by Aida Caldera, Paula Garda and Alberto Gonzalez-Pandiella, OECD Economics Department
Fiscal authorities in Latin America face the challenge of continuing to reduce high public debt levels which increased significantly during the pandemic. This challenge is further compounded by higher interest rates for longer and coupled with other fiscal challenges that the region was facing already before the pandemic (Arnold et al 2023). This includes a need to improve the efficiency of public spending efficiency and to mitigate fiscal policy procyclicality (Cardenas et al. 2021; World Bank, 2020). Despite relatively favorable sovereign debt amortization profiles in many countries in the region, a higher debt service (Figure 1), will mean that countries must increasingly mobilize public resources to ensure debt sustainability. This will need to be achieved without compromising spending in key social programs, health, education and infrastructure, all essential to promote potential growth that is low in the region and to meet increasing social demands.
These fiscal challenges make redoubling efforts to strengthen medium-term fiscal frameworks (MTFFs) particularly timely. A MTFF is a strategic plan where governments outline their fiscal policies and budgetary goals over a medium-term horizon, which is usually a period of 3 to 5 years. Hence, the framework serves as a roadmap for managing government finances and achieving various economic objectives. Most OECD advanced economies have these frameworks in place and existing evidence suggests that successful implementation of MTFFs has many potential benefits (IMF, 2013; OECD, 2019). First, they contribute to maintain a sustainable fiscal stance by generating a credible and predictable annual budget, underpinned by accurate medium-term macroeconomic projections. By incorporating a medium-term perspective into the fiscal framework, it aids in mitigating short-term bias when executing economic policies. They also enable understanding the origin and size of fiscal challenges as well as the impact of revenue and spending policy proposals before they are adopted giving early warnings about the fiscal sustainability of policies. Beyond their fiscal sustainability benefits, MTFFs also improve the efficiency of spending by promoting more effective allocation of expenditure between sectors and priorities and facilitating the planning and resourcing of multi-year policies that need extended time horizons for implementation, such as large capital projects. Lastly, these frameworks play a crucial role in mitigating the pro-cyclicality of fiscal policies, a key problem in Latin American economies. By providing a structured and medium-term approach to fiscal planning, they facilitate that fiscal policy can play a more significant role in smoothing the economic cycle. This implies providing support during downturns and gaining fiscal space when the economy is experiencing robust growth.
Figure 1. Net interest payments, % GDP
Note: Data for Chile refers to 2021 instead of 2022
Source: IMF, Fiscal Monitor, October 2023.
Latin American and Caribbean countries have experienced a surge in MFMP adoption (OECD, 2020 here). However, the level of development is heterogeneous and there is scope for improvement.
What areas for improvement?
- Establish expenditure ceilings. Multi-year aggregate expenditure ceilings, that is estimates of the total amount the government can spend in the years to come, are key elements during the preparation of the budget. This “top-down” approach to budgeting is an effective way of achieving the central objective of medium-term budgeting, which is to ensure that all expenditure and revenue decisions are consistent with aggregate fiscal policy objectives. By putting in place multi-year ceilings, they also help to avoid resorting to sharp budget cuts to achieve fiscal targets.
- Increase transparency and improve communication including with the parliament. An open and transparent budget process helps build citizen trust and can boost tax morale by reinforcing society’s perception that public money is being used correctly. In several OECD countries (such as Canada, France, Germany, New Zealand, Portugal, Sweden, or Switzerland), governments present their multi-year bill to their parliaments, detailing the budget for the current year and the subsequent ones. This prevents election cycle impacts on spending and avoids annual negotiations over incremental resources, making it easier to plan multiyear expenditures. Another good practice is that governments give regular updates to Congress on revenue and expenditure projections and targets, to positively engage Congress.
- Improve coordination across different levels of government. Establishing coincident medium-term frameworks for the different levels of government and mechanisms that facilitate the flow of information and allow joint planning and coordination of the execution of policies among different levels of government helps to improve the coordination between ministries and subnational governments.
- Reduce biases in projections and improve technical capacities: Only with quality information this framework can serve the purpose of guiding policies and investment forward. Reducing optimism biases in GDP and revenue forecasts is a pending and common challenge in many countries in the region. In this context, strong institutions are needed to forecast fiscal paths and risks, monitor the implementation of MTFFs, and enforce compliance with anchors.
- Measure contingent liabilities: Experience in several OECD countries (e.g. Portugal or Spain) show that monitoring and limiting contingent liabilities is particularly important, as they can be conducive to sharp deteriorations of the fiscal accounts and lead to fiscal stress episodes. Extra budgetary funds and contingent liabilities should not be left out but should be integrated into the MTTF.
- Include risk analysis, including climate change. A MTTF can bolster risk analysis, including climate change, by incorporating long-term fiscal projections that consider the potential financial implications of climate-related risks and policy responses. This would enable governments in the region to proactively assess and mitigate fiscal vulnerabilities stemming from climate change, and to devise the necessary policy responses to climate change and to integrate its budget implications in medium-term planning.
Improving medium fiscal frameworks in the region will allow governments to better navigate the economic cycles and signal that fiscal policies are sustainable, ensuring that medium-term expenditure strategies are geared towards strategic and equitable development while maximizing the effective and efficient utilization of resources.
References:
IMF (2013) Public financial management and its emerging architecture / editors, Marco Cangiano, Teresa Curristine, and Michel Lazare – Washington, D.C. : International Monetary Fund.
Cardenas, M., Ricci, L. A, Roldos J. and Werner, A. (2021) Fiscal Policy Challenges for Latin America During the Next Stages of the Pandemic The Need for a Fiscal Pact, IMF Working Paper WP21/77.
OECD (2020), Panorama de las Administraciones Públicas América Latina y el Caribe 2020, OECD Publishing, Paris, https://doi.org/10.1787/1256b68d-es.
OECD (2019), Budgeting and Public Expenditures in OECD Countries 2019, OECD Publishing, Paris. https://doi.org/10.1787/9789264307957-en
World Bank (2020), Fiscal Rules and Economic Size in Latin America and The Caribbean, https://documents1.worldbank.org/curated/en/935121618461168939/pdf/Fiscal-Rules-and-Economic-Size-in-Latin-America-and-the-Caribbean.pdf