Assessing Fiscal Space

Fiscal space is a multi-dimensional concept reflecting whether a government can raise spending or lower taxes without endangering market access and debt sustainability. Making such a determination requires a comprehensive approach considering, among other things, initial economic and structural conditions, market access, the level and trajectory of public debt, present and future financing needs, and dynamic analysis of the liquidity and solvency of the fiscal position under alternative policies. Balancing these considerations involves careful analysis and judgment. Fund staff has over the years developed a variety of indicators to inform assessments of fiscal space in bilateral and multilateral surveillance. The Fund’s core operational framework for such analysis is the debt sustainability framework, which includes a number of indicators, while allowing room for staff judgment. Surveillance also relies importantly on indicators developed by the Fiscal Affairs Department (FAD)––including those that have been used in the internal Vulnerability Exercise and Fiscal Monitors––while more recent methods based on fiscal stress tests and probabilistic approaches proposed in IMF (2016) are also promising. In addition, teams have used scenario analysis and general equilibrium modeling approaches to evaluate fiscal policy choices and their implications for sustainability. When applied to fiscal space, each indicator and approach has pros and cons and none covers all the relevant factors. Ultimately, therefore, assessing fiscal space requires judgment, informed by a broad range of tools. This note seeks to bring together various approaches developed by Fund staff to outline a consistent set of considerations and indicators to help inform assessments of fiscal space, especially for advanced and emerging markets. The intent is to facilitate continued consistency between country team assessments by providing some common considerations and approaches to inform their judgment. The proposed framework will support Fund surveillance and policy advice going forward, informing discussions of the appropriate fiscal stance at all stages of the economic cycle.

This paper reviews the experience with the fiscal space assessment framework that was piloted during 2017–18. In 2016, staff proposed an operational definition of fiscal space and a new four-stage framework for its assessment. These were discussed informally by the Board in June, and a Board paper “Assessing Fiscal Space: An Initial Consistent Set of Considerations” incorporating Directors’ views was published in December. Fiscal space was narrowly defined as the room for undertaking discretionary fiscal policy relative to existing plans without endangering market access and debt sustainability. The framework was developed in response to the need to provide a more systematic approach to assessing fiscal space in the Fund’s surveillance. It was designed as a tool to inform the availability of fiscal space over a 3 to 4 year horizon for discretionary action, as opposed to the optimality of its use. Indeed, it was stressed that the availability of space does not necessarily mean that it should be used or should not be further expanded. The framework was piloted in the Article IV consultations of 34 advanced economies and emerging markets, comprising almost 80 percent of global GDP in PPP terms.

With new initiatives to provide low income countries with external assistance in support of the Millennium Development Goals (MDGs), donors and NGOs are seeking to understand whether "fiscal space" can be provided in the context of IMF-supported programs to support these initiatives. This paper defines the concept of fiscal space and its link to fiscal sustainability, describes alternative ways in which fiscal space can be created, and notes how the IMF can support appropriate efforts to create fiscal space. The paper underscores that the issues that arise in creating fiscal space are not novel, but have always confronted governments in judging whether there is scope for additional expenditure.

Initially defined for overall public purposes, the concept of fiscal space was subsequently developed and adapted for the health sector. In this context, it has been applied in research and policy in over 50 low- and middle-income countries over the past ten years. Building on this vast experience and against the backdrop of shifts in the global health financing landscape in the Sustainable Development Goals (SDG) era, the commentary highlights key lessons and challenges in the approach to assessing potential fiscal space for health. In looking forward, the authors recommend that future fiscal space for health analyses primarily focus on domestic sources, with specific attention to potential expansion from the improved use and performance of public resources. Embedding assessments in national health planning and budgeting processes, with due consideration of the political economy dynamics, will provide a way to inform and impact allocative decisions more effectively.

Abstract: To what extent can public deficits increase without putting fiscal sustainability at risk, given the specific current macroeconomic situation of protracted low growth and low interest rates, combined with relatively high government debt levels? The answer depends on many factors, such as the state of the economy, the fiscal track record and projections of population ageing and their effect on government spending. This paper makes use of three different approaches to better assess fiscal space, which can be defined in a broad manner as the extent to which public debt can increase. These approaches converge to a conclusion that there is fiscal space in most of the large advanced economies. There is also evidence that fiscal space may have risen in most OECD countries since 2014, mainly driven by the decrease in interest rates. Reforms to health and pension programmes would help to create additional fiscal space

This paper reviews the experience with the fiscal space assessment framework that was piloted during 2017–18. In 2016, staff proposed an operational definition of fiscal space and a new four-stage framework for its assessment. These were discussed informally by the Board in June, and a Board paper “Assessing Fiscal Space: An Initial Consistent Set of Considerations” incorporating Directors’ views was published in December. Fiscal space was narrowly defined as the room for undertaking discretionary fiscal policy relative to existing plans without endangering market access and debt sustainability. The framework was developed in response to the need to provide a more systematic approach to assessing fiscal space in the Fund’s surveillance. It was designed as a tool to inform the availability of fiscal space over a 3 to 4 year horizon for discretionary action, as opposed to the optimality of its use. Indeed, it was stressed that the availability of space does not necessarily mean that it should be used or should not be further expanded. The framework was piloted in the Article IV consultations of 34 advanced economies and emerging markets, comprising almost 80 percent of global GDP in PPP terms.

Noting that the aftermath of the global financial crisis has left many advanced economies with very high sovereign debt ratios and some emerging markets with high debt, this report considers whether there are ways to expand fiscal space that do not involve countries paying down debt or promising to do so in the future, to make fiscal consolidation more growth-friendly. It explains that policymakers argue that their fiscal space is limited and that it would be difficult to take advantage of the opportunity of low interest rates to undertake fiscal expansion, and it considers a ways to raise fiscal space that does not require contractionary fiscal policy and whether there is a way to make fiscal consolidation more growth-friendly to produce larger gains in fiscal space. It argues that debt management policies may provide an answer to expanding fiscal space for a given path of primary fiscal balances by reducing the risk that a sovereign may default in bad states and generate a payoff in terms of reduced to real borrowing costs. It describes two debt management policies: issuance of GDP-linked debt and issuance of longer maturity bonds, as opposed to short-term debt. It focuses on the effect of these debt management policies on real borrowing costs and default risk for the sovereign and details the literature on GDP-linked debt and the maturity structure and how the report fills gaps in the literature; how uncertainty affects fiscal space and how debt management can play a role in increasing it, with estimates and simulations of potential gains in fiscal space flowing from debt management; and the sensitivity of the findings to underlying assumptions and policy implications.

This paper presents new empirical evidence on how fiscal space in Sub-Saharan Africa has evolved over the past 15 years. Fiscal space is a multi-dimensional concept that is proxied by indicators capturing aspects of fiscal sustainability, balance sheet vulnerabilities, external debt positions, and market perception. The analysis relies on a new comprehensive database developed on a wide array of indicators (28) for a large set of countries in the world-of which 48 are in Sub-Saharan Africa. The analysis finds that, breaking with history, Sub-Saharan African countries were able to conduct countercyclical policies amid the 2008-09 global financial crisis, thanks to built-up liquidity and policy buffers. The evidence shows that fiscal adjustment efforts in the region were reversed amid the 2014-16 plunge in commodity prices, and oil and minerals and metals exporters saw a sharp deterioration in their primary balance sustainability gap. The paper finds a great deal of heterogeneity in the post-global financial crisis evolution of the fiscal space in the region. In countries with reduced fiscal space, the increase in the number of tax years to repay the debt fully was 1.1 years for the representative country, and in over one-third of the countries, this increase was more than one standard deviation above the median.