Do Fiscal Deficits Cause Economic Instability: The Case of South Sudan
Highlights on a paper entitled: “Do Fiscal Deficits Cause Economic Instability: The Case of South Sudan”
By Prof. Marial Awuou Yol, Juba, South Sudan
Introduction
Thursday, August 27, 2020 (PW) — This paper analyzes the effects of fiscal deficit financed by bank borrowing on macroeconomic instability of a developing country. The paper identifies the oil pipeline shutdown in January 2012, eruption of war in December 2013 and the collapse of global oil prices in the first quarter of 2014 to be responsible for the liquidity shortage that generated a fiscal deficit in fiscal year 2013/2014 for the first time since the country’s independence in July 2011.
Fiscal deficits occur when projected government’s revenues fall short of public expenditures during a particular fiscal year. If the projected government revenues are inadequate to meet public expenditures, the government may resort to borrowing money from banking system to finance the fiscal deficit. This is referred to as creation of new money for filling up the gap between planned expenditures and projected revenues.
When a government finances fiscal deficit by selling treasury bills and bonds to the banking system, monetary base expands, causing a rise in money supply. Consequently, exchange rate depreciates, causing inflation, leading to a severe macroeconomic instability.
Sources of Fiscal Deficit Financing in South Sudan
As the war intensified, public expenditures gradually increased, raising the deficit significantly. With exception of 2012/2013 when the country recorded the first and the last budget surplus of SSP 107.2 million, the country was experiencing increasing fiscal deficits continuously since 2013/2014 to the present day (Tables and Figures for revenues, expenditures, deficits, borrowings, debts, money supply/GDP ratio, deficit/GDP ratio etc. are contained in the full text).
The paper indicates that oil revenues, which outweighs non-oil revenues except in fiscal year 2012/2013, became the main source of financing the country’s budget. As a share of total national revenues, oil revenues constituted 81.1% in 2013/2014, 75.6% in 2014/2015, 59.5% in 2015/2016, 39.1% in 2016/2017, 63.9% in 2017/2018, 64.9% in 2018/2019 and 97.3% in fiscal year 2019/2020 respectively.
As share of GDP, the amounts borrowed to finance the deficit represented 0.55% in 2012, 0.84% in 2013, 26.1% in 2014, 24.1% in 2015, 76.3% in 2016, 28.3% in 2017 and 191.7% in 2018. Although the Deficit-to-GDP ratio, which measures the country’s annual net fiscal loss in a given year, rose moderately over period 2012-2015, the ratio jumped to 76.3 in 2016.
Conventionally, when the ratio exceeds 4.8% of GDP, economic growth is negatively affected. The ratio of 191.7% reported in 2018 was excessive and might have negatively contributed to economic growth rates over period 2017-2019.
Fiscal deficits in South Sudan are generally financed mainly through three main sources all of which are unsustainable: first, loans or advances or overdraft from the central Bank; second, national commercial banks loans/private sector; and third, external borrowing.
The findings reveal three important but interesting observations. First, with exception of fiscal year 2016/2017, oil revenues constituted more than 60% of the nation’s total national revenues over the study period. This supports the common notion that oil is the lifeline of the country’s economy.
Of total expenditures, oil revenues accounted for more than 98% in 2013/2014, 52.3% in 2014/2015, 69% in 2015/2016, 52.3% in 2016/2017, 87% in 2017/2018, 60% in 2018/2019 and 75% in 2019/2020 respectively.
Secondly, the most alarming observation is that, in each fiscal year, the amount of resources borrowed for funding the deficit far exceeded the size of the projected deficit. This was a serious breach of budget rules and regulations. For example, when the fiscal deficit recorded the sum SSP 143 million in fiscal year 3013/2014, borrowing from the BOSS amounted to SSP 1,625 million, that is, approximately 11 times the size of the projected deficit.
Thirdly, the other observation is that the Bank of South Sudan (BOSS) disproportionately funded the country’s fiscal deficit. For example, in fiscal year 2013/2014, 1136% of the public expenditures were funded by BOSS borrowing whereas more than 173% and 196% of total financial requirements in fiscal years 2014/2015 and 2015/2016 were provided by the BOSS.
Similarly, approximately 88%, 74% and 99% of public expenditures were funded by borrowing from BOSS during fiscal years 2016/2017, 2018/2019 and 2019/2020 respectively. As earlier as 2013/2014, the share of BOSS in total borrowing was excessively high, reaching 219.3%.
This implies that as the oil pipeline remained turned off, BOSS funding was the sole and only source of funding public expenditures in the country. This share, however, started to decline only in 2016/2017 although it slightly rose to approximately 59% again in 2019/2020.
Responses of Macroeconomic Indicators to Monetary Shocks
In general, if a deficit is financed by borrowing from the banking system, base money directly expands, causing money supply to increase as commercial banks are able to lend more money. In general, a sale of government treasury bills and bonds to the banking system causes an increase in the base money and consequently, money supply of the country. As money supply increases, domestic exchange rate depreciates, resulting in inflation and a general economic instability.
As to whether fiscal deficits financed through bank borrowing cause macroeconomic instability, the paper finds sufficient evidence to conclude that fiscal deficits financed through bank borrowing caused the current economic instability. As per the period under study, when the government intensified the sale of securities to fund the deficits, base money initially expanded by 154.7% in 2015 and reached a peak of 181.9% in 2016.
