Fiscal consolidation: A risky undertaking
18 March, 2023, 2:30 pm
IN 2019, the International Monetary Fund (IMF) advised the Fijian government to undertake fiscal consolidation as the government had been delivering budgets with high deficits for a number of consecutive years, leading to a perception that it was living outside its means.
The Fijian government heeded this advice and delivered a budget of $F3.8 billion, which was $F0.8 billion lower than the preceding fiscal year’s budget.
That attempt at fiscal consolidation, however, proved to be a turning point, ended a 10-year streak of consecutive growth, and contributed to an economic contraction of 0.6 per cent.
Fiscal consolidation is a highly risky exercise, especially in a state-driven economy like Fiji’s.
Firstly, government spending is often a significant driver of economic growth in such economies. Reducing government spending can result in a reduction in overall demand in the economy, leading to slower growth or even recession, especially if the private sector is not strong enough to compensate for the reduction in government spending. This is the case with the Fijian economy.
Secondly, fiscal consolidation can reduce public investment, which can negatively impact economic growth and long-term productivity. This is especially concerning for state-driven economies that heavily rely on government investment to drive growth, such as those with limited private sector activity or underdeveloped financial markets.
Thirdly, fiscal consolidation may not necessarily improve debt sustainability, as it can lead to a decline in revenues and economic growth, making it harder for governments to service their debts in the long term, particularly when faced with high-interest rates or if external financing becomes more difficult to access. For some of these reasons, state-driven economies, therefore, typically only engage in fiscal consolidation when faced with one or more of these scenarios:
- Unsustainable public debt: If a country’s public debt becomes too high, it may be necessary to reduce the debt burden and avoid a debt crisis by implementing fiscal consolidation measures.
- Economic downturn: During an economic recession or slowdown, tax revenues may decrease while government spending on unemployment benefits and other social programs may increase. To avoid a large budget deficit and maintain the confidence of financial markets, governments may need to undertake fiscal consolidation.
- External pressures: Countries that are dependent on external borrowing may need to implement fiscal consolidation as a condition for new loans from lenders or financial institutions. Let’s examine if Fiji is faced with any of these scenarios.
Critics have argued that Fiji’s public debt is bordering on unsustainability. Economists generally consider a debt-to-GDP ratio between 40 per cent to 60 per cent to be sustainable for developing countries.
This is based on the assumption that developing countries typically have less capacity to service their debt than developed countries because of their smaller economies, weaker institutional frameworks, and greater susceptibility to external shocks. Fiji’s debt to GDP ratio had burgeoned to 89 per cent in 2021-2022.
While this is alarming, Fiji is not the only country that had its debt to GDP ratio increase steeply because of the COVID-19 crisis. Many countries found that, as government revenues plummeted, borrowing was the only solution to enable the government to support their overburdened health systems, provide relief to affected businesses and households and implement fiscal stimulus measures.
It is, however, promising to note that Fiji made a strong recovery from the COVID- 19-induced crisis in 2022, with a higher-than-forecasted growth rate of 15.1 per cent (estimate), making it the fastest-growing economy in the Pacifi c. This sizeable increase in GDP in one fiscal year will have positively impacted on the debt-to-GDP ratio, although official figures have not been released yet.
While there is concern that the nominal level of debt will surpass $10 billion by July 2023, it is important to assess debt sustainability in relation to GDP growth rather than in nominal terms.
It is also pertinent that Fiji’s national debt is, by large, from domestic sources. its recently released Pacific Economic Update, the World Bank has classified Fiji’s public debt as “sustainable” under its Debt Sustainability Analysis (DSA) risk ratings. Based on the current growth trajectory, the World Bank projects Fiji to surpass pre-pandemic GDP level by 2024 and this underscores
the need for supportive policies to sustain the current growth momentum.
The second scenario that necessitates fiscal consolidation is when the governments need to reduce budget deficit and
maintain confidence of financial markets during economic downturns. In the last budget, the deficit was sizable at 7 per
cent of GDP. With things normalising, as the acute phase of the COVID-19 pandemic seems to be over, there may be expectations for the government to deliver a budget with a ‘more acceptable’ deficit.
My strong view, however, is that the government needs some more time before it can deliver more balanced budgets, and that in a state-driven economy, stimulus budgets are necessary during the recovery period. In addition, there are no indications that the financial market, both domestic and international, have lost confidence in the ability of the Fijian government to service its debts.
In fact, Fiji had its credit rating upgraded last October. Conversely, if fiscal consolidation measures lead to a sharp decline in government revenue, this can affect Fiji’s creditworthiness, which would be detrimental.
The third scenario in which governments are forced to implement fiscal consolidation is when it is imposed as a condition by lenders for new loans.
As far as I am aware, there is no pressure from donor agencies or financial institutions to undertake fiscal consolidation, especially in the aftermath of the biggest economic crisis in contemporary history, and in a world where several countries have far worse debt and economic situations.
There are important lessons to be learnt from the 2019 experience, and this is the worst time to experiment with risky policy measures with a great proportion of our people still trying to rebuild their lives, having been battered by the -19 induced
Next week I will discuss how increasing spending efficiency, broadening the tax base and removing wasteful subsidies can
help us achieve fiscal stability without resorting to risky measures like spending cuts and tax increases that have potential
to thwart the ongoing economic recovery.
It is encouraging that the Fijian government is canvassing a wide range of views from different stakeholders in our economy before formulating its short, medium and long term plans for the national economy.
The Fiscal Review Committee and the upcoming economic summit will be very useful instruments for carving the right economic policies.
The economic summit will allow different ideas to be deliberated and debated upon and I commend the government for taking tangible steps to increase civic engagement in policy formulation. Unlike the past, where even good policies were not properly understood or “owned” by the people, these inclusive approaches at policy making will arguably lead to good outcomes. It is however, key, that policy makers engage in these exercises with an open mind and without a rigid stance and pre-determined
- NILESH LAL is the executive director of Dialogue Fiji. The views expressed in this article are the author’s and are not necessarily shared by this newspaper.