## 1. Fiscal Space ## Source details **Canonical URL:** [1. Fiscal Space](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16163.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16163.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16163.pdf.json) --- ### Overview - Fiscal space is defined as “the availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of a government’s financial position” (Heller, 2005). - In this paper fiscal space is operationalized as the difference between a prudent debt level and the actual public debt to GDP ratio. - Debt ceiling (DC) is defined as the debt level beyond which the debt position could bring about macroeconomic risks. - Focus: public debt level and the desirable buffer with respect to a given DC, abstracting from liquidity/rollover risks. - Two stated contributions: - Proposes a probabilistic methodology to estimate a desirable debt margin for a given DC and derive the associated prudent debt level and fiscal space without explicitly estimating fiscal reaction functions and interest rate determinants. - Applies the methodology to LIDCs. ### Analytical framework and methodology - Core debt dynamic: d_{t+1} = (λ(1 + d_t)) + p_t where λ = (1 + r)/(1 + g). - Prudent debt level (d_prudent) is set so that, given shocks to λ, the probability that ex post debt exceeds the DC (d_DC) is small (α). - Desirable debt margin = d_DC − d_prudent. - Risk variable: growth-adjusted interest rate λ; its standard deviation derived from historical implicit values. - Two estimation approaches: - Parametric: assume λ ~ Normal(μ_λ, σ_λ^2); use α = 0.05 and inverse normal 1.645 to solve for d_prudent. - Non-parametric: bootstrap λ 10,000 times from the country-specific sample, compute d_prudent for each draw, take cutoff such that the right tail equals α. - Methodological focus on shocks to growth and interest rates via λ; explicit shocks (exchange rate, contingent liabilities) are not separately modeled but may be partially captured in λ. - Notable implication: countries with the same public debt can have different fiscal space depending on the distribution of λ and the DC. - Counter-intuitive implication: higher DC (reflecting higher policy capacity) implies a larger prudent debt margin expressed as a share of GDP, all else equal. ### Data, sample, and implementation - Sample: 58 countries designated as LIDCs (Afghanistan and Somalia excluded for lack of data coverage). - Data sources: IMF’s World Economic Outlook (WEO) general government aggregates, period 1990–2014 where available; data availability varies between 11 and 23 years per country. - For each year, implicit λ derived from equation (1); variance of λ and prudent debt level computed. - Years with HIPC and MDRI debt relief are dropped for affected countries. - Shapiro-Wilk normality test: for ¾ of countries the normality assumption for λ cannot be rejected at 95 percent confidence. - Parametric and non-parametric results broadly similar; non-parametric used as robustness check where normality may not hold. ### Empirical results — illustrative DCs and key findings - Illustrative DCs used: - IMF/WB DSF public debt thresholds: 49 percent of GDP for low capacity, 62 percent for medium capacity, 75 percent for high capacity. - Debt-related fiscal rules (illustration using a DC of 60 percent of GDP). - Aggregate findings (using 2015 debt data unless otherwise stated): - About 60 percent of LIDCs have fiscal space in 2015 in the sense that their public debt was below their prudent debt level. - A little over 40 percent of LIDCs have no fiscal space. - About 30 percent of all LIDCs have public debt exceeding both their prudent debt level and their DC. - About 12 percent have public debt exceeding their prudent debt level but below their DC. - Countries with medium or high institutional capacity tend to have more fiscal space; low capacity countries more frequently lack fiscal space. - More than 60 percent of low-capacity countries have no fiscal space. - Desirable debt margins (median/mean) implied by the analysis: - Median desirable debt margin for medium/high capacity countries: about 10–11 percent of GDP. - Median desirable debt margin for low capacity countries: about 6–8 percent of GDP. - Across LIDCs using fiscal rule DC = 60 percent of GDP: median