## _wp16226 — conclusions and policy recommendations

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### II. IMPLEMENTATION OF THE FRL IN PARAGUAY — Main features of the FRL
- Main numerical targets:
  - Headline deficit ceiling for the central government of 1.5 percent of GDP.
  - Limit on real current primary expenditure growth of 4 percent for the entire public sector.
- Compliance assessment:
  - "Compliance should be judged based on adhering to these ceilings in the budget approved by congress rather than on the basis of fiscal outturns."
  - Any eventual salary increases for civil servants will be limited by the percentage increase in the minimum wage.
  - Ex-ante (indicative) restriction: the average deficit over three consecutive years presented in medium-term budget plans must not exceed 1 percent of GDP.
- Escape clauses:
  - The headline deficit ceiling can reach up to 3 percent of GDP in cases of national emergency; international crises; or negative growth.
  - Such an increase would require congressional approval and in some cases a report by the central bank and the approval of the national economic team.
- Monitoring and sanctions:
  - The Comptroller General is responsible for monitoring compliance.
  - Sanctions: breaches are deemed a dereliction of duty by the civil servants responsible.
  - The Comptroller General’s audit practice can be delayed (up to 9 months after the close of the calendar year), reducing suitability for timely monitoring.
  - It is not entirely clear who the responsible civil servants are or who might determine responsibility.
- Transparency and medium-term programming:
  - Article 5 mandates open access to reports produced by government agencies (with some exceptions).
  - Article 6 requires a medium-term fiscal plan (covering the next three years) and a debt sustainability analysis to be presented to congress together with the draft annual budget law.

### Table 1 — Main FRL features (highlights)
- Deficit ceiling:
  - Deficit of the central government must not exceed 1.5 percent of GDP.
  - Average deficit (budgeted) over three consecutive budget periods must not exceed 1 percent of GDP (applies to ex-ante medium-term plan).
- Expenditure ceiling:
  - Growth rate of current primary expenditure for the public sector must not exceed 4 percent in real terms.
- Escape clauses:
  - Congress can approve a deficit up to 3 percent of GDP in specified large-shock cases.
- Sanctions:
  - Breach deemed a dereliction of duty by the responsible civil servant.

### II.B Assessment of compliance — key findings and numerical outcomes
- 2015 and 2016 budgets:
  - The 2015 budget exceeded the deficit ceiling by 1.3 percentage points of GDP.
  - The 2015 Budget Law introduced possibility (Article 241 of Ley 5.386/15) of excluding capital expenditure financed by sovereign bonds from the deficit ceiling on a one-off basis.
  - Draft 2016 budget complied with numerical targets; final 2016 budget essentially respected the deficit ceiling though current primary expenditures increased.
  - Ad-hoc exclusion of bond-financed capital expenditures was not added to the 2016 Budget law.
- Ex-post 2015 outturns (Est. 2015 / Approved Budget 2016):
  - Total Revenue: 18.4 / 20.1
  - Expense: 17.6 / 18.4
  - Net Acquisition of non-financial Assets: 2.6 / 3.3
  - Net lending/Borrowing: -1.7 / -1.5
  - Net lending/Borrowing (excl. bond financed capital expenditures)1: -0.6 / ...
  - Real current primary expenditure growth (percent change)2: 7.2 / 8.0
  - Real current primary expenditure growth (percent change), Authorities3: 6.2 / -2.5
  - Memo items:
    - Nominal GDP, G$ bn.: 144,249 / 162,819
    - Current primary expenditure (Central Government), G$ bn: 22,539 / 25,433
  - Notes:
    - 1 Article 241 of the 2015 budget law (Ley 5.386/15) allows excluding capital expenditure financed by sovereign bonds from the deficit ceiling.
    - 2 Deflated using the GDP deflator.
    - 3 Deflated using the mid-range of the CPI inflation target band; follows authorities' methodology.
- Adjusted accounting and statistical changes:
  - Fiscal deficit in 2015 reached 1.7 percent of GDP and real current primary expenditure growth exceeded the 4 percent ceiling.
  - One-off exclusion of bond-financed capital expenditures would yield an estimated adjusted fiscal deficit of 0.6 percent of GDP.
  - Adoption of GFSM 2001 in 2015 moved financial transactions "below the line"; these amounted to about 0.5 percent of GDP in 2015.

### Historical patterns, projection performance, and budget execution
- Fiscal balance:
  - Fiscal balance remained within the FRL limit for almost all years between 2003 and 2015.
- Expenditure growth:
  - Real current primary expenditure growth for the central government systematically exceeded the law’s 4 percent ceiling, with some convergence more recently.
- Budget projection errors:
  - Budgeted revenues systematically higher than realized revenue collection; gap has narrowed (notably for tax revenues).
  - Expenditure underspending relative to budget targets, especially capital investment and transfers.
  - Overall balance deviations generally small except in 2014 when the budgeted deficit was 3 percentage points of GDP larger than the realized one.
  - Note: large differences often driven by residual "other revenue" within non-tax revenue.

### Institutional and legal challenges; policy recommendations
- Legal ambiguity:
  - Annual budget laws passed by congress are on equal footing with the FRL, creating potential tensions and undermining FRL authority.
  - Amending fiscal rules under the FRL without clarity on congress’ scope to modify executive budgets risks weakening the FRL.
- Institutional constraints:
  - Spending rigidities and shortcomings in tax administration hinder FRL implementation.
  - SET (revenue authority) has improved capacity but faces constraints undermining tax compliance; legal procedures for sanctions on tax evasion are weak.
- Key priorities to create fiscal space while limiting public debt increases:
  - Better tax collection and strict control over current expenditure.
  - Civil service reform to reduce spending rigidities and promote efficiency.
  - Improvements in revenue administration, particularly customs.
  - Enhancement of rules-based control procedures, transparency, and risk management to boost revenue over the medium-term.
- FRL design complements:
  - FRL’s limits on public sector wage growth and initiatives for competitive hiring should be complemented by systematic civil service reform.

### III. LESSONS FROM INTERNATIONAL EXPERIENCE WITH FISCAL RULES — characteristics and comparative perspective
- Characteristics of effective fiscal rules (IMF, 2009):
  - i) Unambiguous and stable link between numerical target and ultimate objective (e.g., public debt sustainability).
  - ii) Sufficient flexibility to respond to shocks; rule should not exacerbate temporary macro shocks.
  - iii) Transparency and a clear correction mechanism: deviations should be observable and mapped to corrective actions.
- Common target variables:
  - Countries use budget balance rules, expenditure rules, debt rules, or combinations.
  - "Golden rules" exclude capital expenditures from fiscal targets (defined here as exclusion of capital expenditures).
- Paraguay’s FRL in comparative perspective:
  - Several countries combine expenditure and budget balance rules; Paraguay uses both (combination present in 23 other countries, nine of which are emerging markets).
  - Paraguay’s headline deficit ceiling of 1.5 percent of GDP appears comparatively tight relative to other countries with headline deficit ceilings.
  - Examples of selected budget balance ceilings:
    - Canada (1998): 3% GDP
    - Georgia (2013): 3% of GDP
    - India (2004): 3% GDP (abandoned in 2008)
    - Panama (2012): Target budget deficit of 0.5% GDP (from 2.9%)
    - Peru (2000): Targeted 1.5 to 2% deficit; switched to structural balance in 2013

