Public Financial Management and Fiscal Outcomes In Heavily Indebted Sub-Saharan African (SSA) Countries

Posted by Tej Prakash

A substantial amount of donor aid, estimated to be around US$60 billion from bilateral and multilateral sources, is expected to flow to SSA in the coming years to help these countries alleviate poverty and achieve the Millennium Development Goals (MDG). Also, to provide relief from debt burden, the International Monetary Fund (IMF) and the World Bank (WB) decided to forgive debt to these countries. However, the Bank and the Fund wanted to ensure that these countries had the capacity both to spend this money meaningfully, and to track the actual spending at the lowest level. Hence improvements in PFM systems in these countries was an essential part of debt forgiveness initiative.

In this paper on PFM and Fiscal Outcomes In Heavily Indebted sub Saharan African (SSA) Countries, we try to determine the effect of PFM systems on key fiscal outcomes such as budget balance and overall debt. We use data from two PFM assessments by the IMF and the World Bank in 2000 and 2004 as a part of the debt forgiveness exercise for this group of 22 countries in SSA.

Main findings

Using data from the 2000 and 2004 assessments, we find that the quality of PFM has a significant effect on all fiscal variables, although the degree of significance varies. The relationship is strongest for overall balance, including and excluding grants, interest payments, and external and central government debt. The PFM overall score is positively and significantly related to the overall balance, both including and excluding grants, in accordance with expectations. The budget balance is a policy decision. A government could decide to have a more expansionary fiscal stance even with a well-functioning PFM system. PFM systems thus do not, per se, determine the budget balance, but an efficient PFM system, by providing the government with timely and reliable information on the direction of its budget policy and management, enables it to manage the outcome more consistently with its intentions. We find that PFM overall score is negative and significantly related to primary expenditure, and supports the finding of the positive effect of PFM overall score on the overall balance. One interesting, although intuitive, result is that when budget formulation and execution are measured together, the correlation is slightly stronger.

The PFM overall score is negatively and significantly related to interest payments, external debt, and gross central government debt, in accordance with expectations. GDP growth is negatively related to the debt variables, also in accordance with expectations. The variable for Francophone countries is negative and significantly related to interest payments and external debt, which may be consistent with the need for greater fiscal discipline as a condition of the monetary unions, in which most francophone SSA countries participate. Another explanation is that Francophone system is more hierarchical in nature, and thus more conducive to fiscal discipline.

There is a negative and significant correlation between interest payments, the public and publicly guaranteed external debt, and gross central government debt and the two PFM quality variables. The HIPC initiative entails the reduction of debt stock of these countries, and since improvement in PFM systems was a key trigger for this debt relief, it is expected that there would be a relationship between PFM indicators, interest payments, and debt stocks.The negative and significant relation between debt stocks and PFM quality can be interpreted similarly to the results for overall balances, above. The decision to borrow, especially in the absence of any fiscal rule, is a policy decision, independent of the strength of PFM systems. However, weaknesses in PFM systems make it more likely that a government will incur liabilities, both internal and external. If rules and procedures to control expenditure and borrowing exist but are not enforced, for instance, the line agencies may incur liabilities, especially wage and suppliers’ arrears, when the approved budget is not fully funded. A stronger PFM system, on the other hand, results in better information for the governments on the total amount of liabilities incurred, and to better control and coverage of government guarantees and debts contracted by other entities. Timely accounting and fiscal data would help governments control contracting of sovereign debt as well as contingent liabilities such as guarantees.

In most of these countries, during this period there was some kind of conditionality, both as part of an IMF program as well as other donor expectations, related to borrowing, both internal and external, which would have limited the size of the debt stock. The results show that countries with stronger PFM systems were more successful in meeting these constraints on borrowing. However, some of these countries that were part of a common central bank had a harder legal constraint on automatic financing of the budget by the central bank. But for others, a shortfall in the cash flows and budget excess could be financed through central bank borrowing. In either case, countries could borrow from other domestic sources and externally. The negative and significant relationship holds for both external and overall debt, thus suggesting the robustness of the result, even for countries with varying monetary regimes.

This paper has analyzed the link between PFM and fiscal outcomes. Even though data limitations imply that the results must be interpreted with caution, we have presented evidence that there is a positive and significant correlation between PFM quality and fiscal balances, after controlling for important effects, including the HIPC decision and completion points, and a negative and significant correlation between PFM quality and external debt levels, also after controlling for important effects. These results are similar to those found in previous research, including Latin America and Europe. Another significant finding is that a stronger budget or PFM system, as in Francophone Africa, where the Minister of Finance is more powerful, leads to better fiscal discipline. This argues for strengthening the fiscal role and responsibilities of the Finance Minister in Anglophone Africa. This finding for SSA is similar to the results found in other regions.