Posted by Taryn Parry
How can Latin America reduce its vulnerability to financial crises and global slowdowns?
The answer I developed in a recent IMF working paper is for these governments to focus on their full adherence to the IMF Code of Fiscal Transparency. Although there has been a strong rebound in growth in Latin America since the recession early in this decade, the pace of expansion has lagged behind other emerging market countries, and concerns have been raised about their ability to avoid future crises. Fiscal priorities for the region include avoiding procyclical fiscal policies, continuing to reduce public debt, improving the quality of the tax system, and promoting a better business environment. Fiscal transparency can play a critical role in meeting these challenges and remedying weaknesses in fiscal management practices that have been associated with past financial crises.
What is fiscal transparency? Broadly defined, fiscal transparency is being open to the public about the structure and functions of government, fiscal policy intentions, public sector accounts, and fiscal projections which permits a clear assessment of past fiscal performance, the current fiscal position, fiscal risks, and the future direction of fiscal policy. But fiscal transparency is more than improved monitoring of fiscal performance and future risks. It can also help to:
- strengthen governance and reduce corruption;
- enhance public understanding and boost support for important fiscal reforms;
- aid the efforts of donors and civil society to promote social spending, cut poverty,and achieve greater social equity; and
- invigorate the business environment and attract investment by simplifying tax and business regulations and limiting administrative discretion.
Forty-five good practices in fiscal transparency are outlined in the Code of Fiscal Transparency, and nearly 100 countries have been assessed against this Code in fiscal transparency Reports on the Observance of Standards and Codes (ROSCs). Most of these ROSCs are available to the public [click here].
What are common fiscal management weaknesses in Latin America? An analysis of the Latin American countries that have completed a fiscal transparency ROSC reveals some common fiscal management weaknesses across the region. These include:
- Lack of a sound medium-term budget framework, which has undermined the credibility of fiscal policy, led to pro-cyclical public spending (which precludes the stabilizing role of fiscal policy in macroeconomic management), and limited pro-poor spending to address social inequities.
- Poor monitoring of fiscal risks leading to fiscal surprises. Important fiscal risks in Latin America include contingent liabilities, and off-budget fiscal activities associated with public enterprises or public financial institutions or “quasi-fiscal activities”. Some of the most costly hidden liabilities were related to implicit guarantees in the banking and corporate sectors, court-mandated spending, and central government bailout of overindebted subnational governments.
- Incomplete coverage in budgeting and reporting of fiscal activities. Inadequate monitoring of general governments is partly the result of weak financial management at the subnational level of government. While emerging market economies in Latin America have a strong commitment to publish fiscal data, the lower income Latin American countries lacked a legal requirement to publish data on budget execution.
- Lack of a hard budget constraint. The evidence from ROSCs suggests that clear lines of accountability to the public are critical to promoting fiscal prudence. In a number of countries in Latin America, lack of information on proposed and final budgets obscured responsibility for fiscal policy decisions. A number of countries in Latin America have adopted fiscal responsibility laws or fiscal rules to try to achieve sounder fiscal outcomes.
- An unsupportive business environment, characterized by extensive bureaucracy and weak enforcement of the rule of law, that has impeded growth and diminished resiliency in the face of crises. Countries in Latin America are behind other important emerging markets according to key indicators of governance and the business environment.
How will improving fiscal transparency correct these weaknesses? Although the priorities will vary from country to country, needs to focus on improving fiscal transparency practices in the following areas to maintain growth and stability in the region.
Introduce a medium-term budget and forward-looking analysis of fiscal policy that emphasizes sustainability and medium-term policy goals. While some have made progress in this area, others need to give higher priority to specifying medium-term plans. Since medium-term plans need to be built on a realistic annual budget, improving the quality of budget estimates is an important first step for some countries.
Report and analyze all fiscal risks, especially those arising from hidden liabilities and quasi-fiscal activities. Improving coverage and diminishing budget rigidity by reducing extrabudgetary activities is important for many countries in Latin America, while extending coverage to general government is an important priority for the more decentralized countries in the region.
Keep the public informed: the transparency of budget decisions could be furthered by publishing the executive budget proposal along with the budget passed by the legislature, as well as any budget amendments. At a minimum publication on a government website of more relevant and more frequent fiscal data is a cost-effective way of informing markets and critical for public oversight of fiscal policy. This should also provide an extra incentive to improve the quality of data, for example by improving and regularizing reconciliation practices. A number of countries also could focus on firmer enforcement of accounting practices to enable them to effectively monitor arrears.
Strengthen oversight of fiscal activities: Some countries also need to extend the coverage of institutions subject to regular audit, and publish all audit reports. Many countries could also develop more effective follow-up mechanisms to ensure the recommendations of these reports are implemented. More specifically, large transactions between the government and the private sector, as occur in procurement and privatization, need to be subject to transparency requirements and receive stronger scrutiny.
Promote transparent intergovernmental relations: countries that have pursued decentralization need to give higher priority to promoting fiscal transparency in intergovernmental relations. Well-designed decentralization policies include a clear, and usually exclusive, assignment of responsibilities, and transfers based on stable and transparent criteria.
Promote a transparent business environment: simplify the tax system, reduce discretion in dealing with the private sector, and reinforce oversight to promote investment. Simplified tax regimes would not only be more transparent, but would improve revenue collection while reducing the costs of collection. Regulations affecting business operations need to be streamlined with minimal discretion to promote fairness, permit easy entry and exit of firms, and reduce uncertainty faced by businesses.