desirable margin about 9.8–10.2 percent of GDP. - Using IMF/WB DSF ceilings: median about 9.7–9.9 percent of GDP. - On average, a country should aim at a public debt–to–GDP ratio that is at least 10 percent of GDP lower than the DC. - Additional empirical observations: - λ is much more volatile in low-capacity countries than in medium/high-capacity countries. - For LIDCs with debt exceeding 25 percent of GDP in a given year, the top decile of annual increase in debt to GDP is at least 8.9 percent of GDP. - For LIDCs with debt lower than 25 percent of GDP, the top decile debt increase is at least 4.8 percent of GDP. - Results are similar whether using IMF/WB DSF ceilings or a 60 percent fiscal-rule DC: roughly 60 percent of LIDCs have fiscal space under both DC assumptions, though the composition of countries in the groups varies. ### Caveats, interpretation, and limitations - Methodology assumes future trends can be derived from past behavior; may be biased by the commodities super cycle of the 2000s when growth often exceeded interest rates. - Estimates are illustrative and depend on the chosen DC; IMF/WB DSF thresholds are not formal statutory ceilings but policy-dependent thresholds. - The availability of fiscal space does not justify unproductive investment; composition of debt (external vs. domestic, concessionality, maturity) remains important for vulnerability assessment. - The approach abstracts from liquidity/rollover risks and does not explicitly model other shocks (exchange rate, contingent liabilities), which could increase prudent debt margins if incorporated. ### Conclusions and policy recommendations - Setting a prudent debt level (DC adjusted for a desirable margin) helps ensure that in the event of adverse shocks public debt remains below the DC and fiscal sustainability is preserved. - The probabilistic approach provides country-specific prudent debt levels and desirable margins that serve as guideposts to keep the probability of breaching DCs low. - Policy implications: - Countries without fiscal space should undertake fiscal adjustments and step up structural and institutional reforms to restore fiscal sustainability. - Countries with fiscal space should not interpret this as a license to increase spending indiscriminately because scaling up spending can be difficult to reverse. - Prudent fiscal management and strengthening policy implementation capacity increase the probability that public debt will remain on a sustainable path. ### List and CPIA classification of LIDCs (selected) - Sample size: 58 LIDCs (Afghanistan and Somalia excluded). - CPIA-based capacity categories (2015 CPIA classifications) — illustrative subset: - low capacity: Afghanistan, Burundi, Cameroon, Central African Republic, Chad, Comoros, Congo, DR, Congo, Republic of, Côte d'Ivoire, Djibouti, Eritrea, Guinea, Guinea-Bissau, Haiti, Kiribati, Liberia, Madagascar, Malawi, Mauritania, São Tomé and Príncipe, Solomon Islands, Somalia (excluded), South Sudan, Sudan, Togo, Yemen, Zimbabwe - medium capacity: Bangladesh, Benin, Bolivia, Cambodia, Ethiopia, Gambia, The, Honduras, Kyrgyz Republic, Lao P.D.R., Lesotho, Mali, Mongolia, Mozambique, Nepal, Nicaragua, Niger, Nigeria, Papua New Guinea, Sierra Leone, Tajikistan, Tanzania, Uzbekistan, Zambia - high capacity: Bhutan, Burkina Faso, Ghana, Moldova, Rwanda, Senegal, Uganda, Vietnam *Source: IMF staff.* ### 1. Fiscal Space ........................................................................................................ ### 1. Fiscal Space ### Overview - Section title: "1. Fiscal Space" - Section appears on page 8 of the source PDF. ### Tables included in this section - Table 1. Share of Countries by Debt Position—IMF/WB Debt Thresholds (page 14) - Table 2. Median and Mean Desirable Debt Margins (page 14) - Table 3. Share of Countries by Debt Position—Debt Ceiling of 60 Percent of GDP (page 15) - Table 4. Median/Mean Desirable Debt Margins - Fiscal Rule vs. DSF Ceilings (page 15) - Table 5. List and CPIA Classification of LIDCs (page 18) *Source: _wp16163 - 1. Fiscal Space (PDF)._ ### References ............................................................................................................. ### _wp16163 - References ............................................................................................................. ### Abbreviations