Speech

Laying the Foundations of Good Fiscal Management in the Arab World

February 9, 2019

As Prepared for Delivery

Good morning—Sabah Al-Khair! I am delighted to be back in Dubai, this city of tomorrow, where you—its economic leaders—are dedicated to realizing the vision of a better tomorrow.

This vision is predicated on prosperity that is shared by all, benefiting the poor and the middle class, citizens and immigrants alike; and opportunities that are open to all, including women. It is a vision of fairness over cronyism and partiality, and of trust that government policy is oriented toward the common good.

This is a big vision. But as Sheikh Mohammed bin Rashid Al Maktoum once said “The bigger your vision, the bigger your achievement will be…we cannot let fear keep us small. We have to be brave to be big."

As you know so well, fiscal policy plays a vital role in creating and nurturing this vision of sustainable and inclusive growth—especially as encapsulated in the Sustainable Development Goals. This is because we need fiscal space for spending on health, education, social protection, and public investment—all key priorities in this region.

This is why I wanted to come back to the Arab Fiscal Forum—my fourth time now. In past years, I talked in detail about fiscal policy—the spending and revenue measures needed to achieve sustainable and inclusive growth. This year, I want to go one level deeper—into the foundations of fiscal policy and good fiscal management.

Because without a stable foundation, even the best policies can flounder. Without a stable foundation, fiscal policy will lack credibility.

In this vein, I will address two key pillars of good fiscal management: (i) strong fiscal frameworks; and (ii) good governance and transparency.

Prelude: Global and regional context

Before I do this, let me say a few words about the broader economic context bearing on fiscal policy in the region.

Unfortunately, the region has yet to fully recover from the global financial crisis and other big economic dislocations over the past decade.

Among oil importers, growth has picked up, but it is still below pre-crisis levels. Fiscal deficits remain high, and public debt has risen rapidly—from 64 percent of GDP in 2008 to 85 percent of GDP a decade later. Public debt now exceeds 90 percent of GDP in nearly half of these countries.

The oil exporters have not fully recovered from the dramatic oil price shock of 2014. Modest growth continues, but the outlook is highly uncertain—reflecting in part the need for countries to shift rapidly toward renewable energy over the new few decades, in line with the Paris Agreement. With revenues down, fiscal deficits are only slowly declining—despite significant reforms on both the spending and revenue sides, including the introduction of VAT and excise taxes. This has led to a sharp increase in public debt—from 13 percent of GDP in 2013 to 33 percent in 2018.

At this juncture, the global expansion is weakening, and risks are rising. Just a few weeks ago, we released our revised forecasts. We now think that the global economy will grow by 3.5 percent this year, 0.2 percentage points below what we expected in October. And risks are up, given escalating trade tensions and tightening financial conditions. Unsurprisingly, a weaker global environment has knock-on effects on the region through a variety of channels—trade, remittances, capital flows, commodity prices, and financing conditions.

The bottom line: the economic path ahead for the region is challenging. This makes the task of fiscal policy that much harder, which in turn makes it even more important to build strong foundations to anchor fiscal policy.

1. Fiscal Frameworks

The first building block of this foundation is a good fiscal framework. By this I mean the set of laws, institutional arrangements, and procedures needed to achieve a country’s fiscal policy objectives. Such a framework allows governments to map out budgets over the medium term in a way that reflects clear, consistent, and credible goals.

There is scope to improve fiscal frameworks in this region. Some of the weaknesses are short-termism and insufficient credibility.

On short-termism: given that inclusive and sustainable growth is an inherently medium-term goal, fiscal policy needs a medium-term orientation. Focusing on the immediate horizon makes it harder to implement critical but longer-term reforms in such areas as tackling high public wage bills, designing effective social protection systems, and getting rid of harmful fuel subsidies. Short-termism implies that fiscal policy amplifies rather than tames the waves of booms and busts—making it more difficult to achieve sustainable and inclusive growth.

Turning to fiscal credibility: I am referring to such factors as large amounts of spending kept off-budget and poor risk management. Across the region, it is common for sovereign wealth funds to directly finance projects, bypassing the normal budget process. And state-owned enterprises in some countries have high levels of borrowing—again, outside of the budget. Addressing these fiscal risks would not only enhance budget credibility and transparency but would help keep a lid on corruption. Budgetary credibility also calls for better risk management, with a more comprehensive budget based on realistic forecasts.

