## _sdn1506 — Executive Summary (Fiscal Policy in Latin America)

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---

### Introduction
- Focus: six larger, financially-integrated emerging market economies of Latin America (LA6)—Brazil, Chile, Colombia, Mexico, Peru, and Uruguay—which account for more than 70 percent of the region’s GDP.
- Context: Bold fiscal response to the 2008–09 global financial crisis; more than six years later most countries have not fully rebuilt fiscal space despite buoyant commodity revenues and strong growth in the post-crisis years.
- Core policy questions examined:
  - Impact: How was the fiscal stimulus undertaken and what was the impact on output?
  - Legacies: Did fiscal policy turn procyclical? How large was the increase in spending and what were the drivers? How much have fiscal buffers been eroded? How were fiscal institutions affected?
  - Looking forward: How much do buffers need rebuilding? How much can be achieved by increasing spending efficiency? What institutional reforms are needed?

### Crisis response and output effects
- Fiscal stance in 2009:
  - In most countries fiscal policy was unambiguously expansionary in 2009.
  - Simulations suggest output in 2009 would have been "¾ to 2 percent" lower in the absence of fiscal easing (model-based ranges).
- Fiscal multipliers (IMF FSGM and alternative estimates):
  - IMF FSGM implied average fiscal multipliers: about 1 for public capital and consumption spending, 0.5 for transfers and revenue measures, and 0.5 for policy lending.
  - Alternative econometric multipliers (Ilzetzki (2011) range 0.3−0.4) imply an estimated fiscal impact of "¾ to 1½ percent" of output.
- Interaction with monetary policy:
  - Monetary policy accommodation amplified fiscal effects.

### Composition, persistence, and cyclicality of spending
- Composition and persistence:
  - On average about two-thirds of the 4 percentage points of GDP increase in spending were in current outlays.
  - Much of the fiscal easing came from an upward shift in current expenditures, making reversal harder as growth recovered.
- Post-crisis normalization and cyclicality:
  - The easing in 2008–09 was generally not followed by a fiscal withdrawal of equal magnitude, except in Chile.
  - Cyclically adjusted fiscal balances are well below pre-crisis levels despite buoyant commodity revenues and strong growth.
  - By 2014, cyclically adjusted fiscal balances were, on average, 2¾ percentage points weaker than in 2007.
- Country patterns (year-by-year 2010–12):
  - Chile (and to a limited extent Mexico): consistently tightened fiscal position in 2010–12.
  - Colombia: mostly acyclical fiscal policy in 2010–12.
  - Brazil: countercyclical during downturns (but not upturns).
  - Uruguay: clearly procyclical.

### Fiscal space, debt dynamics, and shock scenarios
- Diminished fiscal space:
  - Fiscal space has been diminished by incomplete reversal of the crisis response; debt levels mostly appear manageable but fiscal risks have heightened.
  - Spending-to-GDP ratios in 2014 were, on average, 4 percent of GDP higher than in 2007.
  - Public capital stock in LA6 is about 40 percent lower than the EM average.
- Sustainability indicators and projection markers:
  - Primary balance gaps declined from positive levels before the crisis to negative levels now.
  - Gross and net debt as a share of GDP are expected to remain above pre-crisis levels in all countries except Peru and Uruguay over the next five years—on average by 4 percentage points of GDP.
- Macro shock scenarios (methodology: Adler and Sosa (2013)):
  - Protracted growth slowdown scenario:
    - Assumption: real GDP growth is ½ percentage point below current projections.
    - Result: public debt ratios would be higher on average by 4 percentage points of GDP in 2020 relative to baseline, with particularly large impacts in Brazil, Colombia, and Uruguay.
  - Commodity price shock scenario:
    - Assumption: energy and metal prices stabilize at 25 percent below the baseline level by end-2017 (decreasing further to levels seen in 2004–05).
    - Result: Similar magnitude debt increases; most affected are natural resource producers—all except Uruguay.
- Policy-risk counterfactuals:
  - If past expenditure growth (2011–14) continues, debt ratios would be 9 percentage points of GDP higher than baseline.
  - Reverting to structural primary balances prevailing in 2007 would lower the 2020 debt burden on average by 7 percent of GDP.
- Counterfactual FSGM simulation public-debt savings from more countercyclical policy:
  - Brazil: 4 percentage points of GDP.
  - Uruguay: 9 percentage points of GDP.

### Institutional legacies and shortcomings
- Erosion of fiscal institutions:
  - To varying degrees there was an erosion of fiscal policy institutions following the crisis, although repair is underway in most countries.
  - Weak adherence to the spirit (not just the letter) of fiscal rules, use of one-off revenues and off-budget/quasifiscal activities undermine credibility.
- Key shortcomings identified:
  - Reliance on nominal (as opposed to structural) targets, creating a procyclical bias.
  - Frequent changes to fiscal rules and targets; repeated use or loosening of escape clauses.
  - Narrow coverage of rules and loopholes (central government coverage, exclusions for PEMEX investment, ad-hoc exclusions for investment and social spending).
  - Use of nonrecurrent revenues and off-budget transactions to meet targets.
  - Pushing fiscal activities outside NFPS into public banks and state-owned companies (example: around 10 percent of GDP transferred to public banks and leveraged for credit expansion in Brazil).
  - Weak budget execution controls: expenditures on average close to 1 percent of GDP above budgeted amounts for the region as a whole.
  - Limited public accountability and no independent monitoring of compliance with fiscal rules.

