24th October 2022, Skopje – Topics covered in this column will pertain to fiscal consolidation, debt and budget financing. Financial close of the 2022 Budget was provided, while Ministry of Finance is to submit the 2023 Draft Budget to the Government within the next seven days. Hence, this is the right time to discuss these matters.
In 2020, as a result of the COVID-19 impact, the world observed the largest one-year debt surge since World War II. As per IMF data, global debt (private and public) rose by 28 percentage points to 256% of GDP, in 2020. This surge was mostly pertinent to the public debt. Global public debt reached historic high 99% of GDP, i.e. it picked up by 19 p.p. of GDP in 2020, an increase like that seen during the global financial crisis, over two years (2008 and 2009). However, public debt increase was justified by the need to protect people’s lives, preserve jobs and avoid a wave of business closures. If governments had not taken action during the COVID-19 induced crisis, the social and economic consequences would have been devastating.
Savings and Economic Growth
Excessive debt amplifies vulnerabilities of the economies. Now that the world is facing a new crisis, wherein the cost of capital is continuously increasing, the need for fiscal consolidation is greater than ever, in particular as regards the developing countries, having limited fiscal space. Fiscal consolidation entails precise policies geared towards budget deficit and debt reduction. Fiscal consolidation plan implies measures focused on gap reduction between revenues and expenditures, by cutting expenditures and/or increasing revenue collection. Budget deficit may also be reduced by reinforced economic growth, which will contribute to higher budget revenues and less expenditures (for instance, less spending on social care, as a result of the unemployment rate reduction).
Fiscal consolidation effects – actions taken on the expenditure and revenue side, as well as the dynamics and the required time period for its implementation, have always been a discussion item among the economists. Keynesian-oriented critics believe that savings may give rise to major adverse consequences, particularly on the short-term growth, as it initially leads to negative effects on domestic demand. Expansionary fiscal contraction hypothesis (for example, Giavazzi and Pagano, 1990) provides a completely opposite perspective thereon, as per which, large cuts in government spending will boost private consumption, as a result of reduced government spending and positive expectations as regards the tax policy in future. In other words, smart fiscal consolidation implies higher average real economic growth in the adjustment year, as well as in the following two years, than the one attained two years before the consolidation.
In times of energy crisis and rising inflation Europe confronts nowadays, and accordingly our country as well, fiscal consolidation is the adequate response thereto in terms of curbing the demand so as to prevent an inflationary spiral in anticipation of further price surge, and hence tightened monetary policy, which is to entail higher interest rates and slowed down economic growth.
SMART Fiscal Consolidation Concept
In times when global economic activity is slowing down, with the inflation being at a decade-long high level, while central banks are raising their policy rates, all factors must be taken into account when carrying out the fiscal consolidation. Smart fiscal consolidation identifies measures, which provide for boosting the growth or being at least less invasive on its slowdown. As I indicated above, the progress in reducing the budget deficit and the general government debt is directly influenced by the GDP growth, as they are expressed as a percentage of GDP. Moreover, economic growth may contribute to consolidation by increasing the government revenues. Smart fiscal consolidation prefers credible detailed medium-term programs, as well as programs that would be activated in case of deteriorated developments, as well as a broad reform process, also including structural reforms aimed at boosting competitiveness and growth potential. This also implies improved efficiency of both the government expenditures and the tax system.
Public expenditures may be divided into public investments, current and social expenditures. Consolidation does not only mean spending cuts, but also targeting the funds towards attaining economic growth. Thus, for example, subsidies extended to areas that will provide for value added, are costs, which will not undermine the respective consolidation. Focus is placed on investments made in the field of human capital, education, and as of recently, digitalization. In addition, expenditure cuts does not necessarily imply public investment cuts, in case new ways of financing, not burdening the budget, are sought.
SMART consolidation is cautious as regards the amount of tax rates since they might slow down the growth. As an alternative, the proposed approach is to broaden the tax base by abolishing the exemptions that mostly apply to high-income entities.
So as for the fiscal consolidation to be effective, as well as support the economic growth, the implementation dynamics and the mix of measures to be applied, is of crucial significance. Appropriate balance between the spending cuts and the tax reforms is one of the key issues as regards SMART fiscal consolidation. Consolidation dynamics is significant as well. As regards the economic theory, there is well-known concept of more aggressive consolidation (front-loaded adjustments), where 50% of the total budget deficit reduction was achieved in the first half of the foreseen time period, and gradual fiscal adjustment (back-loaded adjustments). Approach, which is to be applied, will depend on the specific features of the economy and its structure, however, the gradual approach is recognized as more sustainable in the economic theory.