The good news is that numerous countries are already strengthening their fiscal frameworks—many with IMF assistance. Just to give some examples:

• Saudi Arabia, Kuwait, UAE, Sudan, Qatar, and Lebanon have all set up macro-fiscal units—a useful first step in strengthening the fiscal framework.
• Algeria has recently adopted a new budget law with a strong medium-term orientation, and Bahrain has introduced a fiscal program designed to achieve balance over the medium term.
• Mauritania, Morocco, Jordan, and Lebanon are making great progress with medium-term public investment planning and execution.
• Egypt now publishes a fiscal risk statement with its budget and produces an internal in-year budget risk assessment. The UAE too is rolling out a fiscal risk management project—with the IMF’s help—and will produce its first fiscal stress test this year.

There is scope for further improvement. Perhaps the oil exporters could follow the example of other resource-rich countries such as Chile and Norway in using fiscal rules to protect key priorities such as social spending from commodity price volatility.

Strong fiscal frameworks have other important benefits. They form the basis for sound debt management. They also allow for better coordination between fiscal and monetary policies, so that the two arms of macroeconomic management work together, not at cross purposes.

2. Good Governance and Transparency

Let me now turn to the second pillar of good fiscal management—good governance and transparency. In this context, governance refers to the institutional frameworks and practices of the public sector. Strong institutions are crucial for legitimacy, for fostering a clearer understanding of policy objectives among citizens, enhancing their voice, and generating buy-in for fiscal policy.

On the other hand, as many of you have said, weak institutions imply a weak policy foundation that could crack and crumble—because there is inadequate legitimacy and public accountability. Even worse, these cracks could also let corruption creep in. And you know so well, this is social poison—it feeds discord, disengagement, and disillusionment, especially among the young. The word corruption, after all, comes from Latin root for rotting, breaking apart—disintegration. And the word in Arabic, fasad, also connotes this idea of rotting or coming undone.

Corruption is the great disruptor of fiscal policy. Without trust in the fairness of the tax system, it becomes harder to raise the revenue needed for critical spending on health, education, and social protection. And governments might be tempted to favor white elephant projects instead of investments in people and productive potential. Add this up, and we have a recipe for unsustainable fiscal policy combined with social discord.

This a global issue—relevant for large and small countries, advanced and low-income economies, and the public and private sectors. Given this, it is no surprise that IMF research found that weak governance and corruption are associated with significantly lower growth, investment, FDI, and tax revenues—and higher inequality and exclusion.

Specifically, we found that improving on an index of corruption and governance by moving from the bottom quarter to the mean is associated with an increase in the investment-to-GDP ratio of 1.5–2 percentage points and a bump up in annual GDP per capita growth by half a percentage point or more. [1] We will have more analysis in the upcoming Fiscal Monitor, which will be devoted to the topic of the fiscal costs of corruption and the role of fiscal institutions.

What is the solution to weak governance and corruption? In the fiscal domain, it calls for heightened fiscal transparency—shining a light on all aspects of the budget and the public accounts. This would provide a more accurate picture of the fiscal position and prospects, the long-term costs and benefits of any policy changes, and the potential fiscal risks that might throw them off course. This region has some room for improvement here.

We know that these kinds of reforms pay off. Take the case of Georgia, for example. Until 2003, it was seen as one of the most corrupt countries in the world. But after that, it reformed its institutions and cracked down on corruption. This, along with tax reform, led to immediate improvements. Tax revenues increased from 12 percent of GDP in 2003 to 25 percent of GDP in 2008, as taxpayers had greater faith in the fairness of the system.

I should note that the IMF has been stepping up its engagement in the area of governance and corruption. Last year, we put in place a new framework predicated on a more systematic, evenhanded, effective, and candid engagement on these issues with member countries. We will be reaching out to leaders in this region to discuss how we can work together to implement this framework.

With better governance, we can replace the “disintegration” of corruption with the “integration” of all into the productive economy. We can replace fasad with islah—reforms to set things right, to reconcile people with one another.

Conclusion

Let me wrap up. I have argued this morning that good fiscal policy requires good institutional foundations. And solid foundations in areas such as fiscal frameworks and governance give citizens confidence that fiscal policy serves the good of all, not just the wealthy or the well-connected.

Let me end with some wise words attributed to the great Ibn Khaldun, “He who finds a new path is a pathfinder, even if the trail has to be found again by others; and he who walks far ahead of his contemporaries is a leader.”

You are the pathfinders, the leaders, the visionaries. We hope that we can give useful guidance, but we look to you to find the right path to make this vision a reality.

Thank you—shukran!