### Box 1 — Advantages and disadvantages of different fiscal rules (highlights)
- Expenditure rules (ERs):
  - Simple to implement; allow automatic stabilizers on revenue side; easy to communicate and monitor.
  - Do not anchor longer-term fiscal policy; can shift spending to uncapped categories.
- Budget balance rules (BBRs):
  - Provide operational target linked to sustainability; headline BBRs can be procyclical and vulnerable to off-budget operations.
  - Structural balance variants yield better stabilization but are difficult to implement and communicate.
- Debt rules (DRs):
  - Clear medium-term anchor; vulnerable to shocks and realizations of contingent liabilities (average fiscal cost of a contingent liability realization is 6 percent of GDP).
  - Debt ratios reflect policy slippages with a lag.
- Golden rules:
  - Protect investment but complicate implementation and can weaken sustainability; risk of creative accounting and follow-on increases in current spending.
- Empirical indicators:
  - % of countries that exclude capital and other priority expenditure from the rule:
    - All Countries: 20%
    - Emerging Markets: 27%
    - Western Hemisphere Countries: 31%
  - As of 2014, 24 economies followed some type of structural balance rule.
  - Standard deviation of growth for Paraguay: 4.4 percent over 1992-2014.
  - Assuming an 8 percent nominal growth rate, a 3 percent of GDP headline deficit would imply a steady-state debt to GDP ratio of around 40 percent.
- Enforcement and sanctions:
  - Typical sanctions: reputational (public explanation), budgetary (expenditure cuts, withholding transfers, wage freezes, borrowing freezes).
  - Budgetary sanctions more effective if automatic; reputational sanctions effective with fiscal councils, independent media, or strong observers.
  - Paraguay-specific recommendation: consider administrative measures or additional sanctions for non-compliance beyond individual-level accountability.
- Fiscal council role:
  - Paraguayan authorities plan an independent fiscal council to assess policy and evaluate Ministry of Finance forecasts.
  - Recommendation: council produce a periodical public report and ensure independence, adequate staffing, and media impact.
- Correction mechanisms:
  - Specify paths back to compliance (e.g., lower spending over next three years).
  - Debt brakes (Swiss, German) store deviations in a notional account and require adjustments when thresholds exceeded.
- Escape clauses:
  - Paraguay’s escape clauses triggered only under limited large shocks, including negative growth rates.
  - Scope to increase countercyclicality by adding provisions for substantial growth slow-downs and forward-looking triggers (e.g., quarterly GDP forecasts).
  - Complement escape clauses with medium-term correction plans (examples: Germany, Peru, Romania).

### Revisiting Paraguay’s FRL — reform options and trade-offs
- Three reform types considered:
  - (i) Retain the deficit ceiling.
  - (ii) Make the ceiling more flexible (golden rule, higher ceiling, structural balance).
  - (iii) Remove the deficit ceiling and focus on the expenditure rule.
- A. Retain current deficit rule:
  - Rationale: build track record; avoid perceived dilution of credibility.
  - Design notes: current expenditure ceiling close to estimates of potential GDP growth; constraints on wage-bill growth appropriate but may limit civil service reform.
  - Policy: favor incremental calibration rather than major overhauls.
- B. Golden rule (exclude public investment):
  - Option: exclude public investment from deficit ceiling and add a debt ceiling.
  - Benefits: protects infrastructure investment.
  - Risks: modified ceiling does not ensure debt sustainability; need debt anchor and strict GFS compliance; focus exclusion on externally financed public investment recommended.
- C. Raise the deficit ceiling:
  - Higher ceiling could provide room for cyclical shocks and more public investment; consider investment floor to ensure composition.
  - Fiscal implication: With an 8 percent nominal growth rate, a 3 percent of GDP headline deficit implies a steady-state debt to GDP ratio of around 40 percent.
  - Considerations: transitioning without established compliance track record risks market perceptions of dilution.
- D. Move to structural balance rule:
  - Benefits: better stabilization and allows automatic stabilizers to work.
  - Operational challenges: complex cycle correction, requires institutional prerequisites.
  - Paraguay challenges: high volatility (standard deviation of growth 4.4 percent), importance of agriculture and hydroelectricity complicates potential GDP estimation.
  - Implementation advice: gradual approach; disseminate methodology and historical estimates before formal adoption.
- E. Remove deficit rule (expenditure rule only):
  - Effectively leaves FRL as expenditure rule.
  - Expenditure rules have better compliance records but alone are insufficient for debt sustainability.

### V. SIMULATIONS — setup, scenarios, and principal findings
- Simulation period: 2016-2026.
- Fiscal rules simulated:
  - Rule 1: Golden rule with 1.5 percent deficit excluding capital expenditures.
  - Rule 2: Golden rule with 1.5 percent deficit excluding capital expenditures combined with existing expenditure rule.
  - Rule 3: Overall deficit of 3 percent combined with existing expenditure rule.
    - Rule 3a: capital expenditures fixed and current primary expenditures residual up to deficit or expenditure ceiling.
    - Rule 3b: current primary expenditures grow at 4 percent in real terms; capital expenditures residual up to deficit ceiling.
  - Rule 4: Overall deficit of 1.5 percent combined with existing expenditure rule.
- Growth scenarios:
  - Reference: IMF WEO Live (as of August 19 2016); growth equals potential growth of 3.8 percent after 2021.
  - Boom-bust: positive output gap opens in 2016, peaks in 2018, bust in 2019, slow recovery until 2024; peak shock about 7.5 percentage points of real GDP growth.
  - Negative shock: negative output gap opens in 2016, peaks in 2018, closed by 2023; peak shock about 7.5 percentage points of real GDP growth.
  - Permanent negative shock: potential growth falls to 2.5 percent and growth adjusts starting in 2016.
- Public investment growth effect:
  - Benchmark: a 1 percentage point of GDP increase in public investment yields a 0.25 percent output increase contemporaneously, rising to 0.5 percent four years after the shock.
- Calibration examples and technical assumptions:
  - If capital expenditures fixed at 4.5 percent and 2015 capex about 4 percent of GDP, positive shock to capex in 2016 is about 0.5 percentage points of GDP.
  - Interest payments depend on debt stock and exogenous interest rate (Libor plus Paraguay premium).
  - Revenue projections follow IMF WEO Live (as of August 19 2016) and held constant as share of GDP after 2021.
  - For Rules 3b and 4: current primary expenditures grow at 4 percent per year.
  - For Rule 3a: capital expenditures fixed at 4.5 percent of GDP; current expenditures adjust to meet 3 percent deficit if needed.

### V.B Simulation results — debt sustainability (principal findings)
- Overall summary:
  - Debt sustainability preserved under overall deficit rules (Rule 3 and Rule 4) but may be compromised under golden rules (Rule 1 and Rule 2) depending on current expenditure choices.
- Rule 4 (1.5 percent deficit + expenditure rule):
  - Debt profile almost flat in the reference scenario, staying around 20 percent of GDP (current level of central government debt).
  - Even under large growth shocks, debt path remains sustainable and debt level remains relatively low.
- Rule 3 (3 percent deficit + expenditure rule):
  - Debt increases over time but converges to a steady state.
  - Steady state debt consistent with 3 percent deficit and nominal growth around 8 percent is around 40 percent of GDP—twice the level with a 1.5 percent deficit ceiling.
- Golden rules (Rules 1 and 2):
  - May be unsustainable depending on current primary expenditure choices.
  - Under Rule 1 (no expenditure rule), current primary expenditures could rise to almost 18 percent of GDP under the Reference scenario and still comply with the 1.5 percent deficit excluding capital expenditure.
    - To satisfy the 1.5 percent modified deficit rule as interest payments increase over time, current primary expenditures would have to fall to less than 15 percent of GDP in 2026.
  - Under Rule 2 (with expenditure rule), current primary expenditures grow at 4 percent (vs. 3.8 percent real growth), requiring borrowing for both capital and current expenditures.
- Robustness to shocks:
  - Ranking of rules by debt trajectories preserved across growth shocks: debt levels decrease moving from Rule 1 to Rule 4.
  - Debt-to-GDP levels are higher under negative or permanent shocks; Rules 3 and 4 remain sustainable in simulations.
  - Simulations assume government always complies with the fiscal rule; suspending rules could produce much worse debt outcomes.

