The strongest steel is forged in the hottest fire

Thursday, December 06, 2012

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Fiscal consolidation is mission critical to restore sound fiscal management and bring debt into sustainable limits, with the hope that this will contribute to the resumption of tangible economic growth.

Admittedly, fiscal consolidation is difficult politically in all countries and has been so throughout history. Several Caribbean countries have untenable budget deficits and unsustainable debt. Jamaica and St Kitts have restructured a part of their public debt and Grenada and Belize have defaulted on a part of their debt.

The global financial crisis and the anaemic economic recovery in advanced countries have meant a significant worsening of fiscal management. The average debt/GDP ratio for the Caribbean has increased from 54% in 1997 to 80% in 2010, with Jamaica at 140%. Above 55%, debt becomes a severe constraint on economic growth and over 90% it is impossible to grow out of debt. In any case, economic growth in many countries is non-existent, especially in the tourism-dependent economies. Happily, commodity exporters like Guyana and Suriname and energy-based Trinidad and Tobago have experienced economic growth.

If a country cannot grow out of debt then debt reduction and fiscal consolidation are inevitable. Negotiated debt restructuring hardly ever provides the kind of relief that the debtor wants and needs. Explicit default entails significant reputational damage and increases the cost of future borrowing.

Fiscal consolidation will involve a combination of cuts in government expenditure and increases in revenue, almost invariable involving increased taxation. While raising more revenue is common, reining in expenditure has been a failure. In fact, revenue performance improved in the Caribbean since the mid-1990s but it has been outstripped by increased expenditure.

Past performance does not suggest that the public sector has the discipline or managerial capacity to sustain fiscal consolidation and the political directorate does not have the will or medium term perspective to lead their countries. They would rather hand over and go into Opposition for a few years.

A recent study of episodes of fiscal consolidation since 1980 reveals that the success rate is only 47% and this is similar to the experience of the advanced countries. The quality of fiscal consolidation in the past in the Caribbean is not encouraging because expenditure cuts have been largely in the capital budget which adversely affects public sector performance and efficiency in the private sector. There has been a serious reluctance to trim transfer payments and to restraint the public sector wage bill.

The political challenge of fiscal consolidation must not be underestimated but it has to be done. This will require real leadership which is akin to Churchill in World War II or Franklin D Roosevelt in the Great Depression. The strongest steel is forged in the hottest fire. The Caribbean needs leadership of the strongest steel. This is what is required to carry through the debt restructuring and fiscal consolidation with both expenditure cuts and increased revenue.

Such a policy mix is dictated by economic circumstances and the need to calm the psychology of uncertainty afflicting local and international financial markets. Fiscal consolidation takes time but governments can immediately signal a new resolute commitment to it.

Failure is not an option nor is delay.




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