Figure 4: Domestic borrowing versus external commercial borrowing

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C. Alternative Case Investment Strategies

The alternative case investment strategies (aggressive and modest scenarios) assume the same economic structure of the economy as in the base case but different degrees of public investment scaling-up. The level of grants secured by the government is also similar to that of the baseline. Therefore, no additional financing from concessional borrowing is assumed in the case of more aggressive investment strategy. However, we assume that the government would access external commercial loans to finance part of the fiscal gap. In addition, we assume that coping with both public investment plans requires domestically adjusting the fiscal stance. The rigidity in the adjustment on the spending side would therefore entail some adjustments on the tax side only.

Aggressive public investment scaling up scenario

Transforming the Sierra Leonean economy in order to achieve middle income country status will require more aggressive investment strategy than what is assumed in the baseline. The authorities’ aspirational plan is a medium-term spending profile that will be driven by public investment scaling up (IMF staff report, 2014).18 Therefore, in this alternative investment scenario (figure 5), public investment is projected to rise from 8 percent of GDP to 19

18 Actions are underway with the objective to prevent fiscal slippages, contain the wage bill and strengthen public investment management.

percent of GDP by year 4 (which is more than doubling the baseline investment level in four years), and then falls gradually to 11 percent of GDP, permanently, by year 10.

Assuming that the structural economic conditions remain unchanged and under the assumed financing strategies, the aggressive investment scaling up while beneficial in the long term, would require unfeasible fiscal consolidation in the medium term. The increase in the consumption tax rate is projected to be higher compared to the base case (consumption tax rate reaches a peak of 23 percent in year 9 compared to 17.5 percent in the baseline).

Therefore the additional fiscal effort necessary for the alternative investment strategy represents 5.5 percentage points increase of the consumption tax that corresponds to the baseline investment strategy in year 9. Clearly, such fiscal adjustment is unrealistically achievable in the current context of the Sierra Leonean economy characterized by lower tax base, tax fraud and tax evasion (IMF staff report, 2014). The downside of the fiscal consolidation is lower private consumption and private investment in the short-to medium-term. In particular, private consumption path in the aggressive investment scaling up case is below that of the base case in the first 13 years. Private investment is also lower compared to the baseline, although the difference is marginal. The upside of the fiscal adjustment is a fast decreasing path of the external commercial public debt in the aggressive public investment case compared to the base case. In particular, external commercial public debt is 10 percent of GDP in year 20 in the aggressive public investment case and 14.5 percent of GDP in the base case, which is 4.5 percentage point lower. But the favorable debt dynamics is also the result of the higher long term growth benefits.

Figure 5: Aggressive public investment scaling up

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Lower public investment scaling up scenario

This alternative “investment surge” experiment considers a smaller and frontloaded increase in public investment (at the peak time, the level of investment is 1.2 percentage point lower compared to the base case). As expected, more modest public investment strategy (figure 6) leads to smaller adjustment in tax rates. In addition, the relative merits of it are private consumption and private investment that expand, yet marginally in the short run compared to the baseline. However, modest investment scaling up is not without risk of jeopardizing long term goal such as higher GDP growth rate and sustainable debt path, especially when commercial loans finance part of the fiscal gap.

Figure 6: Lower public investment scaling up

VI. Baseline investment strategy with structural reforms and Policy Conditions A. Structural Reforms

So far we argued that public investment can be self-financing in the long run; the growth dividends that it entails can therefore help contain vulnerability to debt distress. However, the extent of the growth benefits depends on changes in the structural conditions of the economy (changes in efficiency or rate of return on public investment and absorptive capacity). These are essentially institutional factors. They contribute to shape the extent to which the public investment is translated into productive capital. It is generally believed that such factors are weak in fragile states including Sierra Leone. Indeed, the index of public investment management developed by Dabla-Norris et al (2011) ranks Sierra Leone in the bottom quartile, suggesting that the assumed parameter values underpinning such factors in the baseline may seem less conservative (see section III.2 for the discussion on the parameters values), and may suggest that the results discussed earlier are optimistic. This calls for more conservative assumptions. This section therefore conducts sensitivity analysis based on different assumptions of structural conditions of the Sierra Leonean economy: return on infrastructure ( ), efficiency of public investment ( ), user fees on infrastructure (f) and absorptive capacity (ϕ). We assume two different scenarios against the baseline parametrization: optimistic scenario and pessimistic scenario (table 3). The “optimistic scenario” assumes that some structural reforms would help improve the country’s efficiency, but this may take time to implement. In this regard, this scenario reflects a “gradual” increase (or improvement) in the parameter related to efficiency from its baseline value (0.6) to 0.75 within 10 years (figure 7).

