Fiscal Space for Children: an Analysis of Options in Eswatini
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Fiscal Space for Children: An Analysis of Options in Eswatini February 2018 Table of Contents List of abbreviations 5 Preface 7 Executive Summary 9 1 Introduction and methodology 11 1.1 The objective of the Fiscal Space Analysis (FSA) 11 1.2 Methodology – priority expenditure 11 1.3 Methodology - the fiscal-space analysis 12 1.4 Data limitations 13 1.5 Organization of the FSA part 13 2 Eswatini’s macroeconomic and fiscal context 15 2.1 Longer-term national economic trends 15 2.1.1 Economic growth and recent developments 15 2.1.2 Structure and characteristics of the national economy 16 2.1.3 Socio-economic trends 17 2.2 Recent macroeconomic developments 18 2.2.1 International trade (and its consequences for the fiscal accounts) 19 2.2.2 Inflation and exchange rate 20 2.3 Recent fiscal performance 22 2.3.1 Government financial performance 22 2.3.2 Revenue performance 23 2.3.3 Current expenditure performance 24 2.3.4 Implications for priority expenditure 27 3 Priority expenditure trends and policy challenges 29 3.1 Priority-expenditure composition and recent evolution 29 3.1.1 Priority-expenditure components and fiscal space in recent years 29 3.1.2 Recent evolution of priority expenditure 31 3.2 Sectoral issues in priority expenditure 32 3.2.1 Education 32 3.2.2 Health 33 3.2.3 Social welfare 35 4 The base scenario 39 4.1 Base scenario and fiscal space “mapping” 39 5 Alternative scenarios 43 5.1 Options to increase fiscal space 43 5.2 Alternative scenarios and projections compared with the base scenario 44 5.2.1 Increasing tax and non-tax revenue 44 5.2.2 Decreasing non-priority expenditure 49 5.2.3 Improving efficiency of priority sector spending 50 5.2.4 Other options for enhancing fiscal space 51 5.3 Risks to fiscal space and their impact 53 5.3.1 Weak economic growth 53 5.3.2 Decrease in SACU transfers 54 2 Table of Contents 6 Conclusions 57 7 References 59 Appendix 1: Fiscal space projections 61 Fiscal Space for Children: An Analysis of Options in Swaziland 3 List of abbreviations AGOA Africa Growth and Opportunity Act ARV Anti-retroviral CIT Corporate Income Tax CBS Central Bank of Eswatini CPI Consumer Price Index CMA Common Monetary Area DPMO Deputy Prime Minister’s Office DSW Departments of Social Welfare ECCDE Early Childhood Care and Development FAR Fiscal Adjustment Roadmap FPE Free Primary Education FSA Fiscal Space Analysis FY Financial Year GDP Gross Domestic Product IFC International Finance Corporation IMF International Monetary Fund MVAF Motor Vehicle Accident Fund NHSSP National Health Sector Strategic Plan NDS National Development Strategy NPF National Pension Fund OVC Orphaned and Vulnerable Children PIT Personal Income Tax SACU Southern African Customs Union SARB South African Reserve Bank SRA Eswatini Revenue Authority U5M Under 5 Mortality VAT Value Added Tax Fiscal Space for Children: An Analysis of Options in Swaziland 5 Preface The project team would like to thank the Representative and the staff of UNICEF Eswatini who provided valuable support to the project. We also extend our sincere appreciation to officials from the Eswatini Ministry of Finance, the Deputy Prime Minister’s Office and all the line ministries who participated in this process. We are indebted to the officials within these ministries who made themselves available at short notice to share their insights and experiences with the project team. We also take this opportunity to mention the stakeholders from the non-profit sector and the political parties, who gave of their time to share their thoughts with us. Finally, we express our gratitude to UNICEF ESARO for their support and help throughout this project. Fiscal Space for Children: An Analysis of Options in Swaziland 7 Executive Summary Large fiscal deficits in several recent years will put pressure on Eswatini’s ability to expand fiscal space for child-related priorities in the coming years. These deficits resulted from a combination of unstable revenues alongside expansionary fiscal policies and in particular an increasing wage bill. Revenues have been unstable due to Eswatini’s exposure to its larger neighbour South Africa. This exposure results from long-standing economic ties to South Africa; in particular Eswatini’s reliance on volatile Southern African Customs Union (SACU) revenues and its currency’s (the Lilangeni) peg to the Rand. Continuing political and economic policy uncertainty in South Africa thus creates significant downside risk for the country. A large and expanding public wage bill in Eswatini limits its ability to respond to volatile revenues. While current debt levels are still relatively low, fiscal deficits need to be brought under control in the medium term. This report defines (child-related) “priority” expenditures as that within the sectors of education, health and social welfare. Expenditures on education and health have been increasing consistently since FY2011/12, in line with broader expansionary fiscal policy over the period. Social welfare expenditure has been more volatile, largely due to instability in the Elderly Grant. Total priority expenditure per capita has declined significantly in US dollar terms from US$916 in FY2012/13 to US$604 in FY2016/17, although this reduction is almost exclusively the result of the substantial devaluation of the South African rand (and hence the Lilangeni) relative to the US dollar. Education receives approximately 60% of priority expenditure, and is dominated by spending towards primary education. This spending has supported the implementation of the Free Primary Education Act of 2010, but also results from the high repetition and drop-out rates throughout primary grades. 