### Spending effectiveness, efficiency gaps, and illustrative savings
- Sectoral efficiency findings:
  - Health:
    - LA6 countries are below the efficiency frontier—same HALE could be attained by spending less.
  - Social protection:
    - Social assistance: benefit-cost ratios above the EM average except in Colombia.
    - Social insurance (contributory pensions): generally ineffective in reducing poverty and in some cases may exacerbate income inequality.
  - Education:
    - Secondary-education PISA outcomes are relatively good given public education spending levels; Uruguay and Chile particularly efficient.
  - Public investment:
    - Public capital stock in LA6 is about 40 percent lower than the EM average.
    - Colombia, Mexico, and Peru could obtain sizeable gains by improving the quality of public investments.
- Illustrative efficiency-saving scenario (moving to efficiency frontier/LA6 averages):
  - Peru: 1 percent of GDP.
  - Brazil: 3¼ percent of GDP.
  - Technical efficiency analysis indicates potential savings of 1–3½ percentage points of GDP across education, health, social assistance, and infrastructure.

### Country-differentiated assessment and implications
- Chile and Peru:
  - Broadly followed a path of policy smoothing and have retained significant space to react to future shocks (noting part of this space is being eroded by the decline in commodity prices).
- Colombia:
  - Fiscal policy was mostly acyclical after the crisis; public sector retains fiscal space but deploying it warrants caution given potential sustained low commodity revenue.
- Brazil and Uruguay:
  - Have eroded their fiscal position to a point where they may have to tighten policies while economic growth is below potential in the coming years.
- Mexico:
  - Has reversed part of its crisis-related fiscal easing, but the deficit needs to be lowered further to stabilize public debt.

### Policy recommendations and priorities
- Rebuild fiscal buffers:
  - Desired size, pace, and timing vary across countries depending on debt dynamics, fiscal risks, macro outlook, and market conditions.
  - Country-specific consolidation guidance (magnitudes preserved exactly as in source):
    - Brazil and Uruguay: about 2½–3 percentage points of GDP in consolidation needed to put debt-to-GDP ratios on a firmly downward sloping path.
    - Colombia: consolidate 2 percentage point of GDP over the next few years.
    - Mexico: consolidate 2–3 percentage point of GDP over the next few years.
    - Chile and Peru: gradually improve fiscal balances by 1–1½ percentage points of GDP over the medium term.
- Redesign fiscal institutions (beyond restoring pre-crisis frameworks):
  - Move toward fiscal rules that target the structural balance; where preconditions are weak consider expenditure rules as operationally easier alternatives.
  - Adopt broadly defined expenditure rules and ensure broad and stable coverage of rules (beyond central government).
  - Build well-defined escape clauses with limited triggers and specified corrective paths.
  - Establish operationally independent fiscal councils to assess forecasts and monitor compliance.
  - Create rolling medium-term expenditure frameworks with enforceable multiyear spending ceilings.
  - Strengthen mechanisms to save windfalls from commodity-related revenue.
- Strengthen adherence and credibility:
  - Avoid creative accounting and the use of one-off revenues to meet the letter but not the spirit of rules.
  - Close loopholes that allow off-budget or quasifiscal activities.
- Raise expenditure efficiency:
  - Implement micro-level reforms to improve quality of public goods and services while containing spending growth.
  - Health sector priorities: payment reforms, streamlining administration, emphasis on prevention, reducing fragmentation, aligning hospital capacity.
  - Other measures: reform contributory pension schemes where needed; improve public investment management systems (coordination, enforceable quality rules, PPP oversight).

### Quantitative and regression markers (selected exact values)
- Crisis-output simulation ranges: "¾ to 2 percent"; "¾ to 1½ percent".
- Fiscal multipliers: IMF FSGM — public capital and consumption = 1; transfers and revenue measures = 0.5; policy lending = 0.5.
- By 2014, cyclically adjusted fiscal balances were, on average, 2¾ percentage points weaker than in 2007.
- Spending-to-GDP ratios in 2014 were, on average, 4 percent of GDP higher than in 2007.
- Public capital stock in LA6 is about 40 percent lower than the EM average.
- Panel regression (country fixed effects):
  - Adjusted balance t-1: -0.17*** and -0.22***.
  - Commodity price index: 0.55*** and 0.48***.
  - Output gap * 2008 and after: 0.21 (standard error 0.13).
  - Observations: 114; Countries: 66; R-squared: 0.50 and 0.61.
- Country coefficient examples (∆ Adjusted Primary Balance):
  - Brazil: OLS pre-2008 = 0.38; IV-2 since 2008 = -0.31.
  - Chile: OLS pre-2008 = 0.20; IV-2 since 2008 = 0.61.
  - Colombia: IV-2 since 2008 = 0.94***.
  - Mexico: IV-2 since 2008 = 0.53**.
  - Peru: IV-2 pre-2008 = 0.53*.
  - Uruguay: OLS pre-2008 = -0.45***; IV-2 pre-2008 = -0.44***.
- Counterfactual debt savings from more countercyclical policy:
  - Brazil: 4 percentage points of GDP.
  - Uruguay: 9 percentage points of GDP.
- Illustrative efficiency savings:
  - Peru: 1 percent of GDP.
  - Brazil: 3¼ percent of GDP.

*International Monetary Fund (excerpt from the chapter "Fiscal Policy in Latin America" contained in the supplied PDF content).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### _sdn1506 - EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### Introduction
- Focus: six larger, financially-integrated emerging market economies of Latin America (LA6)—Brazil, Chile, Colombia, Mexico, Peru, and Uruguay—which account for more than 70 percent of the region’s GDP.
- Context: Bold fiscal response to the 2008–09 global financial crisis; more than six years later most countries have not fully rebuilt fiscal space despite buoyant commodity revenues and strong growth in the post-crisis years.
- Core policy questions examined:
  - Impact: How was the fiscal stimulus undertaken and what was the impact on output?
  - Legacies: Did fiscal policy turn procyclical? How large was the increase in spending and what were the drivers? How much have fiscal buffers been eroded? How were fiscal institutions affected?
  - Looking forward: How much do buffers need rebuilding? How much can be achieved by increasing spending efficiency? What institutional reforms are needed?

