The State of our Public Finances

Titbits

If we want to comment on the state of our public finances, a cursory look at the budget balance as presented by the Ministry of Finance (MOF) is not enough. We need to go deeper.

First of all, we need to consolidate the figures; the off-budget funds (the Special Funds) will have to be integrated to the budget to generate adjusted comprehensive fiscal aggregates.

TABLE – Consolidated Budget (adjusted for Special Funds)

Consolidated Budget (adjusted for Special Funds)

As a % of GDP

07/08

08/09

2010

2011

2012

2013(E)

2013(Rev)

Revenue minus  grants

20.3

21.4

20.6

20.3

20.7

21.0

20.8

Revenue

20.5

22.4

21.3

21.0

21.4

21.6

21.3

Tax revenue

18.4

18.8

18.5

18.3

18.8

18.7

18.5

Expense

20.2

21.5

21.4

20.0

19.9

21.3

21.5

o/w  Comp. of employees

4.9

5.8

5.9

5.6

5.4

6.0

6.6

Use of Goods and Services

1.6

1.8

2.1

1.9

1.9

2.0

1.9

Interest

4.1

3.8

3.4

3.0

2.9

2.9

3.0

Grants

5.2

6.3

5.2

6.0

4.6

4.0

4.2

Social Benefits

4.0

4.2

4.5

4.4

4.5

4.6

4.7

Capital spending

1.7

2.1

3.4

3.5

3.7

3.9

2.9

BUDGET BALANCE(excl Special Funds)

-2.7

-3.0

-3.2

-3.2

-1.8

-2.2

-2.4

BUDGET BALANCE

-1.5

-1.3

-3.6

-2.4

-2.2

-3.6

-3.1

PRIMARY BALANCE

2.6

2.6

-0.1

0.6

0.8

-0.7

-0.2

You will recall that that these Special Funds were created as a result of the underspending on the capital side. Rather than allowing this underspending to be reflected in smaller budget deficits, the MOF transferred these surplus funds to a set of off-budget Special Funds. Adjusting the Budget figures for these funds will thus ensure greater transparency, reduce budgetary fragmentation and result in stronger expenditure controls in our public finances.

Next, a decomposition of the fiscal aggregates will reveal some of efforts that have been carried out at fiscal consolidation in addition to the priorities and challenges ahead. It also helps to provide an illustration of the pressures on future public spending and revenues that government will need to manage. (The annual government budget for all public spending is broken down into several hundred items for approval by the National Assembly. The presentation and debates on the budget usually focus on expenditure programs as a whole. But the Programme budgets still have capital and current components, usually with only limited freedom to vire between Capital (Capital spending) and current expenditure (Expense) are also somewhat distinguished in the accounts of spending units and in reporting expenditure.)

The evolution of the budget deficit between 2007/08 and 2013 shows an increase of 1.6% of GDP accounted for by a 1.3% hike in expense and 1.2% in capital expenditure and moderated by a 0.8% of GDP growth in revenue. The ratio of the structural primary balance to GDP deteriorated from a surplus of 2.6 to a deficit of 0.2. If we exclude the fortuitous factors like a 1.1% reduction in interest charges and yearly EU grants equivalent to 0.5 to 1% of GDP, the consolidated budget deficit adjusted for Special Funds would have amounted to some 5% of GDP in 2013.

Potentially worrying is the low growth in tax receipts, the high growth in the government wage bill and the continuing upward trend on welfare benefits. Grants and the wage bill were kept in check for some years but the latter exploded with the recent PRB awards to more than 6.0% of GDP. Fiscal revenue (without grants) as a proportion of GDP has stagnated at around 20% of GDP despite the breast thumping during the early years of the tax reform when fiscal revenue was being strengthened. The other major observation is the heavy reliance on indirect taxation, which is now affecting the growth of consumption demand since consumer debt has increased to unsustainable levels. The tax effort is below its potential, as compared with other middle-income countries. Tax revenue is too low at 18% of GDP.