### V.C Simulation results — composition of expenditures (principal findings)
- Composition outcomes:
  - Rules 1 and 2 protect capital expenditures (capex fixed at 4.5 percent of GDP) but current primary expenditures may need to decline when rules bind.
  - If capex is residual, it may suffer relative to current primary expenditures.
- Rules 3a vs 3b:
  - Interest payment profiles identical given same debt stock.
  - Rule 3a: fixed capex share; current primary expenditures can decline as share of GDP when constrained.
  - Rule 3b: current primary expenditures grow at 4 percent in real terms and therefore slowly increase as share of GDP (given potential growth 3.8 percent); capex declines as residual.
- Quantitative example for capex under deficit ceilings:
  - If real current primary spending grows at 4 percent and authorities comply with overall deficit:
    - With 3 percent deficit ceiling (Rule 3b), capex declines from about 4 percent of GDP in 2015 to about 2.5 percent of GDP in 2026.
    - Public investment would be even lower with a tighter 1.5 percent deficit ceiling (Rule 4).
- To allow higher capex the government must:
  - Contract current primary expenditures, or
  - Accept a higher level of debt, or
  - Increase revenue, or
  - Use a combination of the above.
- Revenue assumptions in simulations:
  - Revenues increase from about 18 percent in 2016 to 18.5 percent of GDP in 2026 under simulated reforms; further revenue mobilization may be possible.
- Illustration:
  - Debt in 2026 is much higher under the golden rule (Rule 2) than under an overall deficit ceiling of 3 percent (Rule 3a) when both protect capex at 4.5 percent and include an expenditure rule.
  - Explanation: overall deficit ceiling limits current primary expenditures more than the expenditure rule alone; under golden rule the expenditure rule is the only constraint on current primary expenditures.

### VI. IMPLEMENTATION ISSUES — transition, safeguards, and recommended sequencing
- General caution:
  - Transitioning to a revised fiscal framework needs careful management; benefits weighed against negative effects.
  - Risks heightened by Paraguay’s short and mixed implementation track record.
  - Concern: potential effect of modifications on sovereign spreads and ratings.
- Recommended transition approach:
  - Test and communicate changes carefully; build stakeholder agreement and ownership.
  - Pilot new provisions as government policies before legal embedding (example: Chile tested structural balance rule for five years).
  - Develop a simple, clear communication strategy targeting politicians, private sector, credit rating agencies, and investors.
- Complementary commitments when announcing modifications:
  - Announce FRL modifications alongside commitments to strengthen fiscal institutions and preserve sustainability.
  - Strengthen budgetary processes to ensure ex-ante compliance and sanctions for deviations.
  - Reiterate commitment to fiscal sustainability via a credible medium-term fiscal plan addressing revenue mobilization and spending rigidities.
  - Introduce transparency mechanisms such as periodic congressional hearings (e.g., quarterly) on law implementation and corrective measures.
- Enforcement and correction mechanisms:
  - Consider introducing correction mechanisms and/or additional sanctions for non-compliance.
  - If a debt anchor is introduced, consider a debt brake mechanism specifying a debt path and triggering spending adjustments if deviations occur.
  - Enhance public investment management efficiency and public accounting to ensure correct classification of capital expenditures if adopting a golden rule.
  - If raising the headline deficit ceiling, strengthen budgetary process and FRL provisions on sanctions and enforcement to limit reputational damage.

### VII. CONCLUSION AND POLICY RECOMMENDATIONS — summary recommendations
- Build credibility before changing the FRL:
  - Establish a strong track record of compliance with the FRL before making changes; FRL is new and "learning by doing" is expected.
  - Signs of improved budget forecasting and approved 2016 budget compliance point to potential future effectiveness.
- Exercise caution when amending:
  - Credibility and reputational costs of amending a recently adopted FRL can be large.
  - Legal ambiguities and constitutional considerations require careful legal design of amendments.
  - Transition should be carefully managed, communicated, and accompanied by institutional strengthening.
- Balanced approach if amendments pursue:
  - If adopting a golden rule:
    - Strictly adhere to current expenditure rule.
    - Add a debt ceiling to preserve fiscal sustainability.
    - Enhance public investment management and public accounting to ensure correct classification of capex.
  - If raising the headline deficit ceiling:
    - Strengthen budgetary process and FRL provisions on sanctions and enforcement.
- Strengthen legal and institutional framework:
  - Develop public expenditure management systems to monitor and enforce FRLs.
  - Strengthen budgetary processes, public investment management, credible financial reporting and accounts, and fiscal transparency.
  - Introduce explicit correction mechanisms and more precise provisions on sanctions and enforcement.
- Overall view:
  - Fiscal responsibility laws can enhance fiscal management but cannot substitute for strong budget frameworks and commitment to prudent fiscal policy.

*Source: _wp16226 - conclusions and policy recommendations.*

### conclusions and policy recommendations.

### conclusions and policy recommendations

### II. IMPLEMENTATION OF THE FRL IN PARAGUAY — Main features of the FRL
- Main numerical targets:
  - Headline deficit ceiling for the central government of 1.5 percent of GDP.
  - Limit on real current primary expenditure growth of 4 percent for the entire public sector.
- Compliance assessment:
  - "Compliance should be judged based on adhering to these ceilings in the budget approved by congress rather than on the basis of fiscal outturns."
  - The FRL states any eventual salary increases for civil servants will be limited by the percentage increase in the minimum wage.
  - An ex-ante (indicative) restriction: the average deficit over three consecutive years presented in medium-term budget plans must not exceed 1 percent of GDP.
- Escape clauses:
  - The headline deficit ceiling can reach up to 3 percent of GDP in cases of national emergency; international crises; or negative growth.
  - Such an increase would require congressional approval and in some cases a report by the central bank and the approval of the national economic team.
- Monitoring and sanctions:
  - The Comptroller General is responsible for monitoring compliance.
  - Sanctions in case of breaches are based on personal accountability: breaches are deemed a dereliction of duty by the civil servants responsible.
  - The agency assessing compliance is independent from the Ministry of Finance, but the Comptroller General follows a general audit practice with delays (up to 9 months after the close of the calendar year), making it unsuitable for timely monitoring during budget execution.
  - It is not entirely clear who the responsible civil servants are or who might determine responsibility.
- Transparency and medium-term programming:
  - Article 5 mandates open access to reports produced by government agencies (with some exceptions).
  - Article 6 incorporates medium-term fiscal programming in budget documents: a medium-term fiscal plan (covering the next three years) and a debt sustainability analysis must be presented to congress together with the draft annual budget law.

### Table 1 — Main Features of the Fiscal Responsibility Law (summarized)
- Deficit ceiling:
  - 1. The deficit of the central government must not exceed 1.5 percent of GDP.
  - 2. The average deficit (budgeted) over three consecutive budget periods must not exceed 1 percent of GDP. This rule only applies to the ex-ante medium-term budget plan.
- Expenditure ceiling:
  - The growth rate of current primary expenditure for the public sector must not exceed 4 percent in real terms.
- Escape clauses:
  - Congress can approve a deficit of up to 3 percent of GDP in cases of national emergency; international crisis affecting the domestic economy; or negative growth.
- Sanctions:
  - Any eventual breach is deemed a dereliction of duty by the civil servant responsible.

