The New Today


Transforming the economy with Fiscal Policy: Reforming the Fiscal Responsibility Act

The nation is approaching the time for the preparation and presentation of the 2021 national budget. This budget will be presented in the midst of the Covid-19 crisis. On 17th March, 2020, the Prime Minister invoked the Escape Clause contained in Section 10 of the Fiscal Responsibility Act. This suspended for a period not exceeding one fiscal year the fiscal rules, targets, and corrective measures under sections 7 and 8 of the Act as a result of the public health pandemic and the declaration of a state of emergency by the Governor-General.

The requirements following the invoking of the Escape Clause will now be part of the deliberations on the application of the Fiscal Responsibility Act to the 2021 Budget. This is an opportune time to re-examine the provisions of the Fiscal Responsibility Act, an important element of fiscal policy in Grenada.

The following is a reproduction of a previous Article which I published on reforming the Fiscal Responsibility Act. Specific reference is made to the fiscal rules and targets in the context of the need to resuscitate and transform the economy from the impact of the Covid-19 crisis.

Fiscal targets provide discipline for the implementation of fiscal policy. However, the targets should be designed to allow for adequate flexibility, enabling the authorities to manage the economy. The application of a primary expenditure rule of two (2) percent growth in real terms on an annual basis, restricts the government’s ability to use fiscal policy for stabilising and developing the economy.

A reform of the Fiscal Responsibility Act could take the form of amending the targets, thereby significantly reforming the Act, or revising the Act to facilitate development and ensure transparency and consistency.

Reforming the Fiscal Rules and Targets
In reforming the fiscal rules and targets, the application of a binding expenditure rule should be revisited. Utilising broad-based targets could ensure fiscal sustainability while providing for fiscal space to manage the economy. These broad-based targets are generally easier to calculate and facilitate citizen participation in fiscal policy.

The merits of such targets are:-

(1). Ease of determining the achievement of the targets.

(2). Ease of ensuring consistency in the treatment of the components of the fiscal targets.

(3). Government’s ability to manage among the various components of the accounts, that is, the wage bill, goods and services, transfers or social programmes and capital expenditure.

An alternative to the binding primary expenditure rule of a two (2) percent growth in real terms could be a positive central government primary balance excluding grants and capital expenditure.

This primary balance should be adequate to allow for the financing of interest payments and to contribute to the financing of capital projects. It would be an indicator of the Government’s ability to generate adequate domestic resources to finance operational expenditure and capital projects.

The other target should be an overall balance after grants including provisions for net amortisation, which is positive. This target would cover all government financial operations, including loan disbursements and principal debt repayment, while ensuring the government accumulates reserves.

The above fiscal rules and targets should be combined with a debt to GDP ratio equal to or less than the sixty (60) percent established for the Eastern Caribbean Currency Union (ECCU). As the public sector fiscal data develops, within a specific time, a public sector borrowing requirement could be included in the targets.

A binding primary expenditure rule of two (2) percent in real terms, applied to capital expenditure financed from domestic resources, restricts the government’s implementation of capital projects; as such expenditures are lumpy. It affects government’s ability to undertake major infrastructure projects that are financed from domestic resources. Adequate economic and social infrastructure is a prerequisite to economic development.

Revising the Fiscal Responsibility Act for Transparency and Consistency
An alternative approach would be to revise the Fiscal Responsibility Act for transparency and consistency. In doing so, the following should be addressed:

(1). The coverage of the Act and the accompanying data requirement.

(2). Transparency and consistency of the variables and targets; and

(3). Where applicable, the implementation process which should be presented with clarity.

Reforming the Coverage of the Act and Accompanying Data requirement
In reforming the coverage and accompanying data requirement the focus should be on the Public Sector and Public Sector Debt. As it relates to the public sector, the Fiscal Responsibility Act pertains to central government and covered entities.

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These covered entities are statutory bodies and state enterprises; and the Act outlines the criteria for including these entities in the coverage. Therefore, for analysis of compliance with the Act, comprehensive data on the public sector must be presented.

At present, data is provided on central government operations; while the Act covers central government along with qualifying statutory bodies and public enterprises. A consolidated public sector account, which includes central government, the National Insurance Scheme, statutory bodies, and public enterprises is needed for a thorough assessment of fiscal performance.

The Fiscal Responsibility Act refers to public sector debt; and reporting should therefore cover total public sector debt. In particular, there is the need to account for:

(1). Non-guaranteed debt of public enterprises (3.5% of GDP);

(2). PDV Grenada owed to Petro Caribe debt (11.5% of GDP); and

(3). Bilateral creditors debt (1.6% of GDP) that are not currently reported in the debt to GDP ratio.

The Medium-Term Fiscal Framework and the Medium-Term Debt Strategy, must present a policy position on these outstanding debts even if they are not included in the Fiscal Responsibility Act.

Reforming for Transparency and Consistency of the Variables and Targets
In this area issues of capital expenditure and the primary balance must be addressed. Capital expenditure financed from grants is exempt from the rules and targets. Therefore, capital expenditure, financed from domestic resources should be exempt from the expenditure rule of two (2) percent growth in real terms.

This will improve the transparency and consistency of the Fiscal Responsibility Act which stipulates that capital expenditure financed from grants are exempt from the fiscal rules and targets.

The Fiscal Responsibility Act would need to be specific on the applicable primary balance. That is, whether it is the primary balance, before grants or after grants. According to the Act, capital grants and the associated expenditures are exempt from the fiscal rules and targets. Therefore, capital grants should be excluded from the calculation of the primary balance and the applicable balance should be the primary balance before grants.

Providing Clarity on the Implementation Process
In providing clarity on the implementation process it would be necessary to clarify transfers from the National Transformation Fund.

The Fiscal Responsibility Act stipulates that forty (40) percent of the inflows in the National Transformation Fund should be saved for budgetary expenditure associated with contingencies, natural disasters, and debt repayments.

It also states that the inflows should be transferred to the Consolidated Fund on a monthly basis. For comprehensive analysis, reports on the transactions from the National Transformation Fund should be presented to Parliament. The inflows from the Fund that are transferred to the Consolidated Fund should be identifiable on the reports.

The Medium-Term Fiscal Framework summarises central government’s fiscal performance in relation to the achievement of the fiscal targets and the projections that are consistent with the Fiscal Responsibility Act. To allow for a comprehensive analysis of the fiscal performance, the Medium-Term Fiscal Framework should include data and analysis for two (2) years prior to the year being reviewed.

Information on the primary balance before grants should be included along with the financing component of the accounts. This will ensure that all central government transactions are reported. The performance of the covered entities should be included in the Medium-Term Fiscal Framework.

Ideally, a report on the total public sector operations is required for comprehensive fiscal analysis. Along with reforming the Fiscal Responsibility Act, the referenced documents, namely the Medium-Term Fiscal Framework and the Medium-Term Debt Strategy will need to be revised. Fiscal policy will remain the main instrument for managing the economy.

The Fiscal Responsibility Act will be the legal framework for executing fiscal policy. It is therefore an opportune time to reexamine that Act as a fiscal framework for transforming the economy.

Laurel Bain is a Grenadian-born former economist with the St. Kitts-based Eastern Caribbean Central Bank.