Figure 7: Optimistic scenario: Efficiency of public investment ( , in %)

In the “pessimistic scenario”, the return on infrastructure is set at 15 percent versus 25 percent in the base case. Public investment is less efficient (40 percent) and user fees recoup only 30 percent of recurrent costs of infrastructure. The absorptive capacity binds more (ϕ=5 versus ϕ=2 in the base case).19 In addition, the size of the scaling-up of public investment, the financing mode and fiscal adjustment are similar to those in the baseline.

Table 3: Sensitivity Analysis Assumptions Return on

infrastructure ( )

Efficiency of public

investment ( )

User fees on infrastructure ( )

Absorptive capacity (

Base case 0.25 0.60 0.50 2.00

Pessimistic 0.15 0.40 0.30 5.00

Figure 8 (respectively figure 9) displays the results associated with the “optimistic scenario”

(respectively “pessimistic scenario”). The transition paths under the optimistic scenarios are encouraging compared to the baseline and the pessimistic scenario. Specifically, the effective public capital as well as growth rate reach a much higher level compared to the baseline and total public debt is at a lower level. Fiscal adjustment (revenue side) is not painful. The paths are notably better in the long run. The ratio of external commercial public debt peaks at around 17.5 percent at t=6, while declining at 1.2 percent at t=30, below the base case scenario. Real per capita GDP growth rate reaches a much higher level compared to the base case scenario.

Furthermore, the short and long run outlook in the pessimistic scenario are discouraging.

The path of the real per capita GDP growth rate increases below the assumed long-run growth rate of 3.3 percent and total public debt stock reaches a much lower level compared to the base case. In addition, private consumption path fall in the negative territory by year 7

19Lower value (e.g.: value 0) shows high absorptive capacity while higher value (e.g.: value 5) shows low absorptive capacity.

till year 25 and private investment is below the baseline parametrization as a result of the sharp fiscal adjustment.

We conclude that good institutional factors contribute significantly to the result of public investment and economic growth and sustainability. It is critical that the authorities of Sierra Leone strive to improve those structural factors such as the return of the infrastructure and the efficiency of the public investment, through structural reforms aimed at improving the institutional and regulatory frameworks of project selection and monitoring. Such reforms should include “investing in investing” or investment in capacities that foster new investments and institutional capacities (Collier, 2008).

Figure 8: Higher efficiency of public investment and allowing for commercial public debt

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Figure 9: Lower structural conditions and allowing for commercial public debt

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B. Policy Conditions: Fiscal Limits

Now we investigate how the fiscal policy conditions affect debt sustainability (figure 10). We capture this by comparing a scenario of unconstrained tax adjustment with a scenario where we assume that the tax adjustment is staggered. After all, fiscal adjustment in the context of the Sierra Leonean economy is subject to significant rigidities due to pressure on the spending side (e.g.: labor unions looking for better pay, entitlement spending) difficulties to improve the tax base, etc., and underlying expenditure pressures for non-programed and earmarked expenditure due to continued Ebola outbreak. Weak future fiscal position that limits the government’s ability to respond countercyclically to downturns and shocks

increases risks to debt distress. The literature has recognized that a smaller tax base contributes to higher sovereign default risks in developing countries (e.g.: Hausmann, 2004;

Mendoza and Oviedo, 2004; Celasun et al., 2007; Bohn, 1998, 2008; Ghosh et al., 2011 and Ostry et al., 2010; Bi, 2012; and Juessen et al., 2012). In addition, we distinguish between two cases pertaining to the degree and speed of grant-financing. The first case is similar to the assumed path of loans and grants in the baseline. Specifically, grant-financing is proportional to the degree of public investment scaling up during the first 10 years while growing disproportionately higher after 10 years (Panel A). The second case assumes that the path of loans and grants is permanently proportional to the degree of public investment scaling up (panel B). Furthermore, the public investment strategy is similar to that of the base case discussed earlier and we allow for external commercial borrowing. To capture rigidities in the tax adjustment, we cap the consumption tax rate at 16 percent (red line) and then at 16.5 percent (green line) by year 8.