### II.B An Assessment of Compliance — key findings and numerical outcomes
- 2015 compliance and legal interactions:
  - The 2015 budget exceeded the deficit ceiling by 1.3 percentage points of GDP.
  - The 2015 Budget Law introduced the possibility of excluding capital expenditure (financed by sovereign bonds) from the calculation of the deficit ceiling on a one-off basis (Article 241 of the 2015 Budget law, Ley 5.386/15).
- 2016 budget process:
  - The draft budget for 2016 submitted to congress complied with the numerical targets of the FRL.
  - The final version approved by congress essentially respected the deficit ceiling, though modifications increased current primary expenditures.
  - Ad-hoc provisions for the exclusion of bond-financed capital expenditures were not added to the Budget law for 2016.
- Ex-post 2015 outturns (Table 2 extract):
  - 2015 Est. / 2016 Approved Budget
    - Total Revenue: 18.4 / 20.1
    - Expense: 17.6 / 18.4
    - Net Acquisition of non-financial Assets: 2.6 / 3.3
    - Net lending/Borrowing: -1.7 / -1.5
    - Net lending/Borrowing (excl. bond financed capital expenditures)1: -0.6 / ...
    - Real current primary expenditure growth (percent change)2: 7.2 / 8.0
    - Real current primary expenditure growth (percent change), Authorities3: 6.2 / -2.5
  - Memo items:
    - Nominal GDP, G$ bn.: 144,249 / 162,819
    - Current primary expenditure (Central Government), G$ bn: 22,539 / 25,433
  - Notes:
    - 1 Article 241 of the 2015 budget law (Ley 5.386/15) states that capital expenditure financed by sovereign bonds can be excluded from the calculation of the deficit ceiling in the FRL.
    - 2 Deflated using the GDP deflator. Based on outcomes for 2015 and projections and approved budget numbers for 2016 for the central government.
    - 3 Deflated using the mid-range of the CPI inflation target band. Follows authorities' methodology and compares current primary expenditure for the entire public sector in the approved budget for year t+1 to current primary expenditures in the prevailing budget as of June of year t.
- Adjusted deficit accounting and statistical change:
  - Fiscal outcomes in 2015: fiscal deficit reached 1.7 percent of GDP and growth in real current primary expenditures exceeded the numerical ceiling of 4 percent.
  - If the one-off exclusion of capital expenditures financed by sovereign bonds is invoked, the estimated adjusted fiscal deficit would be 0.6 percent of GDP.
  - The adoption of GFSM 2001 presentation in 2015 moved certain financial transactions "below the line"; these financial transactions amounted to about 0.5 percent of GDP in 2015.

### Historical patterns and budget projection performance
- Historical observations:
  - Fiscal balance has remained within the FRL limit for almost all years between 2003 and 2015.
  - Real current primary expenditure growth for the central government has systematically exceeded the law’s ceiling, with some convergence more recently.
- Budget projection errors and execution:
  - Budgeted revenues have been systematically higher than realized revenue collection, although the gap has narrowed (in particular for tax revenues).6
  - Expenditure side: under-spending relative to budget targets, particularly for capital investment and transfers (comprised in "other expense").
  - Result: deviations for the overall balance have generally not been large except in 2014 when the budgeted deficit was 3 percentage points of GDP larger than the realized one.
  - Note 6: These large differences have typically been driven by a residual category of other revenue within the broad category of non-tax revenue.

### Institutional and legal challenges to effective implementation
- Legal ambiguity:
  - Annual budget laws passed by congress are on equal footing with the FRL, creating potential tensions between them and undermining the FRL’s authority in the budget setting process.
  - Amending fiscal rules under the FRL without legal clarity on congress’ scope to modify the executive’s proposed budget may create future difficulties and risks of weakening the FRL.
- Institutional constraints and policy recommendations:
  - Spending rigidities and shortcomings in tax administration hinder effective FRL implementation.
  - Key priorities to create fiscal space while limiting public debt increases:
    - Better tax collection and strict control over current expenditure.
    - Civil service reform to reduce spending rigidities and promote efficiency.
    - Improvements in revenue administration, particularly in customs.
    - Enhancement of rules-based control procedures and transparency and better risk management to boost revenue over the medium-term.
  - On tax administration specifics:
    - The country's revenue authority (SET) has made institutional and administrative capacity progress but faces constraints undermining tax compliance.
    - Legal procedures for imposing sanctions on tax evasion are weak by international standards.
  - The FRL’s limits on public sector wage growth and initiatives to promote competitive hiring should be complemented by systematic civil service reform efforts.

### III. LESSONS FOR PARAGUAY FROM THE INTERNATIONAL EXPERIENCE WITH FISCAL RULES
- Characteristics of effective fiscal rules (IMF, 2009):
  - i) An unambiguous and stable link between the numerical target and the ultimate objective, such as public debt sustainability.
  - ii) Sufficient flexibility to respond to shocks, so that the rule should at least not exacerbate the adverse impact of temporary macroeconomic shocks.
  - iii) Transparency and a clear correction mechanism: deviations from numerical targets should be easy to observe and there should be an institutional mechanism to map deviations into corrective actions.
- Common target variables across countries:
  - Countries use budget balance rules, expenditure rules, debt rules, or combinations thereof.
  - Some countries follow "golden rules" that allow exclusion of capital expenditures or infrastructure investment from the fiscal target.
  - Definition used here: a golden rule is the exclusion of capital expenditures from the calculation of numerical targets of a fiscal rule (acknowledging the traditional, narrower definition).

### III.A Paraguay’s FRL in a comparative perspective
- Rule combinations and prevalence:
  - Several countries combine expenditure and budget balance rules; Paraguay’s FRL uses both.
  - The combination is present in 23 other countries, of which nine are emerging markets.
- Tightness of Paraguay’s headline deficit ceiling:
  - Paraguay’s headline budget deficit ceiling of 1.5 percent of GDP appears comparatively tight relative to parameters adopted by other countries following headline budget balance rules.
  - Typically, countries that had headline deficit ceilings of the same magnitude as Paraguay’s had less favorable debt trajectories and faced sustainability concerns.
- Selected numerical budget balance rules (Table 3 examples):
  - Canada (Start year 1998): Deficit ceiling of 3% GDP.
  - Georgia (2013): consolidated budget deficit ceiling of 3% of GDP.
  - India (2004): Deficit ceiling of 3% GDP (abandoned in 2008).
  - Indonesia (1985): consolidated deficit ceiling of 3% GDP.
  - Israel (1992): Variable; in normal times overall deficit approx 1.5%.
  - Kosovo (2013): Overall deficit ceiling of 2% of GDP.
  - Montenegro (2014): Deficit ceiling of 3% GDP.
  - Nigeria (2007): Overall deficit ceiling of 3% of GDP.
  - Pakistan (2005): Balanced (current) budget by 2008 and surplus thereafter.
  - Panama (2012): Target budget deficit of 0.5% GDP, coming down from 2.9%.
  - Peru (2000): Targeted 1.5 to 2% deficit, switched to structural balance in 2013.
- Cross-country statistics:
  - Number of countries (2014) by rule type (from IMF Fiscal Rules Dataset, 2015): counts shown in figure (all countries vs emerging markets vs Western Hemisphere) indicate:
    - Expenditure Rule, Budget Balance Rule, Both Rules distribution (figure reproduced in source).

*Source: _wp16226 - conclusions and policy recommendations.*

### Box 1. Advantages and Disadvantages of Different Fiscal Rules

### Box 1. Advantages and Disadvantages of Different Fiscal Rules

### Overview of rule types and trade-offs
- Expenditure rules (ERs)
  - Relatively simple to implement and allow for automatic stabilizers to work on the revenue side.
  - Easy to communicate and monitor and directly enforceable through the budget process.
  - Do not provide an anchor for longer-term fiscal policy.
  - Can lead to potentially undesirable changes in the structure of expenditures as spending may shift to categories not covered by the rule.
- Budget balance rules (BBRs)
  - Provide an operational target with direct links to fiscal sustainability.
  - If given in headline terms, can be procyclical.
  - Vulnerable to off-budget operations or operations recorded as financing items.
  - Structural balance variants yield more favorable economic stabilization but face implementation challenges (cycle corrections can be complex and difficult to communicate).
- Debt rules (DRs)
  - Provide a clear anchor for medium-term fiscal policy; easy to communicate and monitor.
  - Do not offer operational short-run guidance.
  - Vulnerable to shocks outside policy makers’ control (fluctuations in growth rates, interest rates, exchange rate shocks, contingent liabilities).
  - The average fiscal cost of a contingent liability realization is 6 percent of GDP (Bova et al., 2016).
  - Debt ratios typically reflect policy slippages with a lag, making timely remedial action difficult.
- Golden rules
  - Adopted by several countries wishing to safeguard investment expenditures; common in the region and among emerging markets.
  - Rationale: public investment projects generate gains over several years so their full costs need not be attributed to one year; borrowing to finance investment may “pay for itself” through user fees and higher tax revenue.
  - Excluding priority investment expenditures complicates implementation and weakens the link to fiscal sustainability.
  - Incentives to overreport expenditures in protected categories (creative accounting) and likely follow-up increases in current spending due to maintenance costs of higher public capital stock.
  - International experience: golden rules protect public investment but frequently fail to ensure sustainability of public finances.