70% of secondary school aged learners are still in primary school. These low throughput rates are a major impediment to the country’s growth. Throughput rates are impacted by a lack of qualified teachers, the limited public funding towards early childhood development, inadequate funding of secondary education, the impacts of high (though stabilising) rates of HIV and the lack of sufficient social welfare transfers to support learners to stay in school. More broadly, social welfare expenditure should be better targeted towards the poor through the introduction of effective means testing and case management, alongside expanded child grants. Several scenarios have been modelled to estimate the fiscal capacity available to increase priority expenditure. The baseline scenario, which assumes the continuation of recent trends, suggests that priority expenditures in categories relevant for children would average 12.1 percent of GDP between the years FY17-18 to FY21-22. Over these same years, in real terms, total priority expenditures for children averages US$581.7 per child at FY16-17 prices and rates. Under the base-scenario assumptions the projected flows of priority expenditures for children produce a fiscal- space financing “gap” that would have to be covered with internal financing. In this scenario the required internal-financing flow averages 13.6 percent of GDP over the projection years. One option through which fiscal space can be expanded is through increasing tax and non-tax revenue. Two scenarios are modelled in this regard. The first assumes an improvement in the administration of CIT (Corporate Income Tax) and PIT (Personal Income Tax), under the assumption that the Eswatini Revenue Authority (SRA) is effective in increasing tax compliance rates over the medium term. In addition, it assumes an increase priority expenditure through an increase in the elasticity of staff size within the respective priority sectors. The second assumes an increase in the fuel levy and the imposition of a higher VAT (Value Added Tax) rate on alcohol and tobacco products. The government of Eswatini has proposed tax revisions for these items in the Fiscal Space for Children: An Analysis of Options in Swaziland 9 past. As the exact proposed revision rates were not available, it is assumed that the size of the fuel levy increases faster than GDP growth; with the rate of growth incrementally increasing to three times GDP by end-FY22. Simultaneously, the VAT rate on alcohol and tobacco products gradually increases to 18% over the projection period (from the standard rate of 14%). While it would likely not be appropriate to initiate significant tax increases in the current macro-economic environment, there could be room in the short to medium term for a number of targeted taxation efforts. Such increases were shown to have relatively small impacts on total government revenue, but could still be significant to support targeted investments in priority expenditure. The next scenario assumes that fiscal space is bolstered through increased GDP growth as a result of enhanced sugar production due to normalisation of weather conditions, maximised crop yields and strong demand contributing to a strong performance in the sector. The scenario assumes an average growth rate of 4.2% over the projection period: with growth rising incrementally to a high of 5.0% in FY2021-22; relative to 2% in the baseline scenario. As the National Development Strategy (NDS) does not explicitly set out GDP growth targets, the Economic Recovery Strategy’s 5% target is therefore used.1 Additional revenues from increased GDP growth is allocated towards priority expenditure; resulting in average priority expenditure per child increasing by $22.52 to $602.67. Another scenario considers redirecting non-priority expenditure to priority sectors, by way of reducing the proportion of funds expended on defence and police. Currently, the ministries of defence and police account for 6% and 5% of the budget respectively. This scenario assumes spending in these areas is halved over a 5 year period and that all the resultant savings are re- allocated to priority sectors. Relative to the base scenario, per capita priority expenditure is $44.82 higher and priority expenditure as a percentage of GDP 1 percentage point higher.