As expected, it appears clearly that the size of the cap affects the debt path. Smaller size undermines the sustainability of total public debt at a given public investment strategy and structural condition. Considering panel A for instance, when the cap is 16 percent the total debt public debt amounts to 45.6 percent of GDP by year 20; it amounts to 42 percent of GDP by year 20 when the cap is 16.5 percent. More importantly, the way loans and grants adjusts to close the financing gap in the public investment scaling up matters in the presence of constrained tax adjustment. When loans and grants grow quickly than the scaled-up investment (panel A), the debt level is more manageable than otherwise (panel B). In particular, total public debt reaches 45.6 percent of GDP by year 20 in the first case versus more than 79 percent of GDP in the second case for a tax rate restricted to 16 percent.

Figure 10: Different fiscal limits and allowing for external commercial borrowing

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Loans and concessional borrowing only Cap 16% and allowing forcCommercial borrowing Cap 16.5% and allowing for commercial borrowing

C. Timing and Speed of Fiscal Adjustment

The timing and speed of fiscal adjustment are critical, although governments sometimes have little room for maneuver. For example, severe financing constraints may leave governments little choice but to consolidate, and politically sensitive spending (wage bill, anti-poverty spending, etc.) might prevent consolidation until the problems posed by current policies result in a crisis. But when governments have room to maneuver, as a rule, fiscal consolidation should occur during good times.

Panel A

Panel B

The parameters and in equations (21)-(22) determine whether the fiscal policy adjustment is slow or fast (see box 1). Slow adjustment may require a debt level (second component of equations 21 and 22) above its target level until the gap between the current tax rates ( ) and transfers ( ) and their target levels ( ) and ( ) respectively, is close. At a faster pace, fiscal adjustment may not be feasible for Sierra Leone for the raisons mentioned earlier. We compare the debt sustainability impacts associated with faster and slower fiscal adjustment. The run in figure 11 simulates the case when the government speeds up versus delays or postpones the adjustment of the VAT. This is achieved by assuming discrete jumps in the tax rate. In the faster adjustment (respectively slower adjustment), the consumption VAT jumps immediately from the initial level of 15 percent to 16 percent from year 1 to 6 (respectively stuck at 15 percent over this period) and then to 16.5 percent by year 7 (respectively 16 percent). In addition, we distinguish between the case when the concessional loans and grants grow fast compared to the scaled-up public investment (panel A) and the case when both grow proportionately (panel B).

It stands out clearly that the faster adjustment entails lower debt level, while in the presence of delays in the adjustment, the debt blows up, especially when the inflow of loans and grants is proportional to the scaled-up investment (panel B). However, when the grant-financing grows faster than the investment scaling up (panel A), the government can enjoy postponing the fiscal adjustment without any risk of debt distress in the sense that the debt trajectory does not explode.

Figure 11: Speed of tax adjustments with external commercial borrowing and different paths of the grant-financing.

Constrained and faster adjustment Constrained and slower adjustment

Panel A

Panel B

VII. Downside Risks

For the foreseeable future, downside risks are prevalent and will have adverse effects on debt sustainability, from the perspective of other standard measures of debt sustainability (not explored in this framework) such as debt-to-revenue and debt-to-exports. Volatility in the external and domestic outlook is part of the risks, given the country’s growing dependence on iron ore export and the undiversified and narrow export base. Therefore, it is clear the economy is prone to extreme vulnerability to terms of trade shock. In addition, the protracted civil war has seriously damaged the human capital base of the country with the destruction of many basic infrastructures and the fleeing of many qualifies workers. Although progresses have been made thus far, the current Ebola epidemic and the ensuing risks to morbidity could halt the momentum and reverse the post conflict achievements. The economic costs of morbidity is felt in terms of foregone productivity of people directly affected by the epidemic, which in turn translates into foregone output. All of these risks undermine directly or indirectly public finances which can also undermine market expectations through increasing public debt risk premium. Clearly, in the case of commercial borrowing this is likely to induce unsustainable debt levels. But when grants and concessional lending are secured during such ill-times, the shocks are less prone to generate explosive paths of public

Box 1: Speed of Fiscal Adjustment

The equation of the tax rate dynamic (21) can be expressed in the form of Error Correction Model (ECM) as follows:

(21)

Where is the speed of adjustment parameter. It tells us by how many percent the tax rate deviation from its target ( ) is corrected every year. The lag in entails that the adjustment is sluggish.

Following Chiang (1984), (21) indicates that tax rate evolves sluggishly toward its target level at a constant speed ( ) proportional to its distance from :

, or using the adjustment time t:

.

