Fiscal Space for Children: an Analysis of Options in Madagascar
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Fiscal Space for Children: An Analysis of Options in Madagascar March 2018 Fiscal Space for Children: An Analysis of Options in Madagascar March 2018 Client: UNICEF Table of contents List of abbreviations 7 Preface 9 Executive Summary 11 1 Introduction and methodology 13 The objective of the Fiscal Space Analysis 13 Methodology – priority expenditure 13 Methodology - the fiscal-space analysis 14 Data limitations 16 Organization of the report 17 2 Madagascar’s macroeconomic and fiscal context 19 Longer-term national economic trends 19 Real GDP growth 19 Demographic trends 19 Structure and characteristics of the national economy 19 Poverty 21 Recent macroeconomic developments 21 Real GDP growth 22 International trade (and its consequences for the fiscal accounts) 22 External and internal debt 24 Inflation and exchange rate 24 Recent fiscal performance 25 Government financial performance 25 Revenue performance 25 Current expenditure performance 26 Capital expenditure performance 26 State enterprises 26 External support 27 Government debt (external, internal) 28 Prospects 28 3 Priority expenditure trends and policy challenges 29 Priority-expenditure composition and recent evolution 29 Priority-expenditure components 29 Recent evolution of priority expenditure 31 Comparison to international benchmarks 32 Sectoral issues in priority expenditure 35 Education 35 Health 36 Nutrition 38 5 Social protection 39 Water, sanitation and hygiene (WASH) 40 4 The base scenario 43 Base scenario assumptions 43 Base-scenario projection results 43 5 Alternative scenarios 47 Options to increase the fiscal space 47 Alternative scenarios and projections compared with the base scenario 47 Alternative Scenario 1: increase of external grants 47 Alternative Scenario 2: enhanced value-added tax administration 49 Alternative Scenario 3: increase in mining proceeds 50 Alternative Scenario 4: higher (or lower) GDP growth 51 Alternative Scenario 5: increased current expenditure in child-relevant sectors 52 Alternative Scenario 6: increased current and non-recurrent expenditure in child- relevant sectors 54 Alternative Scenario 7: combined Scenarios 2 and 5 55 Alternative Scenario 8: favourable election consequences for growth 56 Alternative Scenario 9: lower GDP growth 57 Alternative Scenario 10: increased transfers to state enterprises 58 Alternative Scenario 11: setting floor target for priority expenditure 59 Summary of scenario results 61 Other possibilities for enhancing the fiscal space 63 Reducing non-priority expenditure 63 Reducing external-debt service through agreements with creditors 63 Increasing external-debt disbursements 63 Increasing net internal borrowing flows 64 Reducing illicit financing flows 64 6 Conclusions 67 7 References 69 Appendix 1: Fiscal space projections 73 6 List of abbreviations CMBMT Cadre Macro-Budgétaire de Mayen Terme DSB Direction de la Synthèse Budgétaire FSA Fiscal Space Analysis FY Fiscal Year FID Fond d’Intervention pour le Developpement GDP Gross Domestic Product GFI Global Financial Integrity IFF Illicit financial flows IMF International Monetary Fund JIRAMA Jiro sy rano malagasy MDG Millennium Development Goals MFB Ministry of Finance and Budget ODA Official Development Assistance OECD Organisation for Economic Co-operation and Development OGT Opérations Globales du Trésor ONN Office National de la Nutrition PNNC National Community Nutrition Programme PPP Purchasing power parity PSE Plan Sectoriel de l’Education SoE State-Owned Enterprises UNICEF United Nations Children’s Fund VAT Value-added Tax WASH Water, Sanitation and Hygiene 7 Preface This report, which focuses on Madagascar, is the seventh of a series of country studies to be carried out by Ecorys for UNICEF over 2016, 2017 and 2018, in various sub-Saharan African states. These studies are deliverables under Ecorys’ contract with UNICEF entitled ‘National Political Economy Analysis and Fiscal Space Profiles of countries in the Eastern and Southern Africa Region’. As per Terms of Reference, the project aims to strengthen UNICEF’s advocacy capacity through a better understanding of the role of political economy factors in processes and decisions around creation and use of fiscal space for investments in children in Eastern and Southern Africa. 