In much of Latin America and the Caribbean, fiscal performance is set to improve from this year, after a period of sharp deterioration in recent years that has necessitated pro-cyclical fiscal tightening, contributing to the region's weak growth performance. A recovery in revenue collection from this year, stemming in part from rising global commodity prices and partly from recent reforms to broaden the tax base, should allow for a narrowing of the region's aggregate fiscal deficit and help to ease expenditure constraints for some of Latin America's large commodity exports. That said, fiscal adjustment in some of the region's largest economies, including Brazil and Argentina, is far from complete. Moreover, with the region continuing to run a fiscal deficit, its public debt ratio will continue to rise, expanding to above 60% of GDP by the end of our five-year forecast period in 2021.
The deterioration of the region's fiscal dynamics stem from the countercyclical fiscal expansion that took place around the time of the global financial crisis in 2009‑10, which subsequently morphed into procyclical fiscal expansion, with expenditure growth continuing apace despite a decline in revenue following the end of the commodities super-cycle. During the peak of the commodities boom in 2003‑08, Latin American economies actually ran a fiscal surplus averaging 1.2% of GDP (the aggregate regional fiscal data include the primary balance only for Brazil), as a rise in revenue was accompanied by some fiscal restraint. This helped to reduce the public debt burden and left the region in an unusually strong position to combat the impact of global crisis and support growth in 2009‑10 with countercyclical macroeconomic policy.
As a percentage of GDP, fiscal revenue peaked in 2011 and has been trending downwards ever since; in 2016 it was around 2.5 percentage points below its 2011 peak. Fiscal expenditure actually rose by around 2.5 percentage points in the same period. The result was a substantial fiscal deficit, estimated at 4.8% of GDP. The region's public debt/GDP ratio rose to an estimated 54% of GDP in 2016, up substantially from the record low of 42% of GDP posted in 2010. Although the regional average public debt burden is still lower than during some previous crisis-related peaks (it was 58% of GDP in 2003), the upward trend risks raising financing costs, and in some cases, such as Brazil, has brought fiscal sustainability into question, damaging market confidence and necessitating deep, painful fiscal adjustment measures.
Adjustments to spending and revenue
Few of the region's commodity producers have been able to avoid making adjustments to lower fiscal revenue in recent years. But fiscal adjustment to date has been complicated by growth during the commodity boom years in relatively fixed areas, such as wages and pensions, in which expenditure is difficult to reverse (all while capital spending has lagged). Consequently, adjustment has in large measure taken the form of revenue-raising measures rather than substantial cuts in expenditure.
One clear exception to this trend is Peru. Between 2012, when it reached a peak, and 2016, fiscal revenue in Peru declined by 6% as a proportion of GDP in response to falling metals prices. In the same period, largely reflecting cuts to spending on infrastructure, the authorities managed to cut expenditure by a substantial 3% of GDP. Given the sheer scale of the decline in revenue, this was not enough to prevent a shift from fiscal surpluses into moderate fiscal deficits of around 2% of GDP since 2015. There has also been a moderate increase in the public-sector debt/GDP ratio, although from a low base; at 24% of GDP in 2016, Peru's public-sector debt ratio remains low by regional and global standards, and perceptions of creditworthiness remain strong.
Elsewhere, the emphasis has been on reforms to expand the non-commodity tax base and maintain spending commitments. In Chile, for example, notwithstanding a sharp fall in revenue from copper in recent years, overall revenue has fallen by only around 1% of GDP from its peak in 2012. In the past two years alone, revenue from non-mining activity has in fact risen by almost 2% of GDP. Although it has not proved universally popular domestically, Chile's recent major tax reform, which has produced progressive increases in the corporate tax rate, taking it from 20% to 27%, has clearly had a net positive impact on fiscal performance, and on the country's ability to maintain social spending.
Although it was also extremely unpopular with business when it was approved, Mexico's landmark 2014 tax reform has similarly helped to bolster non-oil tax revenue in the face of declining income from oil. Between 2014 and 2016 federal tax revenue rose by 4% of GDP, despite a substantial fall in oil revenue in the same period. Mexico has also announced various spending cuts in recent budgets in response to lower budgeted oil prices. However, actual expenditure has continued to increase steadily over the course of the past five years, as above-target revenue (reflecting conservative oil price assumptions) has been spent (on a discretionary basis) rather than saved. Revenue-raising measures to broaden the non-oil tax base have nonetheless helped to keep the deficit in check, at slightly under 3% of GDP in recent years.