and Acronyms - CEMAC Central African Economic and Monetary Community - CPIA Country Policy and Institutional Assessment - DC Debt Ceiling - DSF Debt Sustainability Framework - ECCU Eastern Caribbean Currency Union - HIPC Heavily Indebted Poor Countries - IMF International Monetary Fund - LICs Low-Income Countries - LIDCs Low-Income Developing Countries - MDRI Multilateral Debt Relief Initiative - VaR Value at Risk - WAEMU West African Economic and Monetary Union - WB World Bank - WEO World Economic Outlook ### I. Introduction — framing and definitions - Public debt ratios in LIDCs declined substantially over the last decade, particularly following debt relief under the IMF/WB HIPC initiative. - Public debt is rising in some LIDCs due to infrastructure investment or countercyclical measures. - Fiscal space is defined as “the availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of a government’s financial position” (Heller, 2005). - In this paper fiscal space is operationalized as the difference between a prudent debt level and the actual public debt to GDP ratio. - Debt ceiling (DC) is defined as the debt level beyond which the debt position could bring about macroeconomic risks. - The paper focuses on public debt level and the desirable buffer with respect to a given DC, abstracting from liquidity/rollover risks. - Two stated contributions: - Proposes a probabilistic methodology to estimate a desirable debt margin for a given DC and derive the associated prudent debt level and fiscal space without explicitly estimating fiscal reaction functions and interest rate determinants. - Applies the methodology to LIDCs. ### II. Literature context - Builds on Ostry and others (2010) but offers a purely probabilistic approach where data limitations prevent using a fiscal reaction-function-based approach. - Uses ideas from VaR and uncertainty approaches (Tanner (2013); Barnhill and Kopits (2003)) applied to the debt-stabilizing primary balance. - Notes that IMF/WB DSF public debt thresholds are policy-dependent and reflect country-specific quality of the policy environment. ### III. Analytical framework and methodology - Debt dynamic: d_{t+1} = (λ(1 + d_t)) + p_t where λ = (1 + r)/(1 + g) (presented in the paper as equation (1)). - Prudent debt level (d_prudent) is set so that, given shocks to λ, the probability that ex post debt exceeds the DC (d_DC) is small (α). - Desirable debt margin = d_DC − d_prudent. - Applies a VaR-style approach to the debt-stabilizing primary balance; treats the growth-adjusted interest rate (λ) as the risk variable and derives its standard deviation from historical implicit values. - Two estimation approaches: - Parametric: assume λ ~ Normal(μ_λ, σ_λ^2); use α = 0.05 and inverse normal 1.645 to solve for d_prudent (presented as equation (5)). - Non-parametric: bootstrap λ 10,000 times from the country-specific sample, compute d_prudent for each draw, take cutoff such that the right tail equals α. Methodological notes and implications: - The approach focuses on shocks to growth and interest rates via λ; explicit shocks (exchange rate, contingent liabilities) are not separately modeled but may be partially captured in λ. - Countries with same public debt can have different fiscal space depending on distribution of λ and DC. - Counter-intuitive implication: higher DC (reflecting higher policy capacity) implies a larger prudent debt margin expressed as a share of GDP, all else equal. ### IV. Data, sample, and implementation - Sample: 58 countries designated as LIDCs (Afghanistan and Somalia excluded for lack of data coverage). - Data sources: IMF’s World Economic Outlook (WEO) general government aggregates, period 1990–2014 where available; data availability varies between 11 and 23 years per country. - For each year, implicit λ derived from equation (1); variance of λ and prudent debt level computed. - Years with HIPC and MDRI debt relief are dropped for affected countries. - Shapiro-Wilk normality test: for ¾ of countries the normality assumption for λ cannot be rejected at 95 percent confidence. - Parametric and non-parametric results broadly similar; non-parametric used as robustness check where normality may not hold. ### V. Empirical results — illustrative