Maastricht Rules on Fiscal Sustainability
During the pandemic, in 2022, both in the world and the countries in the region, the general government debt grew sharply by around 10 p.p. to 15 p.p. As a result of the extensive fiscal response to the pandemic, public and general government debt picked up by approximately 11 percentage points in our country as well. As for some EU Member States, public debt increase exceeded even 20 percentage points as a share of GDP. As of the following year already, the debt started to decrease, being lower by around 6 percentage points lower compared to 2020, as per the latest data. In the second quarter of 2022, public debt accounted for 55.4% of GDP, while general government debt accounted for 46.7%, being below the Maastricht Criterion (public debt of 60% of GDP).
With respect to the Maastricht criteria, there are deliberations that the debt (60% of GDP) and deficit (up to 3% of GDP) thresholds no longer match the reality, since they were set three decades ago (the debts of the EU economies are much higher). Even higher thresholds were set in the economic theory, as well as by the international financial organization depending on the development of the economies, however, it is of crucial significance for the debt to remain at a sustainable level, i.e. for the economic output to be sufficient to service the debt, thus leading to its reduction with satisfactory dynamics. So far, I have written a lot about the SMART public finance reform and all aspects thereof. I will herein stress that fiscal consolidation was always a priority in this reform. Adopted new Organic Budget Law is actually in light thereof, under which Fiscal Council and fiscal rules have been introduced, in support of completion and sustainability of the overall fiscal consolidation process.
Under the 2023-2027 Fiscal Strategy, gradual budget deficit reduction per year, was stipulated, by which in the medium-term, it will fall below the Maastricht Criterion, i.e. less than 3% of GDP in 2026. In order to strengthen the fiscal discipline, the medium-term fiscal strategy contains limits on budget expenditures, limits by budget user, as well as medium-term projections for the local government and the public enterprises and the state-owned joint stock companies.
Fiscal consolidation – Case Study of North Macedonia
Gradual fiscal consolidation has been planned, which will underpin the economic growth, combining the following: I. improved budget revenue collection by enhancing the administrative capacities and improving the services of PRO and the Customs Administration, measures aimed at reducing the grey economy and tax reform. II. reducing and restructuring budget expenditures, reducing the current expenditures, greater support to the private sector, support to innovations and boosted competitiveness, revision of methodologies for transfers and subsidies and III. changes in the sources of financing the budget deficit, rescheduling the public debt, greater diversification of the sources of financing the deficit, as well as financing and implementing certain projects through public-private partnerships, Development Fund for Strategic Investments and mobilization of financial capital from the international financial institutions and the private sector.
As regards the first two aspects, the Government has adopted Fiscal Consolidation and Economic Growth Support Plan. It comprises three parts: consolidation of expenditures of government institutions, improved collection of revenues and measures and recommendations for public enterprises and state-owned companies. Moreover, it also includes the concept of consistency and optimization of economic policies and reforms contributing to economic growth, with performance indicators for the budget programs in relation to the priority economic policies and reforms – referred to as “value for money” concept envisaged in the Budget. With respect to the third aspect, adequate mechanisms are envisaged within the Growth Acceleration Plan, which is aimed at economic recovery and accelerated economic growth to 5% in average in the coming five years.
Significant cost savings are possible by rationalizing and optimizing the working processes in the public sector, coupled by optimal systematization, as well as introducing mechanisms for consolidation of expenditures related to goods and services by cutting the overhead expenses and travel expenses, as well as costs related to office supplies. For the purpose of streamlining the expenditures, focus is placed on improving the execution of capital expenditures through the established CAPEF mechanism for “punishing and rewarding” the budget users by reallocating the budget funds throughout the budget year from those underperforming to those showing better execution thereof, coupled by Public Investment Management Assessment – PIMA and methodology for assessing the performance of capital investments via Smart Key Performance Indicators, introduced with the new Organic Budget Law.
Improving the public revenue collection through further improvement of the tax regulations to the end of optimizing the tax system is a must, considering that we are legging behind both the EU and the regional revenue collection average as percentage of GDP. Moreover, mechanisms for strengthening the capacities for public revenue collection, as well as intensified revenue collection from tax and customs debtors, are envisaged. Activities are undertaken so as to increase both the efficiency and the effectiveness of the excise revenue collection system, by developing policies, systems, procedures and instruments for efficient revenue control and collection, further enhancement of the paperless system for handling the excise documents and increasing the efficiency of excise controls by introducing targeted controls over high-risk excise goods, as well as by intensifying the cooperation with the relevant agencies in the EU countries and the international institutions. In addition, activities aimed at tax evasion prevention, raising the public awareness about the detrimental consequences of the informal economy and strengthening the tax morale have been intensified. Both inspection capacities in the country and interinstitutional coordination of control will be enhanced, and digitalization of processes, such as e-invoice, e-fiscalization, track and trace system for the excise goods, will continue.
