Expansionary fiscal policies and weak revenues have led to a surge in public debt and fiscal financing pressures. The central government deficit widened to 8.1 percent of Gross Domestic Product (GDP) in 2013/14 (year ending March) and is expected to reach 9.6 percent of GDP in 2013/14. Central government gross debt (excluding holdings of securities by the National Insurance Scheme) rose to 94 percent of GDP at
Recognizing the need for urgent action, the authorities announced ambitious fiscal consolidation measures during the second half of 2013 aimed at strengthening the fiscal position and arresting the slide in reserves. These measures included a reduction in the size of the civil service by about 13 percent, further downsizing by attrition, wage cuts for elected and appointed officials, and a two year nominal wage freeze. If fully implemented, and assuming slippages are corrected with offsetting measures, these actions could lower the fiscal deficit to 4.9 percent of GDP, and would help to restore stability to external flows. Output is projected to fall by 1.2 percent in 2014 before recovering modestly in 2015, supported by capital inflows to finance tourism and energy related projects. The debt-to-GDP ratio could level off by 2015/16 and decline slowly thereafter, though foreign reserves would remain below desirable levels.
However, the near term outlook will depend on vigorous and timely implementation of the proposed adjustment measures, and the consequences of policy slippage would likely be significant.
Executive Board Assessment2
Executive Directors noted that
Directors agreed that a frontloaded fiscal consolidation is necessary in the current circumstances and stressed the importance of reining in spending and clearing arrears. They welcomed the measures announced in the second half of 2013 and urged their prompt implementation, which should raise confidence, stem the government's cash flow needs, and increase foreign reserves. For the coming years, Directors encouraged the authorities to consider additional tightening, focusing on growth-friendly measures, to put debt on a steeper downward trajectory. They noted that a debt-to-GDP target could serve as a useful medium-term anchor. Directors saw scope for raising revenues by broadening the base, reducing tax exemptions, and improving tax and customs administration. They also stressed the need for public enterprise reforms, particularly to improve oversight and accountability. In light of ongoing efforts to rein in the wage bill, Directors stressed the importance of preserving an adequate and well-targeted social safety net.
Directors noted the authorities' commitment to the nominal exchange rate anchor. They encouraged the central bank to reorient monetary policy towards supporting the exchange rate peg by curtailing direct financing of the government, and allowing domestic short-term interest rates to rise to a level that reflects a credible country risk premium.
Directors underscored the need for a growth strategy focused on improving the business climate while preserving
Directors commended the strides made by the authorities in improving financial sector regulatory and supervisory frameworks. While domestic banks appear resilient to shocks, Directors noted the risks posed by a negative sovereign-financial feedback loop as well as weakening asset quality. They stressed the importance of continued close supervision of both banks and non-bank financial institutions, and looked forward to implementation of the recommendations of the Financial Sector Assessment Program (FSAP) update.
TNS 30BautistaJude 140213-4636247 30BautistaJude
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