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Public finance and development: top reads in September 2022

Written by Tom Hart, Danielle Serebro

Expert comment

See all blogs in our public finance and development series.

Welcome back to the round-up. The global economic picture remains gloomy. Rising inflation and Russia’s invasion of Ukraine have led to what the head of the IMF, Kristalina Georgieva, has called the global economy’s ‘biggest test since the Second World War’. In June, the World Bank downgraded its global growth forecast for 2022 by nearly a third compared to its projections in January, and is now asking if a global recession is imminent. While energy exporters benefiting from higher prices escape the worst forecasts, 2022 growth projections have been revised downwards for nearly 70% of emerging market and developing economies and for 80% of low-income countries. This month, we focus on the fiscal consequences of this slowdown.

Slower growth, higher inflation, rising debt

The World Bank’s Global Economic Prospects (GEP) report highlights that the combination of weaker growth, rising inflation and higher borrowing costs is causing most low- and middle-income countries to tighten fiscal policy over the next few years – as Uganda’s new Charter for Fiscal Responsibility illustrates. Rising interest rates threaten debt sustainability in many countries; a new approach to debt restructuring is needed, as my colleague Judith Tyson notes. The World Bank calls for debt relief to be ‘rapid, comprehensive, and sizable to minimize risks to growth prospects.’

Climate swaps are often proposed as a way of reducing debt burdens and increasing investments in green growth and climate adaptation. But a new IMF paper provides a reality check, highlighting the very narrow circumstances under which debt swaps are better than grants or deeper restructuring.

Due to its bond issuance and large amounts of Chinese debt, Zambia is often seen as a test case for the new sovereign debt restructuring regime, the G20’s Common Framework. At the end of August, the IMF approved a $1.3 billion programme following China’s agreement to participate in restructuring. Many observers do not seem to be happy, however. Ex-IMF economist Peter Doyle argues that the primary surplus targets are too high, and Zambian economist Grieve Chelwa criticises the proposed spending cuts and tax rises to meet these fiscal surplus targets for being anti-poor and pro-rich. International bondholders are critical of the exclusion of domestic debt from any restructuring.

Zambia had to wait the best part of a year between agreeing to an IMF programme and receiving any financing. To give debt-distressed countries financial breathing room and to avoid the kind of social consequences seen in Sri Lanka, Clemence Landers and Nancy Birdsall propose that the G20 agrees to suspend all debt when a country applies for restructuring under the Common Framework, and that the IMF makes financing immediately available in the case of foreign exchange shortages instead of waiting until debt restructuring negotiations are complete. This builds on improvements to the Common Framework that the World Bank and the IMF have been calling for. Given the social costs of default, we certainly hope the G20 will heed these calls at its November meeting.

Challenges in reprioritising expenditure

Given the tight fiscal conditions, the GEP places an emphasis on redirecting spending away from inefficient areas such as fossil fuel subsidies and towards targeted relief for vulnerable households. Without this, rapid food price increases could result in 75 million more people falling into extreme poverty, according to GEP estimates. This will be especially important in South Asia and sub-Saharan Africa, where food accounts for 44% and 37% of average household expenditure respectively.

A World Bank report from earlier in the year, Revisiting Targeting in Social Assistance: A New Look at Old Dilemmas, has useful advice on targeting social assistance. It highlights that while technological advances could help improve targeting, supportive policies and attention to the inter-operability of systems and data quality are nonetheless still needed.

But if targeting expenditure is not straightforward, then reprioritising it is no easier. Governments will need to find areas to cut while at least maintaining, if not increasing, spending on growth-promoting areas such as education and infrastructure. Given the devastating impact that Covid-19 has had on education, we are glad to see the Center for Global Development looking at education spending. Their report, Schooling for All: Feasible Strategies to Achieve Universal Education, argues that the two top education spending priorities should be universal free school meals and free secondary education, as they target challenges that can be resolved with greater investment, are affordable and have a realistic chance of having a successful impact.

