Improving fiscal management in Ghana: The role of fiscal policy rules
Perhaps the single most important factor that could derail Ghana's ability to advance to high middle income status is weak fiscal governance. Fiscal management in Ghana has not been consistently strong.
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Poor revenue collection, built upon inadequate tax base and low tax compliance, has combined with expenditure pressures particularly in election years leading to large and continuous public sector borrowing.
Historically, this unsatisfactory fiscal governance has been at the centre of a vicious cycle in which the public sector's appetite for debt financing has been contributed to high interest rates; put pressure on the exchange rate as economic agents are unsure about the sustainability of public debt; raised and distorted the cost of capital; and crowded out private sector investments.
Breaking the cycle of inconsistent fiscal management clearly requires a balance between market pressure and fiscal rules in order to keep public finances on a sustainable path. Empirical evidence shows that the quality of market signals is by itself an insufficient indicator to accurately guide the conduct of fiscal policy, especially in periods of crisis. This calls for a further quantum improvement in fiscal governance, which embeds a credible improvement in fiscal responsibility and permanently eliminates fiscal deficits, except for well-defined special circumstances. Fiscal consolidation in Ghana needs to be credible in order to anchor market expectations about fiscal sustainability.
Track record
Ghana has a track record of high fiscal deficits, partly reflecting procyclical fiscal policies in good times and electoral cycles. A review of fiscal performance in Ghana over the past two decades shows that the country has not been able to keep the government budget under control and fiscal consolidation has not been successful.
For instance, the average fiscal deficit for Ghana between 2005 and 2013 was 7.5 per cent of gross domestic product (GDP) compared with just three per cent of GDP for sub-Saharan Africa. Fiscal performance in Ghana tends to worsen during election years with concomitant increase in the debt levels.
Over the years, revenue performance has improved significantly while at the same time primary spending has strongly increased. Between 1990 and 2013, total revenue as a share of GDP increased from nine per cent of GDP to around 18 per cent of GDP though still below the average for middle income countries.
At the same time, primary spending has consistently been higher than revenues with spending particularly higher during election periods.
For instance, both the 1992 and 1996 elections resulted in higher fiscal deficits than in the 1990s and the same pattern was observed in the period between 2000 and 2012. Government, concerned about securing the support of public service labour unions, granted substantial wage increases in election years and embarked on ambitious capital projects many of them unproductive.
Wages and salaries are now the biggest component of government spending. Accounting for an average of nine per cent of GDP, its share of GDP has grown significantly over the past three years. Public wage growth outstripped real GDP growth over the past 10 years. Analysing the real growth of expenditures on public wages and salaries together with real GDP growth shows that overall the growth of real expenditure on public wages has been higher than real GDP growth during the past 10 years.
On the positive side, in periods of low GDP growth, wage growth has been particularly low. Additionally, in periods immediately after wage hikes, wage growth decelerated. For example, in 2005 and 2009, public wage growth fell significantly and was below the growth rate of real GDP.
Fiscal consolidation strategy
Addressing Ghana's macroeconomic challenges requires an ambitious fiscal consolidation strategy. The fiscal deficit is currently very high and public debt is rising even though it is still within the range considered sustainable. It is important to note, however, that the debt trajectory is as important as the debt level in terms of influencing investor confidence and economic growth. A huge debt build up tends to undermine investor confidence and can limit growth even in situations where debt levels are low.
International experience suggests that the initial level of fiscal adjustment is important for the success of fiscal consolidation. The question is, "What is the most appropriate route to follow given that the need to reduce the budget deficit comes in a difficult environment of weak growth and difficult political environment?" Based on a survey of country experiences, expenditure-based consolidations with a focus on reducing current spending tend to be more successful than tax-based consolidations.
However, since the adjustment need in Ghana is large, fiscal consolidation needs to be a balanced combination of spending cuts and revenue increases. Fiscal adjustment needs to be completed with a rule-based fiscal policy to lock in the gains of fiscal consolidation and enhance policy credibility.
Several governments across the world have adopted fiscal policy rules, especially against the backdrop of worsening fiscal performances and rising debt levels. Reforms of fiscal institutions and the introduction of fiscal rules are motivated by the objective, similar to those in monetary policy, that rule-based policies are likely to deliver better results.