9 Executive Summary Despite an increase in the real GDP growth rate since the end of the political crisis in 2013, Madagascar’s recovery is still fragile and fully dependent on a few export products like nickel and vanilla. Coupled with a low revenue performance and the precarious situation of some state-owned enterprises (SoE), these elements contribute to rising fiscal deficits and thus limit Madagascar’s overall fiscal space. Government debt is still low compared to neighbouring countries, but continued budget deficits and sluggish economic growth might contribute to its rapid deterioration. Political unrest, which may be aggravated in election-time in 2018, further adds to the fragile situation and affects social and economic outcomes in Madagascar. Among priority sectors – defined as education, health, water, sanitation and hygiene (WASH) nutrition and social protection – government spending in the years following 2013 has shown a meagre overall increase as percentage of total expenditure, with the education sector absorbing the bulk. External funding for the priority sectors also showed a positive trend over the same period, again more evident in the education sector. Priority expenditure remained about 20.5 per cent of total (non-interest) expenditure over the fiscal years 2013-2016– it made up 19.4 per cent of total expenditure in 2013, rose to 20.8 per cent in 2014, then dropped to 19.7 per cent in 2015, and finally 21.6 per cent in 2016. Education represents the biggest share, with an average 13.8 per cent of the total government expenditure. The education sector saw a clear net rise in development expenditures in 2016, worth alone about 2 per cent of the total government expenditure. Budget execution in the other priority spending categories has proven erratic and without a clear pattern, a condition imputable to the regular amendment cuts the budget suffers every summer. In a baseline status-quo scenario where economic growth is in line with recent trends, spending on priority sectors would increase modestly, and the financing gap would be reduced. This positive result is linked to the low level of spending and growth in expenditure levels in priority sectors. In this scenario, per-child expenditure would reach US$37.38 (2016 prices) in 2021, which represents an increase of about US$2.25 compared to 2016. The fiscal gap would decline from 0.4 per cent of the GDP to 0.16, mirroring a decrease from 2.36 to 0.35 per cent of GDP in terms of fiscal deficit. If Madagascar’s expenditure on education and health were higher, all other things being the same, either the government’s deficit and net internal financing flow would be higher, or its own revenue (or aid) flows would need to be higher. All other things being equal, any increase in donor financing would reduce the fiscal gap and the fiscal deficit. Comparable results would be obtained by strengthening the efficiency of tax administration or by increasing the magnitude of the mining proceeds, both plausible outcomes if the government manages to finalize the ongoing reform of the tax code and of the Mining Law. If it is able to increase revenue flows in this way, the government will then have to choose in what proportions to apply the increases to reducing the fiscal gap and to increasing allocations to priority sectors. Hence, the positive fiscal outcomes do not impact the level of per capita expenditures for priority sectors, which would remain at US$37.38 in 2021 – the same as the baseline scenario. However, when combining a scenario of increased tax efficiency with a scenario of increased recurrent expenditure in the priority sectors, it appears such a reform could fund an increase of priority expenditure as well as still reduce debt-GDP levels. 11 Higher GDP growth, reaching 6 per cent in 2021 compared to 5 per cent assumed in the baseline scenario, would also deliver a reduction of the financing gap and of the fiscal deficit. These would decrease to 0.04 and -0.24 per cent, respectively. In this case, priority expenditures would grow at a slow pace, delivering an average annual increase in per capita child- friendly expenditures of US$0.35. Other events could impact the fiscal outlook, including the 2018 elections and financing trends to SoEs. A peaceful election process could lead to higher economic growth and higher inflow of external grants, which could increase per child priority expenditure with an annual average of US$0.35 and at the same time close the financing gap. However, political unrest could decrease both growth perspectives and aid inflows, increasing the fiscal gap to 1.78 per cent of GDP in 2021 and decreasing per child expenditure from US$34.90 in 2016 to US$34.77 in 2021. A continued increase of support to SoEs would cause the financing deficit to grow to 0.9 per cent of GDP on average (2016-2021) compared to 0.47 per cent of GDP in the base scenario. Although this scenario would not cause major fiscal harm, it would further strain the capacity of the government to invest more in the priority sectors. Additional options to expand fiscal space for spending on priority sectors include reducing non-priority expenditures as well as external debt service. In general, these approaches seem less advisable. Reducing non-priority expenditure, especially infrastructure expenditure, could have the effect of slowing economic growth and hence revenue flows, which would widen the fiscal gap. Spending floors could encourage a Government to spend at least a minimum amount on its social sectors. However, if there is little room for additional fiscal space, this means this funding would come from a reduction in non-priority expenditure for such an increase to be fiscally neutral. Reducing external debt service is not at present a practical option for Madagascar.