### Main findings and empirical results
- Crisis response and output:
  - In most countries fiscal policy was unambiguously expansionary in 2009.
  - Simulations suggest output in 2009 would have been "¾ to 2 percent" lower in the absence of fiscal easing (model-based ranges).
  - IMF FSGM implied average fiscal multipliers: about 1 for public capital and consumption spending, 0.5 for transfers and revenue measures, and 0.5 for policy lending.
  - Alternative econometric multipliers (Ilzetzki (2011) range 0.3−0.4) imply an estimated fiscal impact of "¾ to 1½ percent" of output.
  - Monetary policy accommodation amplified fiscal effects.
- Composition and persistence of spending:
  - On average about two-thirds of the 4 percentage points of GDP increase in spending were in current outlays.
  - Much of the fiscal easing came from an upward shift in current expenditures, making reversal harder as growth recovered.
- Post-crisis fiscal normalization and cyclicality:
  - The easing in 2008–09 was generally not followed by a fiscal withdrawal of equal magnitude, except in Chile.
  - Some evidence that intended policies were more countercyclical than outcomes in cases where post-crisis growth surprised to the upside.
  - Cyclically adjusted fiscal balances are well below pre-crisis levels despite buoyant commodity revenues and strong growth.
- Fiscal space, debt, and risks:
  - Fiscal space has been diminished by incomplete reversal of the crisis response; debt levels mostly appear manageable but fiscal risks have heightened.
  - If the region had tightened fiscal policy during 2010–14 (maintaining countercyclicality), public debt dynamics would have been more favorable and output variability would have been lower.
- Institutions:
  - To varying degrees there was an erosion of fiscal policy institutions following the crisis, although repair is underway in most countries.
  - Weak adherence to the spirit (not just the letter) of fiscal rules, use of one-off revenues and off-budget/quasifiscal activities undermine credibility.

### Country-differentiated assessment and implications
- Chile and Peru:
  - Broadly followed a path of policy smoothing and have retained significant space to react to future shocks (noting part of this space is being eroded by the decline in commodity prices).
- Colombia:
  - Fiscal policy was mostly acyclical after the crisis; public sector retains fiscal space but deploying it warrants caution given potential sustained low commodity revenue.
- Brazil and Uruguay:
  - Have eroded their fiscal position to a point where they may have to tighten policies while economic growth is below potential in the coming years.
- Mexico:
  - Has reversed part of its crisis-related fiscal easing, but the deficit needs to be lowered further to stabilize public debt.

### Policy recommendations and priorities
- Rebuild fiscal buffers:
  - The desired size, pace, and timing of adjustment will vary across countries depending on debt dynamics, fiscal risks, macro outlook, and market conditions.
  - In some cases existing space allows fiscal policy to counter negative shocks in the near term; in others quicker consolidation will be needed even with disappointing growth.
- Redesign fiscal institutions (beyond restoring pre-crisis frameworks):
  - Build features to distinguish temporary from permanent revenues.
  - Avoid procyclicality and ensure a more symmetric response to downturns and expansions.
  - Incorporate well-defined escape clauses.
  - Give greater prominence to the multi-year consequences of budget decisions in public debate and institutional processes.
  - Be cautious with expansions of lasting expenditure commitments (e.g., higher wages, new social programs) that are not funded by revenue increases.
- Strengthen adherence and credibility:
  - Avoid creative accounting and the use of one-off revenues to meet the letter but not the spirit of rules.
  - Close loopholes that allow off-budget or quasifiscal activities.
- Raise expenditure efficiency:
  - Implement micro-level reforms tailored to country circumstances to improve the quality of public goods and services while containing spending growth.
  - Illustrative potential savings from reducing inefficiencies could help rebuild buffers without cutting core services (figures and country-specific estimates provided in the full note).

### The fiscal policy reaction to the crisis — summary points
- LA6 entered the crisis with historically large fiscal buffers accumulated during the early 2000s upswing; improvements were driven largely by strong growth and commodity prices, alongside institutional reforms and fiscal rules.
- 2009 discretionary stimulus packages ranged from about "1½ to 3¼ percent of GDP" in Brazil, Chile, Mexico, and Peru and typically included public investment, targeted transfers, tax relief, and policy lending.
- Automatic stabilizers accounted for only a small share of total fiscal stabilization in emerging markets; discretionary measures played a major role in the LA6 response.
- By 2011 output in the LA6 had almost returned to pre-crisis trends, outperforming many other emerging markets and advanced economies.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2015/_sdn1506.pdf*

### 0.5 for policy lending. Uruguay is not included in the

### _sdn1506 - 0.5 for policy lending. Uruguay is not included in the

### Legacies of the Crisis
- The window to withdraw fiscal stimulus was missed in most LA6 countries, partly due to uncertainty and political difficulty in unwinding spending increases.
- End results:
  - Decline of fiscal buffers; some countries now face the need to undertake procyclical tightening.
  - Erosion of fiscal institutions.
- By 2014, cyclically adjusted fiscal balances were, on average, 2¾ percentage points weaker than in 2007.

### A. An End to Fiscal Procyclicality?
- Year-by-year country behavior in 2010–12:
  - Chile (and to a limited extent Mexico): consistently tightened fiscal position in 2010–12 as output climbed toward and above potential.
  - Colombia: mostly acyclical fiscal policy in 2010–12.
  - Brazil: countercyclical during downturns (but not upturns).
  - Uruguay: clearly procyclical.
- Interpretation:
  - Regression analysis suggests lessened procyclicality in the LA6 from 2008 onwards, both on average and country-by-country (Figure 6; Box 1).
  - The identified countercyclical stance was largely driven by the 2009 stimulus rather than persistent post-crisis policy behavior.
  - There is some evidence policymakers intended a more countercyclical path; delayed withdrawal was partly due to expectations of a tepid recovery and perceived downside risks.

