Emerging Europe: The Fiscal Policy Stance

Publication date
Friday, 25.01.2002

Augusto Lopez-Claros



The table below presents the key budget aggregates for the main countries in emerging Europe (and South Africa, for purposes of additional comparison) for the period 1998-2002. Putting aside methodological issues concerning international comparability of government finance statistics (in particular, the issue of comprehensiveness of coverage), it is possible to discern a number of interesting common features as well as differences in fiscal performance during the past several years. A brief summary follows:

With the exception of Russia (since 2000), all countries have run budget deficits over the entire four-year period 1998-2001. In the Czech Republic the fiscal position has deteriorated substantially in the last couple of years, reflecting the fiscal costs of a major banking sector cleanup. The underlying, cyclically adjusted, deficit has also risen, however, ahead of this year’s parliamentary elections. At 7.5% of GDP in 2001 (and projected to rise to 9% of GDP in 2002), the Czech authorities have a major problem of fiscal consolidation in coming years, a significant worry ahead of EU entry. A partially mitigating factor should be the relatively low level of public sector indebtedness, well under 25% of GDP, even if the (unrecorded) losses of the banking sector are assumed gradually to make their way into the public accounts.

In Poland, for different reasons, mainly to do with a depressed economy and the weakness of the last government, the deficit target in 2001 was overshot by over 3% of GDP. The high cost of pension reform has also pushed the deficit higher in recent years. In both countries debt-service costs have remained broadly stable, although at a much lower level in the Czech Republic. Hungary, on the other hand, has not seen the same deterioration in the fiscal position. The deficit is actually on a downward path of adjustment (mainly led by a drop in the expenditure/GDP ratio) and the authorities are running a primary surplus. While total public sector debt levels, running at 61% of GDP, are higher than in Poland and the Czech Republic, they are seen as manageable in a medium-term context. All three countries have managed to maintain revenue/GDP ratios at relatively stable levels in recent years, although the weakness of output in Poland has constrained the authorities’ options more noticeably than in Hungary or the Czech Republic, where output growth has remained buoyant.

Emerging Europe: Fiscal indicators
Percentage of GDP


Turkey has by far the most complicated fiscal picture. The public debt’s interest burden on the budget in 2001 was close to 22% of GNP, forcing the authorities to run a large primary surplus. Some of the deterioration seen in the last couple of years, with the overall deficit more than doubling in relation to GNP, reflects the incorporation into the budget of quasi-fiscal operations not properly accounted for in the past. This has contributed to increase the transparency of Turkey’s fiscal accounts (a good thing), but it means that, to ensure sustainable fiscal accounts and prevent repeated financial crises, the authorities will have to run large primary surpluses for the foreseeable future.

This is likely to entail serious political economy challenges for the authorities, particularly against the background of an economy that remains depressed; real GNP fell by 8.5% in 2001. A second, equally worrisome, problem is that the government has relied heavily on official debt inflows (mainly fr om the IMF) to finance its budget deficit. While this has relieved pressures on domestic interest rates, there are growing concerns about the emergence of a large public sector debt overhang, a growing share of which is denominated in foreign exchange. The public sector debt/GNP ratio at end-2001 was over 90%, more than 30 percentage points higher than at the outset of the IMF’s programme in early 2000. Close to 40% of total public debt is now external, and the share is growing rapidly.

Russia’s fiscal accounts, which as late as 1998 were running large deficits, have recently moved sharply into a surplus position. Terms of trade gains, a rapidly expanding economy, and increasingly effective expenditure control mechanisms have resulted in a fairly massive swing in the fiscal balance, equivalent to some 8.5 percentage points of GDP in the three-year period to 2001. While the recovery of oil prices has had much to do with the improvement in the fiscal accounts, a number of structural changes have also been major contributing factors. First, with the approval of a tax code in 2000, the tax regime became more transparent and predictable, a major gain with respect to the pre-crisis period. The authorities have managed to reduce tax rates and seen actual improvements in revenue collected. Tax compliance rates have improved in a tangible way, in sharp contrast to the pre-1998 crisis days when the federal government appeared to be gradually losing control of tax collection in the regions.

Second, with the domestic debt default and the after-effects of the crisis, the government lost access to the international capital markets and there was a drying up of official finance as well. This effectively imposed a hard budget constraint on the public finances which the authorities have used well. The public debt to GDP ratio has fallen sharply, from 82% of GDP in 1999 to 46% in 2001 and is projected to decline further this year. A rise in dollar GDP explains some of this drop, but large debt repayments are the main factor. Indeed, Russia has begun to amortize debt ahead of schedule; some $2.7 bn to the IMF in 2001.

Elsewhere in the emerging world, South Africa has continued to follow a cautious fiscal policy.  Revenue growth has been remarkably resilient over the past few years. An upgrade of the tax collection system involving improvements in computerisation has contributed to sharply lim it the scope for tax evasion. These reforms did not just yield one-off benefits, but have boosted the tax take despite significant cuts in personal tax rates. Expenditure is budgeted to increase sharply over the coming years. The Medium Term Expenditure Plan is focussing on increasing infrastructure investment as well as dealing with a broad range of social problems. The budget deficit has consistently beaten expectations, but a good performance over the next few years will depend on a successful privatisation programme, starting with the IPO of Telkom later in 2002.



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