Peru: Two approaches for the fiscal sustainability analysis Jean Paul Rabanal Economics and Social Studies Division Ministry of Economy and Finance - Perú XVIII Seminario Regional de Política Fiscal Santiago, 24 de enero de 2006

2 Introduction  Fiscal sustainability is based on the need for financing the fiscal deficit  Two approaches known in the economic literature:  Ex-post: Intertemporal Government budget constrain with a long-term relationship between revenues and expenditures.  Structural Breaks in the economy (90s “First generation reform”)  Public debt data  Ex-ante: Foreseeable future path of revenues, expenditures and other relevant macroeconomic variables.  Blanchard indicator

3 Fiscal unbalance  Two periods: High and moderate fiscal deficits Fiscal Deficit (percentage of GDP)  : Fiscal policy oriented to impulse aggregate demand: investment projects, rising salaries, transfers, among others. And shocks: International debt crisis, Fenomeno del Niño.  1990-Now: Stabilization program. Privatizations. Tax collection improvements. Fiscal Responsibility Law Source: Central Bank

4 Fiscal unbalance (II)  In general, prociclical fiscal policy contributed to the volatility of the economy. Fiscal impulse and Output Gap (percentage of GDP) Output gap Fiscal Impulse Note: Estimated with HP filter

5 Fiscal unbalance (III)  Increasing debt ratios. Public debt (percentage of GDP)  1970s: Public enterprises, Banca de Fomento, and Loans by the Central Bank.  1980s: Stop of the foreign capital. Fixed exchange rate.  1990s: Constitutional Reform. Plan Brady (1997)  Last 1990s and 2000s: International Crisis and Domestic debt. Source: Central Bank

6 Ex-post model  Following, Ahmed & Rogers (1995) and Bohn (1995,1998)  Budget constraint (BC):  Present Value BC:  Taking first difference…  Debt is sustainable if G*, I cointegrate with a vector (1,-1):

7 Results  Unit root test: Variation of public debt is stationary  However, B is greater than 1 Long-term relationship

8 Results (II)  Gregory-Hansen test: Reject the null hypothesis “no cointegration in presence of structural breaks (1993)” Gregory-Hansen Test  Structural Reforms has an important effect on the fiscal sustainability Wald Test

9 Ex-ante model  Following, Jimenez (2004): Modified Blanchard indicator by different origin of debt  Budget constraint:  Modified Permanent Blanchard Primary Balance where:  So, the Sustainabiliy Indicator (I):

10 Scenarios  Basis assumptions:  Three scenarios: (1) Multiannual Macroeconomic Framework (2) Rule 1: Fiscal Deficit = 1% of GDP (3) Rule 2: Structural primary balance = 1% of GDP Basic assumptions

11 Scenarios (II)  New debt is financed by external sources Fiscal assumptions for the sustainability analysis

12 Scenarios (II)  If Peruvian economy followed the actual fiscal rule… fiscal sustainability risk! Fiscal assumptions for the sustainability analysis

13 Scenarios (III)  Several risk on the public accounts (exchange rate, commodities price, etc.)  Emphasize internal risk (unsatisfied public expenditure and political pressures) Commitment to fiscal rules? Source: Central Bank. Projections: MEF

14 Conclusions and recommendations  Reforms in the 90’s have had a strong positive effect on the sustainability of the public debt.  This suggests that an economy can not violate permanently the restrictions confronted by the Government.  Considering the MMF, Fiscal policy is sustainable.  But, there are several risks that could have a negative impact on the fiscal sustainability.  For this reason, apply a single fiscal rule based on the structural balance.

Peru: Two approaches for the fiscal sustainability analysis Jean Paul Rabanal Economics and Social Studies Division Ministry of Economy and Finance - Perú XVIII Seminario Regional de Política Fiscal Santiago, 24 de enero de 2006