Speech of the Vice Governor Emilija Nacevska - Strengthening Domestic Anchors to Assist with Crisis Exit Strategies at the High Level Regional Policy Dialogue, Washington, April 23, 2010
Session: Countries' Assessments and Roundtable Discussion
I will start my intervention with the concluding remarks of my expose at the Tirana’s workshop in December last year. The core of them was to emphasize that despite the external anchors being important, there is a great need for strong domestic policies and domestic anchors. In the aftermath of the global crisis, when large fiscal deficits and public debt urge the need for credible and effective exit strategies, the issue of having domestic policies and institutions with capacity of pursuing orderly and transparent exit is of a crucial importance. “A comprehensive fiscal exit strategy should spell out the debt ratio objective and broad policies it envisages to underpin the fiscal adjustment path” (IMF, 2010). In other words, prudent debt levels are required, which entails the need for vigorous and sustained fiscal adjustment. This can be achieved, not only through withdrawing the temporary stimulus, but also through structural fiscal reforms. As for the latter, strengthened fiscal institutions are perceived as being important in supporting fiscal consolidation.
The aforementioned on the fiscal exit, implicitly points to the necessity of building a nexus between external and domestic anchors. Why is this so? Apparently, two pillars in fiscal consolidation are crucial: fiscal rules and fiscal institutions. The fiscal rules can be externally set, but the crisis has shown that their simplicity poses problems. Hence, they have to be augmented, reformed and underpinned by strong, country-tailored domestic fiscal rules. The structural fiscal reforms (the reduction of primary expenditures, dealing with the fiscal impact of aging, increasing revenues on sustained basis) do ask for stronger institutions and improvement of the process of formulation and implementation of fiscal frameworks. This of course should be domestically done, but the external support through various forms is also needed. Some of the international financial institutions, the World Bank particularly, through its programs does have a proactive role in this respect. Other, like the EU, through various platforms (like NPAAs, PEP’s assessments) does pinpoint the areas where progress is needed, but larger support in terms of sketching the action plans for filling the gaps might be beneficial.
One of the well known fiscal rules is the one set in the Stability and Growth Pact. Budget deficit of bellow 3% of GDP and public debt of up to 60% of GDP are the main pillars of public finances’ benchmarks. Of course, a priori it is known for the one rule not been able to fit all, but, the crisis pointed to serious shortcomings of these general rules. Not in their very concept, but in the way they are observed and implemented. First, much of a weight is put on the fiscal deficits, thus pushing the debt aside. As the sustainability of public finances has the debt sustainability in its core, it is more than obvious that deficits and debt targets must be consistent and always seen in a joint perspective. But, the sustainable debt path differs in different countries. Second, the fiscal benchmarks are being perceived in isolation. Achieving a deficit of 3% of GDP and public debt of 60%, not necessarily always presents a prudent fiscal stance. It has to be put into perspective of the external imbalances and macro-financial specifics of the country.
The flaws of this external anchor, or supranational fiscal rule, and the proposal for changing some intrinsic parts of it, clearly suggests a wide room and need for introducing domestic fiscal rules. Although they might prove to be ineffective when large shocks (like the recent crisis) hit, or when large fiscal adjustment is needed (fiscal rule in this case might provoke abrupt adjustment) in general, I presume we all agree on the need for domestic rules. They have to fulfill four general criteria. First, they have to be embedded in a binding document and they have to imply accountability. Second, they have to have a medium term dimension. Third, the sustainability of public finances, or the debt sustainability must underpin the rule. Fourth, domestic fiscal rules have to be profiled as to mirror the specific country dimension. Maybe a good example it would be to go through the Macedonian example. With an exchange rate peg and large structural external imbalances, it is more than clear that the fiscal stance must be set in a prudent way. In practice, this might imply even more prudency in the fiscal policy, that the supranational rule in the SGP envisages. Fiscal rules in this case might not be fully consistent with the external anchor. In fact as a result of the peg constraints they might be even more tight, asking for lower fiscal deficit and lower debt levels. The external position, also acts as a constraining factor. Even if the fiscal position is complying with 3% ceiling within the SGP, the large external imbalances might prompt the need to set targets well bellow the external fiscal rule. In our context, it is more than clear that the medium term fiscal strategy, the setting of the fiscal target and the debt plans, should be consistent with the environment of the stable exchange rate, thus promoting strong monetary-fiscal coordination.
But, “While rules can help anchor medium-term expectations, the current crisis has exposed their limits in many cases when faced with extreme shocks” (IMF, 2009). According to the IMF in over half the countries with national fiscal rules only, the existing frameworks were able to deal with the crisis. This was aided by flexibility built into numerical constraints, timeframe for adjustment, and/or escape clauses. Another quarter of the countries with only national rules modified them or put them into abeyance in response to the crisis. A conflict between the fiscal rules and the desired policy response was seen, and it was expected that the rules would be modified or suspended. No supranational rule were modified, but for sure they were broken. The recent experience with the crisis demonstrated that in case of a shock, at least temporary it is to go beyond the rules. As regards this, what is to be asked, whether preconditions for such a strong countercyclical stance exist. For countries like Macedonia for example, besides the initial fiscal buffers, the preconditions refer also to the financing constraints. A room for larger deficit might exist, it can even comply with the fiscal rules (domestic and external), bit the capacity for financing might be low. As commonly this scenario is to materialize in presence of shock, borrowing at the international capital market might not be the optimal solution. This opens the question of a conditionality-underpinned streamlined financial support. It is viable within the EU Member States, but how the financial support is to be defined for the perspective EU countries? The latter probably is to be answered by the EC/EU itself.
Designing and adhering to fiscal rules requires institutional capacity. This applies from the top to the bottom, or from the strategic to the operational level. Designing a strong, clear and credible fiscal framework requires large institutional capacity. Creating simple, but effective rules, checking how consistent are they with the deficits required in the debt sustainability framework, assessing the cycle of the economy, trying to plot reasonable assumptions within the medium term scenarios, being able to assess the main risks and their implications, having capacity to put the fiscal framework into the monetary policy perspective require strong skills and knowledge. The capacity building might be a process driven by domestic and external anchors. Programs with IFI’s, EU funds for building institutional capacity should be well targeted, focused, and subjected to results measuring process. But the fiscal framework should be free of political bias, or the political influence should be minimal. Due to the former, recently lively discussions on independent fiscal agencies, councils, probably have grounds. But at this point, it is difficult to say what the scope of a body like this should be. Should it have a decisive role, or just a role on a consultancy basis and raising public awareness for certain problems.
At the end, from what I am able to see, obviously consensus exists on the need for going beyond the fiscal rules in form of external anchors, i.e. adopting domestic rules as well. This is stressed at the current juncture when, after the large stimulus, fiscal consolidation must be underway. Some might argue whether clear and unbiased fiscal rule can be established, but no doubts I have that fiscal benchmark are useful and a reflection of a good fiscal management. If the rules are focused on the spending side, they might be even asking for bold structural reforms, which might be supported by the external institutional anchors. Fiscal rules must be underpinned by the general economic outlook, i.e. they must be tailored to the current and prospective internal and external position of the economy, with the monetary stance included as well. The design and the implementation of the fiscal framework, might be supported by external factors, that is through various programs for structural reforms and institutional building. But, let’s us not forget, especially referring to EU perspective members, to rethink the possibility of their stronger and more clear financial support when shocks occur, as a more favorable financial solution, supportive of the concept of debt-sustainability.