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Former Yugoslav Republic of Macedonia: Selected Issues

Author(s):
International Monetary Fund. European Dept.
Published Date:
September 2015
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Fiscal Rules to Ensure Sustainability1

  • The public debt of FYR Macedonia has almost doubled since 2008 and is projected to reach 54 percent of GDP by 2020. While not excessively alarming, such level of public debt is elevated for a country like FYR Macedonia, where fiscal policy serves as the main macroeconomic policy tool, a significant part of public debt carries FX risks and long-term spending pressures are considerable. Against this backdrop, the authorities’ intention to entrench fiscal sustainability using fiscal rules is a step in the right direction.
  • This paper argues that the proposed debt ceiling at 60 percent of GDP is too high in the case of FYR Macedonia and recommends a lower debt ceiling of 50 percent of GDP to ensure adequate fiscal space. For this outcome, an upfront consolidation would be needed to reduce fiscal deficit to below 3 percent of GDP by 2017 in line with the authorities’ Medium-term Fiscal Strategy (MTFS) and pursuing a primary balance path that would stabilize public debt by 2018.
  • In light of FYR Macedonia’s high infrastructure needs, an alternative to a lower operational threshold could be combining a higher debt cap with debt brakes mechanism. While the higher debt limit would be justified by the needed investment in infrastructure, any scaling up of public infrastructure investment should be accompanied by measures to strengthen public investment management: notably clear and transparent procedures to assess, prioritize, and monitor public investment projects.
  • Finally, given that effective implementation of fiscal rule requires supporting institutions in public finance management, the paper recommends: (i) further development of the MTFS so that it can more effectively guide the budget preparation process; (ii) enforcement of strict expenditure controls as well as implementation of effective cash and debt management to ensure that the budget is executed as planned; (iii) increased robustness of macroeconomic projections to prevent revenue over-optimism; and (iv) strengthening both ex-ante and ex-post independent scrutiny including the eventual establishment of a fiscal council.

FYR Macedonia: Historical Fiscal Path and Growth

Sources: WEO database.

A. Context

1. The fiscal situation in FYR Macedonia has deteriorated since the global financial crisis. Benefiting from strong economic growth, FYR Macedonia entered the crisis with one of the lowest public debt level in emerging Europe. Since 2008, there has been a reversal. This reflects fiscal support for the economy in the aftermath of the crisis, but also policy choices and low revenue efficiency. Loosening of the fiscal policy pushed the overall fiscal balance into a deficit of 0.9 percent of GDP by end-2008 and the overall deficit increased to 2.5 percent of GDP in 2011. The government’s renewed stimulus beginning in 2012 steadily increased the fiscal deficit to 4.2 percent by 2014. As a result, public debt has risen from 23 percent of GDP in 2008, to 30 percent of GDP in 2011, and further to 44 percent in 2014. The projected debt path in the absence of adequate measures shows that public debt would continue trending upward and reach 54 percent of GDP by 2020.

2. Although not alarmingly high, the projected level of public debt at 54 percent of GDP is elevated for a country like FYR Macedonia, where fiscal policy serves as the main macroeconomic policy tool, a significant part of public debt carries FX risks, financing needs are high, and long-term pressures from pensions and health spending are considerable. Against this backdrop, the authorities’ intention to entrench fiscal sustainability using fiscal rules is a step in the right direction.

General Government Debt, FYR Macedonia and Peers

(percent of GDP)

Sources: WEO database.

Emerging Europe includes Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Kosovo, Latvia, Lithuania, FYR Macedonia, Montenegro, Poland, Romania, Serbia, Slovak Republic and Slovenia. Emerging Asia includes China, India, Indonesia, Malaysia, Phillipines, Thailand and Vienam. Emerging Latin America includes Argetina, Brazil, Colombia, Mexico, Peru and Venezuela.

3. This paper aims to help the authorities’ efforts regarding the design and implementation of fiscal rules. Section B and C review the objectives and types of fiscal rules as well as the necessary underlying institutions. Section D discusses key considerations of fiscal rules in the context of FYR Macedonia. Section E lays out the supporting Public Finance Management (PFM) measures to ensure successful adoption and implementation of fiscal rules.