Key regression and panel results (selected exact values from Box 1 and Table 1):
- Panel regression (country fixed effects):
  - Adjusted balance t-1: -0.17*** and -0.22*** (robust standard errors in parentheses).
  - Commodity price index: 0.55*** and 0.48***.
  - Output gap * 2008 and after: 0.21 (standard error 0.13).
  - Observations: 114; Countries: 66; R-squared: 0.50 and 0.61 (two specifications).
- Country-by-country coefficient examples (dependent variable: ∆ Adjusted Primary Balance):
  - Brazil: OLS pre-2008 = 0.38; IV-2 since 2008 = -0.31.
  - Chile: OLS pre-2008 = 0.20; IV-2 since 2008 = 0.61.
  - Colombia: IV-2 since 2008 = 0.94***.
  - Mexico: IV-2 since 2008 = 0.53**.
  - Peru: IV-2 pre-2008 = 0.53*.
  - Uruguay: OLS pre-2008 = -0.45***; IV-2 pre-2008 = -0.44***.

Counterfactual FSGM simulation findings (how a more symmetric countercyclical response could have affected outcomes):
- Brazil and Uruguay:
  - More countercyclical post-crisis policy would have reduced output variability and saved 4 and 9 percentage points of GDP in public debt, respectively.
- Chile:
  - A more paced withdrawal would have lowered volatility but led to modestly higher public debt.
- Peru:
  - Some reduction in output volatility with relatively little effect on the public debt ratio.
- Mexico and Colombia:
  - Trade-offs are more ambiguous; effects are relatively small.
- Assumption for simulation:
  - For countries with countercyclical fiscal response in 2009 (Brazil, Chile, Colombia, Mexico, Peru), the reaction of the cyclically adjusted balance to the output gap in 2010–14 is assumed equal to the reaction in 2009.
  - Uruguay (which did not ease fiscal policy in 2009): acyclical fiscal policy is assumed from 2009 onwards.

### B. A Step-Up in Public Sector Spending
- Spending dynamics:
  - The 2008–09 expansion saw sizable increases in spending across all LA6 countries.
  - Subsequent fiscal adjustment came entirely from higher revenues (tax policy reforms, buoyancy, better tax administration).
  - Spending-to-GDP ratios in 2014 were, on average, 4 percent of GDP higher than in 2007.
  - Spending levels: broadly stayed at elevated 2009 levels in Chile, Colombia, Mexico; rose further in Brazil, Peru, Uruguay.
- Composition of the spending increase:
  - In all countries except Peru (and to a lesser extent Colombia), the increase came from higher current outlays rather than capital spending.
  - On average, only one-third of the increase in spending came from capital spending.
  - Current spending increases raise fiscal rigidity (public wages, pensions, social protection, health care).
- Major drivers by country (selected):
  - Brazil and Peru: higher social protection.
  - Chile: health and education.
  - Mexico: pensions.
  - Uruguay: health care and education.
- Nature of increases:
  - Some increases reflect entitlement reforms (notably Chile and Uruguay), but in most cases there were no major new entitlement programs.
  - Many increases appear permanent and were not matched by similar permanent changes in revenue policies.

Spending effectiveness and efficiency findings:
- Primary spending levels:
  - Except for Brazil, primary spending is below the emerging market (EM) average, yet outcomes are generally worse than implied by lower spending.
- Frontier analysis and cost-benefit indicators (summary of sectoral findings):
  - Health:
    - Loss in HALE due to spending inefficiency in LA6 is below the EM average, but all countries are below the efficiency frontier—same HALE could be attained by spending less.
    - HALE and average per capita health spending indicators shown in Figure 14 panels a and b.
  - Social protection:
    - Social assistance: benefit-cost ratios above the EM average except in Colombia.
    - Social insurance (contributory pensions): generally ineffective in reducing poverty and in some cases may exacerbate income inequality.
  - Education:
    - Secondary-education PISA outcomes are relatively good given public education spending levels.
    - Uruguay and Chile appear particularly efficient; Peru and Mexico slightly below the frontier; Colombia and Brazil have larger efficiency gaps.
  - Public investment:
    - Public capital stock in LA6 is about 40 percent lower than the EM average.
    - Brazil, Chile, and Uruguay: low levels of public investment but relatively efficient provision.
    - Colombia, Mexico, and Peru: could obtain sizeable gains by improving the quality of public investments.

### Key quantitative markers (preserved exactly as in source)
- By 2014, cyclically adjusted fiscal balances were, on average, 2¾ percentage points weaker than in 2007.
- Spending-to-GDP ratios in 2014 were, on average, 4 percent of GDP higher than in 2007.
- Public capital stock in LA6 is about 40 percent lower than the EM average.
- Panel regression specific values:
  - Adjusted balance t-1: -0.17*** and -0.22***.
  - Commodity price index: 0.55*** and 0.48***.
  - Output gap * 2008 and after: 0.21.
  - Observations: 114; Countries: 66; R-squared: 0.50 and 0.61.
- Counterfactual public-debt savings from more countercyclical policy:
  - Brazil: 4 percentage points of GDP.
  - Uruguay: 9 percentage points of GDP.

*International Monetary Fund (excerpt from the chapter "Fiscal Policy in Latin America" contained in the supplied PDF content).*

### 13.      These findings highlight the potential

### 13.      These findings highlight the potential

### Illustrative efficiency savings from reducing spending inefficiencies
- Scenario: LA6 countries move to the efficiency frontier in education, health, and infrastructure spending, and to the LA6 average in social assistance.
- Estimated efficiency savings:
  - Peru: 1 percent of GDP
  - Brazil: 3¼ percent of GDP
- Source for illustrative savings: IMF staff calculations.

