CEPAL Review no. 124

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Fiscal sustainability and the cyclically adjusted balance policy: methodology and analysis for Chile Mauricio G. Villena, Cristóbal Gamboni and Andrés Tomaselli Abstract This paper sets forth a framework for analysing fiscal sustainability in the Chilean economy. It starts by making an ex post calculation of indicators of vulnerability and fiscal sustainability, based on the estimation of a sustainable debt level, with public finances considered in stationary state. It then develops an ad hoc dynamic fiscal sustainability model for Chile’s public finances, which for the first time incorporates the dynamic of the Pension Reserve Fund (FRP) with its accumulation and disbursement rules, together with the cyclically adjusted balance policy. Lastly, the study simulates the path of the budgetary central government’s net debt up to 2025, using the projections made in the 2018 Public Finance Report, under a macroeconomic trend scenario and another adverse scenario, all framed by the cyclically adjusted balance rule. Keywords JEL classification Authors Tax administration, fiscal policy, public finance, macroeconomics, public debt, economic indicators, economic trends, Chile E62, H6, O23, O11 Mauricio G. Villena is a full professor in the Business School at Adolfo Ibáñez University, Santiago, Chile. Email: mauricio.villena@uai.cl. Cristóbal Gamboni is Senior Economist at BBVA Research, Chile. Email: cristobal. gamboni@bbva.com. Andrés Tomaselli is a student enrolled in the master’s programme in public policy of the University of Chile. Email: aptomaselli@gmail.com.
204 CEPAL Review N° 124 • April 2018 I. Introduction High and rising debt levels undermine a country’s credit rating, thereby generating greater uncertainty in financial markets and driving up the risk premium. This forces the country in question to spend more on debt service, thereby putting greater pressure on other expenditure. In many cases, the only way to reduce the deficit in the short term is by cutting back on public spending, which has negative social consequences. The dynamics and sustainability of the public debt depend on the behaviour of the public deficit and its interrelationship with the different phases of the business cycle, its vulnerability or volatility in the face of exogenous shocks, capital markets, domestic and external interest rates, and the real exchange rate. A country’s net public debt represents accumulated past fiscal outturns, while future balances incorporate the resulting interest income and expenses. Systematic fiscal imbalances will thus generate future interest expenditure, which in turn will contribute to the accumulation of new debt. For nearly two decades, Chilean fiscal policy has been based on a cyclically adjusted balance (CAB) rule applicable to total central government, which is consistent with the medium-term macroeconomic equilibria —in other words with a level of public debt that is sustainable through time. 1 In practice, this implied a decreasing trend in the accumulation of gross liabilities by the budgetary central government 2 until 2010, which has tended to reverse more recently but without returning to the levels of pre-rule years. Figure 1.A shows that, on average, the gross debt/GDP ratio fell from 22.6% in 1990-2000 to 11.1% in 2001-2016. Figure 1 Central government debt, 1990-2016 A. Central government financial assets and total gross financial liabilities, 1990-2016 (Percentages of GDP) 50 45 40 35 30 25 20 15 10 5 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Total gross financial liabilities Financial assets 1 The total central government encompasses institutions that are subject to the same budgetary planning and execution rules, which are closely related to the Executive Branch, plus the extra-budgetary operations associated with this level of government. 2 Although this paper considers income and expenditure flows for total central government, it analyses both gross and net debt stocks for the budgetary central government. The perimeter of the latter excludes unpaid recognition bonds for reasons explained below. Fiscal sustainability and the cyclically adjusted balance policy: methodology and analysis for Chile
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APRIL • 2018 More unequal or less
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Alicia Bárcena Executive Secretary
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Page 240: EDITORIAL BOARD Osvaldo Sunkel Chai
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