B. Fiscal Rules: Objectives and Types

4. A fiscal rule is a type of institutional setting under which fiscal variables are allowed to develop sustainably in the medium to long run. It imposes a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates. Providing a credible medium-term anchor has been the pervasive motive for adopting fiscal rules or strengthening fiscal policy after the experience of the global financial crisis.

5. There are four main types of fiscal rules with most countries using a combination of two or more rules (Box 1). The four types of rules set targets on debt, budget balance, expenditure and revenue respectively, and these rules have different properties with regard to the objectives, operational guidance, and transparency. While the choice of fiscal rules depends on a country’s economic circumstances, public debt and budget balance rules seem to dominate the choice often used in combination. About 80 percent of all fiscal rules in the world constrain the public debt or the budget balance (Figure 1). Expenditure rules are also prevalent, however mostly in advanced economies. In contrast, revenue rules are much less common. About 80 percent of the countries using fiscal rules use a combination of two or more rules. About 59 percent of countries that use a combination of rules adopt a debt rule that caps the overall public debt level and a fiscal balance rule that provides guidance to ensure this outcome.

Figure 1.Types of Fiscal Rules in Use, 2014

Sources: FAD database, IMF.

Emerging Europe includes 15 countries: Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Kosovo, Latvia, Lithuania, Montenegro, Poland, Romania, Russia, Serbia, the Slovak Republic, and Slovenia. Emerging Economies outside Europe includes 23 countries: Antigua and Barbuda, Argentina, Botswana, Brazil, Chile, Colombia, Costa Rica, Ecuador, Equatorial Guinea, India, Indonesia, Jamaica, Malaysia, Mauritius, Mexico, Namibia, Pakistan, Panama, Peru, Sri Lanka, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadine. The numbers indicate shares in total.

Box 1.Four Types of Fiscal Rules

  • Debt Rule (DR). The debt rule sets an explicit limit or target for the public debt in percent of GDP. This rule is effective in ensuring convergence to a debt target and is relatively easy to communicate. However, debt levels take time to be impacted by budgetary measures and therefore, do not provide a clear short-term guidance for policy makers. Moreover, fiscal policy may become pro-cyclical when the economy is hit by shocks and the debt target is binding.
  • Budget Balance Rule (BBR). The budget balance rule constrains the various budgetary balances that primarily influence the debt ratio and are largely under the control of policy makers. Budget balance rule can be specified as the overall balance, the structural balance, the cyclically adjusted balance or the balance over the cycle. While the first type of rule does not have any economic stabilization features, the other three types explicitly account for economic shocks. However, estimating the adjustment, typically through the output gap, is very challenging and makes the rule more difficult to communicate and monitor.
  • Expenditure Rule (ER). The expenditure rule sets limits on total, primary, or current spending. Such limits are typically set in absolute terms or growth rates, and occasionally in percent of GDP with the time horizon ranging often between three to five years. These rules are not linked directly to the debt sustainability objective since they do not constrain the revenue side. They can provide, however, an operational tool to trigger the required fiscal consolidation consistent with sustainability when they are accompanied by debt or budget balance rules. These rules also do not restrict economic stabilization features of fiscal policy and are in general easy to communicate and monitor.
  • Revenue Rule (RR). The revenue rule sets ceilings or floors on revenues and aims at boosting revenue collection and/or preventing an excessive tax burden. Most of these rules are not directly linked to public debt, as they do not constrain spending. These rules alone could result in a pro-cyclical fiscal policy but like the expenditure rules, they can directly affect the size of the government by adjusting the scale of revenue.

6. This broad pattern, i.e., most countries using a combination of budget balance and debt rule, is true for advanced and emerging Europe as well. Almost two-thirds of fiscal rules in emerging Europe are a combination of debt and budget balance rules, which partly reflects the supranational rules imposed by the EU’s SGP framework (Box 2). The upper limit for the numerical target for debt rule ranges from 40 percent of GDP in Kosovo to 60 percent of GDP in Poland (Table 1). The scope of public debt rule mostly encompasses general government debt where the general government consists of the central government, the local government as well as entities where central government is the source of 50 percent of revenues. However, countries with debt limits at 60 percent of GDP typically start putting in debt brakes at 50 percent which constitutes an automatic correction mechanism (Table 2). The numerical target for the budget balance rule ranges from 1 percent of GDP in Serbia to 3 percent of GDP in emerging European countries.

