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Public finance reform inevitable for some oil exporting economies

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Staff writer ▼ | November 23, 2015
Oil prices are expected to remain lower, for longer. According to PwC, this bears some resemblance to the decade-long oil price drop recorded from the mid-1980s onwards.
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Analysis   According to PwC economists:
One key difference, however, is the policy response. Back then policymakers in most oil exporting economies had responded by cutting government spending which helped put public finances on a sounder footing.

Now, most of the fiscal action is too modest compared to what is required. As a result public finances have deteriorated significantly and fiscal deficits have grown.

Said Richard Boxshall, senior economist: “One way to fund deficits would be to use up fiscal buffers sheltered in central banks and sovereign wealth funds. This, however, is only a short-term fix. Fiscal buffers are finite, and some assets are ring-fenced. As the IMF has pointed out, fiscal buffers for some GCC economies are expected to run out in less than a decade.”

One way to bring about tighter fiscal control is by setting up or strengthening medium-term expenditure frameworks (MTEFs), as recommended by the international financial institutions like the World Bank and the International Monetary Fund (IMF). Doing so comes with three main benefits:

First, it sets hard constraints on government spending by forcing policymakers to plan spending using a multi-year rather than a single year time frame.

In fact, the World Bank estimates that fiscal balances improve on average by around 2.6 percentage points of GDP in the three years after implementing a MTEF.

Second, MTEFs help delink government spending from the economic cycle. If done properly this could make public finances more credible to international investors and rating agencies.

PwC's analysis shows that comprehensive implementation of MTEF are associated with lower risk premiums on financial assets, which has positive knock-on impacts on both the public and private sectors.

Third, MTEFs link the government’s budget to the country’s long-term economic plan by targeting and prioritising spending on strategically important sectors.

This goes to the heart of an even bigger policy challenge that many oil-exporting economies face, which is to diversify their sources of economic growth by expanding their non-oil private sectors.