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INTRODUCTION TO PUBLIC FINANCE MANAGEMENT
Module 2.1 :Macroeconomics of the budget
Module map
Fiscal sustainability?
Expenditure
Debt/deficit
Revenues
Appetizer
To understand the macroeconomic constraints that frame the preparation of the budget.
• To understand the relationship
Objectives of the module
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Public Finance Management
Public Finance Policy
Economic stability, growth and poverty reduction
Public Finance Policy
Public Finance Management
Revenue
Expenditure
Deficit/Surplus, Debt
(Positive effects)
Crowding out
Current account
Debt/Deficit financing
1. Definitions
2. Impact channel: Crowding Out
3. Impact channel: Financing
4. Impact channel: Current Account
5. What can PFM do?
MODULE OUTLINE
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7Source: Government Finance Statistics (GFS). IMF
1. Definitions
Which budget deficit?
‘A deficit may be like an elephant: one always recognises it when one sees it, even though it may be difficult to measure or describe it in a way that is satisfactory to everybody and for every purpose’ (V. Tanzi)
Three commonly used concepts: • Overall balance• Primary balance• Overall balance without external grants
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1. Definitions
• Overall balance (‘budget deficit’)Is a measure of the net financial borrowing requirements of the consolidated government.
• Primary balanceIs the difference between the total revenue and the expenditures excluding interest charge on the debt
• Overall balance excluding external grants Shows the amount of financing that would be required in
absence of this external funding
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1. Definitions
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Government budget
‘in every country the budget speech refers to a different kind of deficit’
Budget structure: ‘below or above the line’
- ‘Above the line’: revenue/expenditure
- ‘Below the line’: its net financing (because it creates or takes away a liability)
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Which items above or below the line?
• Interest payment
• Principal repayment (amortisation)
• New loans
1. Definitions
2. Impact channel: Crowding out
3. Impact channel: Current Account
4. Impact channel: Financing
5. What can PFM do?
MODULE OUTLINE
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Extra government expenditure: • if financed by a additional tax: this
might reduce private consumption or investment
• if financed by domestic borrowing: this might increase the interest rate and the cost of borrowing for private sector (or directly limits availability of finance in developing countries)
• absorbs scarce resources (e.g. qualified labour) at the expense of the private sector
2. Impact Channel: Crowding out
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1. Definitions
2. Impact channel: Crowding out
3. Impact channel: Financing of the budget deficit
4. Impact channel: Current Account (BoP)
5. What can PFM do?
MODULE OUTLINE
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Banks
Individuals
Others
Banks
Financial institutions
Governments
Domestically
Externally
2. “Printing Money”
3. Selling Assets
4. Not paying and building up Arrears
Options:
1. Borrowing
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Financing options
3. Impact channel: financing
3. Impact channel: financing
Borrowing Borrowing Debt Debt
????? Sustainable ????????? Sustainable ????
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Debt Sustainability: Concept
• Ability to meet its current and future debt service obligations in full, without:• Debt rescheduling or accumulation of arrears• Compromising economic growth
• Debt sustainability is essential for:• Economic stability, growth and poverty reduction• (Future) access to capital markets
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Reliability of DSA • Highly dependent on “accuracy” of macroeconomic
projections
Important exogenous factors• Exchange rates • Export and import prices on world market (e.g. oil)• Weather (good or bad harvest)• Changing international interest rates
Debt Sustainability Analysis (DSA)
Debt Sustainability Analysis (DSA)
“The Snow Ball”Deficit is kept stable, but debt is substantially increasing.
Example:•2% GDP growth •7% inflation•10% interest rate •Fixed % primary revenue and expenditure of GDP
3. Impact channel: financing
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3. Impact channel: financing
Debt/GDP ratio worldwide
3. Impact channel: financing
Debt sustainability? Historic overview
147% in 2012 Including Bank Bail-outs
70% in 2012
1. Definitions
2. Impact channel: Crowding out
3. Impact channel: Financing
4. Impact channel: Current Account (BoP)
5. What can PFM do?
MODULE OUTLINE
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Balance of Payments: •Current account•Capital & financial account
•Records transactions in goods, services, and assets between the country’s residents and foreign residents during a calendar year – it records flows
4. Impact channel: Current Account
4. Impact channel: Current Account
• Bop accounts are based on the double entry accounting system – the BoP is therefore always in balance!
4. Impact channel: Current Account
4. Impact channel: Current Account
Imports
Payments
Exports “Earnings”
Current Account
Capital Account
revenue
Balance of Payments Government Deficit
inflation
money
reserves
Exchange rate
“financing”
Financing
4. Impact channel: Current Account
What is a Sustainable Current Account Deficit?
• If a country can attract borrowing & foreign investments against reasonable rates, then the Current Account Deficit can ‘ be seen’ as sustainable
What can be done if not sustainable? Short term: reduce domestic absorption (= stabilisation) Medium term: increase domestic revenue (structural reforms to
generate growth)
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4. Impact channel: Current Account
Current account deficit per capita
1. Definitions
2. Impact channel: Crowding out
3. Impact channel: Financing
4. Impact channel: Current Account
5. What can PFM do?
MODULE OUTLINE
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A. Expenditure ceilings
Fit within overall spending ceiling determined by
sustainable resource availability macroeconomic policy objectives capacity constraints public service provision needs and overall governance factors
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5. What can PFM do?
B. Medium-Term Frameworks
Budget in medium-term perspective allows to:
•Compare the aggregate budgetary objectives with economic prospects (growth, inflation, international prices, …)
•Assess the impact of the budget choices on the future economic and fiscal developments
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5. What can PFM do?
B. Medium Term Frameworks
To allow linking budget with economic projections and assess impact of budget choices, we need:
• The main macro-economic indicators
• Government Operations Table (GOT)
• Summarized balance of payments
• A monetary survey (banking sector)
• A forward analysis of the public debt
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5. What can PFM do?
Links between the GOT and the other accounts
Real Sector
Ressources GDP ImportsUses
ConsumptionPrivatePublic
InvestmentPrivatePublic
Exports
Monetary Sector
AssetsNet foreign assetsCredit to the GovernmentCredit to the economy
LiabilitiesMoney/quasi money
Private Sector
Obtained by difference
Government OperationsTableRevenue Grants Other RevenueExpenditures
Current primaryInterestCapital
FinancingDomestic
of w. BankForeign
Balance of Payments
Current balanceExports of g. & s. Imports of g. & s.Net factor incomeNet transfers
PrivateOfficial
Capital balancePublic MT & LTOther
Variation of reservesBehavioural relation
Accounting relation
C. Fiscal Rules
Fiscal rules are meant to bind a government into a specific fiscal behaviour and to remove discretionary intervention
They aim at fiscal discipline and economic stability
They may apply to every tier of government
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5. What can PFM do?
5. What can PFM do?C. Fiscal rulesRules for: Debt, Deficit, Revenue, Expenditure
Source
: IMF w
ebsite
C.Fiscal rules
Legal: local councils are not allowed to borrow Loose targets: bring debt down over time
Annual targets: annually adjusted level of borrowing
Common agreed targets: EU, Gov.Deficit/GDP ratio < 3%, Public debt to GDP ratio < 60%
Supervised targets: supported by IMF and OECD
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5. What can PFM do?
• The sustainability of the external (current account) deficit of the country is the key macro-economic constraint
• The government deficit is a key policy variable because:
• It has a direct impact on the current account deficit
• Its magnitude and the way it is financed has an impact on the growth of the economy and on the sustainability of the macro-financial framework
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Key Messages