Table 1.Types of Numerical Targets in Emerging Economies
CountryBalance rule

(in percent of GDP)
Debt rule

(in percent of GDP)
Inside Europe
Kosovo240
Serbia145
Hungary350
Poland, the Slovak160
Republic, Romania
Bulgaria0.5 percent of GDP for structural deficit60
Outside Europe
Namibia25-30
Panama240
PakistanBalance or surplus of basic balance60
Costa RicaGolden rule70
Sources: Fiscal Rules at a Glance, April 2015, IMF.
Sources: Fiscal Rules at a Glance, April 2015, IMF.
Table 2.Debt Brakes in Emerging Europe
CountryTypes of Debt Brake
The Slovak RepublicWhen the debt to GDP ratio reaches 50 percent, the Minister of Finance is obliged to clarify the increase to parliament and suggest measures to reverse the growth. At 53 percent of GDP, the cabinet shall pass a package of measures to trim the debt and freeze wages. At 55 percent, expenditures would be cut automatically by 3 percent and next year’s budgetary expenditures would be frozen, except for co-financing of EU funds. At 57 percent of GDP, the cabinet shall submit a balanced budget.
PolandCorrective actions are triggered when debt ratio reaches the thresholds of 50, 55 and 60 percent of GDP. When debt ratio exceeds 55 percent of GDP, measures to improve budgetary situation - such as increasing VAT—are triggered automatically.
HungaryParliament may not adopt a State Budget Act which allows state debt to exceed 50 percent of GDP. As long as state debt exceeds 50 percent of GDP, Parliament may only adopt a State Budget Act which contains state debt reduction in proportion to the GDP.
Sources: Implementation of the Fiscal Compact in the Euro Area Member States, German Council of Economic Experts, and FAD database, IMF.
Sources: Implementation of the Fiscal Compact in the Euro Area Member States, German Council of Economic Experts, and FAD database, IMF.

Box 2.Stability and Growth Framework

Budget Balance Rule:

  • The Maastricht criteria include a limit of 3 percent of GDP for the fiscal deficit. If the deficit exceeds that limit, an excessive deficit procedure (EDP) is normally opened. (corrective arm)
  • In addition to the ceiling for the headline deficit, medium term budgetary objectives (MTO) are set for the structural budget balance. (Preventive arm) MTOs are defined as a budgetary position “close to balance or in surplus.”

Debt Rule:

  • The Maastricht criteria include a limit of 60 percent of GDP for general government debt. With the November 2011 governance reform, a required annual pace of debt reduction was introduced (based on a benchmark of 1/20th of the distance between the actual debt ratio and the 60 percent threshold on average over three years), starting three years after a country has left the current EDP procedure.

If progress is insufficient during the transition period, an excessive deficit procedure can be opened, with sanctions and fines for euro area members.

7. Several econometric studies covering both EU and non-EU countries find that fiscal rules are associated with stronger fiscal performance (Debrun et al, 2008; European Commission, 2006; Deroose, Moulin, and Wierts, 2006; Debrun and Kumar 2007, Kopits, 2004; and Corbacho and Schwartz, 2007). The main findings of these empirical studies are that: (i) tighter and more encompassing fiscal rules are correlated with stronger cyclically-adjusted primary balances in EU countries; (ii) the budget balance and debt rules have contributed to better budgetary outcomes than expenditure and revenue rules; and (iii) the rules covering a wider level of government have been

associated with more fiscal discipline. Schaechter et al (2013) find that countries in the top quartile of fiscal performance have at least two numerical rules in place and share many supporting institutional features, such as an independent monitoring mechanism to ensure compliance and a broad coverage encompassing the general government.

