Fiscal solvency and sustainability in economic management

Abstract

Fiscal policy is central to a country's economic and social objectives, from macroeconomic stability to sustainable growth and poverty reduction. But evaluations of a country's fiscal performance, over time or relative to other countries, are often conducted independent of other development objectives, disregarding the links between fiscal, monetary, and exchange rate policies. A budget deficit of 4 percent of GDP, for example, may be acceptable in one country but not in another, because of different initial conditions and policy priorities. In the same country, a level of fiscal deficit may be acceptable one year but not the next, depending on developments and changes in policy objectives. The author argues for assessing fiscal performance (1) as part of the entire framework of economic policy, (2) against a policy objective, (3) by taking into account both short- and long-term considerations, and (4) with an eye to the quality of adjustment (whether there are income inequalities or other social issues, for example) as well as its magnitude. The approach he proposes for assessing country fiscal performance requires a minimum of data and takes into account flow and stock variables on internal and external debt. The approach addresses the shortcomings of conventional analysis by incorporating the debt dynamics and other macroeconomic targets of growth, inflation, and external and internal debt. While its theoretical foundation is well known in the literature, this approach has not been adapted for assessing fiscal performance either over time or across countries, and he discusses practical issues arising from this adaptation. The author proposes two indicators to measure fiscal adjustment efforts: Fiscal solvency adjustment, which measures how far additional fiscal efforts must be taken to restore solvency to the fiscal sector. Fiscal sustainability adjustment, which measures how far additional fiscal efforts must be taken to maintain the ratios of internal and external debt to output. The author applies the proposed framework to evaluate recent fiscal performance in three countries-Argentina, India, and Zambia-each with a different income level and located on a different continent. The countries were selected on the basis of recent World Bank economic work using the proposed approach or an equivalent. The author finds the proposed approach useful for identifying key fiscal issues, for assessing the adequacy and pace of fiscal adjustment consistent with the overall economic and social objectives, and for highlighting the tradeoffs between policy initiatives. Sound fiscal policy is crucial for macroeconomic stability. When fiscal issues are under control, it is easier to coordinate other policies. When fiscal issues are part of the problem, the tradeoffs between policy outcomes become pronounced, and economic management, including the management of capital flows, becomes much more difficult.Strategic Debt Management,Economic Theory&Research,Payment Systems&Infrastructure,Banks&Banking Reform,Environmental Economics&Policies,Economic Stabilization,National Governance,Economic Theory&Research,Strategic Debt Management,Banks&Banking Reform