10 priorities for fiscal adjustment in emerging economies

10 Priorities forFiscal Adjustment in LAC

Andrew PowellResearch Department

Inter‐American Development Bank

*Strictly my own views, not those of the IDB nor its Board of Directors.

• Where are we?

• How did we get here?

• What are countries doing?

• 10 Priorities

Plan of the talk

Where are we? Considerable heterogeneity…

Expected growth rates for 2016 and 2017 (%)

Source: WEO (October 2016)

Dominican RepublicPanamaNicaraguaCosta RicaGuyanaPeruBoliviaHondurasParaguayGuatemalaEl SalvadorColombiaMexicoChileBarbadosJamaicaHaitiThe BahamasUruguayBelize

ArgentinaEcuadorTrinidad and TobagoBrazilSurinameVenezuela

Even among a set of inflation targeters…Source: IDB ( Revela )

Source: IDB (Revela)

2016 Growth Expectations

Many countries continuing counter cyclical fiscal policy this year, some still expanding

Structural Fiscal Balance (% of GDP)

“Output Gap” (% of GDP)

Source: WEO (“Output Gap” is the difference between expected growth for 2016 and that for 2021) Counter Cyclical

Fiscal PolicyPro‐cyclical Expansion

Brazil

Mexico

But financing constraints are likely to bind…

• Heterogeneous debt levels, fiscal deficits imply debt is rising• Some countries with combinations that are a concern…

(Gross) Debt/GDP

Overall Fiscal Balance (% of GDP) Source: WEO Oct 2016

Brazil

Mexico Jamaica

While countries have deficits, surpluses are needed just to stabilize debt levels…

Debt Sustainability Analysis

Required Fiscal Surplus and Adjustment to stabilize the ratio Debt/GDP, in % of GDP.

BaselineShocks

1pp increase in interest rate

1pp decrease in growth rate Combined

Required Surplus 0.85 1.33 1.33 1.81

Required Adjustment 2.29 2.76 2.77 3.24

Average Required Adjustment for 24 countries is 2.3% and this is assuming average potential growth of just over 3%. If potential growth has fallen required adjustments would be larger as they would if real interest rates rise

Source: IDB Staff Estimates

And again there is variation across countries…

(Gross) Debt/GDP

Required fiscal adjustment

Source: WEO, IDB and authors’ calculations

BrazilMexico

Jamaica

• Where are we?



• 10 Priorities

Plan of the talk

How did we get here? Policy in 2009

In the global financial crisis, 69% of the region’s GDP was expanding counter‐cyclically, i.e., countries were running deficits with output below potential

∆ Structural Primary Surplus

∆ Structural Primary Deficit

GDP below potential GDP above potential

% of regional GDP

35% of countries 10% of countries

55% of countries

“Time to Act” IDB 2016

Fiscal policy ‐ 2012

In 2012, expansionary fiscal policy remained despite GDP exceeding potential: 72% of the region’s GDP expanded fiscal spending pro‐cyclically


% of regional GDP

4% of GDP

72% of GDP

22% of GDP

2% of GDP


40% of countries15% of countries



Fiscal policy ‐ 2015

By 2015, 64% of the region’s GDP were pro‐cyclically cutting spending and 25% continue to expand fiscal spending pro‐cyclically.


% of regional GDP





The response to the crisis and its aftermath…(Summary of various IDB Macro Reports)

• Automatic stabilizers are weak• The crisis response relied on discretionary fiscal policies• But these focused on increasing transfers and salaries• (consumption rather than investment)• Spending increased largely on inflexible items • This was not reversed as output came back to potential• So we had a period of pro‐cyclical expansion• No doubt influenced by the commodity boom in some countries so

not enough was saved – see The Forking Paths of 2012

See www.iadb.org/macroreport

• Where are we?



• 10 Priorities

Plan of the talk

Fiscal Adjustment Programs

• 15 countries in LAC announced an adjustment program• Average length: 4 years, maximum: 10.0 (Brazil), excluding Brazil: average is 3.5, maximum is 5.0

• The average fiscal adjustment is 3.6% of GDP– 2.45% of GDP on average by cutting spending– 1.14% of GDP on average by increasing revenues

• Fiscal expenditures cuts– 1.84% of GDP on average current by spending reductions– 0.61% of GDP on average by capital spending reductions

Source: Internal survey of IDB Country Economists

What is the main constraint to the adoption of an adjustment Program?

• Executive (not keen to adjust): 33%• Congress (executive has a plan but cannot get through congress): 24%

• Fear of impact on growth: 24%• Other: 19%


More LAC countries now announced a program and more emphasis on cutting current spending

But optimistic budgeted GDP growth (2/3rd of countries). GDP growth in the 2016 budget is on average 0.6 p.p. above actual growth estimations


Explicit Growth Programs (in 13 of 21 countries),what are the main pillars?

• Public investment in 11 countries• Subsidies to specific sectors in 3 of countries• Red‐tape reduction in 3 of countries• Other pillars: Labor reform, Private investment, Energy Sector And Education, PPP projects...


11 of 21 countries have an explicitpublic investment program

• On average almost 9% of GDP in total…• And to be applied through following 4 years• Consistency with the adjustment effort?


10 Priorities for Adjustment in LAC

• In 1992 Blanchard and Cottarelli published 10 Commandments for Advanced Economies on iMF Direct

• These priorities draw on but also adapt that list…

Ten Priorities for “Considerate Consolidation”See “How to Adjust” on Ideas Matter

1) If output is below potential then “slow is pro.”, but have a credible medium term plan

2) Make targets explicit for fiscal outcomes and debt, if debt is high the plan should aim to reduce debt, if not stabilization may be enough

3) If taxation is high, don’t tax more, reduce spending, but if spending is low, look for ways to enhance revenues

4) Spending, look for cuts that will not affect growth, efficiency gains, reducing leakages, cutting subsidies that go to the non‐poor, avoid cutting productive capital investment – e.g.: see The Early Years

5) Consider more fundamental tax reforms and improving tax administration : inevitably tax reforms must be country specific, see More than Revenues for a review

Ten thoughts on “Considerate Consolidation”See “How to Adjust” on Ideas Matter

6) Develop a medium term plan to reduce informality, consider reducing labor and other taxes that incentivize informal activity

7) Consider pension reforms – see Savings for Development8) Make Considerate Consolidation consistent with a plan for growth:

structural reforms, investment programs and Rethink Prod. Dev. Pols.9) Strengthen fiscal institutions: when growth > potential again, there

should be fiscal savings, especially for commodity exporters10) Consider mechanisms to make fiscal and monetary policy consistent

Thank you

10 priorities for fiscal adjustment in emerging economies

Economy & Finance