Colombia was slower to act on tax reform, but in late 2016 the administration of Juan Manuel Santos pushed through a reform designed to raise revenue mainly via a higher value-added tax (VAT) rate, the elimination of VAT exemptions and the widening of the income taxpayer base. These measures, combined with past efforts to crack down on evasion, should help the government to maintain expenditure levels at around their current level of around 19% of GDP, as well as helping to finance Colombia Repunta, a stimulus package announced earlier this year. Colombia Repunta earmarks spending for investments in roads and other civil works, housing, social development, projects associated with the implementation of a recent peace deal with the leftist FARC rebels, and additional transfers to regional governments for their own investment needs.
Laggards under pressure
Although the likes of Peru, Chile, Mexico and Colombia have all faced difficult fiscal dilemmas related to the decline of revenue from commodities, their respective adjustment processes has been relatively smooth in comparison with those experienced by the likes of Ecuador, Venezuela, Argentina and Brazil. Although the political and policy outlook in Argentina and Brazil has changed substantially over the course of the past 18 months, all four of these countries have been marked to some extent in recent years by the impact of highly expansionary fiscal policy and falling revenue from commodities on fiscal, debt and balance-of-payments sustainability.
In Venezuela and Ecuador, required policy adjustments are not yet underway. In Argentina and Brazil, adjustment is underway, but will need to be deep and is proving difficult, reflecting the scale of distortions built up in past years as a result of a failure to enact fiscal adjustment in a timely manner in response to weak revenue. In Argentina, in the five years to 2015 (during the 2007‑15 administration of Cristina Fernández de Kirchner), fiscal expenditure rose by almost 6% of GDP. Spending rose by less in Brazil in the same period, but revenue collection deteriorated by more. In both cases, spiralling fiscal deficits created pressure on the currency and raised questions over debt sustainability. In Brazil in particular, the public debt has skyrocketed, rising from slightly over 50% of GDP in 2010 to 70% of GDP by the end of 2016.
In Brazil and Argentina, the governments of Michel Temer and Mauricio Macri, in place since August 2016 and December 2015 respectively, have committed to gradualist but nonetheless substantial (and politically difficult) fiscal adjustment measures. The centrepiece of the adjustment plan in Brazil is a series of expenditure caps combined with complementary pensions reforms required to reduce the high level of earmarked expenditure commitments. These are controversial, but we assume that they will be approved in a diluted form. In Argentina, adjustment is centred on the reduction of the public-sector workforce, a decline in energy subsidies and a reduction in the deficits of state companies. We expect this plan to bear fruit in the form of a return to modest primary surpluses by 2019 and a stabilisation of the public debt/GDP ratio to around 50%.
An improving outlook
Our forecast for substantial adjustments by the likes of Argentina and Brazil (and eventually even in Venezuela, on the assumption of a change of government in 2019), combined with projected growth in both commodity revenue and, especially, non-commodity fiscal revenue across the region, is reflected in our aggregate public-sector finance forecasts for the region. For the region as a whole, we expect fiscal revenue to rise from 28% of GDP in 2016 to 29.6% of GDP by 2021, and for aggregate fiscal expenditure (including primary spending only for Brazil) to fall from 32.7% of GDP in 2016 to 30.4% of GDP in the same period. The region will continue to register deficits throughout 2017‑21. By end-2021, however, the fiscal deficit will at least have narrowed to 0.8% of GDP, and the public debt/GDP ratio will have stabilised at around 60% of GDP.
This weighted average figure disguises some substantial regional variation. For example, whereas Brazil's debt/GDP is forecast to stabilise in the second part of the forecast period, Mexico's public debt/GDP ratio is projected to continue to rise throughout the coming five years. In both countries, the debt ratio will be high, whereas in Chile and Peru it will remain low by regional and global standards. But despite these variations, it seems clear that the fiscal picture, broadly speaking, is improving moderately. However, whether this improved performance is sustainable over the long term will depend on the ability of the region's governments to enact further fiscal reforms designed to broaden the non-commodity tax base, reduce evasion and improve the quality of fiscal spending.
The Economist |