C. Fiscal Rules: Underlying Institutions

8. The success of fiscal rules largely depends on institutional settings and checks and balances underpinning these rules. Typically, a number of institutional settings are put in place to ensure proper implementation:

  • Legal basis: Rules enshrined in a higher level of legislation are more difficult to reverse and therefore tend to be longer lasting since they are more difficult to modify even with a change of government.
  • Top-down process: A top-down budgeting process, where the aggregate expenditure limit is decided before the distribution of expenditures, and medium-term budget frameworks (MTBFs) are useful to exercise a better control over public expenditure, thereby ensuring adherence to the rule.
  • Fiscal Responsibility Law (FRL): Fiscal rules can be supported by FRLs, which typically set out procedural and transparency responsibilities of the government towards the parliament.
  • Independent Body: Establishing independent bodies, such as independent fiscal councils, could further enhance the credibility of fiscal rules. These bodies can provide an independent assessment of the implementation of fiscal rules.
  • Enforcement: Enforcement and automatic correction mechanisms are critical to the success of the fiscal rule. The use of automatic mechanisms to correct past deviations from the rule is a tool that seeks to prevent deviations leading to a systematic debt buildup.
  • Escape clause: Escape clauses can provide the flexibility to deal with unforeseen and severe events. These should clearly specify the circumstances where rules-based fiscal framework can be temporarily suspended and include a limited range of factors that allow such escape clauses to be triggered into legislation. There should also be clear guidelines on the interpretation and determination of events, and the regime that applies in the interim, including specification on the time path back to the rule.
  • Data availability: Reliable data availability and technical forecasting capacity is of importance to ensure credibility, while budget reporting system and timely release of fiscal data are needed to allow internal and external monitoring of the rule, thereby securing accountability.

9. Over the last decade, fiscal rules have become more comprehensive with a convergence of design features between advanced and emerging economies. Supporting procedures such as the monitoring of budget implementation by an independent body have become more widespread in advanced and emerging economies, particularly after the recent global crisis. Other characteristics

such as a strong legal basis and formal enforcement procedures have also become more common across country groups.

D. What Type of Fiscal Rules Makes Sense for FYR Macedonia?

10. The authorities intend to introduce a fiscal rule by 2017. The envisaged fiscal rule intends to cap the overall budget deficit at 3 percent of GDP and the public debt at 60 percent of GDP as of 2017. The authorities appear to have used the Maastricht criteria as a benchmark for the sustainable level of debt for this economy. The authorities are currently looking also at possible options to secure compliance of fiscal rule, which include debt brakes.

Table 3.Illustrative Path for Fiscal Balance and Debt Under the Current Proposal for Fiscal Rules
2014201520162017201820192020
Fiscal balance (% of GDP)-4.2-3.8-3.4-3.0-3.0-3.0-3.0
Primary balance (% of GDP)-3.2-2.9-2.5-2.1-2.1-2.1-2.1
Debt to GDP ratio43.443.947.649.851.451.952.0
Note: The illustrative path assumes fiscal deficit decreases steadily to 3 percent of GDP by 2017 per the fiscal rule objectives, and stays at this level thereafter.
Note: The illustrative path assumes fiscal deficit decreases steadily to 3 percent of GDP by 2017 per the fiscal rule objectives, and stays at this level thereafter.

11. The debt ceiling at 60 percent of GDP would be non-binding under the baseline projections and create inadequate fiscal policy space. Even with fiscal deficits at 3 percent of GDP, public debt would be below the 60 percent threshold for some time limiting the operational guidance for fiscal prudence. In addition, the following would argue that the proposed debt ceiling of 60 percent of GDP is too high in FYR Macedonia’s circumstances.