### C. Diminished Fiscal Space — sustainability and risks
- Assessing fiscal space requires analysis of:
  - level and expected path of public debt,
  - primary balance gap (actual minus debt-stabilizing primary balance),
  - vulnerability to shocks,
  - adjustment flexibility (tax-raising possibility, budgetary rigidities),
  - future spending pressures,
  - contingent liabilities.
- Sustainability indicators:
  - Primary balance gaps declined from positive levels before the crisis to negative levels now, illustrating diminished fiscal space (Figure 16, panel b).
  - Deterioration reflects a weaker structural primary balance and increased debt following the 2009 stimulus, and an increased interest-growth differential.
  - Absent primary balance improvements, public debt ratios would trend upward.
  - Policy adjustments in Brazil, Colombia, Mexico, and Peru will diminish sustainability risks.
  - Gross and net debt as a share of GDP are expected to remain above pre-crisis levels in all countries except Peru and Uruguay over the next five years—on average by 4 percentage points of GDP (Figure 16, panel a).
- Macroeconomic shock scenarios (methodology: Adler and Sosa (2013)):
  - Protracted growth slowdown scenario:
    - Assumption: real GDP growth is ½ percentage point below current projections.
    - Result: public debt ratios would be higher on average by 4 percentage points of GDP in 2020 relative to baseline, with particularly large impacts in Brazil, Colombia, and Uruguay (Figure 17, panel a).
  - Commodity price shock scenario:
    - Assumption: energy and metal prices stabilize at 25 percent below the baseline level by end-2017 (decreasing further to levels seen in 2004–05).
    - Result: Similar magnitude debt increases; most affected are natural resource producers—all except Uruguay—via lower government revenue and endogenous growth slowdown.
  - Notes on growth-slowdown impact determinants:
    - End-2014 debt ratio,
    - Projected increase in debt ratios under the WEO baseline,
    - Elasticity of primary deficits to GDP (larger in countries with high expenditure ratios—Brazil, Uruguay, Colombia—and/or low natural resource revenues as percent of GDP—Uruguay, Brazil),
    - Endogenous responses of exchange rates and interest rates.
- Policy risks:
  - If recent past expenditure growth patterns (2011–14) continue, debt ratios would be 9 percentage points of GDP higher than baseline—generally surpassing adverse macroeconomic shock impacts—and could lead to unsustainable trends in Brazil and Uruguay (Figure 16, panel b).
  - Reverting to structural primary balances prevailing in 2007 would lower the 2020 debt burden on average by 7 percent of GDP.
- Fiscal risks (contingent liabilities):
  - Sources include guarantees to Public-Private Partnerships (Peru, Colombia, Chile); state-owned banks and public credit operations (Brazil, Chile, Mexico, Uruguay); implicit guarantees to state-owned enterprises (Brazil, Chile, Colombia), sub-national governments, and the financial sector; contingent liabilities related to lawsuits against the state (Brazil, Chile, Peru); and natural disasters (Chile, Mexico, Peru).
  - Quantification is difficult owing to variable availability of public information across LA6 countries.
- Spending pressures:
  - Likely to grow with rising income (Wagner’s law).
  - Baumol effect: price of public services may grow faster than private goods and services.
  - Demographic trends will increase age-related spending pressures across all LA6, particularly health care (Table 3).
- Conclusion and policy implication:
  - Given risks, uncertainty, and limited fiscal space, there is a clear case to rebuild fiscal buffers across all LA6.
  - Flexibility to adjust fiscal position varies across countries:
    - Increases with share of discretionary spending (vs. mandatory or earmarked spending).
    - Decreases with the tax burden.
  - Excessive earmarking distorts fiscal management and can reduce investment space and reallocation flexibility.

### Key cross-country observations on flexibility and rigidities
- Brazil and Uruguay:
  - Highest revenue ratios; least headroom to raise taxes (Figure 18).
  - Brazil: widespread revenue earmarking.
  - Uruguay: high and increasing “rigid” spending (public wages, pensions, social assistance) (Figures 19 and 20).
- Colombia:
  - Relatively high spending rigidity, but scope to raise taxes and lower public debt level.
- Mexico, Chile, Peru:
  - More flexibility due to relatively low tax ratios and lower earmarking and spending rigidities.
  - All three face volatility in commodity revenue.

### D. An Erosion of Fiscal Institutions — pre-crisis reforms and subsequent weakening
- Pre-crisis decade reforms created frameworks to build fiscal buffers:
  - Adoption of fiscal rules (primarily nominal deficit ceilings), caps on sub-national borrowing or expenditure growth, medium-term budget frameworks, fiscal responsibility laws, top-down budgeting, and stabilization funds.
  - LA6 compared favorably to G20 peers in budget institution quality (Figure 21).
- Crisis revealed weaknesses and consequences of discretionary changes without medium-term anchors:
  - Many countries “bent the rules” via ad-hoc adjustments to accommodate the 2009 fiscal impulse (Table 5).
  - Initially justified by urgency and limited flexibility, these relaxations became, de facto, permanent in subsequent years with insufficient re-anchoring of medium-term objectives; in some cases frameworks weakened further.
  - More recently, several countries have refocused on strengthening fiscal institutions.
- Figure 22 evidence:
  - Fiscal loosening and numerical rule relaxations in 2009 included revisions to deficit targets, accounting adjustments, changes to escape clauses, policy lending, and use of escape clauses.
  - Change in primary balances in 2009 shows variations across LA6, with some changes justified by fiscal rules and ad hoc adjustments.
- Institutional elements summarized in Table 4 (numerical fiscal frameworks and other fiscal institutions) indicate variation across LA6 in original laws, latest changes, scope (NFPS, CG, consolidated public sector), numerical targets, escape clauses, medium-term expenditure frameworks, stabilization funds, and independent reviews.