### Empirical indicators (as presented)
- % of countries that exclude capital and other priority expenditure from the rule:
  - All Countries: 20%
  - Emerging Markets: 27%
  - Western Hemisphere Countries: 31%
- As of 2014, 24 economies were following some type of structural balance rule.
- The standard deviation of growth for Paraguay was 4.4 percent over the period 1992-2014.
- Assuming an 8 percent nominal growth rate, a 3 percent of GDP headline deficit would imply a steady-state debt to GDP ratio of around 40 percent.

### Enforcement and sanctions
- Typical sanctions for non-compliance:
  - Reputational sanctions: obligation to publicly explain deviations from the fiscal rule.
  - Budgetary sanctions: expenditure cuts, withholding of transfers, wage freezes for civil servants, freezes on further borrowing.
- Effectiveness considerations:
  - Budgetary sanctions are more likely to succeed if automatic; delayed or politically mediated sanctions may affect successors rather than rule violators.
  - In countries with fiscal councils, independent media, or strong academic and policy observers, reputational sanctions can be effective.
- Paraguay-specific recommendation:
  - Consider administrative measures or additional sanctions for non-compliance; the current approach relies on individual-level accountability with no institutional sanctions or administrative measures for congress or the Executive.

### Fiscal council role
- Paraguayan authorities plan to introduce an independent fiscal council to assess fiscal policy and evaluate Ministry of Finance forecasts.
- Empirical evidence: mere establishment of a fiscal council does not automatically improve fiscal performance; councils need characteristics such as independence (legal or operational), adequate staffing, or high media impact to be associated with better outcomes.
- Recommendation: the council should produce a periodical report made public, consistent with norms in the IMF fiscal council dataset.

### Correction mechanisms
- Correction mechanisms can specify a path back to compliance after rule breaches:
  - Example: commit to lowering spending over the next three years to offset a breach of the deficit or expenditure rule in budget outturns.
  - “Debt brakes” (Swiss, German structural balance rules): deviations from the structural budget balance are stored in a notional account and accumulated; when accumulated deviation exceeds a threshold, improvements in the structural balance are required, typically over the next three years.
  - Debt-rule countries (Poland, Slovakia) include thresholds that trigger cabinet-parliament discussions or automatic spending cuts to avoid breaching the debt ceiling.

### Escape clauses
- Paraguay’s escape clauses:
  - Triggered only under a limited range of relatively large shocks, including negative economic growth rates.
  - FRL also limits fiscal deterioration allowed under escape clauses (similar to Peru and Panama).
  - These features align with best practices, but scope exists to increase countercyclicality by:
    - Adding provisions for substantial growth slow-downs (beyond outright negative growth rates).
    - Incorporating forward-looking elements to escape clause triggers (e.g., quarterly GDP forecasts and invoking clauses when a significant growth slow-down is projected over two quarters).
- Complementary measures:
  - Escape clauses could be complemented by a medium-term plan to correct deviations once invoked (examples: Germany, Peru, Romania).

### Revisiting Paraguay’s FRL — reform options and trade-offs
- Framing:
  - Discussion concentrates on the overall deficit ceiling of the central government.
  - Three reform types considered: (i) retain the deficit ceiling; (ii) make the ceiling more flexible (golden rule, higher ceiling, structural balance rule); (iii) remove the deficit ceiling and focus on the existing expenditure rule.

- A. Retaining the current deficit rule
  - Justification for minimal modification:
    - Build a solid track record of compliance; rating agencies, international financial institutions, and investors are monitoring early compliance.
    - Changes soon after initial implementation could be perceived negatively and affect ratings and sovereign spreads if not properly explained.
  - Design notes:
    - Current expenditure ceiling is close to estimates of potential GDP growth; adjustments may be needed if potential GDP decreases.
    - Constraints on wage-bill growth seem appropriate given compensation of employees’ relatively large share of total expenditures but could limit ambitious civil service reform.
  - Policy approach:
    - Favor incremental calibration of parameters rather than major overhauls to avoid credibility costs.

- B. Making the deficit rule more flexible: “Golden Rule”
  - Option: exclude public investment expenditure from deficit ceiling and add a debt ceiling to mitigate sustainability risks.
  - Benefits: protects infrastructure investments that improve long-term growth.
  - Risks: modified deficit ceiling does not ensure debt sustainability; an additional debt anchor is needed.
  - Design suggestions:
    - Retain the current expenditure rule to contribute to sustainability and moderate reputational costs.
    - Focus exclusion on externally financed public investment (less likely to crowd out domestic financing).
    - Commit to strictly follow international standards for government finance statistics to mitigate classification issues and monitor implementation.

- C. Making the deficit rule more flexible: Raising the deficit ceiling
  - A higher headline ceiling could provide room for cyclical shocks and increases in public investment; consider an investment floor to ensure favorable composition of spending.
  - Fiscal implications:
    - With an 8 percent nominal growth rate, a 3 percent of GDP headline deficit implies a steady-state debt to GDP ratio of around 40 percent.
  - Considerations:
    - Important transition implications given the lack of an established compliance track record; markets may perceive an increase as a dilution of fiscal discipline.

- D. Making the deficit rule more flexible: Moving to a structural balance rule
  - Potential benefits:
    - Structural or cyclically-adjusted balance rules can yield more favorable economic stabilization and allow full operation of automatic stabilizers.
  - Operational challenges:
    - Correction for the economic cycle and other factors is complex.
    - Successful implementation often requires institutional prerequisites (examples: Chile, Colombia, Peru).
    - Paraguay faces particular difficulty estimating potential GDP due to volatility (standard deviation of growth 4.4 percent over 1992-2014) and the importance of agriculture and hydroelectricity (“binationals”).
  - Technical approaches:
    - Analysts advocate measuring “core” GDP that excludes agriculture and binationals; output gap estimates for total vs. core GDP can differ significantly (HP and Christiano-Fitzgerald filters used to illustrate differences).
    - IMF country team’s operational measure during Article IV: total government revenues excluding royalties from electricity exports and grants, adjusted for the output gap of non-agriculture non-energy GDP (elasticity of one), expressed as a share of potential non-agro non-energy GDP.
  - Implementation advice:
    - Gradual approach: widely disseminate methodology and historical estimates before formal incorporation.
    - Communication challenges: current headline ceiling is well understood; moving to a structural anchor requires careful management.

- E. Removing the deficit rule (move to expenditure rule)
  - Effect: FRL would effectively become an expenditure rule.
  - International experience:
    - Expenditure rules have a better compliance record, partly because they are easy to monitor and directly enforceable through the budget process.
    - The current Paraguayan expenditure rule addresses risks of excessive growth in current expenditures, a policy concern.
  - Caveat:
    - An expenditure rule alone is not sufficient to ensure debt sustainability.