We define the adjustment ratio as: , From (21),

The time it takes to close percent of the gap is therefore:

When the speed of adjustment, , then it takes two to three years to cut half (i.e.

) the gap between the current tax rate and its target value. However, it takes one to two years to cut it half when the adjustment is speed up (e.g.: ).

debt. Thus, given the path of the grant-financing similar to the baseline, we investigate the impacts of terms-of-trade (TOT) and total-factor productivity (TFP) shocks in the presence of external commercial debt-financing.

A. Terms-of-Trade Shocks

We investigate two scenarios of unexpected and permanent negative terms-of-trade shock hitting the economy at a time of higher economic vulnerability, i.e. when total public debt amounts to higher level. This period corresponds to year 9. The first scenario is 10 percent decline in the TOT while the second one assumes 20 percent decline.

As exemplified in figure 12 (panel A) negative terms-of-trade shifts can lead to unsustainable debt levels. As expected, the magnitude of the shock matters for the debt level. In addition, the scale and speed at which loans and grants adjust to the scale of public investment matters.

Here, we assumed that the concessional financing increases more than proportionally compared to public investment. If it was just proportional, then the debt paths would be explosive (see figure 11). Therefore, although our analysis indicates that Sierra Leone’s debt distress is moderate, the narrow export base and difficulties to delink the economy from volatility in the iron ore resources could reverse that finding. This underscores the need to continue seeking mostly grants and highly concessional loans to cover the financing needs.

Figure 12: Negative TOT and TFP Shocks

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80 Total Public Debt (% of GDP)

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B. Total Factor Productivity Shocks

One of the main direct and indirect channel through which the economic impact of the Ebola epidemic operates is known to be the contraction in the labor supply due to sickness and death and the rising cost of healthcare recourses (World Bank, 2014). We investigate the implications for growth and debt sustainability of unexpected non-permanent (first-three years) negative total-factor productivity (TFP) shocks as a way to model disaster shocks.

After all the Ebola outbreak and ensuing human and economic damage is similar to a natural disaster. The human damage is understood as a destruction of the human capital-base, most of skilled labor force dying from the disease and some fleeing the country to save their life and the life of their belongings. Moreover, as the country is cut off from the rest of the world, any migration of external skilled labor force to Sierra Leone is hampered. This, added to a protracted civil war that has already killed and displaced the labor force will convincingly imply a worsening of the total factor productivity and ultimately the domestic production and

Panel A TOT Shock

Panel B TFP Shock

supply. To capture this, we introduce a negative shock on TFP as a gradual, equal and simultaneous decline in the productivity scale factors in tradable and nontradable sectors over the first-three years. In particular, we assume a simultaneous and equal decrease of 5 percent, 3 percent and 1 percent in the TFP scale factors in “year 1”, “year 2” and “year 3”, respectively.

Panel B of figure 12 and figure 13 depict the results of the TFP shocks. Real GDP contracts relative to the steady state by 4.3 percent, 3.1 percent, and 1.1 percent and in “year 1”, “year 2” and “year 3”, respectively. These results are broadly close to the recent World Bank’s estimates and forecasts. Indeed, at the beginning of the year 2014, the World Bank forecasted that GDP growth in 2014 would amount to 11.3 percent for Sierra Leone. In mid-August 2014, as a result of these factors, and bearing in mind that the risks are to the downside, the World Bank revised these estimates to 8.0 percent accordingly, which is 3.3 percentages point decline (World Bank, 2014). In January 2015, the actual GDP growth (7.3) points to 4 percentages point decline of GDP growth in 2014, and the World Bank forecasts that GDP growth in 2015 would contract by 2 percent.

On the public debt side, the TFP shocks do not induce explosive paths for public debt when the government contracts commercial loans. This is so because we assumed that the concessional loans component of the fiscal gap financing is higher in the long term. Indeed, the long term path of concessional loans is slightly more than proportional to the path of the public investment (see figure 11), which rules out any risks to larger debt burden.

On the public debt side, the TFP shocks do not induce explosive paths for public debt when the government contracts commercial loans. This is so because we assumed that the concessional loans component of the fiscal gap financing is higher in the long term. Indeed, the long term path of concessional loans is slightly more than proportional to the path of the public investment (see figure 11), which rules out any risks to larger debt burden.

문서에서 Macroeconomic Challenges of Structural Transformation: Public Investment, Growth and Debt Sustainability in Sierra Leone WP/15/ 164 (페이지 25-0)