Distributional Analysis of Fiscal Policies at the IMF PREM 2011 Knowledge and Learning Forum World Bank April 25, 2011

Outline IMF involvement in distributional analysis Formation of the PSIA group Objectives Modus operandi Subsidy reform Development of a reform strategy Other topics addressed 1

IMF involvement in distributional analysis The IMF has taken a more active stance on social policies over the years IMF-supported programs have increasingly incorporated social safety nets and protected or increases social spending Focus sharpened with the introduction of the PRSP approach Key feature of PRGF 2002 review of PRGF-supported programs 2

3 Formation of the PSIA group PSIA Group set up in 2005 Reflects recognition by the Fund of: The importance of understanding the broader implications of its policy advice, and The need for some internal capacity to energize and facilitate the integration of PSIA into program design Work entirely in macro and structural contexts Now part of the mainstream work of the Fund

4 Objectives Better understand the likely impact of key reform measures on different population groups, in particular the poor; Assess the appropriateness, timing, and sequencing of alternative measures in the design of programs; and Where appropriate, design and integrate into IMF programs measures to mitigate any negative effects of reform policies.

5 Modus Operandi Mix of approaches to inform design of— primarily—PRGF programs: Absorb lessons from existing PSIAs carried out by other development stakeholders Carry out own PSIAs where information gap exists Support PSIA activities by country fiscal economists and desk economists (and elsewhere)

6 Modus Operandi (cont’d) Complement to, not substitute for, the work of other, more important producers of PSIA In particular, close cooperation with WB Our niche is “rapid response,” either with interpretation of existing results or our own analysis

Modus Operandi (cont’d) Work program developed with the area departments of the IMF—demand driven Participation in area department missions Stand alone technical assistance missions HQ-based TA Support to area department teams in conducting distributional analysis 7

8 Subsidy reform Fuel Subsidies Distributional analysis of fuel subsidies Advice on implementation of automatic pricing mechanism of petroleum products Smoothing mechanisms to reduce volatility of domestic petroleum prices Recommendations on alternative measures to mitigate the impact of rising fuel prices on the poor More general subsidy reform

9 Most of the benefit accrues to higher-income groups

10 Subsidy reform (cont..) Low prices provide insufficient incentives to reduce consumption and worsen terms of trade impact Low prices can result in smuggling abroad, higher fiscal costs, and domestic supply shortages High fiscal cost crowds-out high priority public investments in education, health, and infrastructure

11 Developing a reform strategy I Successful strategy needs to prepare population for reforms Identify clearly the size of the fiscal cost of subsidies Link cost to crowding out of key public investments which are crucial for growth and development (best way to protect most of population from high prices is through growth) Highlight the high share of benefits going to higher groups and identify better ways of protecting poor Identify inefficiencies of subsidies (smuggling, shortages, energy inefficiency)

12 Developing a reform strategy II Reform strategy needs to be set out in advance Identify key public investments that will benefit from reallocation of budgetary savings Identify well-targeted programs that will be expanded/created to protect the most vulnerable social groups Subsidy reform may involve other policy changes such as monetary and exchange rate policies, investment incentives, credit access, etc.

13 Developing a reform strategy III Sequenced and gradual reform approach may be warranted if large price increases required (and fiscal conditions allow ) Instant adjustment of subsidies that mostly benefit the rich (higher quality foods, gasoline, jet kerosene and LPG?) More gradual adjustment of other products to allow industry to adjust (e.g., diesel and LPG?) Delay increase in fuels most important to poor (e.g., lower quality foods, kerosene) But there is a limit to sequencing since large price differentials can cause market disruption (adulteration)

14 Developing a reform strategy IV Develop strategy for reform of social safety net Limit subsidies to products most important for lower income groups (low quality foods, kerosene) Limit quantities of subsidized products Limit eligibility for subsidized products to lower income groups (differential subsidy rates, means or proxy-means testing) With improved targeting, consider switching from price subsidies to price-indexed cash transfers However, subsidies and cash transfers address the symptoms but not the causes of persistent poverty Consider developing conditional cash transfer programs

Other topics covered Trade liberalization, devaluation and poverty Elimination of trade preferences in the Caribbean Agricultural sector reform Fertilizer subsidies (Malawi) Reform of groundnut sector (Senegal and The Gambia) Indirect tax and public pricing reforms 15