Distributional Analysis of Fiscal Policies at the IMF

1. Distributional Analysis of Fiscal Policies at the IMF PREM 2011 Knowledge and Learning Forum World Bank April 25, 2011

2. Outline • IMF involvement in distributional analysis • Formation of the PSIA group • Objectives • Modus operandi • Subsidy reform • Development of a reform strategy • Other topics addressed

3. IMF involvement in distributional analysis • The IMF has taken a more active stance on social policies over the years • IMF-supported programs have increasingly incorporated social safety nets and protected or increases social spending • Focus sharpened with the introduction of the PRSP approach • Key feature of PRGF • 2002 review of PRGF-supported programs

4. Formation of the PSIA group • PSIA Group set up in 2005 • Reflects recognition by the Fund of: • The importance of understanding the broader implications of its policy advice, and • The need for some internal capacity to energize and facilitate the integration of PSIA into program design • Work entirely in macro and structural contexts • Now part of the mainstream work of the Fund

5. Objectives • Better understand the likely impact of key reform measures on different population groups, in particular the poor; • Assess the appropriateness, timing, and sequencing of alternative measures in the design of programs; and • Where appropriate, design and integrate into IMF programs measures to mitigate any negative effects of reform policies.

6. Modus Operandi • Mix of approaches to inform design of—primarily—PRGF programs: • Absorb lessons from existing PSIAs carried out by other development stakeholders • Carry out own PSIAs where information gap exists • Support PSIA activities by country fiscal economists and desk economists (and elsewhere)

7. Modus Operandi (cont’d) • Complement to, not substitute for, the work of other, more important producers of PSIA • In particular, close cooperation with WB • Our niche is “rapid response,” either with interpretation of existing results or our own analysis

8. Modus Operandi (cont’d) • Work program developed with the area departments of the IMF—demand driven • Participation in area department missions • Stand alone technical assistance missions • HQ-based TA • Support to area department teams in conducting distributional analysis

9. Subsidy reform • Fuel Subsidies • Distributional analysis of fuel subsidies • Advice on implementation of automatic pricing mechanism of petroleum products • Smoothing mechanisms to reduce volatility of domestic petroleum prices • Recommendations on alternative measures to mitigate the impact of rising fuel prices on the poor • More general subsidy reform

10. Most of the benefit accrues to higher-income groups

11. Subsidy reform (cont..) • Low prices provide insufficient incentives to reduce consumption and worsen terms of trade impact • Low prices can result in smuggling abroad, higher fiscal costs, and domestic supply shortages • High fiscal cost crowds-out high priority public investments in education, health, and infrastructure

12. Developing a reform strategy I • Successful strategy needs to prepare population for reforms • Identify clearly the size of the fiscal cost of subsidies • Link cost to crowding out of key public investments which are crucial for growth and development (best way to protect most of population from high prices is through growth) • Highlight the high share of benefits going to higher groups and identify better ways of protecting poor • Identify inefficiencies of subsidies (smuggling, shortages, energy inefficiency)

13. Developing a reform strategy II • Reform strategy needs to be set out in advance • Identify key public investments that will benefit from reallocation of budgetary savings • Identify well-targeted programs that will be expanded/created to protect the most vulnerable social groups • Subsidy reform may involve other policy changes such as monetary and exchange rate policies, investment incentives, credit access, etc.

14. Developing a reform strategy III • Sequenced and gradual reform approach may be warranted if large price increases required (and fiscal conditions allow) • Instant adjustment of subsidies that mostly benefit the rich (higher quality foods, gasoline, jet kerosene and LPG?) • More gradual adjustment of other products to allow industry to adjust (e.g., diesel and LPG?) • Delay increase in fuels most important to poor (e.g., lower quality foods, kerosene) • But there is a limit to sequencing since large price differentials can cause market disruption (adulteration)

15. Developing a reform strategy IV • Develop strategy for reform of social safety net • Limit subsidies to products most important for lower income groups (low quality foods, kerosene) • Limit quantities of subsidized products • Limit eligibility for subsidized products to lower income groups (differential subsidy rates, means or proxy-means testing) • With improved targeting, consider switching from price subsidies to price-indexed cash transfers • However, subsidies and cash transfers address the symptoms but not the causes of persistent poverty • Consider developing conditional cash transfer programs

16. Other topics covered • Trade liberalization, devaluation and poverty • Elimination of trade preferences in the Caribbean • Agricultural sector reform • Fertilizer subsidies (Malawi) • Reform of groundnut sector (Senegal and The Gambia) • Indirect tax and public pricing reforms