*Source: Box 1. Advantages and Disadvantages of Different Fiscal Rules, _wp16226*

### introduction of a debt anchor would be instrumental to preserving fiscal sustainability in this

### introduction of a debt anchor would be instrumental to preserving fiscal sustainability in this case.

### V. SIMULATIONS — setup and assumptions
- Simulation period: 2016-2026.
- Primary goals:
  - Evaluate debt sustainability under each fiscal rule.
  - Compare the level of public investment under each rule.
- Fiscal rules considered (illustrative):
  - Rule 1: Golden rule with 1.5 percent deficit excluding capital expenditures.
  - Rule 2: Golden rule with 1.5 percent deficit excluding capital expenditures, combined with the existing expenditure rule.
  - Rule 3: Overall deficit of 3 percent combined with the existing expenditure rule.
    - Rule 3a: Rule 3, assuming capital expenditures are fixed and current primary expenditures are a residual up to the deficit or expenditure ceiling, whichever is more restrictive.
    - Rule 3b: Rule 3, assuming current primary expenditures grow at 4 percent in real terms, and capital expenditures are a residual category up to the deficit ceiling.
  - Rule 4: Overall deficit of 1.5 percent combined with the existing expenditure rule.
- Growth scenarios:
  - Reference scenario: growth rates per IMF’s WEO Live database as of August 19 2016, with growth equal to potential growth of 3.8 percent after 2021.
  - Boom-bust scenario: positive output gap opens in 2016, peaks in 2018, bust in 2019, slow recovery until 2024; peak shock about 7.5 percentage points of real GDP growth.
  - Negative shock scenario: negative output gap opens in 2016, peaks in 2018, closed by 2023 when growth returns to potential of 3.8 percent; peak shock about 7.5 percentage points of real GDP growth.
  - Permanent negative shock scenario: potential growth falls to 2.5 percent and growth adjusts to this new potential starting in 2016.
- Public investment effect on growth (benchmark estimates for emerging market economies from IMF (2014)):
  - Contemporaneous effect of a 1 percentage point of GDP increase in public investment is a 0.25 percent increase in output, gradually increasing to 0.5 percent four years after the shock.
- Specific calibration example:
  - If capital expenditures are fixed at 4.5 percent and 2015 capex was about 4 percent of GDP, the positive shock to capital expenditures in 2016 is about 0.5 percentage points of GDP.
- Other technical assumptions:
  - In golden rules, capital expenditures assumed fixed at 4.5 percent of GDP.
  - Interest payments depend on debt stock and an exogenously determined interest rate (Libor plus a premium for Paraguay).
  - Government revenue projections follow IMF’s WEO Live database as of August 19 2016 and are assumed constant as a share of GDP after 2021.
  - For Rules 3b and 4: current primary expenditures grow at 4 percent per year (the maximum growth rate permitted by the expenditure rule).
  - For Rule 3a: capital expenditures fixed at 4.5 percent of GDP; current expenditures adjust to satisfy overall deficit of 3 percent if necessary.

### B. Simulation Results: Debt sustainability — principal findings
- Overall summary:
  - Debt sustainability is preserved under the overall deficit rules (Rule 3 and Rule 4) but may be compromised under the two golden rules (Rule 1 and Rule 2), depending on current expenditure choices.
- Rule 4 (overall deficit of 1.5 percent + expenditure rule):
  - Debt profile is almost flat in the reference scenario, staying around 20 percent of GDP (the current level of central government debt).
  - Even under large growth shocks, the debt path remains sustainable and the debt level remains relatively low.
- Rule 3 (overall deficit of 3 percent + expenditure rule):
  - Debt increases over time but at a slower rate; appears to converge to a steady state.
  - As shown in annex Table 1, the steady state level of debt consistent with an overall deficit rule of 3 percent and a nominal growth rate of around 8 percent is around 40 percent of GDP—twice the level with a 1.5 percent deficit ceiling.
- Golden rules (Rules 1 and 2):
  - May be unsustainable depending on the level and growth of current primary expenditures that the government chooses.
  - Under Rule 1 (no expenditure rule), current primary expenditures could rise to almost 18 percent of GDP under the Reference scenario and still comply with the modified deficit rule of 1.5 percent excluding capital expenditure.
    - Note: this high level of current primary expenditures would be debt financed and, to satisfy the 1.5 percent modified deficit rule, as interest payments increase over time, current primary expenditures would have to fall to less than 15 percent of GDP in 2026.
  - Under Rule 2 (with expenditure rule), current primary expenditures would grow at 4 percent (vs. 3.8 percent real growth), requiring borrowing for both capital and current expenditures.
- Robustness to shocks:
  - General ranking of rules with respect to debt trajectories is preserved across growth shocks: debt levels decrease moving from Rule 1 to Rule 4.
  - Debt-to-GDP levels are higher under negative or permanent shocks; still, Rules 3 and 4 remain sustainable in simulations.
  - Simulations assume government always complies with the fiscal rule regardless of shock severity; suspending the rule in response to shocks could produce much worse debt outcomes.

### C. Simulation Results: Composition of expenditures — principal findings
- Composition outcomes vary substantially across rules:
  - Rules 1 and 2 protect capital expenditures by design (capital expenditures fixed at 4.5 percent of GDP), but current primary expenditures may have to decline as a share of GDP when rules bind.
  - If capital expenditures are a residual (not explicitly protected), they may suffer relative to current primary expenditures.
- Rules 3a vs 3b (same fiscal rule, different expenditure composition assumptions):
  - Interest payment profiles identical (given same debt stock).
  - Rule 3a: fixed capital expenditures as share of GDP; current primary expenditures can decline as a share of GDP when constrained by the overall deficit of 3 percent or the expenditure rule of 4 percent growth, whichever is more restrictive.
  - Rule 3b: current primary expenditures grow at 4 percent in real terms and therefore slowly increase as a share of GDP (given potential growth 3.8 percent), but capital expenditures decline as a residual.
- Quantitative examples on capital expenditures:
  - If real current primary spending grows at 4 percent and authorities comply with an overall deficit ceiling:
    - With a 3 percent deficit ceiling (Rule 3b), capital expenditures decline from about 4 percent of GDP in 2015 to about 2.5 percent of GDP in 2026.
    - Levels of public investment would be even lower with a tighter 1.5 percent deficit ceiling (Rule 4).
  - To allow higher capital expenditures, the government must:
    - Contract current primary expenditures, or
    - Accept a higher level of debt, or
    - Increase revenue, or
    - Use some combination of the above.
- Revenue assumptions and possibilities:
  - Simulations incorporate some revenue reforms and assume revenues increase from about 18 percent in 2016 to 18.5 percent of GDP in 2026; further revenue mobilization may be achievable.
- Illustration contrasting golden rule vs expenditure rule with higher deficit ceiling:
  - Both rules with capital expenditures fixed at 4.5 percent and an expenditure rule: debt in 2026 is much higher under the golden rule (Rule 2) than under an overall deficit ceiling of 3 percent (Rule 3a).
  - Explanation: with an overall deficit ceiling of 3 percent (Rule 3a), the deficit ceiling limits current primary expenditures more than the expenditure rule alone; under the golden rule, the expenditure rule is the only constraint on current primary expenditures.
  - Emphasis: having (and complying with) an overall deficit ceiling is important for limiting current primary expenditures and debt accumulation.

### VI. IMPLEMENTATION ISSUES — transition and safeguards
- General caution:
  - Transitioning to a revised fiscal framework needs careful management; benefits must be weighed against possible negative effects.
  - Risks of amending the framework are heightened by Paraguay’s short and mixed track record of implementation.
  - A key concern is the potential effect of modifications on sovereign spreads and ratings.
- Recommended transition approach:
  - Test and communicate changes carefully given political sensitivity and potentially large costs.
  - Build stakeholder agreement and “ownership” of reforms.
  - Consider piloting new provisions as government policies before legally embedding them (example: Chile tested the structural balance rule for five years before legal adoption).
  - Develop a simple, clear and effective communication strategy that:
    - Educates the public on objectives of FRL reform.
    - Links reforms to benefits such as greater scope for infrastructure spending and consequent improvements in growth and quality of life.
    - Starts early and targets multiple audiences (politicians, private sector, credit rating agencies/investors, etc).
- Complementary commitments when announcing modifications:
  - Announce FRL modifications alongside concrete commitments to strengthen fiscal institutions and preserve sustainability.
  - Avoid perceptions of fiscal laxity or dilution of the FRL.
  - Strengthen budgetary processes to ensure ex-ante compliance and sanctions for deviations.
  - Reiterate commitment to fiscal sustainability via a credible medium-term fiscal plan addressing revenue mobilization and spending rigidities.
  - Introduce transparency mechanisms such as periodic congressional hearings (e.g., quarterly) to discuss law implementation and corrective measures.
- Enforcement and correction mechanisms:
  - Consider introducing correction mechanisms and/or additional sanctions for non-compliance.
  - If a debt anchor is introduced, consider a debt brake mechanism (as in German and Swiss models) that:
    - Specifies a particular debt path appropriate for Paraguay.
    - Triggers adjustments to spending if significant deviations occur.
  - Enhance public investment management efficiency and public accounting to ensure correct classification of capital expenditures if adopting a golden rule.
  - If raising the headline deficit ceiling, strengthen budgetary process and FRL provisions on sanctions and enforcement to limit reputational damage.