  • Empirical studies point to lower long-term debt thresholds for emerging economies. Historical experience shows that many economies with rapid growth of public debt in the midst of economic crisis have faced great difficulties to restore the public debt level to their pre-crisis level, while being exposed to higher fiscal vulnerabilities. The long run debt level for emerging markets (EMs) also tends to be lower than advanced economies (AEs) (IMF, 2011). Cross country median estimates for the period 1985–2002 range from 50 to 75 percent of GDP for AEs, while for EMs, the ratio is 25 percent of GDP. A re-estimation of public debt thresholds for a sample of EMs for the period 1993–2009 gives a range of 49–58 percent for the long run debt level, reflecting improved fiscal performance over the past decade.
  • At elevated debt levels, there are fiscal risks from lower growth, exchange rate changes and high financing needs. Public sector borrowing has pushed up gross external debt already to around 70 percent of GDP and gross fiscal financing needs, currently at 15 percent of GDP, is projected to rise to 18 percent by 2020. Foreign currency-denominated debt accounted for 84 percent of public debt at end-2014. Large increases in debt level given current debt profile would increase risks of debt distress if the exchange rate comes under pressure. Furthermore, the Debt Sustainability Analysis shows that adverse shocks to growth, real interest and real exchange rate could significantly push up the debt level (text chart).
  • Fiscal policy becomes less effective at higher level of debt. A growing literature finds that fiscal policy becomes ineffective when the debt-to-GDP ratio is high (Perotti 1999, Sutherland 1997, Chung and Leeper 2007, Faverro and Giavazzi 2007, Corsetti et al 2012, etc). Nickel and Tudyka 2013 estimates for a group of European countries that responses of real GDP and private investment to fiscal stimulus become negative when public debt surpasses 50 to 60 percent of GDP. Similar results are reported in Ilzetzki, 2010 for 44 countries including 24 developing countries, and in Kirchner et al 2010 for the euro area.
  • Fiscal space to absorb long-term spending pressures from pensions and health services would be inadequate at higher level of debt. The consolidated general government budget shows that pension deficitis 2.9 percent of GDP with spending on pensions amounting to 9.1 percent of GDP or 28.7 percent of total spending in 2014. Pension spending is expected to steadily climb due to rapid ageing. According to the UN population projections, the share of people aged 65+ in the population would more than double by 2050 from 12 percent in 2010 to 26 percent in 2050 (text chart). Public health spending, amounting to 4.2 percent of GDP in 2014, would also face significant upward pressures due to ageing.

FYR Macedonia: Public Debt Trajectory under Shock Scenarios

(percent of GDP)

Sources: IMF staff estimates.

Note: The real GDP growth shock reduces growth by 1.5 percentage points throughout the projection period; the real interest rate shock assuems a 200 bps increase in real interest rates each year; and the real exchange rate shock assumes REER depreciation of 10 percent.

Public debt includes debt of the general government and non-financial SOEs.

12. FYR Macedonia’s particular circumstances would warrant the following considerations while designing numerical fiscal rules.

  • (i) There is a need for fiscal rule to be simple and easy to communicate to the public as FYR Macedonia is still in the very early stage of adopting a fiscal rule.
  • (ii) Since FYR Macedonia has long-standing ambitions to join the EU, a combination of debt and budget balance rules would be in line with other EU members.
  • (iii) Given the rapid rise in public debt, a debt ceiling would need to be complemented by a budget balance rule to provide clear guidance to reverse the debt trajectory.

Percentage of 65+ in Total Population: FYR Macedonia and European Peers

Sources: United Nations World Population Prospects, 2012 Revision.

13. Reflecting the discussion in paragraphs 11–12, a lower debt ceiling would be more suitable for FYR Macedonia. Accordingly, the overall fiscal deficit needs to be reduced to well below 3 percent of GDP by 2017, and further consolidation will be needed to reverse the debt build-up and keep the debt level comfortably below 50 percent of GDP in the medium term. This will create sufficient fiscal space to accommodate counter-cyclical policies in bad times and spending pressures from population ageing as well as to reduce risks of debt distress.

14. Given the high infrastructure needs for the small and landlocked economy, a somewhat higher debt limit may be justified accompanied by a debt brake mechanism. Public infrastructure spending, notably in the transport sector, is expected to grow significantly in the medium term. The planned expenditure in road construction represents more than 2.2 percent of GDP from 2015 onwards, contributing to the PESR’s projected debt buildup from 2.3 percent of GDP in 2014 to 6.6 percent by 2017. Debt brake could be triggered starting at 50 percent of GDP and pre-planned fiscal consolidation measures could then be introduced to arrest a rapid rise.

FYR Macedonia: Recommended Path for Public Debt and Deficits

(Percent of GDP)

Sources: IMF staff estimates.

15. The growth potential from scaled up infrastructure investment will only be realized if the current weaknesses in public investment management are addressed. Historically, weaknesses in public investment management have resulted in inadequate returns in many countries. Low returns to public investment arise from poor selection and implementation of projects due to limited information, waste and leakage of resources, and weak technical expertise. A substantial scaling-up of public investment, as envisaged by the authorities, in a relatively weak institutional setting runs the risk of potentially undermining its growth benefits as well as fiscal and debt unsustainability.

