strategy

Maintaining national monetary and fiscal discipline

Synonyms:
Ensuring prudent national budget policies
Implementing prudent fiscal policy
Improving fiscal compliance
Maintaining sustainable fiscal policies
Description:
The aim is for developing countries, in particular, to promote price stability and external balance by maintaining monetary and fiscal discipline.
Context:
Fiscal discipline is more than a matter of controlling borrowing and allocating spending more efficiently. Three important areas are: eliminating interagency arrears; improving the transparency of the financial reporting and monitoring of state-owned enterprises (SOEs); and increasing the accountability of SOE managers. Experience in several developing countries has shown that after progress has been made in these areas, sound public finance becomes much more feasible.

Large fiscal deficits are often at the root of both external and internal macroeconomic imbalances. External imbalances express themselves as current account deficits, capital flight and rapidly expanding external debts. Internal imbalances take the form of high real interest rates, falling private investment and rising inflation. Domestic savers respond to unsustainable fiscal deficits by sheltering their assets abroad, this capital flight worsening the debt problem. Prudent fiscal policy - that is, fiscal deficits consistent with low and stable inflation, a sustainable level of foreign debt and a favourable climate for private investment - is indispensable to stabilization and adjustment. It guards against the risks of excessive foreign debt and overvalued currencies. Furthermore, reforms in many other areas - financial liberalization, currency devaluation, price deregulation, trade reform and so on - can work only if the fiscal implications are taken into account. Public finance offers many opportunities for budgetary reform. The ways in which governments raise revenue can substantially affect economic efficiency. Similarly, the quality and composition of public spending strongly influence development.

Implementation:
This strategy features in the framework of Agenda 21 as formulated at UNCED (Rio de Janeiro, 1992), now coordinated by the United Nations Commission on Sustainable Development and implemented through national and local authorities.

Countries with commodity booms are a special example of the importance of prudent fiscal policy. Mistaking a temporary boom in revenue as permanent carries heavy long-term costs, because it can take years to cut spending and reverse the accumulation of debts incurred during the boom. By contrast, erring on the side of caution - treating a permanent boom as temporary - is easily put right later. Boom revenue can then be used to accumulate external assets or repay debt, thus avoiding the risk of inflation and an appreciating exchange rate. In many countries during the 1970s, public revenues accelerated rapidly as the export prices of commodities soared. The windfall encouraged governments to increase spending - sometimes by more than the windfall, as higher domestic revenues were leveraged through foreign borrowing. However, much of this spending went to higher consumer subsidies or investment projects of dubious economic merit. After the boom, spending kept rising while revenue contracted sharply. The resulting fiscal deficits led to fiscal and external debt crises that finally forced spending cuts. Some commodity exporters - Botswana, Cameroon, and Indonesia, for example - managed to avoid destructive boom and bust cycles by cautious fiscal management of the boom revenues. They moderated spending increases during the boom and used the rise in public savings to accumulate external assets or repay external debt. They also adjusted rapidly to the end of the boom by cutting spending and maintaining low inflation, stable exchange rates and solid performance in other exports.

Countries like Indonesia, the Republic of Korea and Thailand had sustainable fiscal policies during the 1970s. They accumulated smaller stocks of public debt in relation to their capacity to service it. They also adjusted their fiscal policies quickly in the early 1980s and took steps to prevent their real exchange rates from rising excessively. As a result these countries - which might easily have joined the problem debtors - steered clear of debt troubles.

Claim:
Moderate and sustainable public deficits, with some allowance for cyclical ups and downs, are far preferable to successive phases of rapid fiscal expansion followed by sharp fiscal contraction. Debt accumulation, capital flight and loss of confidence during the expansion ensure that the ensuing contraction will be all the more severe. The poor then bear the greatest burden. They are unable to shield income by moving assets abroad, and they are often the first to lose their jobs in times of recession. Public deficits should thus be at levels consistent with low and stable inflation, an acceptable external debt service burden and reasonable real interest rates. A higher rate of domestic saving and more productive use of public resources will permit higher deficits consistent with prudent fiscal management.
Facilitated by:
Improving fiscal policies
Subjects:
Maintenance
Finance
Money
Taxation
Sustainable development
Reform
Policy
Perseverance
Type Classification:
E: Emanations of other strategies