Macroeconomic Challenges of Structural Transformation: Public Investment, Growth and Debt Sustainability in Sierra Leone

IMF Working Papers, July 20, 2015

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The paper analyzes the link between public investment, economic growth and debt sustainability in Sierra Leone using an inter-temporal macroeconomic model.
In the model, public capital improves the productive capacity of private capital, generating positive medium and long term effects to increases in public investment.
The model application indicates that a large increase in public investment would have positive macroeconomic effects in the medium term.
Rigidities in tax adjustment would entail unrealistic and unachievable adjustment in the current spending to cover recurrent costs and ensure debt sustainability.
A more ambitious increase in public investment would entail more fiscal adjustment, particularly if external commercial loans are secured to complement the adjustment.
Model simulations emphasize the importance of improvements in the structural economic conditions to reap growth dividends.
Downside risks such as terms of trade shifts and Ebola-induced productivity shortfall expose the country to increased risk of unsustainable debt dynamics.
The findings underscore the need to remove bottlenecks to growth and maintain prudent borrowing policies.

Public capital acts to raise the productive capacity of private capital, creating positive medium- and long-term effects from increased public investment.
Large-scale public investment can yield favorable macroeconomic outcomes in the medium term under the model.
Fiscal rigidity, especially in tax adjustment, constrains the ability to finance recurrent costs associated with scaled-up investment without unrealistic cuts to current spending.
Use of external commercial loans to finance investment magnifies the fiscal adjustment required to preserve debt sustainability.

Remove bottlenecks to growth to ensure that scaling-up public investment translates into sustainable growth dividends.
Maintain prudent borrowing policies to reduce exposure to adverse shocks and the risk of unsustainable debt dynamics.
Carefully assess fiscal adjustment needs if considering ambitious increases in public investment, especially when relying on external commercial borrowing.

Terms of trade shifts present a downside risk to debt sustainability.
Ebola-induced productivity shortfalls can materially increase the risk of unsustainable debt dynamics despite favorable long-term macroeconomic implications under some structural improvements.
Structural economic improvements are critical for realizing the long-term benefits of public investment scaling-up; absent these, favorable long-run outcomes are less likely.