percent for the fixed-rate countries.
On January 12, 1994, the CFA franc was devalued from FF 1 = 50 FCFA to FF 1 = 100 FCFA.
Another adjustment instrument that has been used by some sub-Saharan African countries is commercial policy. Theoretically, a real devaluation can be approximated through a uniform surcharge on imports and a uniform subsidy on exports (see Devarajan and De Melo (1987)). However, this approach is difficult to implement, partly because of the need to impose subsidies on the value added rather than on the gross value of exports and partly because of substantial unrecorded border trade from non-CFA countries, particularly Nigeria.
Although trade with France amounts to a sizable share of CFA franc zone imports and exports, prices of major exports (coffee, cocoa) and imports (petroleum products) are denominated in U.S. dollars.
For instance, The Gambia did not drop the peg to the pound sterling until 1986.
Simple annual averages across each group have been derived for the fiscal aggregates.
The main limitation of this concept is the implicit assumption that all investment is good and all current expenditure (including health, education, operations, and maintenance) is consumption and does not contribute to growth.
Nontax revenue, which accounts for about 2 percent of GDP in both country groups, hardly changed in the variable-rate countries and increased by 0.5 percent of GDP in fixed-rate countries.
These results, as well as those pertaining to taxes on goods and services, should be interpreted cautiously since tax reforms have tended to lower tariffs and shift taxation to domestic transactions. However, this pattern of tax reform has affected both groups of countries in a similar fashion.
In some countries, central-bank profits constitute a sizable share of nontax revenues.
Explicit export taxes, which were small in the early 1980s, have been further reduced through tax reform, which has eliminated them in a number of countries. However, when implicit export taxes are added, export taxes can become significant—between 1 percent and 2 percent of GDP.
Among the largest contributors of excise and sales taxes are the manufacturers of mass-market goods, such as petroleum products, textiles, shoes, beverages, plastics, cigarettes, fertilizers, cement, and processed foods.
When real GDP is adjusted for the decline in the terms of trade, growth of national income can be substantially weaker than the growth of GDP. Thus, in Côte d’lvoire, the cumulative growth of real GDP between 1980 and 1991 was 5.3 percent but, when adjusted for terms of trade changes, real national income fell by 20.6 percent. This may be an extreme example since Côte d’lvoire, with its exports concentrated on cocoa and coffee, has experienced a 56 percent decline in terms of trade between 1980 and 1991. However, other countries, particularly Cameroon, Gabon, Nigeria, Tanzania, and Uganda, have experienced even larger declines, although the effect on national income depends on the relative shares of imports and exports in GDP.
These products include cigarettes and tobacco, beverages, furniture, textiles, plastics, glass products, aluminum, vehicles, pesticides, lubricants, electrical machinery, and electrical appliances.
These flows should be distinguished from capital movements which are effected mostly through the banking system.
See Secrétariat du comité monétaire de la zone franc (several issues). On August 1 and 2, 1993, in reaction to a sharp increase in the outflow of their currency, the 13 CFA franc zone countries suspended the repurchase of their currency notes, in effect partially suspending the convertibility of the CFA franc.
The linkages among government revenue, the terms of trade, and the real exchange rate have been tested using panel data over the 1980–91 period. The econometric results, available from the authors, indicate that tax revenue in sub-Saharan Africa is negatively correlated with movements in the real value of the domestic currency: an appreciation of the real exchange rate would yield a fall in the ratio of tax revenue to GDP. It is also negatively correlated with the terms of trade. Here, the positive price effect of an increase in import prices dominates the negative income effect of the terms of trade deterioration. Similar results are obtained when total revenue is used as an independent variable.
See World Bank (1994). The literature on optimal taxation has made a case for some degree of seigniorage revenue.
Under the dual exchange rate regimes that have been pursued in the past (Nigeria, Tanzania, and Zambia), the official overvalued exchange rate would serve as a basis for customs valuation of imports, resulting in the erosion of this tax base under inflation.
As the fiscal deficit is reduced, tax revenue would be expected to fall further in relation to GDP, so that the actual fiscal effort required may be greater than the initial deficit.
When the government wage bill in fixed-rate countries is contrasted with some indicators of private sector income, such as producer prices for coffee and cocoa, which were reduced by half during the second half of the 1980s, or with trends in private consumption as estimated by national accounts during the same period, it appears that government adjustment efforts to improve the fiscal balance have lagged well behind those of the private sector (Secretariat du comité monétaire de la zone franc (1992 and other issues)).
The same factors may account for a doubling of grants to 3.6 percent of GDP in variable-rate countries over the 1980s, while in fixed-rate countries they declined from 3.2 percent of GDP in 1980–81 to 2.4 percent of GDP in 1990–91.