The objective of adopting a fiscal rule is to strengthen fiscal solvency and sustainability, contributing to macroeconomic stabilisation, and making fiscal policy design and execution more resilient to government corruption and private sector lobbies.
Fiscal policy rules could be defined as a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates. This definition implies that boundaries are set for fiscal policy, which is difficult to change frequently and some operational guidance is provided by specifying a numerical target that limits a particular budgetary target.
Fiscal rules are normally aimed at correcting distorted incentives and containing pressures to overspend, particularly in good times, so as to ensure fiscal responsibility and debt sustainability. In many countries, the existence of many competing interest groups usually results in the "voracity effect", where different groups compete and push for overspending, especially in good times leaving little or no room for counter cyclical policies in bad times.
To solve these problems, a number of fiscal institutions, including fiscal rules and medium term budget frameworks have been established around the world over the past three decades with a view to supporting more prudent and balanced fiscal policies.
Fiscal rules
Another justification for the implementation of numerical fiscal rules is to prevent policy makers from worsening macroeconomic volatility through procyclical fiscal policies. More specifically, there is a widespread consensus on the impact of fiscal rules that restrict government expenditure. According to the European Commission, enforced national expenditure rules help to counteract forces leading to procyclical fiscal policy in good times and thus prevent the need for fiscal austerity measures in difficult times.
A cursory look at Ghana's fiscal framework suggests existing fiscal rules are insufficient to improve fiscal discipline. There is, therefore, the need to implement a fiscal rule that has broad coverage of the budget more generally and further reduce discretionary policy interpretations.
Fiscal rules tend to be most effective when they incorporate the entire public sector and are enacted by law or incorporated in the constitution. Effective fiscal rules are also expected to include well-defined sanctions if the rules are broken and clearly defined correction mechanisms. International experiences suggest that fiscal rules do not function in isolation and require supporting institutions and reforms to deliver the anticipated outcome.
Key reforms to make fiscal rules effective in Ghana include the establishment of an independent fiscal policy council; strengthening budget preparation, apportionment and execution; enhancing revenue forecasts; improving monitoring and enforcement procedures; and legislative changes to make the fiscal rule legally binding.
Strengthening the precision of revenue forecasts and the sanctions regime are important to establish a credible fiscal rule. Projections of available resources in the next fiscal year are needed earlier in the budget preparation process to determine realistic expenditure ceilings. An automatic correction mechanism can control for ex- post deviations from the fiscal rules. Strengthening enforcement procedures, such as sanctions for breaches of budgetary procedures and expenditure controls, will also be needed to encourage ex-ante compliance with the rules. Strengthening the sanctions regime will need to be addressed in legislation.
Fiscal policy council
An independent fiscal policy council will enhance the quality of budget discussions and foster greater transparency. Independent fiscal policy councils can play the same role as monetary policy committees, deciding on deficits and the evolution of public debt.
In Ghana, an independent fiscal council can have a key role in assessing the reliability of the macroeconomic and revenue assumptions underpinning the budget, and estimating the fiscal impact of proposed measures. In some countries, fiscal councils also play a "watchdog" role by monitoring compliance with fiscal rules. In addition, forecasts produced by fiscal councils can serve as a neutral baseline to assess the fiscal cost and macroeconomic impact of policy proposals.
The mandate of fiscal councils in a few countries even allows for direct influence over the budget by specifying technical inputs, such as the macroeconomic and budgetary forecasts. To be effective, fiscal policy councils need to be given a clear mandate, debt sustainability, so that they are freed from the time inconsistency problem that leads to a deficit bias.
In addition to fiscal rules, strengthening fiscal performance in Ghana will require gaining control over the wage bill. Efforts should be devoted to ensuring a clean payroll system in the country. In addition, the wage setting process needs to be reviewed with a possible shift towards multi-year agreements.
The incorporation of these recommendations into Ghana's present fiscal framework will help in the achievement of fiscal targets and aid in the correction of fiscal loopholes that have proven so costly to the performance of the broader economy.
