Govt Spending Key To Reviving Economy
Kishti Sen is ANZ’s economist for Pacific Island countries where his primary role is to lead ANZ’s Pacific macro-research capabilities. He is a former senior economist with the Reserve Bank of Fiji.
After running an appropriately expanAsionary
fiscal framework last decade, the FijiFirst government was on a path towards fiscal consolidation this decade – aiming to reduce spending and tackle deficits and debt.
However, the COVID-19 pandemic, the subsequent tourism slump and massive decline in jobs and demand has knocked fiscal consolidation off course.
While Fiji avoided a health emergency, the pandemic has caused calamitous economic damage.
Leisure travellers, a mainstay of the economy, have been locked out by closed borders since April, leading to widespread job losses.
But this is not the only problem.
We think remittances will fall substantially as economic conditions in source markets deteriorate.
And this will further dent consumer demand. To cushion the economic impact, Fiji’s government embarked on a pro-growth stimulus package.
The first package was unveiled on March 26, (FJ$1b) with further income and lending support schemes announced in April and May.
We expect additional stimulus to be revealed when the 2020-21 National Budget is handed down in Parliament on July 17.
As the government works to counter the adverse impacts of closed borders and weak global economics, we think government spending, and fiscal policy more broadly, is an important area for attention.
On that basis, we make the following comments in relation to the forthcoming National Budget for Fiji:
• Budgets will be tight and there will be constraints on expenditure, but offsetting the fall in revenue with drastic expenditure cuts or by broad based tax increases may prove counterproductive.
• The policy responses adopted since March will limit the adverse impact of the pandemic, but more fiscal support would help address the near- to short-term economic priorities.
• We believe an overwhelmingly expansionary budget and government expenditures of close to FJD3.8bn would support jobs and demand in the near- to short-term while tourism is in abeyance. Further, it will underwrite future growth.
• Naturally, this will lead to a higher deficit and debt, but without an expansionary budget, the decline in economic output will be more severe.
A large deficit budget during an unparalleled economic downturn, such as the one Fiji is currently facing, is also prudent.
• A targeted stimulus package that includes a combination of cash handouts, small and local projects as well as large national infrastructure investment (mainly roads but possibly railways) and education and health building would help create jobs and keep the economy in shape until tourism comes back and takes over as the driver of growth from late next year.
• Fiscal responsibility – a smaller deficit and debt to appease lenders and keep ratings agencies onside, thereby keeping interest rates on borrowings low – is important too.
However, it is tough times now for Fiji and it’s not going to get better quickly.
The weak economy needs an expansionary budget and it is premature to think about a plan to return the budget to a stronger position.
Let’s get through the economic crisis and limit the damage to jobs and businesses.
We believe that’s where the focus should be for now.
Real work on the expenditure side to give the economy some support
The government kept most of the initially budgeted 2019-20 expenditure, in the COVID-19 response budget tabled in March.
Some expenditure cuts in recent months would have been inevitable in response to rapidly declining revenue.
We estimate government payments will come in around $3.2b for the 2019-20 financial year, which ends on July 31.
For the next financial year, we believe a hefty operating and capital expenditure budget – something in the order of $3.8b – may be required to soften the blow from the pandemic and to keep a decline in economic output in the low double digits as opposed to something worse.
In terms of the stimulus itself, cash payments to lower income groups, small and local projects such as schools and buildings and large nation building and infrastructure projects are likely to have the best affect.
We are not totally in favour of infrastructurefocused stimulus because it has a long gestation period.
Cash handouts and small local projects have a shorter gestation and would support economic activity while planning for the major infrastructure projects is under way.
Not the time to take more revenue out of the economy
We estimate the government will take a $1.4b hit on revenue in 2019-20 due to weakness in economy and tourism tax receipts virtually disappearing in the second half of the financial year.1
Based on our forecasts of lost visitor arrivals and overall economic contraction, we think revenue will fall from the initial 2019-20 budget projection of $3.5b to $2.1b.
For the 2020-21 financial year, we believe revenue will fall further to $1.9b due to ongoing weakness of the economy.
Importantly, given the fragile state of the economy, we don’t think this is the time to take more revenue out of the economy.
Falling revenue and expenditure trimming are likely to result in a deficit of FJD1.1b
But nothing is wrong with large deficits in a severe downturn.
Leisure travel will be the last thing to recover when the pandemic crisis wanes, as shifting people’s attitude, perception and confidence about international travel will take time.
This means we are unlikely to see a return to pre-pandemic holiday arrivals until the second half of next year, and that is only if a vaccine is available.
The current environment does not call for smaller deficit budgets.
The sharply contracting economy needs a counter-cyclical fiscal policy to stimulate demand now.
In the absence of an expansionary budget, the expected economic decline will be more severe than the −12.9 per cent we are forecasting.
A rough gauge of the overall effect of fiscal policy is the change in budget balance as a per centof GDP.
If the underlying cash balance is falling, it implies easing in fiscal conditions and a boost to the economy.
A deficit smaller than −16.8 per cent in 2020-21 will cause a drop in GDP that is worse than our forecast, in our view.
Deficit financing options
We believe a deficit of $1.8bn can be financed through:
• An IMF loan under its Rapid Credit Facility
• Domestic borrowings through issuance of government bonds
The IMF can allow drawdowns of the maximum SDR quota under its Rapid Credit Facility.
So far, 72 countries have accessed this program since March this year to meet Balance of Payments (BoP) financing and for budget support.
Loans under this facility have zero per cent interest with a grace period of five-and-a-half years and a term of 10years.
Fiji can draw down $293m under this facility. We believe a case for such a loan can be made.
With tourism export receipts stalled and lower inward remittances, the pressure on foreign reserves to fund the BoP needs would be too much.
An IMF loan would reduce the need to meet BoP requirements from foreign reserves, which, in turn, would provide confidence to the current exchange rate regime.
We think it is unlikely that the IMF would impose harsh conditions – such as the need to bring deficits and debt down in a hurry – as the current times are unprecedented.
Also it has supported large fiscal programs to mitigate risks from the pandemic.
Of course, it will require transparency and good governance but the Fiji government is doing a lot of these things as part of the ADB/WB support to refinance its maturing USD bond.
However, the IMF loan by itself wouldn’t be enough. The remainder of the deficit could be financed by issuing bonds in the domestic market.
If liquidity is tight, the RBF may buy existing government bonds under a repurchase agreement to free up cash for institutional investors.
The Reserve Bank Act also allows the central bank to purchase up to $900m of government bonds in the primary market, which equates to 30 per centof average annual government revenue over the last three years.
That said, we expect the government to use the market to raise most of its deficit financing so the Bank retains the autonomy of an independent monetary policy while still having a fixed exchange rate regime.
Debt? Let’s get through the current crisis first
Fiscal responsibility – a smaller deficit and debt to appease lenders and keep ratings agencies onside, thereby keeping interest rates on borrowings low – is important too.
However, it is tough times now for Fiji and it’s not going to get better quickly.
The weak economy needs an expansionary budget and it is premature to think about a plan to return the budget to a stronger position. Let’s get through the economic crisis and limit the damage to jobs and businesses. We believe that’s where the focus should be for now, three per cent of GDP) in 2019-20.