A Call for New Fiscal Rules
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Bibliographic details
- Authors: Arminio Fraga
- Published: March 1, 2022
Overview
- Advanced and emerging market economies need new criteria for debt sustainability to allow mobilization of large-scale investment without undermining fiscal health.
- Author: ARMINIO FRAGA; Publication: F&D Magazine.
Background and context
- The Maastricht rules historically demanded a debt-to-GDP ratio below 60 percent and a nominal public deficit of no more than 3 percent of GDP.
- By 2019: France’s debt ratio was 98 percent; Italy’s was 135 percent.
- Post-pandemic debt ratios in advanced economies are about 20 percentage points higher than pre-pandemic levels.
- The 3 percent ceiling for budget deficits was, for the most part, treated as a floor.
Market conditions enabling fiscal slippage
- Long-run decline in interest rates since Maastricht: 10-year Bund yields fell from above 6 percent to near zero.
- Italian bond spreads versus Bunds are cited at 136 basis points.
- France’s spreads to Germany remain very low despite a debt ratio 43 percentage points higher.
- Emerging market general government debt now averages 64 percent of GDP, compared with 122 percent for advanced economies.
- Examples of 10-year local currency bond yields among some emerging markets:
- Brazil, India, Indonesia, Mexico, Russia, and South Africa: about 7 percent (at one point).
- Russia: 8 percent (current in text); the others at or below 7 percent but still higher than advanced economies.
Brazil: fiscal history and current dynamics
- Brazil’s general government debt ratio:
- Low of 53 percent in 2014.
- Peaked at 89 percent in 2020.
- Now at 83 percent.
- Fiscal slippage:
- Overall swing in the primary balance from surplus to deficit reached nearly 6 percentage points of GDP after the fiscal collapse of 2014.
- Since 2015 Brazil has run primary deficits.
- Yields and spreads:
- 10-year inflation-linked government bonds yield over 5 percent (a 6 percent difference over US Treasury Inflation-Protected Securities).
- Nominal 10-year paper yields more than 10 percent.
- Contributing factors: very low per capita growth, higher interest rates returning, and reliance on short maturity financing contribute to unsustainable debt dynamics.
- Institutional notes: major reforms in the 1990s and a fiscal responsibility law enacted in 2000 were initially effective; later a freeze on government expenditures in real terms was added to the constitution but is now described as "full of holes." Confidence in the fiscal regime is characterized as "all but gone."
IMF Fiscal Monitor features and proposed priority upgrade
- IMF Fiscal Monitor’s three desirable features for a fiscal framework:
1. “sustainability of public finances” 2. “stabilization of the economy through countercyclical fiscal policy, when appropriate” 3. “for fiscal rules in particular, simplicity.”
- The author adds resilience as a fourth priority and proposes upgrading resilience to number four on the list.
Four pillars proposed for a new fiscal regime (as proposed for Brazil, applicable to advanced economies)
- Public debt should be sized to allow for access to financing (usually under stress), at a reasonable cost, in case a fiscal expansion is needed.
- The primary balance should be set so that, in normal times, the debt-to-GDP ratio remains stable.
- If for whatever reason the debt ratio deviates from its target level, the primary balance should be adjusted to gradually bring the debt ratio back to the target.
- The average debt maturity should be long, with limited concentration at the short end, to match long-term horizons, lower the risk of run-like financial or currency crises, and reduce vulnerability to sudden stops in financing.
Implementation guidance and governance
- Debt-ratio targets are subjective and depend on economic, political, institutional, and historical factors.
- Targets in pillars 1 and 2 should be periodically revised, but not too frequently and at preannounced dates, to minimize short-term political temptations.
- The cost of funding long-term debt is a reasonable measure of the success or failure of a country’s macroeconomic regime.
- Markets are prone to booms and busts; current ultra-low interest rates in advanced economies should not be assumed permanent.
- The adaptive reaction function of pillar 3 (adjusting the primary balance when debt deviates from target) is emphasized as the most important pillar.
Conclusion
- A fiscal regime based on the four pillars, properly managed, would provide a resilient and possibly durable anchor for both advanced and emerging market economies.
Source: A Call for New Fiscal Rules — ARMINIO FRAGA, F&D Magazine
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