This led to rise of money supply by 118% in 2015 and 141.6% in 2016. The rise of money supply, in turn, caused exchange rates to rapidly depreciate by 82.3% in 2015 and 80% in 2016. In response, inflation soared by 110% in 2015 and further skyrocketed by 479% in 2016. As a result, economic growth faltered. The period 2013-2015 enjoyed positive rates of 13.7% in 2013, 16.3% in 2014 and 2.03% in 2015 respectively. However, growth rates began to deteriorate as low as -0.7% in 2017, -5.3% in 2018 and -2.4% in 2019 respectively.
On other hand, when the growth rates of base money slowed, the growth rates of other macroeconomic indicators reversed too. For example, when the growth rates of base money dropped, say, from 181.9% in 2016 to 48.6% in 2017 and to 26.5% in 2018, growth rates of money supply slowed from 141.6% in 2016 to 69.7% in 2017 although the rates moderately rose by 82.9% in 2018. Similarly, currency depreciation rates dropped from 80% in 2016, 35.2% in 2017 and 16.9% in 2018.
Furthermore, inflation rates dropped from the peak of 479.7% in 2016 to 117.7% in 2017 and to 41.2% in 2018. As can be seen here, changes in base money seemed to cause changes in other macroeconomic indicators. This leads us to conclude that initial changes in base money/money supply caused changes in other indicators and the general economic instability.
Findings and Policy Recommendations
The paper identified the shutdown of oil pipelines in 2012, eruption of war at the end of 2013 and the collapse of global oil prices in 2014 as the three main factors that gave rise to shortage of funds. These factors jointly generated a fiscal deficit of SSP 143 million in fiscal year 2013/2014 for the first time since the country’s independence.
These changes among macroeconomic indicators seem to be consistent with the hypothesis that financing fiscal deficits through bank borrowing can, inevitably lead to a rise in base money which, in turn, causes money supply to rise. This causes the depreciation of exchange rate and, consequently, soaring inflation. These changes eventually led to the deterioration of economic growth – macroeconomic instability – the country is undergoing.
Based on these fundamental findings, this paper makes the policy recommendations as follows:
First and foremost, to avoid such economic instability from recurring, governments need to wean off themselves from the practice of financing fiscal deficit from bank borrowing. In other words, governments should avoid taking advantage of high-powered money from bank vaults for financing fiscal deficits and instead, should concentrate on developing own resources (e. g. custom duties on imports and agricultural duties) for financing public expenditures. They should develop and promote local revenue administrations to collect own resources instead of relying on bank borrowing or money printing as the practice is the root cause of macroeconomic instability.
The recently established South Sudan Revenue Authority should be strengthened and facilitated to streamline and professionalize the national tax collection and administration. Studies have shown that autonomy of revenue authorities is associated with high levels of performance, the higher the levels of autonomy, the higher the levels of performance.
The finding that oil revenues constituted more than 60% of the nation’s total revenues over the study period clearly underscores the critical need for economic diversification. The government strive to diversify revenue sources and avoid the risk of depending on a single export commodity. This can, in addition, can give the government necessary tax base for mobilizing sufficient resources for financing public expenditures.
The observation that the Bank of South Sudan (BOSS) shouldered the lion’s share in funding the country’s fiscal deficit underlines a need to set limits and targets for deficit financing. Globally, central banks are not permitted to finance fiscal deficits. This not permitted in countries such as Australia, UK, and New Zealand, and EU.
Where it is allowed, governments place curbs on financing. For instance, in Costa Rica, a central bank is allowed to finance only up to 5% of government expenditure and 25% of the national budget. Therefore, the government of South Sudan should set rules and regulations that specify the percentage of public expenditures to fund through central bank borrowing, with the required amount to not exceed the size of the deficit.
The alarming finding that the amount of resources borrowed for funding the fiscal deficits far exceeded the size of the projected deficit in each fiscal year constitutes a serious breach of budget rules and regulations. Through over-borrowing for deficit financing purposes, corrupt government officials could collude with business hoodlums to loot public coffers in complete absence of transparency and accountability.
As such, it is necessary to establish strict measures for controlling and regulating public expenditures. The fact that, in each fiscal year, the amount of resources borrowed for funding the deficit far exceeded the amount of the projected deficit provides a wider loophole for corrupt officials to swindle public resources in the name of deficit financing. The good example is that, when the fiscal deficit amounted to SSP 143 million in fiscal year 3013/2014, the Ministry of Finance and Economic Planning borrowed the amount of SSP 1,625 million from the BOSS, which is approximately 11 times the size of the projected deficit.
To prevent corrupt practices such as over-borrowing for the purpose of fiscal deficit financing that breaches budget rules and regulations by the officials of the Ministry of Finance and Economic Planning, there is serious need to establish an institution legally tasked with responsibility of combating corruption in the country.
Corruption, which is broadly defined as “the use of public office for unauthorized private gain”, is behind all malpractices that besiege financial institutions in the country. More importantly, it is necessary to establish an anti-corruption institution that will work in complementary with national Auditor-General’s Chamber to combat corrupt practices and set strict rules for controlling and regulating public revenues and expenditures.
The author is a former undersecretary and minister in the government of South Sudan and currently the vice chancellor of the Upper Nile University in South Sudan.
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