IMF Art IV Consultations 2017 Press Release: A wake-up call

(Published in L'Express)

The IMF is appreciative of the projected level of real GDP growth of 3.9% in 2017, and of the continued robust economy, but considers that “vulnerabilities are rising”, namely with regard to a) the rising public debt and high budget deficit, b) rising inflation and low interest rates, and c) the rising current account deficit, and the overvaluation of the rupee exchange rate.

a.     High Budget Deficit and Rising Public Debt

The IMF end of mission report expresses concerns about the trend in the budgetary and debt situation. There is a need for “rebuilding the credibility of the fiscal anchor”. The fiscal anchor is the statutory public sector debt ceiling of 50% of GDP under the Public Debt Management Act, which has lost much of its credibility by its deadline extension by 2 ½ years from Dec 2018 to June 2021. The statutory public debt target acts as an anchor in limiting increases in budget expenditures and in the budget deficit, and in fiscal borrowing which would increase public debt. The credibility of the fiscal anchor has also been affected by the tortuous accounting in the budget figures via the newly created extra budgetary funds which when integrated with the official fiscal balances yields much higher (consolidated) budget deficit figures.(see arguments below)

There is also a need for “creating fiscal space for infrastructure and human capital investment.” The budget deficit is too high to allow for a needed increase in capital spending and the budgetary outcomes are turning out to be significant threats to fiscal soundness and sustainability. However, for the IMF mission debt sustainability was not an issue if the right policies are pursued. The IMF therefore recommends a reduction in the budget deficit through additional revenue measures – “Staff recommends supplementing the planned fiscal consolidation with additional revenue stabilization efforts to strengthen the credibility of the fiscal anchor.” The revenue measures would not involve higher taxation, but improved tax efficiency and collection efforts.

The planned fiscal consolidation (i.e., reduction), as stated in the 2017-18 budget document, projects a ratio of the budget deficit to GDP of 3.2% in 2017-18, 3.0% in 2018-19, and 2.8% in 2019-20, showing a downward trend from 3.6% in 2015-16, and 3.4% in 2016-17.  Public Sector Debt as a ratio to GDP would be reduced to 63% in June 2018, 62.8% in June 2019 and 62.2% in June 2020. The IMF considers this budget deficit and debt reduction as too weak, hence the need to “strengthen” the credibility of the fiscal anchor.

The IMF recommendation is that the budget deficit, starting from this fiscal year, 2017-18, should be reduced further by additional revenue measures, to lower the need for borrowing and thus limit the increase in public debt. If the deficit is not reduced further, the accompanying public debt increase will lead to another missing of the public sector debt target (redefined to 60% of GDP) to be attained by June 2021 and thus will not be judged as credible.

b.   Rising Inflation and low interest rates

 The IMF also expresses concerns about the level of interest rates. It considers that inflationary pressures need to be tackled - “Inflation has picked up …., but there are signs of building of inflationary pressures.”, and that interest rates are too low – “Nominal interest rates are at historically low levels, and real market interest rates are negative.”

The IMF therefore recommends an increase in nominal interest rates – a “tightening of monetary policy”, to tackle rising inflationary pressures.

c.   Rising Current Account Deficit and Rupee Overvaluation

 The IMF expresses concerns about rising external imbalances, namely, that “the overall current account deficit, as percent of GDP,…. is expected to widen over the medium term”.  The IMF recommends that the rupee exchange rate of the rupee be allowed to depreciate further , for e.g., by buying foreign currencies to build up our external reserves further – “Staff recommends allowing more flexibility of the exchange rate to help address the emerging imbalances”. and “improving competitiveness to support growth”.

A weaker rupee would help to boost exports and discourage imports, thus reduce the current account deficit.  The current account imbalance is also caused by reduced cost competitiveness, relative to our foreign competitors, due to our real wage growth in excess of productivity gains.  Rupee depreciation is thus necessary to preserve export competitiveness, and reduce the current account deficit.  Structural reforms to improve the functioning of the labor market and to improve the supply of labor would also contribute to better align real wage and productivity growth, and raise export as well as overall growth. The IMF also highlights rising “financial stability risks” on account of the rising level of nonperforming bank loans and also mentions that pension reforms (which will be among the measures for fiscal consolidation to put our public finances back on a sustainable path) had not been a subject of study by the mission.

Note:

There had been a change of guards at MOFED but their ways of doing things have not changed. The scenario has remained more or less the same.  I have no choice but to raise my pen once again to pen down these financial cons who are at their old game of creative accounting, à la ex-Emperor Ali, to misguide the PM and the Nation. 

The risks of weakening macroeconomic fundamentals are too high to allow them to get away with their budgetary gimmicks. The IMF Article IV consultations press release is the wake-up call for the unravelling of these budget charlatans who have been trying to take us, including you, for a ride at every budget exercise. They continue with their colorable devices, their curious arithmetic and dubious accounting, their special and extra budgetary funds , their concocted definition of debt and their back -of-the- envelope projections which are ultimately earning us the reprimand of the IMF . Our budget figures "are not comprehensive," and it is only by consolidating the budget figures that we will "increase fiscal transparency and provide a better measure of the fiscal stance” and the level our debt commitments.

First Point :  In 2017-18, the budget deficit is estimated to widen to 4.4% of GDP.  The official deficit estimates of 3.2% of GDP is understated, because the transfer of balances of Rs5.7 billion upon the closure of two special funds should not be considered as revenue. The GFS system defines Revenue as an increase in net worth resulting from a transaction. The increase in Net Worth happened in the previous fiscal year from a transaction and it was recorded in the Annex H (Net Worth) to the budget document as an increase in financial asset. Any transfer of funds merely changes the classification of the balances under financial assets , it does not increase revenue.

Thus surplus balances of special funds cannot be counted as revenue upon consolidation with the budget. Their drawdown only provides an alternative way of financing the deficit. Transferring Rs 5.7 billionn from the special funds to the budget only means that debt financing needs for the consolidated deficit will accordingly be  reduced. Just as drawing on the savings balance does not enhance a household’s income, but only serves to finance its revenue-expenditure deficit, without having to borrow more.  The drawdown of the bank balance does not reduce the household deficit, only the means of financing.

Second Point : To derive the consolidated budget for fiscal year  2017-18  we should also include the  off-budget capital expenditures of some extra budgetary units amounting to Rs10.4 bn, or 2.2% of GDP. The consolidated budget deficit works out to be Rs 31.6 billion, equivalent to 6.6% of GDP

Last Point : The whole storyline of the budget , as detailed out in the medium term fiscal framework,  of delivering a budget deficit of 2.8% of GDP by 2019-20,  is not convincing. Unfortunately, as in previous years, these over-optimistic projections of planned fiscal consolidation seem to have been drawn from the back of an envelope.  And it is not surprising that the wake-up call from the IMF draws our attention to the credibility of our whole fiscal exercise.