TABLE — Evolution of Fiscal Aggregates

In the recent IMF Art IV 2013, the IMF had recommended revenue raising measures to better balance the budget and to be on the safe side. It had proposed: “Increases in the revenue-to-GDP ratio could be achieved through growth-friendly and environmentally-sustainable taxes (including excises, VAT, and real estate taxation). The tax system should also be reviewed with the objective of eliminating remaining exemptions (including several of the VAT exemptions introduced in the 2013 budget) and improving the design and administration of the major taxes. There is potential to introduce a true carbon tax, and also to raise taxation of fuel products, both serving environmental and external balance objectives.”

The main criticism about the evolution of the fiscal accounts over the past six years is insufficient capital spending, which is now beginning to hurt the current growth potential — water, power, energy and transport sectors. The MOF has consistently failed to address the underlying causes of implementation delays especially in physical infrastructure, with the exception of road construction. It is very important to increase public investment to reduce the infrastructure deficit and support domestic demand, and thus boost growth given that private investment is projected to remain subdued in 2013.

It is not only the level of expenditure that matters, but the quality and composition of expenditure also matter because they ensure its effectiveness at the end of the chain. Government should rebalance and prioritise its expenditures to improving health, education, technical training, innovation and infrastructure facilities which in turn will encourage private investors. Finally, the Welfare State is becoming a synonym for massive inefficiency and waste, with the continuous deterioration in public services, particularly education and health. Private spending in education and health is high and substituting for ineffective public spending. The quality and delivery of public health services are increasing out of line with the fast changing needs of an ageing society (putting direct pressure on the public finances through impacts on age-related expenditure, such as state pensions or health care) and cannot cope with new and more expensive health requirements, e.g. for cancer treatment. Education and health reform are a priority. The government should generate more fiscal space to meet these priorities which will generate future productivity growth.

* * *

The Central Bank’s Macroprudential Measures

We have not heard much from the members of the Monetary Policy Committee (MPC) in reaction to the macroprudential measures taken by the Bank of Mauritius. Or do they consider it not to be their turf? But whether they like or not, the use of macroprudential policy is likely to interact with the transmission mechanism of monetary policy decisions as they both affect the behaviour of financial intermediaries.

The Bank of Mauritius (BOM) is supposed to discuss and take account of the financial stability risks connected with a given monetary policy stance in formulating its macroprudential policies. Monetary policymakers in turn should take account of action or inaction on the part of the macroprudential authority when calibrating monetary policy. Mutual internalisation of policy action that is conducive to an optimal policy mix can be more readily achieved when the central bank works in coordination with the MPC. They are expected to complement and support each other. However, there is also potential for a conflict of interest, or at least trade-offs, between them, such as a monetary policy that is too loose and is amplifying the financial cycle or, conversely, a macro-prudential policy that is too restrictive having detrimental effects on credit provision and hence monetary policy transmission.

What exactly is macroprudential policy? The financial crisis has demonstrated the need for a broader set of policy tools that can be used to mitigate systemic risk. Time-varying macroprudential policy aims to enhance the resilience of the banking system and over-exuberance in the supply of credit by discouraging the build-up of financial imbalances that might otherwise have led to a systemic banking crisis. A number of macro-prudential instruments (MPIs) such as caps on loan-to-value ratios or loan-to-income ratios, margin and haircut requirements and loan-to-deposit ratio thresholds are used. This broad array of macro-prudential instruments is intended to ensure that the goal of macro-prudential policy, namely of reducing systemic risk, is achieved. Systemic risk is an elusive and multi-layered concept, and hence it is generally recognised that multiple macro-prudential policy instruments may be needed to prevent the materialisation of systemic risks.

What surprises us is the facility with which the measures are being implemented without any questioning, especially from the MPC members, on the timing, appropriateness and effectiveness of some of the macroprudentail measures. Since when has the Central Bank acquired the expertise of diagnosing “bubbles” and “systemic” risks? Which systemic risks?

Our financial system does not have those toxic innovative financing mechanisms like securitisation, credit swaps, over the counter hedging vehicles and so on that led through some systemic shocks to the near collapse of the financial systems of some developed economies. So why this heavy arsenal of MPIs that may turn out be countercyclical and a major hindrance to growth?