### VII. CONCLUSION AND POLICY RECOMMENDATIONS — summary recommendations
- Establish a strong track record of compliance with the FRL before making changes:
  - FRL is new; learning by doing is expected.
  - Signs of improvement in budget forecasting and approved 2016 budget compliance point to potential future effectiveness.
  - Cementing current rules to build credibility may be preferable to immediate changes.
- Exercise caution and deliberation when considering amendments:
  - Credibility and reputational costs of amending a recently adopted FRL can be large.
  - Legal ambiguities and constitutional considerations require careful legal design of amendments.
  - Any transition should be carefully managed, communicated, and accompanied by institutional strengthening.
- Follow a balanced approach if amendments are pursued:
  - If adopting targeted exemptions or a “golden rule” (excluding public investment from the deficit ceiling):
    - Strictly adhere to the current expenditure rule.
    - Add a debt ceiling to preserve fiscal sustainability.
    - Enhance public investment management efficiency and public accounting to ensure correct classification of capital expenditures.
  - If raising the headline deficit ceiling:
    - Strengthen budgetary process and FRL provisions on sanctions and enforcement to contain reputational costs.
- Strengthen legal and institutional aspects of the fiscal framework:
  - Public expenditure management systems need development to monitor and enforce FRLs.
  - Paraguay should strengthen budgetary processes, public investment management framework, credible financial reporting and accounts, and fiscal transparency.
  - Introduce explicit correction mechanisms to address deviations and specify paths back to compliance.
  - Provide more precise provisions on sanctions and enforcement.
- Overall view:
  - Fiscal responsibility laws can enhance fiscal management but cannot substitute for strong budget frameworks and a commitment to prudent fiscal policy.

*Source: IMF staff analysis and simulations as presented in the provided content.*

### References

### _wp16226 - References

### References
- Ardanaz, M., Corbacho, A., Gonzales, A., Caballero, N.T. (2015) “Structural Fiscal Balances in Latin America and the Caribbean” IDB Working Paper IDB-WP-579 (Washington: Inter-American Development Bank).
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- Caceres, C. and Ruiz-Arranz, M. (2010) “What Fiscal Rule Would Work Best for the UK?” United Kingdom Selected Issues Paper, IMF Country Report No. 10/337 (Washington: International Monetary Fund).
- Corbacho, A., and G. Schwartz (2007) “Fiscal Responsibility Laws,” in Promoting Fiscal Discipline, ed. by T. Ter-Minassian and M. Kumar (Washington: International Monetary Fund), pp. 58–77.
- Cordes, T. and Kinda, T., Muthoora, P. and Weber, A. (2015) “Expenditure Rules: Effective Tools for Sound Fiscal Policy?” IMF Working Paper 15/29. (Washington: International Monetary Fund).
- Debrun, X., Epstein, N., Symansky, S. (2008) “A New Fiscal Rule: Should Israel “Go Swiss?” IMF Working Paper WP/08/87 (Washington DC: International Monetary Fund).
- Debrun, X. and Kinda, T. (2014) “Strengthening Post-Crisis Fiscal Credibility—Fiscal Councils on the Rise. A New Dataset” IMF Working Paper WP/14/58. (Washington: International Monetary Fund).
- van Eden, H. Khemani, P. and Emery, R. (2013) “Developing Legal Frameworks to Promote Fiscal Responsibility: Design Matters” in Public Financial Management and Its Emerging Architecture, ed. by Marco Cangiano, Teresa Curristine, and Michel Lazare (Washington: International Monetary Fund), pp. 79–105.
- Escolano, J. (2010) “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates,” Technical Notes and Manuals 10/02 (Washington, DC: International Monetary Fund).
- Eyraud, L. and Wu, T. (2015) “Playing by the Rules: Reforming Fiscal Governance in Europe” IMF Working Paper WP/15/67. (Washington: International Monetary Fund).
- Ilzetzki, E. and Vegh, C. A. (2008) “Procyclical Fiscal Policy in Developing Countries: Truth or Fiction” NBER Working Paper 14191, July, Cambridge: MA.
- International Monetary Fund (2009) “Fiscal Rules—Anchoring Expectations for Sustainable Public Finances,” Prepared by the Fiscal Affairs Department (Washington: International Monetary Fund).
- International Monetary Fund (2014) “Is it Time for an Infrastructure Push? The Macroeconomic Effects of Public Investment” Chapter 3 of the October World Economic Outlook (Washington: International Monetary Fund).
- International Monetary Fund (2015) “Can Fiscal Policy Stabilize Output?” IMF Fiscal Monitor, Chapter 2, April, Washington, DC.
- Kinda, T., C. Kolerus, P. Muthoora, and A. Weber (2013) “Fiscal Rules at a Glance,” Update of the IMF Working Paper 12/273 (Washington: International Monetary Fund).
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- Schaechter, A., T. Kinda, N. Budina, and A. Weber (2012) “Fiscal Rules in Response to the Crisis—Toward the ‘Next-Generation’ Rules: A New Dataset,” IMF Working Paper 12/187 (Washington: International Monetary Fund).
- Tereanu, E. Tuladhar, A. and Simone, A. (2014) “Structural Balance Targeting and Output Gap Uncertainty” IMF Working Paper 14/107 (Washington: International Monetary Fund).
- Valencia, F. (2015) “Strengthening Mexico’s Fiscal Framework” Mexico Selected Issues Paper, IMF Country Report No. 15/314 (Washington: International Monetary Fund).

### Annex I: Equations Underlying the Simulated Debt Trajectories
- Main recursive equation for the debt ratio:
  - (1) 푑t = 1/(1+훾t) 푑t−1 − 푏t
    - where dt is the ratio of debt to GDP; γt is the nominal growth rate of GDP; bt is the overall balance, as a share of GDP.
- Decomposition with revenue and expenditure components:
  - Definitions:
    - Rt is the ratio of revenue to GDP
    - CPEt is the ratio of current primary expenditures to GDP
    - CapExt is the ratio of capital expenditures to GDP
    - IPt is the ratio of interest expenditures to GDP
    - PtYt is the nominal GDP
    - gt is the real GDP growth rate
    - πt is the inflation rate
    - pbt is the primary balance as a share of GDP
    - it is the nominal interest rate
  - (2) 푑t = 1/(1+훾t) 푑t−1 − Rt − CPEt − CapExt − IPt / (PtYt)
  - (3) 푑t = 1/(1+훾t) 푑t−1 − Rt − CPEt − CapExt / (PtYt) + IPt / (PtYt)
  - (4) 푑t = 1/(1+훾t) 푑t−1 − pbt + IPt / (PtYt)
  - (5) IPt / (PtYt) = it Dt−1 / (PtYt) = it Dt−1 / ((1+gt)(1+πt) Pt−1 Yt−1) = it (1+gt)/(1+πt) Dt−1/(Pt−1 Yt−1) = it/(1+훾t) dt−1
    - since PtYt = (1+gt)(1+πt) Pt−1 Yt−1 and (1+gt)(1+πt) = 1+훾t.
- Derived form commonly used when targeting the primary balance:
  - dt = (1+it)/(1+훾t) dt−1 − pbt
- Simulation specification for interest payments as share of GDP:
  - (6) IPt / (PtYt) = it * 1+훾t * dt−1
- Effective nominal interest rate taking currency composition into account:
  - (7) ito* = ((1−α) iht + α itf) + α εt (1+ itf)
    - where ito* is the nominal effective interest rate; α is the share of foreign currency denominated debt; iht is the nominal interest rate for domestic currency denominated debt; itf is the nominal interest rate for foreign currency denominated debt; ε is the nominal depreciation.
- Additional relations and approximations:
  - Note that iht = ε + itf.
  - If r denotes the real interest rate and assuming rf = rh and rf = Libor + premium, then:
    - if ≈ rf + πf
    - ih ≈ rh + πh = rf + πh ≈ if − πf + πh ≈ if + ε
- Steady state debt formula:
  - d = b / ((1+γ)/γ)  (presented in text as d = b 1+γ / γ)
    - where d is the debt level; b is the headline deficit; γ is the nominal growth rate of the economy.
- Footnote: The assumed premium for Paraguay is 400 basis points.

