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March 08, 2011

A Proposed Approach to Effective Fiscal Policy Management in the Caribbean

Posted by Michel Marion

The IMF’s regional technical assistance center in the Caribbean, CARTAC, has been assisting the authorities in a number of countries in the preparation of medium-term fiscal projections. During most missions, this begins with the completion of the base case (or no-policy-change) fiscal projections for the next 4 or 5 years. In the last two years, with the world recession which followed the financial melt-down, for most countries this has meant projections of rising deficits, and debt. Where they have been instituted, estimates show that legislated debt targets or other fiscal rules are expected to be breached. This leads to a determination of fiscal targets, deemed to be “sustainable” and “feasible” in terms of garnering public and political support.

The fiscal gap between the base case projections and the “updated” fiscal targets is an important measure. It typically kicks off the next step of the exercise: the preparation of an alternative “Fiscal Policy” scenario, intended to close this fiscal gap. As a first step, the focus is on the primary balance, as the projected revenue and expenditure effects of policy actions which are deemed appropriate and implementable are “layered” onto the base-case values of the corresponding components of revenues and non-interest spending. The induced interest savings are then calculated and added in. This usually involves an incremental, multi-step process. Initially, “rough” estimates of the amounts expected or needed are factored into the fiscal solution. Once direction is provided by the leadership team or Minister of Finance more detailed analysis and more refined estimates are prepared by dedicated teams.  

Critical to the success of this approach is for the team members to have the information required to formulate and assess various specific policy options, and to feel that they have the full support of the Minister and Ministry of Finance (MoF) leadership team. In the absence of either of these critical success factors, what typically happens is that at some point during the preparation of the “Fiscal Policy” scenario, the team decides to suspend the policy-development work; and to present the interim results to the leadership team (sometimes including the Minister) with a request for feedback and direction on the magnitude, timing and scope of the required fiscal action. Depending on the feedback received, sometimes a re-energized team reconvenes and the work can resume. In other cases, the work to develop policy estimates halts, and the focus shifts to documenting the results achieved to date in a draft mission report that is presented to the leadership. On occasion, during the CARTAC adviser’s or consultant’s end-of-mission presentation and discussion of the results, a follow-up mission can be scheduled so that the work can be completed in full.

On some occasions, especially if there is no opportunity to present the interim results to the Finance or Permanent Secretary, or the Minister, no decision is made on the next steps. In that case, the following approach is proposed. As an initial step, it is recommended that following the mission, the team leaders present and discuss the interim results to the PS/FS and to the Minister and seek explicit direction. In our experience, the Minister would generally appreciate receiving briefings wherein alternative strategic and policy options are put forward together with their implications, and pros and cons. Some Ministers also appreciate that one option is put forward with the team’s recommendation and accompanying rationale. Even if the Minister’s enthusiasm is muted, if properly structured, officials can derive solace from the fact that their efforts will have contributed to providing the Minister with a logical analytical framework that feeds into a well structured decision-making process and is supportive of sound decisions – recognizing nonetheless that decisions to contain expenditures or to enhance revenues are never going to be easy as they will attract criticism from all stakeholders who will be adversely affected by these decisions.

In those cases when it has not been possible to complete the Policy Scenario or the Medium-Term Fiscal framework (MTFF) during the mission timeframe, it is suggested that the team proceed in stages – rather than preparing a single large document containing a myriad of options and possibilities. Some possible stages could be:

  1. Set out the highlights of the base-case fiscal projections (and make ample use of charts to present the likely path of the key fiscal indicators in a no-policy-change environment). Then the reality of the fiscal targets/rules being breached or of the unsustainable results and implications should be underscored. Then alternative debt targets can be proposed; for each set, the magnitude of the required fiscal action should be provided, in level terms and as a percent of GDP: for each set, the merits and downsides should be provided; and officials should agree on one option that they are prepared to recommend and to present the accompanying rationale. This would then be submitted to the Minister for discussion and feedback.
  2. Once the feedback has been received and the big fiscal targets (principally total debt and the breakdown between domestic and foreign) have been settled, the magnitude and timing of the overall fiscal action will also have been revealed. This triggers the second phase, the development of alternative fiscal policy courses of action. Initially there can be generic or illustrative explanations of what it would mean if all of the required action comes from the revenue side or from the expenditure side. Examples should be given for each of these “bookend” options (e.g. to get X $ from the revenue side will mean raising all taxes by an average of a% or so; or to get Y $ from the expenditure side, then the wage bill has to be reduced by b% or subsidies reduced by c% compared to base case.) This helps the Minister come to terms with the type of revenue and expenditure mix he or she would be comfortable with and paves the way for the next stage in the policy development work.
  3. The next step would be to develop more precise measures associated with the overall fiscal adjustment effort and mix. At this stage, we are into the analysis of specific measures which together will make up the overall fiscal effort. For each measure being considered, its projected fiscal impact is quantified over the medium term, and an analysis made of which group(s) would be affected, the economic effects, etc. Revenue-side action should be fleshed out and analyzed by an inter-agency team which brings together members of the Macro-Fiscal unit (or the tax policy unit), and the Tax/Customs Department. Consideration must be given to the incidence of the tax measure, its efficiency and its impact on various income groups and feedback effects. Two facets or phases can be contemplated in respect of the expenditure-side action: the MoF can come up with policy options which affect certain input costs, government wide (e.g. action on the wage bill, mandated “efficiency” increases imply restraint in non-interest recurrent costs; decisions concerning subsidies to agencies, or  transfers to persons or to sub-national governments). This first “rather blunt” approach managed from the center, can yield significant savings. Some advance work carried out by the macro-fiscal unit and the budget department is generally required to come up with reliable estimates and effects (e.g. the implications of certain actions on the wage bill, or on average employee wages, on subsidies and transfers to agencies and others).
  4. However, beyond a certain point, decisions to secure additional savings require a more refined involvement of the Budget Department and of operating ministries, as the discussion shifts from how to secure cost savings  to identifying which specific government programs will no longer be delivered; and which activities will be scaled back or will no longer be carried out. Line ministers and ministries are then called upon to derive complete and accurate cost figures for each of their programs; and to propose a realistic ranking of their programs and activities from highest to lowest priority. It may take some time before the full information on that becomes available.

CARTAC has experienced that support for the analytical and policy development work sketched above is of great help to Ministers of Finance in the Caribbean, and indeed to the entire Cabinet.

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