There are currently suggestions – so far muted — that after two years of fiscal consolidation, the time has perhaps come to relax some of the spending restrictions of the program adopted in 2013, in favor of more expansionary policies. One could say the authorities are caught in a dilemma of their own making: the claim that the economy has turned the corner from negative to positive growth, on the one hand, and the reality that there is no fiscal space to finance new investment and that there are few avenues for borrowing on reasonable terms and conditions, on the other.
In a democracy, waning public support for any policy, however well-intentioned, is grounds for a review of where we are and to what extent a course correction may be justified. For many, the “sell by date” for austerity has come and gone. After all, some argue, there is an encouraging turnaround in the tourism sector, the fiscal deficit, though not on target, continues to improve, and oil import prices are lower than expected and continue their downward slide.
So where exactly are we, and where do we go from here?
The eight hundred pound gorilla in the room is our gross debt to the tune of 110% of GDP and the fact that our access to external loan financing on reasonable terms and conditions has all but disappeared. In short, we need to address two audiences: one domestic and the other external. Whether we agree with them or not, external lenders – both commercial and multilateral — view a debt to GDP ratio of more than 90% as an indication that repayment of loans carries higher than normal risks. Moreover, tax revenues as a percent of GDP are just over 26%. There is therefore not a great deal of room for further increases in taxes without harming growth prospects.
Admittedly, higher growth would likely improve tax receipts. But the average annual rate of growth over the last five years was negligible (0.34%). From a creditor’s way of thinking, we are not likely to realize an annual rate of growth over the next two to three years much higher than 1% — that is, three times higher than the trend rate of growth.
Fortunately, there are still things we can do to make us a more attractive lending prospect than we currently are. Briefly put, we must improve our capacity to service debt. In other words, we must continue to borrow and to reduce the burden of debt relative to available resources at the same time.
We will face a long winter of austerity if we cannot significantly improve growth in the medium term. As pointed out above, however, it is fanciful to think, that we can achieve in the short-term a rate of growth more than three times the trend rate of growth (the average annual rate of growth, say, in the last 5 years). Nevertheless, there are things we can do to improve the current rate of growth. A far better job has to be done in identifying, preparing and executing major projects than has been done in the recent past. Far too many major projects have been announced and then withered on the vine. In this connection, public confidence in growth prospects could be greatly improved by making public the conclusions of financial and technical feasibility studies of projects that require government approval and/or underwriting.
Against a background of limited growth prospects, Government’s thinking on how it proposes to reduce and manage a high and unsustainable level of debt should be disclosed by officially adopting fiscal and debt rules. A primary surplus (the fiscal surplus before payment of interest on the debt) of 0.7% of GDP is not compatible with debt reduction or capacity to repay loans. A medium term target of several multiples of the current ratio should be adopted without delay. The debt to GDP ratio should also be officially targeted for reduction to below 90%. The view that this ratio does not matter is misguided.
Some thought should be given to combating fiscal adjustment fatigue. The authorities should be unequivocal in stating their determination to achieve the already declared fiscal targets and in explaining that some adjustment measures are more growth friendly than others. For example, there is ample evidence to support the view that expenditure reduction is more growth friendly than tax increases, which can quickly reach a point of diminishing returns.
There are worse things than austerity. A complete loss of creditor and investor confidence is one of them.