DCs and key findings - Illustrative DCs used: - IMF/WB DSF public debt thresholds (DSF thresholds: 49 percent of GDP for low capacity, 62 percent for medium capacity, 75 percent for high capacity). - Debt-related fiscal rules (illustration using a DC of 60 percent of GDP). - Key aggregate findings (using 2015 debt data unless otherwise stated): - About 60 percent of LIDCs have fiscal space in 2015 in the sense that their public debt was below their prudent debt level. - A little over 40 percent of LIDCs have no fiscal space; about 30 percent of all LIDCs have public debt exceeding both their prudent debt level and their DC; about 12 percent have public debt exceeding their prudent debt level but below their DC. - Countries with medium or high institutional capacity tend to have more fiscal space; low capacity countries (many fragile states) more frequently lack fiscal space and more than 60 percent of low-capacity countries have no fiscal space. - Desirable debt margins (median/mean) implied by the analysis: - Median desirable debt margin for medium/high capacity countries: about 10–11 percent of GDP. - Median desirable debt margin for low capacity countries: about 6–8 percent of GDP. - Across LIDCs using fiscal rule DC = 60 percent of GDP: median desirable margin about 9.8–10.2 percent of GDP; using IMF/WB DSF ceilings: median about 9.7–9.9 percent of GDP. - On average, a country should aim at a public debt–to–GDP ratio that is at least 10 percent of GDP lower than the DC. - Additional empirical observations: - λ is much more volatile in low-capacity countries than in medium/high-capacity countries. - For LIDCs with debt exceeding 25 percent of GDP in a given year, the top decile of annual increase in debt to GDP is at least 8.9 percent of GDP. For LIDCs with debt lower than 25 percent of GDP, the top decile debt increase is at least 4.8 percent of GDP. - Results are similar whether using IMF/WB DSF ceilings or a 60 percent fiscal-rule DC: roughly 60 percent of LIDCs have fiscal space under both DC assumptions, though the composition of countries in the groups varies. ### VI. Caveats, interpretation, and limitations - Methodology assumes future trends can be derived from past behavior; may be biased by the commodities super cycle of the 2000s when growth often exceeded interest rates. - Estimates are illustrative and depend on the chosen DC; IMF/WB DSF thresholds are not formal statutory ceilings but policy-dependent thresholds. - The availability of fiscal space does not justify unproductive investment; composition of debt (external vs. domestic, concessionality, maturity) remains important for vulnerability assessment. - The approach abstracts from liquidity/rollover risks and does not explicitly model other shocks (exchange rate, contingent liabilities), which could increase prudent debt margins if incorporated. ### VII. Conclusions and policy recommendations - Setting a prudent debt level (DC adjusted for a desirable margin) helps ensure that in the event of adverse shocks public debt remains below the DC and fiscal sustainability is preserved. - The probabilistic approach provides country-specific prudent debt levels and desirable margins that serve as guideposts to keep the probability of breaching DCs low. - Policy implications: - Countries without fiscal space should undertake fiscal adjustments and step up structural and institutional reforms to restore fiscal sustainability. - Countries with fiscal space should not interpret this as a license to increase spending indiscriminately because scaling up spending can be difficult to reverse. - Prudent fiscal management and strengthening policy implementation capacity increase the probability that public debt will remain on a sustainable path. ### VIII. List and CPIA classification of LIDCs (selected) - Sample size: 58 LIDCs (Afghanistan and Somalia excluded). - CPIA-based capacity categories used in the analysis (2015 CPIA classifications) — illustrative subset from Table 5: - low capacity: Afghanistan, Burundi, Cameroon, Central African Republic, Chad, Comoros, Congo, DR, Congo, Republic of, Côte d'Ivoire, Djibouti, Eritrea, Guinea, Guinea-Bissau, Haiti, Kiribati, Liberia, Madagascar, Malawi, Mauritania, São Tomé and Príncipe, Solomon Islands, Somalia (excluded), South Sudan, Sudan, Togo, Yemen, Zimbabwe - medium capacity: Bangladesh, Benin, Bolivia, Cambodia, Ethiopia, Gambia, The, Honduras, Kyrgyz Republic, Lao P.D.R., Lesotho, Mali, Mongolia, Mozambique, Nepal, Nicaragua, Niger, Nigeria, Papua New Guinea, Sierra Leone, Tajikistan, Tanzania, Uzbekistan, Zambia - high capacity: Bhutan, Burkina Faso, Ghana, Moldova, Rwanda, Senegal, Uganda, Vietnam - Full list and CPIA classification provided in Table 5. *Source: IMF staff.