16. Recent IMF report finds the economic and social impact of public investment to critically depend on its efficiency (IMF, 2015). The overall strength of Public Investment Management (PIM) is the weakest in Low-Income Developing Countries (LIDCs) and the strongest in AEs during all three investment cycles: planning, allocation, and implementation (Figure 2). The economic dividends from closing this efficiency gap are substantial: the most efficient public investors get twice the growth bang for their public investment buck than the least efficient ones. Strengthening PIM practices can thus reduce the public investment efficiency gap by around two-thirds, with the largest payoffs in EMs and LIDCs.

Figure 2.Public Investment Institutional Overall Score by Country Group

Source: Making Public Investment More Efficient, June 2015, IMF.

Priorities for strengthening PIM institutions vary across country groups with EMs needing more rigorous and transparent arrangements for the appraisal, selection, and approval of investment projects. A study by Era Dabla-Norris et al. in 2011 shows FYR Macedonia ranks somewhere in the middle among 31 middle income countries in public investment efficiency. A close look at sub indices of public investment efficiency—notably project appraisal, selection, management, and evaluation—shows that the project appraisal stage in FYR Macedonia lags the most in comparison to middle income peers (Figure 3).

Figure 3.Public Investment Efficiency Index

Sources: IMF staff calculations based on IMF Working Paper No. 11/37.

1/ Thirty one countries are included in Middle Income Countries: South Africa, Brazil, Colombia, Tunisia, Thailand, Peru, Kazakhstan, Botswana, Jordan, Belarus, Serbia, Ukraine, FYR Macedonia, Turkey, Philippines, Namibia, El Salvador, Kosovo, Jamaica, Montenegro, Albania, Pakistan, Indonesia, Azerbaijan, Egypt, Barbados, Trinidad and Tobago, Swaziland, Gabon, West Bank and Gaza, and Belize.

Public Investment Efficiency Index is composed of 17 indicators grouped into four stages of cycle: (i) Strategic Guidance and Project Appraisal; (ii) Project Selection; (iii) Project Implementation; and (iv) Project Evaluation.

17. The legal framework for the fiscal rule should include independent monitoring and oversight, as well as other enforcement mechanisms, such as corrective measures to restore deviations over a certain period of time. All of these would be beneficial in maximizing the contribution of fiscal rules to improving fiscal soundness. Many emerging European economies, such as Romania, Poland, The Slovak Republic, Kosovo and Lithuania, have introduced these systems along with establishing independent bodies that effectively oversee implementation of fiscal rules. The Macedonian authorities are doing research on practices in other countries and considering which design features to include in their new fiscal responsibility law once the Constitution has been amended. International experience also shows that fiscal rules cannot substitute a strong commitment to fiscal discipline as these rules can be circumvented, ignored, or simply abandoned over time.

E. Supporting Public Finance Management Measures

18. A country’s ability to implement fiscal rules is directly linked to the strengths and weaknesses of the institutional arrangements for preparing and executing budgets. In particular, fiscal rules would need to put greater attention on the quality of the government’s medium-term fiscal and budgetary framework as well as on the mechanisms to ensure budgetary discipline during execution. Enhanced transparency and accountability arrangements to publicly review the government’s fiscal proposals and evaluate their performance are also needed.

19. The government of the FYR of Macedonia first introduced a medium-term Fiscal Strategy (MTFS) in 2005. It provides projections of macroeconomic and fiscal aggregates at the general government level, broken down by major budget users—central government, funds, and local government. While the MTFS provides a snapshot of the government’s overall fiscal policy intentions for a given budget year, there is no reconciliation with the previous years’ projections nor with actual outturns. This lack of reconciliation undermines the credibility of the medium-term fiscal planning process, and would need to be addressed as part of the action plan to implement the fiscal rules.

20. While the MTFS includes fiscal policy changes over the medium-term, these are not costed. Furthermore, the fiscal implications of policy initiatives are not systematically provided by the Ministry of Finance (MoF) prior to their adoption by the government, and it is unclear whether the MoF’s capacity to evaluate such costs is sufficient. Inadequately costed policy initiatives often have unplanned consequences on future year’s budgets and can undermine the government’s ability to keep the budget on track. The authorities are encouraged to review its arrangements and capacities for evaluating the costs of all policy initiatives as part of the preparatory actions for the implementation of fiscal rules.