*INTERNATIONAL MONETARY FUND*

### 18.      Specific shortcomings of the fiscal frameworks revealed during and subsequent to

### 18.      Specific shortcomings of the fiscal frameworks revealed during and subsequent to

### Key shortcomings identified
- Reliance on nominal (as opposed to structural) targets, creating a procyclical bias to policies (although, to some extent, expenditure rules—when binding—did seem to help stem spending pressures).
- Frequent changes to fiscal rules and targets, including invoking escape clauses repeatedly (examples cited: Peru in 2010; Mexico in 2010–12; Uruguay—for the net debt rule—in 2010, and 2012–14).
- Narrow coverage of fiscal rules:
  - Coverage limited to the central government in Chile.
  - Mexico: coverage excludes state and local governments and uses a non-standard definition of the fiscal deficit (counting certain financing items as revenues and excluding some expenditures).
  - Ad-hoc exclusions introduced in Mexico (PEMEX investment), Brazil (investment and tax cuts through the adjustor), and Peru (infrastructure maintenance, some social spending and equipment purchases for security forces).
- Lack of (or poorly defined) escape clauses: Chile and Colombia had no escape clause and targets were missed to accommodate 2009 stimulus; Mexico and Uruguay repeatedly used escape clauses (Uruguay loosened theirs over time).
- Reliance on nonrecurrent revenues to meet fiscal targets in letter but not spirit (Brazil and Mexico).
- Use of off-budget and nonrecurrent transactions to meet targets:
  - Examples: tax amnesties, concession proceeds, withdrawals from sovereign wealth funds; deferred payment of spending obligations since targets are on a cash basis.
- Pushing fiscal activities outside NFPS into public banks and state-owned companies:
  - Around 10 percent of GDP transferred from the federal government to public banks and leveraged to expand public credit (Brazil).
  - Quasi-fiscal losses in Petrobras and Eletrobras through price controls (outside NPFS coverage).
- Weak budget execution controls: expenditures on average close to 1 percent of GDP above budgeted amounts for the region as a whole.
- Limited public accountability and no independent monitoring of compliance with fiscal rules.
- Multi-year budgetary frameworks often not policy-relevant or used to guide the budget process.

### Brazil: fiscal framework shortcomings and mechanisms used (summary)
- Backbone: Fiscal Responsibility Law (FRL) with yearly NFPS primary surplus targets; Budget Guidance Law (LDO) creates binding first-year target and indicative targets for next two years. Since 2006 some space allowed via an “investment adjustor”.
- Adjustor widened:
  - From less than 0.2 percent of GDP in 2006 to 1.3 percent of GDP by 2013.
  - In 2014, late revision eliminated the ceiling on the adjustor altogether.
- Narrowing of coverage:
  - Traditionally covered whole NFPS with federal government compensating shortfalls.
  - In 2013 federal government no longer required to compensate shortfalls elsewhere, effectively narrowing to federal government primary balance; clause eliminated in 2015 restoring NFPS constraint.
- Extensive reliance on non-recurrent and off-budget transactions to comply:
  - Tax amnesties, concession proceeds, withdrawals from sovereign wealth fund.
  - Deferred payments and recognition of unpaid spending obligations.
- Off-budget stimulus via public banks and state-owned companies:
  - Around 10 percent of GDP transferred to public banks and leveraged for credit expansion.
  - Policy lending to public banks to be discontinued from 2015.
- Retroactive renegotiation of subnational debt terms lowering net payments from subnational governments by around ½ percent of GDP.
- Dilution of executive control over budget execution:
  - Starting in 2015, parliamentary amendments to the budget made compulsory for up to 1.2 percent of net current revenue (provided half of expenses pertain to health services).
- Compliance often depended on nonrecurrent revenues and floating debt management.

### Lessons and policy recommendations — restoring fiscal space and countercyclicality
- Countercyclical fiscal policy must be symmetric during downturns and recoveries; institutions that provide a credible fiscal anchor are key.
- Restore fiscal buffers; required magnitude, timing, and pace vary by country:
  - Brazil and Uruguay: about 2½–3 percentage points of GDP in consolidation needed to put debt-to-GDP ratios on a firmly downward sloping path.
  - Colombia: consolidate 2 percentage point of GDP over the next few years.
  - Mexico: consolidate 2–3 percentage point of GDP over the next few years.
  - Chile and Peru: gradually improve fiscal balances by 1–1½ percentage points of GDP over the medium term to accumulate larger buffers.
- Part of adjustment underway:
  - Brazil announced a primary surplus target of 1.2 percent of GDP for 2015 and of at least 2 percent of GDP in 2016 and 2017; ending policy lending from the Treasury to public sector banks.
  - In Colombia and Mexico, fiscal balance projected to strengthen by more than 2 percentage points over the medium term.
  - Mexico: supported by expenditure reductions in 2015 and 2016.
  - Uruguay: 2015 budget entails an adjustment amounting to only ¾ percent of GDP.

### Redesigning fiscal institutions — specific reforms
- Adjust for the cycle:
  - Move toward a fiscal rule that targets the structural balance (adjusting for the cycle and, in resource-rich countries, for deviations in commodity prices) to limit procyclicality.
  - Where structural-rule preconditions are weak (e.g., real-time output gap uncertainty) consider expenditure rules as operationally easier alternatives.
  - Existing examples: Chile uses a structural balance rule; Colombia introduced a structural balance anchor via a constitutional amendment in 2011; Peru has an indicative structural balance anchor starting with the 2015 budget feeding into a binding constraint on spending.
- Adopt broadly defined expenditure rules to limit procyclicality when appropriate (Mexico has complemented a nominal deficit target with an expenditure rule covering about half of expenditures).
- Ensure broad and stable coverage of rules (beyond central government) and eliminate loopholes (Mexico moved to give more prominence to broader public sector borrowing requirement).
- Establish operationally independent fiscal councils to assess budgetary forecasts and monitor compliance with rules (Chile and Colombia have fiscal councils; Chile’s lacks formal independence).
- Build well-defined escape clauses:
  - Limited range of trigger factors, clarity on use, and specify a path back to the rule (examples: Colombia’s 2011 explicit escape clause with corrective path; Peru’s law with detailed definitions and corrective path).
- Create rolling medium-term expenditure frameworks with multiyear spending ceilings that are enforceable (not merely indicative).
- Strengthen mechanisms to save windfalls from commodity-related revenue; reforms in oil and mining regimes in Colombia and Mexico to create or improve a savings fund.

