Peru: Two approaches for the fiscal sustainability analysis

1. Peru: Two approaches for the fiscal sustainability analysis Jean Paul Rabanal Economics and Social Studies Division Ministry of Economy and Finance - Perú XVIII Seminario Regional de Política Fiscal Santiago, 24 de enero de 2006

2. Introduction • Fiscal sustainability is based on the need for financing the fiscal deficit • Two approaches known in the economic literature: • Ex-post: Intertemporal Government budget constrain with a long-term relationship between revenues and expenditures. • Structural Breaks in the economy (90s “First generation reform”) • Public debt data • Ex-ante: Foreseeable future path of revenues, expenditures and other relevant macroeconomic variables. • Blanchard indicator

3. Fiscal unbalance • Two periods: High and moderate fiscal deficits Fiscal Deficit (percentage of GDP) Source: Central Bank • 1970-1990: Fiscal policy oriented to impulse aggregate demand: investment projects, rising salaries, transfers, among others. And shocks: International debt crisis, Fenomeno del Niño. • 1990-Now: Stabilization program. Privatizations. Tax collection improvements. Fiscal Responsibility Law

4. Fiscal unbalance (II) • In general, prociclical fiscal policy contributed to the volatility of the economy. Fiscal impulse and Output Gap (percentage of GDP) Output gap Fiscal Impulse Note: Estimated with HP filter

5. Fiscal unbalance (III) • Increasing debt ratios. Public debt (percentage of GDP) Source: Central Bank • 1970s: Public enterprises, Banca de Fomento, and Loans by the Central Bank. • 1980s: Stop of the foreign capital. Fixed exchange rate. • 1990s: Constitutional Reform. Plan Brady (1997) • Last 1990s and 2000s: International Crisis and Domestic debt.

6. Ex-post model • Following, Ahmed & Rogers (1995) and Bohn (1995,1998) • Budget constraint (BC): • Present Value BC: • Taking first difference… • Debt is sustainable if G*, I cointegrate with a vector (1,-1):

7. Results • Unit root test: Variation of public debt is stationary • However, B is greater than 1 Long-term relationship

8. Results (II) • Gregory-Hansen test: Reject the null hypothesis “no cointegration in presence of structural breaks (1993)” Gregory-Hansen Test • Structural Reforms has an important effect on the fiscal sustainability Wald Test

9. Ex-ante model • Following, Jimenez (2004): Modified Blanchard indicator by different origin of debt • Budget constraint: • Modified Permanent Blanchard Primary Balance where: • So, the Sustainabiliy Indicator (I):

10. Scenarios • Basis assumptions: Basic assumptions • Three scenarios: (1) Multiannual Macroeconomic Framework (2) Rule 1: Fiscal Deficit = 1% of GDP (3) Rule 2: Structural primary balance = 1% of GDP

11. Scenarios (II) • New debt is financed by external sources Fiscal assumptions for the sustainability analysis

12. Scenarios (II) • If Peruvian economy followed the actual fiscal rule… fiscal sustainability risk! Fiscal assumptions for the sustainability analysis

13. Scenarios (III) • Several risk on the public accounts (exchange rate, commodities price, etc.) • Emphasizeinternal risk (unsatisfied public expenditure and political pressures) Commitment to fiscal rules? Source: Central Bank. Projections: MEF

14. Conclusions and recommendations • Reforms in the 90’s have had a strong positive effect on the sustainability of the public debt. • This suggests that an economy can not violate permanently the restrictions confronted by the Government. • Considering the MMF, Fiscal policy is sustainable. • But, there are several risks that could have a negative impact on the fiscal sustainability. • For this reason, apply a single fiscal rule based on the structural balance.

15. Peru: Two approaches for the fiscal sustainability analysis Jean Paul Rabanal Economics and Social Studies Division Ministry of Economy and Finance - Perú XVIII Seminario Regional de Política Fiscal Santiago, 24 de enero de 2006