21. The MTFS should be based on realistic macro-economic forecasts. The quality of the forecasts depends on the availability, quality and timeliness of underlying data on the economy. It also depends on the models used to prepare the forecasts, and the availability of alternative scenarios. The credibility of fiscal projections, revenues in particular, will partly depend on the robustness of the process of preparing macro-economic forecasts. The implementation of fiscal rules will require a closer look at the institutional arrangements for collecting and forecasting macroeconomic data, including the arrangements for independently reviewing the forecasts (see paragraph 25 below).

22. Analysis of recent macroeconomic and fiscal data shows mixed performance. The analysis shown in Figure 4, based on the 2008–10 to 2015–17 MTFS documents, shows generally overoptimistic revenues and expenditures projections when compared with actual outturn, resulting in significant difference between deficit projections and actuals during the same period. This optimism bias also shows up in the analysis of GDP forecasts as well, particularly in the outer years.

Figure 4.Recent Trends in Revenue and Expenditure Forecasts

Sources: Medium Term Fiscal Strategies (MTFS) and IMF staff estimates.

23. The MTFS does not include detailed medium-term budgetary estimates for central government institution. Furthermore, the MTFS is often issued late in the year (September) and therefore cannot effectively guide the budget preparation process. Despite this, the government does issue spending limits along with its annual budget circular, although it is unclear to what degree line ministries respect these limits in their budget submissions. The MTFS needs to be further developed to qualify as a medium-term budgetary framework which effectively guides the budget preparation process. In addition to the reconciliation mentioned above, these improvements include a more detailed analysis of sectoral/ministerial budgets, separated between on-going policy and new initiatives, identification of fiscal risks, and adoption of the MTFS by the government by midyear as well as submission to the parliament at least for information. These improvements are also required under the EU convergence program.

24. The current wording in the draft Constitutional amendment suggests that the deficit rules will only apply to the central government, while the debt rules will apply to public debt, defined as general government plus guaranteed debt of non-financial SOEs. Under the EU fiscal framework, both rules apply to the general government, as defined in ESA2010. If possible the draft Constitutional amendment should be changed to reflect this coverage, the alternative being to review the regulatory arrangements for funds and local governments to ensure that they also adhere to the fiscal rules. This is one of several aspects that will need to be included in the revisions to the public financial management (PFM) legislation once the Constitution is amended.

25. Ensuring that budgets are executed as planned is essential to the effective implementation of fiscal rules. This means strict expenditure controls, effective cash and debt management, and timely and comprehensive reporting. The government’s recent record on arrears raises questions as to the effectiveness of its expenditure controls. Addressing the underlying causes of arrears and changing institutional behavior regarding arrears will be important measures to be implemented prior to the adoption of the fiscal rules. In this regard, the recent improvements in multiyear commitment controls would appear to have addressed the central government arrears issues. Establishing proactive cash management that ensures that budget institutions are able to spend according to their approved plans will be an important complement to the measures on arrears.

26. Finally, the credibility of medium-term budgeting based on fiscal rules depends on effective external scrutiny. The ex-post scrutiny undertaken by the supreme audit institution is in general focused on compliance issues, not on the evaluation of fiscal policies. For this new institutional arrangements are required, equipped with macro economic capacities rather than accounting ones. More and more countries are now establishing fiscal councils to perform the fiscal policy evaluation task, both ex-ante and ex-post and consideration should be given to which model is appropriate for FYR Macedonia. The establishment of a fiscal council will require new legislation, which will need to be prepared and enacted prior to the implementation of the fiscal rules. However, since the authorities are not convinced that a fiscal council would become beneficial at this time, they could, instead consider strengthening their macroeconomic forecasting capacity by establishing an autonomous professional institute to do the macroeconomic forecasts, following the example of other countries in the region, notably Slovenia.

27. The implementation of fiscal rules requires careful attention to PFM reform actions that will ensure success. A number of other countries in the region have also introduced fiscal rules and accompanying fiscal responsibility legislation. Two of these, Slovakia and Serbia, could be of specific interest to the authorities in FYR Macedonia. The reform actions they undertook in the context of fiscal rules are summarized in Box 3. The authorities have started preparing a new fiscal responsibility law to implement the fiscal rules. The key actions that may be relevant to FYR Macedonia are identified in Table 4, along with a timeline linked to the year in which the rules are expected to come into force. The authorities are already planning to include some of these actions in their PFM reform strategy which will be prepared once the PEFA is completed.