The Plan also includes measures and recommendations for the public enterprises and the state-owned companies to be implemented by preparing five-year financial and business plans for their profitable operations. Reorganization of their working processes is also recommended, without thereby disrupting the everyday functioning. Possibility to generate savings as regards current expenditures is huge, envisaging savings up to 20%. With respect to certain loss-makers, being a liability for the Budget, but also being able to operate in market conditions, their privatization or public private partnership will be recommended.
Moreover, what is of great importance for the fiscal consolidation and the economic growth in the long term is structural reforms, for instance, human capital reforms and investments, in particular, reforms in the health sector and the pension system, education, R&D investments, reprogramming the subsidies in terms of their better targeting and efficiency and similar labour market and business climate improvement reforms. Still, considering their complexity requiring extensive elaboration, and given the limited space allotment for writing, I will tackle these topics in more details in one of my next columns.
Mobilizing Finances following the Example of the Juncker Plan
Accelerated economic growth in the medium term will also provide for stabilization of the budget deficit, hence the debt as well. Growth Acceleration Plan sets mechanisms which will multiply the public investments, according to the good practices of the Juncker Plan (under which much more funds were mobilized than the one allocated by the state). The purpose of the Plan is to scale up the total investments in the economy, thereby staying on the set path to gradually reduce the fiscal deficit and to maintain stable debt level.
Sources and mechanisms for mobilizing additional funds include the IPA funds and funds from IFIs, the private sector, development funds, innovation support funds, guarantee funds, equity funds, venture capital funds and similar instruments for support of export-oriented companies, small- and medium-sized enterprises, as well as social enterprises. Public-private partnerships, concessions and other instruments for financing public capital projects are also planned to be put in places, to be coupled by financing private sector projects. Growth Acceleration Plan will support public and private sector projects aimed at boosting the competitiveness of the economy and better quality of life, i.e. covering areas such as environment, digitalization, innovations, human capital and social inclusion.
Consolidation Continues despite the Repayment of Prior Debts Falling Due
Financing of the Budget for this year has been ensured. Although we might say it has been a challenge, considering the ongoing circumstances, the tightening of the interest rates by the big central banks and the significant deterioration of the conditions on the capital market. In times when highly developed economies compared to our, with a much higher credit rating, paid higher interest rates, we have managed to optimize our portfolio with the lowest costs for the country (weighted interest rate of borrowings is around 3.2%). This portfolio included IFIs’ instruments, as well as government securities issued for the first time on the German market (following the example of highly developed economies). Estimated savings generated only on the basis of interest under this portfolio are around EUR 40 million.
Cooperation with the international development partners is of crucial importance in this period of “complex insecurity”. IMF’s Precautionary and Liquidity Line (PPL) arrangement, made available only to countries with sound economic fundamentals and policies, inspires additional credibility of the macroeconomic policies we implement and enhances the confidence of the participants on the global capital market. We have designed the new Country Partnership Framework together with the World Bank, focusing on the driving force of sustainable economic growth, emphasizing the social inclusiveness and the green transition. Eradication of informal economy, promoting fiscal decentralization and poverty reduction are the areas in which we cooperate with the UNDP. Ensuring support for green transition, strengthening the stability and the sustainability of the energy system, as well as many other major infrastructure projects, are areas of cooperation with the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB). Intensified activities are being undertaken jointly with the US Department of the Treasury and USAID in the field of public financial management reform, coupled with further strengthening of transparency and accountability.
Next year’s challenge will be even greater, taking into account the forecasts on extended duration of the crisis, as well as the prior debts falling due next year. Prior debts falling due in 2023 on the basis of principal alone amount to around EUR 800 million, EUR 450 million out of which on the basis of the Eurobond issued in 2016. Interest falling due next year amounts to around EUR 240 million, or both debt and interest falling due exceed billion euros. Still, taking into account all measures planned for the fiscal consolidation, we remain on the path to gradual reduction of the deficit. In line with next year’s Budget, fiscal deficit gradually narrows so as to respond to the medium-term targets. Next year’s budget deficit is expected to decline in relation to this year, hence we continue reducing the deficit third year in a row following 2020, i.e. after the COVID-19 crisis.
On the medium term, several barriers remain to be overcome in terms of financing the arrears, above all those accumulated during the COVID-19 crisis. However, with a prudent and moderate approach and the mix of savings and conducting adequate policies to stimulate growth and increase revenues, we will surmount them as well.
At the end, I will conclude by expressing a notion always running through my columns. What is important in the economy is to look at the big picture with a medium-term and long-term perspective for the economic growth. Adequate measures and policies in the short term are often unpopular and criticized, but it is these measures that provide for the economic well-being of all in the long term. In order to reach our goals, we have to be cautious – to vigilantly monitor, we have to be efficient – to react swiftly and finally, we have to act strategically – to have focus in the long run.
Fatmir Besimi, Minister of Finance
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