### Raising expenditure efficiency — potential gains and priorities
- Technical efficiency analysis indicates the LA6 could potentially save 1–3½ percentage points of GDP by improving efficiency in public spending on education, health, social assistance, and infrastructure.
- Health sector offers largest savings potential; reform priorities include:
  - Correcting distortions and adopting payment methods that incentivize providers to contain costs and improve quality.
  - Streamlining collection and administration of health care resources.
  - Emphasizing health promotion and preventive care.
  - Reducing fragmentation of health care systems.
  - Aligning hospital capacity with needs.
- Other efficiency measures:
  - Reform contributory pension schemes where needed to contain budget pressures.
  - Improve public investment management systems to realize efficiency gains in infrastructure (principal gains from better coordination among levels of government and enforceable quality rules for public infrastructure spending, especially PPPs).

*Source: IMF staff estimates based on information obtained from Ministries of Finance.*

### References

### References

### Fiscal policy and institutions
- Adler, Gustavo, and Sebastian Sosa, 2013, “External Conditions and Debt Sustainability in Latin America,” IMF Working Paper No. 13/27 (Washington: International Monetary Fund).
- ___________, and Nicolas Magud, 2013, “Four Decades of Terms-of-Trade Booms: Saving-Investment Patterns and a New Metric of Income Windfall,” IMF Working Paper No. 13/103 (Washington: International Monetary Fund).
- Auerbach, Alan J., and Yuriy Gorodnichenko, 2012, “Measuring the Output Responses to Fiscal Policy,” American Economic Journal: Economic Policy, Vol. 4, pp. 1–27.
- Ayuso-i-Casals, Joaquim, 2012, “National Expenditure Rules: Why How and When,” Economic Papers 473 (December), (Brussels: European Commission).
- Baum, Anja, Marcos Poplawski-Ribeiro, and Anke Weber, 2012, “"Fiscal Multipliers and the State of the Economy," IMF Working Papers 12/286, International Monetary Fund,” IMF Working Paper No. 12/286 (Washington: International Monetary Fund).
- Cebotari, Aliona, Jeffrey Davis, Lusine Lusinyan, Amine Mati, Paolo Mauro, Murray Petrie, and Ricardo Velloso, 2009, “Fiscal Risks: Sources, Disclosure, and Management,” (Washington: International Monetary Fund).
- Debrun, Xavier, and Tidiane Kinda, 2014, “Strengthening Post-Crisis Fiscal Credibility: Fiscal Councils on the Rise—A New Dataset,” IMF Working Paper No. 14/58 (Washington: International Monetary Fund).
- Heller, Peter, 2005, “Understanding Fiscal Space,” Policy Discussion Paper No. 05/04 (Washington: International Monetary Fund).
- Hemming, Richard, and Philip Joyce, 2013, “The Role of Fiscal Councils in Promoting Fiscal Responsibility,” in Public Financial Management and Its Emerging Architecture, ed. by Marco Cangiano, Teresa Curristine, and Michel Lazare (Washington: International Monetary Fund).
- Ilzetzki, Ethan, 2011, “Fiscal Policy and Debt Dynamics in Developing Countries,” Policy Research Working Paper Series No. 5666 (Washington: World Bank).
- Klemm, Alexander, 2014, “Fiscal Policy in Latin America over the Cycle,” IMF Working Papers, No. 14/59 (Washington: International Monetary Fund).
- Ley, Eduardo, 2009, "Fiscal Policy for Growth," World Bank Operational Studies No. 11120, (Washington: World Bank).
- Ter-Minassian, Teresa, 2011, “Should Latin American Countries Adopt Structural Balance-Based Fiscal Rules?” Revista de Economía y Estadística, Vol. XLIX, pp. 115–143.
- Vegh, Carlos, and Guillermo Vuletin, 2014, “The Road to Redemption: Policy Response to Crises in Latin America,” IMF Economic Review, Vol. 62, No. 4 (Washington: International Monetary Fund).

### Public investment and efficiency
- Albino-War, Maria, and others, 2014, “Making the Most of Public Investment in MENA and CCA Oil-Exporting Countries,” IMF Staff Discussion Note No. 14/10 (Washington: International Monetary Fund).
- Budina, Nina, Tidiane Kinda, Andrea Schaechter, and Anke Weber, 2013, “Numerical Fiscal Rules: International Trends” in Public Financial Management and Its Emerging Architecture, ed. by Marco Cangiano, Teresa Curristine, and Michel Lazare (Washington: International Monetary Fund).
- Frank, Jonas, 2013. “Public Investment Management in Latin America and the Caribbean: Institutions under Evolution,” Country Case Study, (Washington: World Bank).
- Rajaram, Anand, Tuan Minh Le, Kai Kaiser, Jay-Hyung Kim, and Jonas Frank, 2014, “The Power of Public Investment Management: Transforming Resources into Assets for Growth,” (Washington: World Bank).
- Schwellnus, Cyrille, 2009, “Achieving Higher Performance: Enhancing Spending Efficiency in Health and Education in Mexico,” Economics Department Working Paper No. 732 (Paris: Organization for Economic Co-operation and Development).
- ___________, 2015b, “Making Public Investment More Efficient,” IMF Policy Paper (forthcoming; Washington).