The IMF’s Public Investment Management Assessment is increasingly used to evaluate the quality of capital investment systems, including in the UK. The first handbook was published over the summer. For those seeking an alternate view, the World Bank has also published its Infrastructure Governance Assessment Framework (‘InfraGov’) and will complete 20 of these this year. Bent Flyvberg’s forthcoming book on megaprojects, How Big Things Get Done, will also provide useful advice, judging by Tim Harford’s preview: ‘Large projects are complex and difficult, but the basic principles are not. Take your time planning. When the plan is complete, execute it as quickly as possible. Keep things as simple as you can, using repeated modular elements and avoiding eye-catching world firsts. Above all, ask yourself what you’re trying to accomplish before you start.’

Estimating expenditure baselines (the path of future expenditure, assuming policy remains unchanged) can be useful to support the reprioritisation of expenditure. They can help clarify available fiscal space, as well as the size of savings or cuts needed to introduce new programmes or expand existing ones. An IMF technical note discusses various methodologies for producing them and how they can be put to use most effectively. Mark Robinson argues that setting hard budget ceilings early in the budget process is a zombie idea in PFM and that instead, the process should aim to show expenditure baselines and any available fiscal space on top of this. Agencies should then be allowed to bid for this during the strategic phase of the budget cycle.

Managing fiscal risks

The IMF has launched a Fiscal Risk Management Portal, including a Fiscal Risk Toolkit – which aims to help countries identify, assess, manage and disclose different sources of risks – and a Knowledge Hub, which includes the IMF’s guidance, latest research and country examples.

A recent World Bank paper finds that fiscal risks from PPPs are low in South Asian countries – less than 0.3% of government revenues under normal conditions. However, this could rise to as much as 4% of revenues in the case of a macro-financial shock that causes early termination. Lessons from Chile’s large PPP programme suggests that contract renegotiation is the major source of fiscal risk, increasing costs by around a third, but that the use of variable-term contracts dramatically reduce renegotiations.

Greater openness is often advocated as a way of reducing fiscal risks. The brilliantly named Skeptic's Guide to Open Government aims to convince, well, sceptics, of the benefits of open government. We are not sure it does that – the evidence highlighted feels a little too cherry-picked – but the background papers are certainly worth a look for a more nuanced picture of the evidence on issues such as fiscal transparency, open contracting and social audits.

The challenges of budget reform

Budget processes are often criticised for focusing on the inputs, not the results, of spending. Reforms such as programme-based budgeting (PBB) and results-based financing aim to correct this by increasing the focus on results while giving agencies greater flexibility in managing inputs. However, in practice this has often not been the experience, as a new World Bank paper notes. Many countries end up maintaining input controls because of the perceived risks of moving away from their current system of fiscal control: ‘Program budgeting has too often been associated with the undermining of control, while the pursuit of control has been at the expense of the higher-level goals of program budgeting.’ The paper outlines a set of proposals to pragmatically manage this tension between financial control and management flexibility.

Similarly, the World Health Organization has published a guide to programme budgeting in the health sector. While it is great to see an in-depth examination of this reform in the health sector, we remain unconvinced that there will be much benefit from the additional complexity that PBB adds to an already challenging budget process in many countries. The report sets out sensible policy goals (improved policy alignment; enhanced transparency and accountability for outputs; greater financial flexibility), but the question remains whether PBB is likely to achieve these. As well as the financial control issues covered by the World Bank paper, PBB reform must still grapple with challenges. These include ensuring the effective and routine use of performance data, limiting the transactions costs of reporting, and making PBB part of broader reforms that encourage public sector managers to pay attention to performance and results.

A World Bank blog adds to the ongoing discussion about the feasibility of integrating performance-based financing in education and health with traditional PFM systems.

Gender budgeting is another tool that has received much attention in recent years. But amid the advocacy, there has been much less detailed work looking at the gendered impact of tax and spending policies. We welcome the publication of a gendered fiscal incidence for Ethiopia analysing the incidence, progressivity and pro-poorness of different taxes and transfers.