### Annex I: Steady State Debt Levels (Annex Table 1)
- Table title: Steady State Debt Levels, given nominal growth and overall balance
- Columns: Long-term nominal growth; Implied central government debt (in percent of GDP) for a CG deficit of 1 percent of GDP, 1.5 percent of GDP, 2 percent of GDP, 2.5 percent of GDP, 3 percent of GDP, 3.5 percent of GDP.
- Values (rows list long-term nominal growth then corresponding debt levels):
  - 0.5%: 1% 20% 30% 40% 2% 50% 3% 60% 3% 70% 4% (table formatting in source is dense; preserve cell values as presented)
  - 1.0%: 10% 15% 20% 25% 30% 35%
  - 1.5%: 6 8% 10% 13% 16% 9% 20% 3% 23% 7% (source table layout preserves exact numbers)
  - 2.0%: 5 1% 7 7% 10 2% 12 8% 15 3% 17 9%
  - 2.5%: 4 1% 6 2% 8 2% 10 3% 12 3% 14 4%
  - 3.0%: 3 4% 5 2% 6 9% 8 6% 10 3% 12 0%
  - 3.5%: 3 0% 4 4% 5 9% 7 4% 8 9% 10 4%
  - 4.0%: 2 6% 3 9% 5 2% 6 5% 7 8% 9 1%
  - 4.5%: 2 3% 3 5% 4 6% 5 8% 7 0% 8 1%
  - 5.0%: 2 1% 3 2% 4 2% 5 3% 6 3% 7 4%
  - 5.5%: 1 9% 2 9% 3 8% 4 8% 5 8% 6 7%
  - 6.0%: 1 8% 2 7% 3 5% 4 4% 5 3% 6 2%
  - 6.5%: 1 6% 2 5% 3 3% 4 1% 4 9% 5 7%
  - 7.0%: 1 5% 2 3% 3 1% 3 8% 4 6% 5 4%
  - 7.5%: 1 4% 2 2% 2 9% 3 6% 4 3% 5 0%
  - 8.0%: 1 4% 2 0% 2 7% 3 4% 4 1% 4 7%
  - 8.5%: 1 3% 1 9% 2 6% 3 2% 3 8% 4 5%
- Note: Table in source is compact; values preserved as presented.

### Annex II: Elasticities of Revenue and Expenditure to GDP in Paraguay
- Data and method:
  - Estimates based on autoregressive distributed lag (ARDL) regressions of cyclical components (HP filter) of revenue and expenditure items on the cyclical component of GDP.
  - Sample: seasonally-adjusted quarterly data covering 2003Q1 to 2015Q3.
  - Fiscal variables deflated using the GDP deflator; all variables transformed in logs.
- Main regression specification:
  - y represents the cyclical component of different revenue and expenditure items; "gap" is the output gap (cyclical component of GDP).
- Key findings from Annex Table 2 (ARDL regressions):
  - Tax revenue:
    - Appears sensitive to the output gap with positive sign; estimated coefficient statistically significant at conventional levels in specification 2.
    - Total revenue coefficient on output gap is smaller and only marginally significant (10 percent level).
  - Current primary expenditures and social expenditures:
    - Contemporaneous coefficient for the output gap in current primary expenditures is not statistically significant (specification 7).
    - The second lag of the output gap in current primary expenditures presents a negative (countercyclical) and significant coefficient (unusual for Paraguay’s development level).
    - Social expenditures do not present a statistically significant cyclical response in the baseline specification (specification 6).
  - First-difference specifications:
    - Coefficients for changes in GDP in specifications for both total and tax revenue are about 0.6 and statistically significant.
    - For current expenditures, the first lagged difference in output is significant with a negative sign, coefficient about -0.3 (smaller than -0.5 from other specification).
  - Econometric concerns:
    - Results subject to endogeneity and omitted variable bias.
    - Two-stage-least-squares (2SLS) regressions instrument GDP with Paraguay’s trade partners’ growth rates and lagged values of GDP (approach follows Ilzetzki and Vegh (2008)).
- Annex Table 2 (selected ARDL results; t statistics in brackets; ** at 1% level; * at 5% level):
  - Revenue regressions (columns 1–7): observations 49 (or 46/48 where noted); R-squared vary by specification (e.g., 0.048 for Total Revenue, 0.388 for Tax); F-statistics range (e.g., 1.159 to 41.794).
  - Notable coefficients (with significance):
    - Gap_t coefficient for Tax revenue: 0.571 [3.942]**.
    - Gap_t coefficient for Trade revenue: 1.592 [2.736]**.
    - Gap_t-2 coefficient in Current Primary expenditures: -0.506 [-2.493]*.
- Annex Table 3 (Two Stage Least Squares regressions, variables in first differences; observations 46; R-squared reported):
  - Constant (C) and ΔGDPt coefficients (t statistics in brackets):
    - Total Revenue: C = 0.004 [0.555]; ΔGDPt = 0.901 [2.355]*.
    - Tax Revenue: C = 0.006 [1.317]; ΔGDPt = 1.012 [2.649]*.
    - Social: C = -0.022 [-1.298]; ΔGDPt = -1.867 [-1.935].
    - Current Primary: C = 0.019 [2.655]*; ΔGDPt = 0.054 [0.123].
  - Note: GDP growth was instrumented using trade partners' growth rates and lagged growth. HAC Standard Errors and Covariance used.

### Estimating Fiscal Stabilization Coefficients
- Method:
  - Bivariate regression of the overall budget balance on the output gap using annual data, following IMF (2015).
  - Coefficients indicate effectiveness of fiscal policy in smoothing output fluctuations (fiscal balance should increase when output rises and decrease when output falls for stabilizing policy).
- Results and comparisons (Annex Figure 1 discussion):
  - OLS estimates for Paraguay are notably smaller than for several other countries and not statistically significant at conventional levels.
  - When instrumenting output gap by trade partner growth (IV / 2SLS, corrected for weak instruments), Paraguay’s fiscal stabilization coefficients become broadly similar to those of several Latin American countries, except Chile which has a larger coefficient.
  - Median fiscal stabilization coefficient for emerging and developing economies is 0.58 (IMF, 2015), close to the IV estimate for Paraguay.
  - Contribution of automatic stabilizers:
    - Median contribution in emerging markets and developing economies: around 30 percent (IMF, 2015).
    - Median contribution in advanced economies: 60 percent.
    - For Paraguay: estimated contribution of automatic stabilizers to fiscal stabilization is close to 25 percent (based on IV coefficients), somewhat lower than the median for emerging markets and developing economies.

*Source: _wp16226 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16226.pdf_