Table 4.Priority PFM Measures for Implementing Fiscal Rules in Year T (currently 2017)
MeasureDetailed actionsTiming
1. Improve the credibility of the MTFS- include a reconciliation table highlighting changes from previous MTFST-1 July
- systematically evaluate the cost of all new policy measures, including investments, and include these costs in the medium-term projections of the MTFS
- expand the detail of medium-term projections to main budget institutions
- adopt the MTFS, with binding ministerial ceilings for the budget year, prior to the start of budget preparation
2. Strengthen the budget preparation process- strengthen the capacities of line ministries to prepare costed strategic plans and to design and manage public investment projectsT-1 & T
- strengthen the analytical capacity in the Ministry of Finance to review line ministry budget proposals and to manage the public investment programT-1 & T
- develop the methodology to separate on-going policies from new initiatives in budget proposalsT
3. Strengthen the capacity to monitor fiscal risks- identify key fiscal risks, including from SOEsT-1 & T
- establish/strengthen institutional arrangements to routinely monitor and analyze fiscal risks
- include fiscal risk reporting in the MTFS
4. Strengthen the capacity to prepare realistic macro-economic forecasts and revenue projections- review and broaden the institutional participation in the preparation of macro-economic forecastsT-1

1st half
- include alternative scenarios in the macro-economic forecastsT-1 July
- strengthen the capacity to prepare realistic revenue forecastsT-1 1st half
5. Establish an independent scrutiny of fiscal projections- agree on the design choices and institutional anchor for a fiscal councilT-2 Dec
- implement an independent scrutiny of the government’s macro-economic and fiscal projectionsT-1 July
6. Strengthen expenditure controls, accounting and reporting, and cash management- review and strengthen expenditure control arrangements and their associated sanction provisionsT-2 Dec
- strengthen the requirements and coverage for fiscal reporting that meet ESA2010 standardsT-1 Dec
- improve the monitoring of assets and liabilities through a gradual adoption of IPSAS standards in accountingT to T+3
- improve in-year cash flow planning and its coordination with debt managementT-1
- design and implement supporting enhancements to the PFM IT systems to support improved budget executionT-1
7. Amend the PFM legal framework to support fiscal rules- prepare revisions to existing provisions aimed at strengthening the MTFS, improving the budget preparation process, and enhancing expenditure controlsT-2 Dec
- prepare new provisions (or a separate law with qualified majority) to operationalize fiscal rules and to establish the independent oversight (e.g., fiscal council) essential for their effective monitoring and oversight

Box 3.PFM Reforms and Implementation of Fiscal Rules—Two Experiences from the Region

The Slovak Republic: Prior to the introduction of its debt brake rule in 2012, the Slovak Republic’s debt was rising rapidly and fast approaching the EU’s 60 percent debt limit. The authorities recognized the need for consolidation efforts, underpinned by a series of PFM reform measures, aimed at: (a) identifying savings through improved costing and monitoring of spending; (b) setting fiscal objectives in a more transparent and systematic manner; (c) improving the quality and reliability of macro-economic forecasts through independent scrutiny (Council for Budget Responsibility); (d) rigorously assessing the impact of all new policy measures; and (e) strengthening fiscal risk identification and management. The fiscal rules and accompanying measures have had a high degree of consensus, which encouraged effective enforcement of early warning measures under the debt break provisions in 2013 and 2014

Serbia: The adoption in 2009 of new fiscal responsibility provisions in the Law on Budgets was accompanied by a number of measures aimed at strengthening the credibility and management of the budget. These included:

(a) adoption of a two-stage budget process; (b) addition of sections on fiscal risks and medium-term budget forecasts to the annual Fiscal Strategy Document; (c) launch of program budgeting; and (d) strengthening of expenditure controls to address the arrears problem. Some of these measures have taken time to implement (e.g., program budgeting which was completed in 2015). Serbia’s recent EU ambitions have given a renewed impetus to these reforms.

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1Prepared by Hua Chai, Jubum Na and Duncan Last.

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