In its October Inflation Report, the BOM blames the MOF for the lack of an expansionary fiscal policy that has stayed too focussed on the need to meet statutory debt targets and this has led to sustained cutbacks in public investment. But in chasing the barely visible cobwebs of systemic risks, the BOM may equally stand guilty of throttling growth and investment. Fine-tuning a poorly understood system goes quickly awry. The science of “bubble” management is, so far, imaginary.” How can the BOM predict bubbles but the market can’t? How does the BOM know what is an actual bubble and what isn’t a bubble but just a rise in prices?

Much of the macroprudential policy is still under development. To date, a variety of MPIs have been suggested, but verification of their effectiveness is needed if they are to be applied in the real world. A review of the existing literature shows that studies are still being done on the effectiveness of macroprudential tools, including quantifying the effect of macroprudential policy instruments on credit growth, leverage, asset prices, and asset price bubble.

Another set of research addresses how monetary policy and macroprudential policy should be coordinated, including the question of the interaction between macroprudential policy and monetary policy and modelling of financial intermediation and frictions therein in macroeconomic models used for monetary policy purposes.

Though there is a growing consensus among academics and policymakers that macroprudential policy is theoretically an effective and sophisticated policy tool to combat systemic risk, there is need for further research on the effectiveness of macroprudential instruments in order to yield more consistency to findings reached by means of cross-country experiences. In some emerging markets, the specific calibration (design and magnitude) of the macro-prudential rule determines its effectiveness in contributing to macroeconomic stabilisation.

In the recent discussion paper by the Bank of England on ‘The role of macroprudential policy’ mention is specially made of the clear limitations on the extent to which prudential policy might moderate the credit cycle, given free capital mobility and uncertainties over the transmission mechanism — particularly at peaks and troughs of the cycle which are very relevant to our local context. It also recommends that “that constraints be placed on a macroprudential regime to ensure transparency, accountability and some predictability. That would call for clarity around the objectives of macroprudential policy, the framework for decision-making, and the policy decisions themselves. It also suggests the need for robust accountability mechanisms.”

If our tone of scepticism about the macroprudential measures seems to be overly cautious, it is only because the stakes are indeed so high.

* * *

The Poverty Trap

There has been too much talk recently about “assistanat” on the issue of poverty rather than the painstaking sustained and consistent efforts that are needed to support the poor. What if you were told that for those living in poverty, they develop a scarcity mindset, that makes coping with poverty even harder. “If you want to understand the poor, imagine yourself with your mind elsewhere. You did not sleep much the night before. You find it hard to think clearly. Self-control feels like a challenge. You are distracted and easily perturbed. And this happens every day. On top of the other material challenges poverty brings, it also brings a mental one… The failures of the poor are part and parcel of the misfortune of being poor in the first place.” Then your whole thinking about poverty would actually be different.

This is exactly what Harvard economist Mullainathan and Princeton psychologist Shafir using behavioural economics argue in their recent book ‘Scarcity: Why Having Too Little Means So Much’. Their book examines the psychology of scarcity and the scarcity mindset that narrows perspective and perpetuates lack through the limiting of one’s options. This is an important new work that addresses the psychology of poverty and how people’s minds work differently when they feel they lack something. The results of their research show empirically that the feeling of scarcity places very real limits on what people are able to see, and the authors offer strategic interventions as behavioural solutions to help break these cycles that lead to the scarcity mindset

By making people slower-witted and weaker-willed, scarcity creates a mindset that perpetuates scarcity, the authors argue. In developing countries too many of the poor neglect to weed their crops, vaccinate their children, wash their hands, treat their water, take their pills or eat properly when pregnant. “The poor are not just short of cash. They are short on bandwidth.”

Ingenious schemes to better the lot of the poor fail because the poor themselves often fail to stick to them. The authors describe these shortcomings as the “elephant in the room” — which poverty researchers ignore because it is disrespectful to the people they are trying to help. But if these so-called character flaws are a consequence of poverty, and not just a cause of it, then perhaps they can be faced and redressed. There are also some excellent ideas about ways to improve social support programs, such as graded reductions in support rather than a shocking cut-off. Perhaps this can be of help to our NEF instead of sterile statements like “nous ne tolérons pas l’assistanat’.


* Published in print edition on 8 November 2013

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