1. The Public Finances and the Pacto Fiscal: Comments Adrienne Cheasty Senior Advisor, Fiscal Affairs Department International Monetary Fund CEPAL 20 th Regional Seminar on Fiscal Policy Santiago de Chile January 28-31, 2008 The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its managemen t

2. 2 Thank you, CEPAL Latin America is in better fiscal shape than considered possible 20 years ago Some of the credit must go to CEPAL, and to this seminar, for its success in: –raising awareness of fiscal issues –becoming a focal point for policymakers and academics to develop their thinking on them – influencing fiscal strategies by clear-minded thematic agendas and publications

3. 3 However, the Agenda of the Fiscal Pact remains valid Consolidate the ongoing fiscal adjustment Raise the productivity of public spending Make fiscal activities more transparent Promote equity Support the development of democratic institutions

4. 4 Consolidate the ongoing fiscal adjustment (1) The good fiscal performance may not be robust to an unfavorable international environment More than half the variation in Latin American GDP can be explained by external shocks (Osterholm and Zettelmeyer, 2007)

5. 5 Although there is a positive output gap....

6. 6 Downside risk is increasing for the region

7. 7...And recent fiscal gains are tailing off,...

8. 8... mainly because spending continues to grow rapidly

9. 9 Consolidate the ongoing fiscal adjustment (2) Some aspects of the fiscal environment will be different in the coming 20 years. –Easier access to market financing –Redemption from original sin? –More capital flows

10. 10 New: easier access to market financing More fiscal discipline, or less? The less the financing constraint, the greater the possibility for counter-cyclical fiscal policy Fiscal multipliers may be different Crowding out via the interest rate channel is reduced as capital mobility increases Switching from captive sources of financing may mean domestic interest rates become more sensitive to fiscal policy Trade openness reduces fiscal multipliers (but not by much) Households with better access to credit may become more Ricardian—offsetting a fiscal contraction by increasing borrowing

11. 11 A shift towards domestic debt— because of improvements in terms...

12. 12... and redemption from original sin

13. 13... imply improved debt composition and less risk, so debt tolerance has increased But: Need to maintain a balance between local and foreign currency debt, to reduce temptation to inflate away local debt—and to establish borrowing benchmarks Ensure government borrowing from the banking system does not lead to inefficiencies and delayed development of domestic capital markets Will original sin return if global credit tightens?

14. 14 New: more capital flows Fiscal tightening is not always appropriate –As a response to inflows when the external current account is in surplus –As a response to outflows with non-fiscal causes and consequences But it very often is appropriate –Need to ‘pre-position’ fiscal policy, to give it market credibility, and the flexibility needed to confront the new sources of volatility associated with financial globalization

15. 15 Raise productivity of public spending Pre-positioning largely means savings on the spending side, as revenue is decelerating along with growth –Key pending fiscal reform: tackle budget rigidities/revenue earmarking –To close the infrastructure gap, make public investment more efficient rather than cutting it Remove unintended constraints on high-return investment by well-run public enterprises

16. 16 Raise productivity of public spending (example) Remove unintended constraints on high- return investment by well-run public enterprises Criteria for permitting low-risk public enterprises to be excluded from fiscal targets (managerial independence, governance, financial sustainability, etc.) The criteria create a roadmap for public enterprise reform and reduction of an important category of fiscal risk

17. 17 Make fiscal activities more transparent Emphasis on transparency is a key innovation of the last two decades... But still a frontier –Standards and codes (mainstreaming ROSCs/EITI) –Comprehensive oversight and monitoring Public enterprises Public-private partnerships Guarantees Other contingent liabilities

18. 18 Promote equity Fewer gains here, and more at stake –CEPAL’s tax project –Must fiscal termites win? An effective PIT Better compliance

19. 19 Develop democratic institutions Fiscal advances: transparency, FRLs – not enough to be democratic, but also need to be responsible. We have learned how to make FRLs better –Transparency and accountability –Broad coverage –Procedural rules are more durable than numerical –If the rule has to be numerical, follow best-practice –Effective enforcement mechanisms –Integration with public finance legislation