Emerging Europe: The Fiscal Policy Stance

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.