Speech by Nazaré da Costa Cabral, President of the Senior Board of the Portuguese Public Finance Council, at the 5th Annual Conference of the European Fiscal Board, with the theme "Centralization versus Decentralization of the European Union's Budgetary Framework", held in Brussels on May 11th.
Panel “Can Debt Sustainability be made Operational?
Two types of remarks:
a) More general remarks
- With this EC’s proposal of a new economic governance framework having the debt sustainability analysis, DSA as a departing point, it seems the EMU is moving to a more decentralized model of ex ante hard budget constraints that stands in the national ownership of fiscal rules, which in a way tends to offset the centralized and very stark model of ‘ex post hard budgets constraints’ resultant from the Treaty with its ‘non-bailout clause’.
- In my view, the idea of assigning member states with the responsibility to adopt ‘national medium-term fiscal-structural plans’ based on their own projected debt paths is justified by the need to balance in the right dose decentralization and centralization of fiscal and budgetary policies, in particular to have a balanced combination between decentralization and centralization of hard budget constraints, and to calibrate better national appropriation and flexibility with self-responsibility and accountability.
- A source of concern, especially for those countries that have an historical record of weak compliance and weak enforceability of fiscal rules is to know whether this more national ownership-based framework will open the door, once again, to a more lenient attitude towards fiscal discipline. In turn, the possibility enclosed in the proposal to revise the consolidation fiscal plan, during the adjustment trajectory, can also affect the medium-term perspective and deviate it to short-term interests, including electoral interest of the national government in question. A change of government, in the middle of the plan’s implementation, can have also disturbing effects in the accomplishment of its objectives. Moreover, spillover effects to other Member States from this possible increased leniency should not be neglected. On the other hand, it is positive to see in the Commission proposal an increased role of national Independent Fiscal Institutions, IFIs, during the implementation of the consolidation plan, assessing possible deviations in the net expenditure trajectory. It is not clear, however, how their involvement will be in the initial stage of designing the national plans. And we do not know whether Commission’s view will prevail or not (consider the last position of the Council on this respect that in my view downgrades the role of IFIs in this new framework). As a note of caution, I think it should be avoided a political pretext, at the national level, to downgrade IFIs role.
- Another source of concern is related with what Sebastian Barnes mentioned early morning. It has to do with coherence between EU operational rule (the trajectory in the medium-term for net expenditure) with domestic rules. Specific rules applied to the State and also specific rules applied to regional and local governments sometimes can be useless to enforce the EU set of rules or anchors and they can even be detrimental to that effort. In the case of Portugal, we have this experience. We find that the rules applied to regional and local governments have been incoherent with State sector specific rules and incoherent with the overall framework of EU rules applied to the entire Public Administrations on national accounts.
b) The DSA approach in particular:
- I agree that DSA is a very useful tool to assess fiscal risks, providing a good picture about debt level and debt dynamics and about country’s fiscal space. It is a realistic and operational tool – at current stage, it benefits already from deep technical work that has been done in the previous decade to make it more comprehensive and the most accurate as possible, starting with the IMF and now with the ECB and EC technical work (also from academics contributions, in particular Blanchard’s approach). There are, however, some aspects that require to be detailed in its implementation at the EMU level. One issue relates to the role and relevance of the DSA risk classification as a basis for defining the national fiscal consolidation plan, including a technical trajectory for net expenditure. In general terms, I believe that EMU countries, in particular highly indebted countries, with this more tailored-made model of fiscal adjustment will actually be even more exposed to market sentiment than they were with the one-size-fits-all model.
- Additionally, this can in turn involve asymmetric efforts of fiscal adjustment between countries and maybe affecting the level playing field that is supposed to exist between each other. In particular, it is not clear to me, when reading the Commission’s Regulation proposal, how to reconcile required efforts of national investment in the digital and green areas – which will be decisive to foster potential growth in the next decade – with the new expenditure indicator. Fiscal space to keep national investment up is affected by the need to bring debt down, and at the same time fiscal space to reduce debt ratio is affected by such investment requirement.
- Although DSA is a very comprehensive tool, it is not entirely clear how additional indicators needed to signal liquidity and solvency risks will be inserted in the DSA to be adopted from now on. In particular, longer-term solvency risks as the public debt structure (maturity, currency composition and type of interest rate), the dimension of contingent liabilities, the net financial position of the economy and political and institutional risks – how will they be considered. Moreover, it is needed a clarification on how this approach will be related with the ‘Macroeconomic Imbalance Procedure’ (the reference in the proposal is very vague) and this is crucial to become operational and well elaborated.
- Risks of sudden stops or of market freeze can repeat (as they happened in 2010) and I do not think this dimension is conveniently enclosed in this proposed fiscal framework, starting with the projections themselves. In particular, an attention to EMU payment system and to the bilateral current and financial accounts between members of the area should be subject to some attention in this new setup.
- The DSA approach covers the medium-term (10 years in the projection). Even if the horizon is wider than it was in the IMF DSA, still it doesn´t fully acknowledge debt dynamics in the long run. And the fact is that countries with higher short-to-medium run risks can, on the other hand, be less exposed to long-term risks, for example due to less ageing risks or due to pension systems previous reforms. The 2022 Debt Sustainability Monitor shows that very well. I think that the DSA approach, with a medium term focus and without a convenient link with the long-term dimension, may become counter-productive if minimizing structural reforms aimed at bring down debt pressures in the longer term. Note that the plan is qualified by the Commission proposal as well as a structural plan, but I am afraid that this latter dimension can be neglected in the assessment exercise.
- Further, it is not clear how will risks related to the monetary policy will be considered in this new DSA framework. This issue was previously addressed by Enrique Alberola with the research presented and the simulations that were made, mainly having in mind the impact of Quantitative Easing in debt sustainability (with a mention also to Quantitative Tightening). Considering now conventional monetary policy, it should be also taken into consideration that in some countries the transmission on monetary policy to interest rates, including to sovereign debt bonds interest rates, is much faster than in other countries. Such transmission is not symmetric in the sense that probably it is much faster when the ECB raises interest rates than when it decreases them, and this pace is not similar in all EMU countries. What is sure is that this affects the cost of financing, and will affect prospects for debt dynamics.
- IFIs should be able to do their own DSAs, either deterministic scenarios and stochastic projection for confronting with the official ones and to anchor better their future assessment. Note that several IFIs (and the CFP is one of them) do their own macro fiscal projections in order to facilitate their task of endorsing government’s projections. The same should happen with DSAs. For that, it is very important for IFIs to have access to information, data, code files, assumptions and qualification criteria, not only from the Government but also from the Commission, also in order to a proper understanding of the consolidation plan and of the respective consistency with the required reduction of debt level during the covered period. In case of the Portuguese Fiscal Council, we have the intention to (re)use the DSA tool in our next biannual Report about medium to longer term risks to public finances and that will be published this year, and we will for sure benefit from recent technical inputs including the ones that were given today.
Nazaré da Costa Cabral
President of the Senior Board of the Portuguese Public Finance Council
(The presentations and the recording of the meeting are available here.)
Date of last update: 29/05/2023