PRSPs, Macroeconomic Constraints and Fiscal Policy Humberto Lopez (PRMPR)

Fiscal Policy: Three levels Aggregate fiscal policy /framework Deals with HOW MUCH WE CAN SPEND. Budget envelope, sustainability of fiscal policy. Efficient allocation of resources Deals with WHERE WE SPEND. Sectoral envelopes, policy priorities. Operational efficiency Deals with HOW WE SPEND. Modalities of service delivery.

This presentation … Deals with the First Level and covers Why is important to have a sound fiscal framework?  In principle, a poverty reduction strategy that is not embedded in a coherent macroeconomic framework will not be credible (sustainability, resources) What do we understand by a sound fiscal framework?  Beyond philosophical considerations, what is that operational staff should be looking at? What does a sound fiscal framework implies for poverty reduction strategies?  One example (Honduras) that computes the fiscal and social envelopes available for a Poverty Reduction Strategy.

Importance of sound fiscal policy. Lack of fiscal discipline has been blamed for: Crisis LAC Debt crisis in the 1980s, HIPC Initiative, Argentina Poor economic performance Unambiguously, deficits are bad for private investment, growth, and hence for poverty reduction Increased Vulnerabilities One of the few policy measures we know to raise national savings (a critical element to reduce vulnerabilities) is to increase public savings All these elements have significant negative effects on whole population, but especially on the poor.

More close to the HD network Lack of fiscal discipline leads eventually to: Program discontinuity …  Cancellation of programs, in many cases in the social sectors, due to lack of funds. Inefficiencies …  Problems with counterpart funds, delays in implementation schedules, etc. And as a result, WASTE  Sunk costs, cost-benefit changes due to longer implementation schedules, etc.

When a fiscal framework is sustainable? One possible definition (not unique!). In principle, deficit must be consistent with non- explosive debt dynamics.  Requires defining what we mean by non explosive dynamics. For HIPC countries, the HIPC thresholds seem a natural choice. Deficits should be fully financed.  In developing countries, it might help assuming that the deficit is fully financed with external concessional resources. There remains the problem of how to deal with the tax level.  Depending on existing tax levels, and given the negative impact of tax increases on growth, one has to be careful about proposing a tax increase.

Fiscal policy 101  Stock of foreign debt=Deficit –  * Stock of foreign debt  =(  +  -  )/(1+  +  ) Given inflation (  ), GDP growth (  ) and exchange rate (  ) expectations it is possible to compute the Deficit (as a % of GDP) the country can afford. Deficit (% of GDP)=  * Debt target (% of GDP)

One example: Honduras Debt and Deficit consistent targets

But we could not find resources to finance it … Best estimate of financing US$250 million per year against requirements of

Implications for poverty reduction strategies Two main ingredients: Overall spending envelope  Growth rate  Tax levels, sustainable deficit levels Allocation to social sectors within the budget (social sectors envelope!)  Social expenditure ratio (SER) (UNDP recommendation 40%)

HND: Social spending Scenarios

But … When we take into account population growth and current per capita spending …

Conclusions We have to face fiscal constraints: Consistency with the macro framework. Consistency with financing availability. We have to be realistic: What is the mileage we can get from the available resources.