Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
January 8, 2008
Prospects for stronger and more stable economic growth in Latin America hinge on stronger fiscal management and higher-quality public spending.
Market in Valparaiso, Chile—only Latin American country with stronger budget institutions, IMF study says (photo: Vassilis Constantineas/IML Image Group)
FISCAL MANAGEMENT
Despite a sharp rebound in growth after a serious economic downturn during 1999-2002, concerns have been raised about the region's ability to maintain strong and stable growth, according to a recent IMF Working Paper. The pace of expansion still lags other emerging market and developing countries, and periods of rapid growth have tended to be followed by sharp slowdowns.
The issue: Latin America remains vulnerable to financial crises and global slowdowns. Better fiscal management and transparency will help increase economic growth, as well as its stability and quality, and help avoid a repeat of previous economic crises.
The evidence: Despite a decade of structural reforms, Latin America suffered an extended economic downturn during 1999-2002. Many countries were hurt by financial crises of major Latin American countries, and by the global slowdown in 2001. Although growth has rebounded sharply in recent years, it remains lower and less stable than in emerging market countries in other regions.
Policy considerations: Priorities for fiscal policy include avoiding pro-cyclical fiscal policies, continued public debt reduction, improving the quality of the tax system, and promoting a better business environment. Stronger fiscal transparency can play a critical role in meeting these challenges.
Fiscal priorities for the region include continued debt reduction, avoiding pro-cyclical fiscal policy, improving the equity of tax systems, more productive investment, and promoting a fairer and transparent business environment. "Fiscal transparency" can play a critical role in meeting these challenges and remedying weaknesses in fiscal management practices that have been associated with past financial crises.
Why fiscal transparency?
Fiscal transparency refers to the practice of a government disclosing to the public information about its structures and functions, fiscal policy intentions, public sector accounts, and fiscal projections. The lack of such transparency contributed to a loss of confidence and fed global instability in the late 1990s. Particularly in Latin America, weaknesses were related to poor monitoring of off-budget fiscal activities that eventually had large fiscal consequences.
Fiscal transparency permits a clear assessment of past fiscal performance, the current fiscal position, fiscal risks, and the future direction of fiscal policy. Most important, identifying and better monitoring fiscal risks can prevent unpleasant fiscal surprises. More generally, improvements in the quality and timeliness of fiscal data can help improve the analysis of fiscal data and the quality of fiscal policy decisions.
But fiscal transparency is more than improved monitoring of fiscal risks. It can also help to:
• strengthen governance and reduce corruption;
• enhance public understanding and boost support for important fiscal reforms;
• aid the efforts of donors and civil society to promote social spending, cut poverty, and achieve greater social equity; and
• invigorate the business environment and attract investment by simplifying tax and business regulations and limiting administrative discretion.
The accompanying discussion of fiscal transparency is based on the analysis of the Reports on the Observance of Standards and Codes (ROSCs) on fiscal transparency for 12 Latin American countries. ROSCs summarize the extent to which countries observe certain internationally recognized standards and codes. The Fund and Bank have identified 12 areas and associated standards as useful for their operational work—one of these being fiscal transparency. ROSCs are used to help sharpen the policy discussions of the Fund and Bank with national authorities, and in the private sector (including by rating agencies) for risk assessment.
Fiscal management weaknesses
Improvements in Latin America's fiscal policy and a decline in its public debt-to-GDP ratios have helped fuel the growth resurgence of recent years. But important weaknesses remain including a poorly designed and administered tax system, weak budget institutions, and rigid government spending patterns that cannot be easily adapted to changing needs.
Key fiscal weaknesses among Latin American countries include the following:
1. The lack of a sound medium-term budget framework has undermined the credibility of fiscal policy, led to "pro-cyclical" public spending (which precludes the stabilizing role of fiscal policy in macroeconomic management), and (owing to the rigidity of public spending patterns) limited pro-poor spending to address social inequities.
2. Fiscal surprises have occurred because of poor monitoring of contingent liabilities and unawareness of the fiscal impact of off-budget fiscal activities associated with public enterprises or public financial institutions (referred to as "quasi-fiscal activities"). Some of the most costly hidden liabilities were related to implicit guarantees in the banking and corporate sectors, court-mandated spending, and central government bailout of overindebted sub-national governments.
3. Weak monitoring of subnational governments led, in many cases, to incomplete coverage in budgeting and reporting of fiscal activities. Inadequate monitoring is partly the result of weak financial management at the subnational level of government and insufficient oversight due to the lack of fiscal information.
4. Most countries in the region lack strong and centralized budget authority and a hard budget constraint. Chile is the only country that has notably stronger budget institutions, which may have helped it pursue sound fiscal policy and better weather economic volatility. The evidence from ROSCs suggests that clear lines of accountability to the public are critical to promoting fiscal prudence. In a number of countries in Latin America, lack of information on proposed and final budgets obscured responsibility for fiscal policy decisions. A number of countries in Latin America have adopted Fiscal Responsibility Laws or fiscal rules to try to overcome institutional weaknesses and achieve sounder fiscal outcomes. While the laws have contributed to the transparency of policy intentions, the transparency of budget decisions could be furthered by publishing the executive budget proposal along with the budget passed by the legislature, as well as any budget amendments.
5. An unsupportive business environment—characterized by extensive bureaucracy and weak enforcement of the rule of law—has impeded growth and diminished resiliency in the face of crises.
How to improve fiscal transparency
Increased fiscal transparency in Latin America will strengthen the investment environment and address weaknesses in fiscal management.
Latin American policymakers need to:
• Introduce a medium-term budget and forward-looking analysis of fiscal policy that emphasizes sustainability and medium-term policy goals. While some have made progress in this area, others need to give higher priority to specifying medium-term plans. Since medium-term plans need to be built on a realistic annual budget, improving the quality of budget estimates is an important first step for some countries.
• Report and analyze all fiscal risks, especially those arising from hidden liabilities and quasi-fiscal activities. Improving coverage and diminishing budget rigidity by reducing extrabudgetary activities is important for many countries in Latin America, while extending coverage to general government is an important priority for the more decentralized countries in the region.
• Keep the public informed and strengthen oversight of fiscal activities: publish the draft budget as well as more relevant and frequent fiscal data, particularly on general government activities. Strengthen oversight by extending the coverage of institutions subject to regular audit, and publish all audit reports.
• Promote transparent intergovernmental relations: countries that have pursued decentralization need to give relatively high priority to promoting fiscal transparency in intergovernmental relations. Well designed decentralization policies include a clear, and usually exclusive, assignment of responsibilities, and transfers based on stable and transparent criteria.
• Promote a transparent business environment: simplify the tax system, reduce discretion in dealing with the private sector, and reinforce oversight to promote investment. These are areas where much of the region clearly falls behind other regions of the world. Simplified tax regimes would not only be more transparent, but would raise revenue collection while reducing the costs of collection. Regulations affecting business operations need to be streamlined with minimal discretion to promote fairness, permit easy entry and exit of firms, and reduce uncertainty faced by businesses.
Of course, priorities will vary from country to country, but the common goal should be to maintain economic growth and avoid future crises through high-quality and more sustainable public finances.