* ### References ### _wp16163 - References ### Fiscal sustainability and fiscal space - Barnhill, Jr., Theodore M., and George Kopits, 2003, “Assessing Fiscal Sustainability Under Uncertainty,” IMF Working Paper No. 03/79 (Washington: International Monetary Fund). - Escolano, Julio, 2010, “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates,” Technical Notes and Manuals No. 2010/2 (Washington: International Monetary Fund). - Heller, Peter S., 2005, “Understanding Fiscal Space,” IMF Policy Discussion Paper No. 05/4 (Washington: International Monetary Fund). - Ostry, Jonathan D., Atish R. Ghosh, Jun I. Kim, and Mahvash S. Qureshi, 2010, “Fiscal Space,” IMF Staff Position Note No. 10/11 (Washington: International Monetary Fund). - Ostry, Jonathan D., Atish R. Ghosh, and Raphael Espinoza, 2015, “When Should Public Debt Be Reduced,” IMF Staff Discussion Note No. 15/10 (Washington: International Monetary Fund). - Tanner, Evan, 2013, “Fiscal Sustainability: A 21st Century Guide for the Perplexed,” IMF Working Paper No. 13/89 (Washington: International Monetary Fund). ### Sovereign debt, debt sustainability, and safe debt - Collard, Fabrice, Michel Habib, and Jean-Charles Rochet, 2015, “Sovereign Debt Sustainability in Advanced Economies,” Journal of the European Economic Association, Vol. 13 (3), pp. 381–420. - Saxegaard, Magnus, 2014, “Safe Debt and Uncertainty in Emerging Markets: An Application to South Africa,” IMF Working Paper No. 14/231 (Washington: International Monetary Fund). - ——— and World Bank, 2012, “Revisiting the Debt Sustainability Framework for Low-Income Countries” (Washington). ### Low-income countries, vulnerability, and macroeconomic developments - Dabla-Norris, Era, and Yasemin Bal Gündüz, 2014, “Exogenous Shocks and Growth Crises in Low-Income Countries: A Vulnerability Index,” World Development, Vol. 59 (C), pp. 360–78. - International Monetary Fund, 2011, “Managing Volatility: A Vulnerability Exercise for Low-Income Countries” (Washington). - International Monetary Fund, 2014a, “Proposed New Grouping in WEO Country Classifications: Low-Income Developing Countries” (Washington). - International Monetary Fund, 2014b, “Macroeconomic Developments in Low-Income Developing Countries: 2014 Report” (Washington). - Novignon, Jacob, and Justice Novignon, 2015, “Fiscal Space for Health in Sub-Saharan African Countries: An Efficiency Approach,” Munich Personal RePEc Archive, MPRA Paper No. 63015. - World Bank, Country Policy and Institutional Assessment (Washington). ### Regional studies, fiscal rules, and public investment financing - International Monetary Fund, 2013, “Regional Economic Outlook: Sub-Saharan Africa—Building Momentum in a Multi-Speed World,” World Economic and Financial Surveys, May (Washington). - International Monetary Fund, 2015, “Regional Economic Outlook: Middle East and Central Asia,” World Economic and Financial Surveys, October (Washington). - Hulbert, Claudia, and Camila Vammalle, 2014, “A Sub-national Perspective on Financing Investment for Growth I – Measuring Fiscal Space for Public Investment: Influences, Evolution, and Perspectives,” OECD Regional Development Working Papers No. 2014/02, pp. 45 (France: OECD Publishing). - Schaechter, Andrea, Tidiane Kinda, Nina Budina, and Anke Weber, 2012, “Fiscal Rules in Response to the Crisis—Toward the “Next-Generation” Rules. A New Dataset,” IMF Working Paper No. 12/187 (Washington: International Monetary Fund). - Schick, Allen, 2009, Evolution in Budgetary Practice. OECD. ### Health sector perspective on fiscal space - Williams, Gareth, and Roger Hay, 2005, “Fiscal Space and Sustainability from the Perspective of the Health Sector,” The Policy Practice, High-Level Forum on the Health MDGs (Paris, France, November 14–15). *Source: _wp16163 - References* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16163.pdf_