INTRODUCTION TO PUBLIC FINANCE MANAGEMENT

Module 2.1 :Macroeconomics of the budget

Module map

Fiscal sustainability?

Expenditure

Debt/deficit

Revenues

Appetizer

To understand the macroeconomic constraints that frame the preparation of the budget.

• To understand the relationship

Objectives of the module

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Public Finance Management

Public Finance Policy

Economic stability, growth and poverty reduction

Public Finance Policy

Public Finance Management

Revenue

Expenditure

Deficit/Surplus, Debt

(Positive effects)

Crowding out

Current account

Debt/Deficit financing

1. Definitions

2. Impact channel: Crowding Out

3. Impact channel: Financing

4. Impact channel: Current Account

5. What can PFM do?

MODULE OUTLINE

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7Source: Government Finance Statistics (GFS). IMF

1. Definitions

Which budget deficit?

‘A deficit may be like an elephant: one always recognises it when one sees it, even though it may be difficult to measure or describe it in a way that is satisfactory to everybody and for every purpose’ (V. Tanzi)

Three commonly used concepts: • Overall balance• Primary balance• Overall balance without external grants

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1. Definitions

• Overall balance (‘budget deficit’)Is a measure of the net financial borrowing requirements of the consolidated government.

• Primary balanceIs the difference between the total revenue and the expenditures excluding interest charge on the debt

• Overall balance excluding external grants Shows the amount of financing that would be required in

absence of this external funding

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1. Definitions

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Government budget

‘in every country the budget speech refers to a different kind of deficit’

Budget structure: ‘below or above the line’

- ‘Above the line’: revenue/expenditure

- ‘Below the line’: its net financing (because it creates or takes away a liability)

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Which items above or below the line?

• Interest payment

• Principal repayment (amortisation)

• New loans

1. Definitions

2. Impact channel: Crowding out

3. Impact channel: Current Account

4. Impact channel: Financing

5. What can PFM do?

MODULE OUTLINE

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Extra government expenditure: • if financed by a additional tax: this

might reduce private consumption or investment

• if financed by domestic borrowing: this might increase the interest rate and the cost of borrowing for private sector (or directly limits availability of finance in developing countries)

• absorbs scarce resources (e.g. qualified labour) at the expense of the private sector

2. Impact Channel: Crowding out

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1. Definitions

2. Impact channel: Crowding out

3. Impact channel: Financing of the budget deficit

4. Impact channel: Current Account (BoP)

5. What can PFM do?

MODULE OUTLINE

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Banks

Individuals

Others

Banks

Financial institutions

Governments

Domestically

Externally

2. “Printing Money”

3. Selling Assets

4. Not paying and building up Arrears

Options:

1. Borrowing

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Financing options

3. Impact channel: financing

3. Impact channel: financing

Borrowing Borrowing Debt Debt

????? Sustainable ????????? Sustainable ????

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Debt Sustainability: Concept

• Ability to meet its current and future debt service obligations in full, without:• Debt rescheduling or accumulation of arrears• Compromising economic growth

• Debt sustainability is essential for:• Economic stability, growth and poverty reduction• (Future) access to capital markets

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Reliability of DSA • Highly dependent on “accuracy” of macroeconomic

projections

Important exogenous factors• Exchange rates • Export and import prices on world market (e.g. oil)• Weather (good or bad harvest)• Changing international interest rates

Debt Sustainability Analysis (DSA)

Debt Sustainability Analysis (DSA)

“The Snow Ball”Deficit is kept stable, but debt is substantially increasing.

Example:•2% GDP growth •7% inflation•10% interest rate •Fixed % primary revenue and expenditure of GDP

3. Impact channel: financing

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3. Impact channel: financing

Debt/GDP ratio worldwide

3. Impact channel: financing

Debt sustainability? Historic overview

147% in 2012 Including Bank Bail-outs

70% in 2012

1. Definitions

2. Impact channel: Crowding out

3. Impact channel: Financing

4. Impact channel: Current Account (BoP)

5. What can PFM do?

MODULE OUTLINE

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Balance of Payments: •Current account•Capital & financial account

•Records transactions in goods, services, and assets between the country’s residents and foreign residents during a calendar year – it records flows

4. Impact channel: Current Account

4. Impact channel: Current Account

• Bop accounts are based on the double entry accounting system – the BoP is therefore always in balance!

4. Impact channel: Current Account

4. Impact channel: Current Account

Imports

Payments

Exports “Earnings”

Current Account

Capital Account

revenue

Balance of Payments Government Deficit

inflation

money

reserves

Exchange rate

“financing”

Financing

4. Impact channel: Current Account

What is a Sustainable Current Account Deficit?

• If a country can attract borrowing & foreign investments against reasonable rates, then the Current Account Deficit can ‘ be seen’ as sustainable

What can be done if not sustainable? Short term: reduce domestic absorption (= stabilisation) Medium term: increase domestic revenue (structural reforms to

generate growth)

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4. Impact channel: Current Account

Current account deficit per capita

1. Definitions

2. Impact channel: Crowding out

3. Impact channel: Financing

4. Impact channel: Current Account

5. What can PFM do?

MODULE OUTLINE

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A. Expenditure ceilings

Fit within overall spending ceiling determined by

sustainable resource availability macroeconomic policy objectives capacity constraints public service provision needs and overall governance factors

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5. What can PFM do?

B. Medium-Term Frameworks

Budget in medium-term perspective allows to:

•Compare the aggregate budgetary objectives with economic prospects (growth, inflation, international prices, …)

•Assess the impact of the budget choices on the future economic and fiscal developments

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5. What can PFM do?

B. Medium Term Frameworks

To allow linking budget with economic projections and assess impact of budget choices, we need:

• The main macro-economic indicators

• Government Operations Table (GOT)

• Summarized balance of payments

• A monetary survey (banking sector)

• A forward analysis of the public debt

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5. What can PFM do?

Links between the GOT and the other accounts

Real Sector

Ressources GDP ImportsUses

ConsumptionPrivatePublic

InvestmentPrivatePublic

Exports

Monetary Sector

AssetsNet foreign assetsCredit to the GovernmentCredit to the economy

LiabilitiesMoney/quasi money

Private Sector

Obtained by difference

Government OperationsTableRevenue Grants Other RevenueExpenditures

Current primaryInterestCapital

FinancingDomestic

of w. BankForeign

Balance of Payments

Current balanceExports of g. & s. Imports of g. & s.Net factor incomeNet transfers

PrivateOfficial

Capital balancePublic MT & LTOther

Variation of reservesBehavioural relation

Accounting relation

C. Fiscal Rules

Fiscal rules are meant to bind a government into a specific fiscal behaviour and to remove discretionary intervention

They aim at fiscal discipline and economic stability

They may apply to every tier of government

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5. What can PFM do?

5. What can PFM do?C. Fiscal rulesRules for: Debt, Deficit, Revenue, Expenditure

Source

: IMF w

ebsite

C.Fiscal rules

Legal: local councils are not allowed to borrow Loose targets: bring debt down over time

Annual targets: annually adjusted level of borrowing

Common agreed targets: EU, Gov.Deficit/GDP ratio < 3%, Public debt to GDP ratio < 60%

Supervised targets: supported by IMF and OECD

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5. What can PFM do?

• The sustainability of the external (current account) deficit of the country is the key macro-economic constraint

• The government deficit is a key policy variable because:

• It has a direct impact on the current account deficit

• Its magnitude and the way it is financed has an impact on the growth of the economy and on the sustainability of the macro-financial framework

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Key Messages