### Health systems, health expenditure, and social protection
- Bitran, Ricardo, 2013, “Explicit Health Guarantees for Chileans: The AUGE Benefits Package,” UNICO Studies Series 21 (Washington: World Bank).
- Bonilla-Chacín, Maria E., and Nelly Aguilera, 2013, “The Mexican Social Protection System in Health,” UNICO Studies Series No. 1 (Washington: World Bank).
- Gragnolati, Michele, Magnus Lindelow, and Bernard Couttolenc, 2013, “Twenty Years of Health System Reform in Brazil: An Assessment of the Sistema Único de Saúde,” Directions in Development (Washington: World Bank).
- Grigoli, Francesco, and Javier Kapsoli, 2013, “Waste Not, Want Not: The Efficiency of Health Expenditure in Emerging and Developing Economies,” IMF Working Paper No. 13/187 (Washington: International Monetary Fund).
- Giedion, Ursula, Ricardo Bitrán, and Ignez Tristao, eds., 2014, “Health Benefit Plans in Latin America: A Regional Comparison,” (Washington: Inter-American Development Bank).
- Pardo, Cristian, and Whitney Schott, 2013, “Health Insurance Selection in Chile: A Cross-Sectional and Panel Analysis,” Health Policy and Planning, pp. 1-11.
- Seinfeld, Janice, Vilma Montañez, and Nicolas Besich, 2013, “The Health Insurance System in Peru: Towards a Universal Health Insurance,” Global Development Network.
- Torres, Fernando M., and Oscar B. Acevedo, 2013, “Colombia Case Study: The Subsidized Regime of Colombia’s National Health Insurance System,” UNICO Studies Series No. 15, (Washington: World Bank).
- Bonilla-Chacín, Maria E., and Nelly Aguilera, 2013, “The Mexican Social Protection System in Health,” UNICO Studies Series No. 1 (Washington: World Bank).
- Cotlear, Daniel, 2011, “Population Aging: Is Latin America Ready?” Directions in Development (Washington: World Bank).

### Inequality, redistribution, and labor-market effects
- Caminada, Koen, Kees Goudswaard, and Chen Wang, 2012, “Disentangling Income Inequality and the Redistributive Effect of Taxes and Transfers in 20 LIS Countries Over Time,” LIS Working Paper Series No. 581 (Luxembourg: Luxembourg Income Study).
- Goñi, Edwin, Humberto J. López, and Luis Servén, 2011, “Fiscal Redistribution and Income Inequality in Latin America,” World Development Vol. 39(9), pp. 1558-1569.
- Lustig, Nora, George Gray-Molina, Sean Higgins, Miguel Jaramillo, Wilson Jiménez, Veronica Paz, Claudiney Pereira, Carola Pessino, John Scott, and Ernesto Yañez, 2012, “The Impact of Taxes and Social Spending on Inequality and Poverty in Argentina, Bolivia, Brazil, Mexico and Peru: A Synthesis of Results,” Working Paper No. 1216, Tulane Economics Working Paper Series (Tulane University).
- ___________, Carola Pessino and John Scott, 2013, "The Impact of Taxes and Social Spending on Inequality and Poverty in Latin America: Argentina, Bolivia, Brazil, Mexico, Peru and Uruguay," Public Finance Review, November, pp. 1–17.
- Organization for Economic Cooperation and Development, 2011, Divided We Stand: Why Inequality Keeps Rising, (Paris).
- Paulus, Alari, Mitja Čok, Francesco Figari, Peter Hegedüs, Natasa Kump, Orsolya Lelkes, Horacio Levy, Christine Lietz, Silja Lüpsik, Daniela Mantovani, Leszek Morawski, Holly Sutherland, Peter Szivos, and Andres Võrk, 2009, “The Effects of Taxes and Benefits on Income Distribution in the Enlarged EU,” EUROMOD Working Paper EM8/09 (Essex: University of Essex).

### Macroeconomic and methodological analysis
- Frankel, Jeffrey A., Carlos A. Vegh, and Guillermo Vuletin, 2013, “On Graduation from Fiscal Procyclicality, Journal of Development Economics, Vol. 100, pp. 21-47.
- Grigoli, Francesco, Alexander Herman, Andrew Swiston, and Gabriel Di Bella, 2015, "Output Gap Uncertainty and Real-Time Monetary Policy," IMF Working Paper No. 15/14 (Washington: International Monetary Fund).
- Inter-American Development Bank, 2013, “Colombia: Support for Reform of the General Social Security Health Care System”, Loan Proposal (Washington).
- Izquierdo Alejandro, and Ernesto Talvi, 2008, “All that Glitters May Not Be Gold: Assessing Latin America’s Recent Macroeconomic Performance,” (Washington: Inter-American Development Bank).
- Schwellnus, Cyrille, 2009, “Achieving Higher Performance: Enhancing Spending Efficiency in Health and Education in Mexico,” Economics Department Working Paper No. 732 (Paris: Organization for Economic Co-operation and Development).
- Rajaram, Anand, Tuan Minh Le, Kai Kaiser, Jay-Hyung Kim, and Jonas Frank, 2014, “The Power of Public Investment Management: Transforming Resources into Assets for Growth,” (Washington: World Bank).

### IMF and World Bank publications and regional studies
- International Monetary Fund, 2009a, “Regional Economic Outlook—Western Hemisphere,” May 2009 (Washington: International Monetary Fund).
- ___________, 2009b, “Fiscal Implications of the Global Financial Crisis,” IMF Occasional Paper No. 269 (Washington).
- ___________, 2013a, “Reassessing the Role and Modalities of Fiscal Policy in Advanced Economies,” IMF Policy Paper, (Washington).
- ___________, 2013b, “The Functions and Impact of Fiscal Councils,” IMF Policy Paper, (Washington).
- ___________, 2014a, “Budget Institutions in G-20 Countries: An Update,” IMF Policy Paper, (Washington).
- ___________, 2014b, “Fiscal Monitor—Public Expenditure Reform: Making Difficult Choices,” (April), (Washington).
- ___________, 2015a, “Fiscal Monitor—Now Is the Time: Fiscal Policies for Sustainable Growth,” (April), (Washington).
- ___________, 2015c, “Fiscal Policy and Long-term Growth,” IMF Policy Paper (forthcoming; Washington).
- World Bank Group, 2013, “Uruguay - Public Expenditure Review: Mitigating Fiscal Risks,” Latin America and Caribbean region, Poverty reduction and economic management, Public Expenditure Review Report No. 68770-UY, (Washington).

*Source: _sdn1506 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2015/_sdn1506.pdf_