Apr 24, 1990

THIRD WORLD: EXTERNAL VARIABLES AND REMEDIES CAUSED DISORDERS.

GENEVA, APRIL 21 (BY CHAKRAVARTHI RAGHAVAN) -- The macro-economic disorders plaguing the Third World in recent years sprang from abrupt changes in external variables and the remedies applied to bring about the payments and fiscal adjustments may have contributed to the worsening of the disorders.

This is brought out in an UNCTAD report (TD/b/c.3/234) to the thirteenth session of the Committee on Invisible and Financing related to Trade (CIFT).

The report also brings out that the adjustment policies - currency devaluations and import tariff cuts and other trade liberalisation measures - have contributed to the budgetary deficits in the Third World countries.

The report argues that ending the macro-economic disorder in Third World countries requires lifting the external debt burden, arriving at a social consensus on how the burdens and fruits of adjustment are to be shared, and stepping up investment especially in exports.

"Growth", UNCTAD says, "cannot be sustained for long without stability; but since income growth is essential in order to obtain social consensus, a revival of development is best viewed as a pre-requisite, and not simply as the end product, of financial stabilisation".

The domestic macro-economic disorder in the Third World in recent years, the report notes, has manifested itself in various imbalances including high inflation rates, rapid monetary expansion, very high interest rates, very large fiscal deficits, as well as low rates of investment and growth.

Though excessive expansionary fiscal policies are often the cause of internal and external disequilibria, the origins of the disorder in the Third World lie elsewhere.

The large payments deficits in the early 80’s sprang from abrupt changes in external variables, rather than domestic policy, and gave rise to huge outward resource transfers and sharp currency depreciations which provided the impetus for inflationary pressures.

The massive deterioration in budget balances, and rapid growth of internal debt and money supply, were the result and not the source of monetary and financial instability and loss of momentum in growth.

The rise in interest payments swelled public sector deficits while cutbacks in lending created a financing gap. In many countries the external resource transfer problem became also a domestic problem and a struggle between private and public sectors over the size and composition of the budget. Also, the collapse of commodity prices reduced government earnings.

The solutions (advised by the international institutions and creditors) themselves damaged the government budgets: import reductions and tariff cuts reduced revenues from trade taxes; currency-depreciation raised the domestic currency cost of debt servicing and of imports for public investment; and debt conversion has tended to aggravate the domestic transfer problem. The slowdown in economic activity and rise in inflation contributed to widening public sector deficits.

Faced with the challenges of counteracting influences beyond their control, many debtor countries have managed to bring public sector deficits from the high levels of the 80’s down to the level of the 70’s, but have to cover the deficits now through domestic financing rather than foreign loans.

Analysing some of the experiences, the report points out that the impact of trade shocks and payments adjustment on the fiscal balance has been especially marked in Third World countries since, for most of them, taxes on international trade are an important source of revenue - on an average it is five percent of GDP and more than a quarter of total tax revenue.

Trade taxes are particularly important for low-income countries. While import duties are the main source of revenue, export taxes too are important in agricultural commodity exporting countries.

Government revenues from trade taxes are determined by trade performance (volume and prices of imports and exports), degree of trade liberalisation (tax rates on traded goods) and the real exchange rate (the real value of the trade tax base in terms of domestic currency).

On average, between 1980-1981 and 1985-1986, there was a moderate decline in average import tax revenues and in the majority of the highly indebted countries the fall reflected the tariff reductions. In most countries where the implicit tax rates fell, quantitative restrictions had already been replaced by tariffs in the 70’s, and the emphasis in the 80’s was on tariff cuts.

For a sample of 20 debt-troubled countries, government revenues from import taxes fell by one percent of GDP between 1980-1981 and 1985-1986 because of import cuts and tariff reductions. Similarly declines in implicit average effective tax rates on exports, along with poor export performance, reduced average shares of export taxes in GDP.

Declines in commodity prices in world markets accounted for entire fall in export earnings and had adverse impacts on government revenues.

UNCTAD estimates that trade policies, import cuts and commodity price declines together inflicted revenue losses averaging l.5 percent of GDP. Most of the loss was due to import cuts, but reduced tax rates on trade were also important.

Currency depreciation, another adjustment policy that indebted countries have been forced to adopt, may help improve trade performance but has generally had a negative overall impact on fiscal balances, the report points out.

Overall for the sample of countries analysed, revenue losses from trade taxes due to import cuts, declines in export prices and tariff reductions represented, on average, about 40 percent of the actual budget deficit in recent years.

In most countries currency depreciations increased trade tax revenues by less than they raised cost of real government spending, especially where level of public investment was high and net transfers were negative. In many low-income countries they had a positive or small negative impact because trade tax receipts were high relative to interest payments abroad.

"Nevertheless, almost everywhere currency depreciations together with changes in trade taxes brought budgetary losses. For the highly indebted countries such losses amounted to about two-thirds of the average budget deficit during 1985-1986. In six of the indebted countries the losses amounted to half the budget deficit while in three it was more than the entire deficit".

The market-based menu of options for creditors, which require the public sector generating resources and which is often not possible without further deflation and/or price instability, are also increasing the difficulties of fiscal and budgetary management, UNCTAD says.

"Under the present crisis conditions in the debt-troubled countries, there is a serious risk that many of the mechanisms of the market-based menu can become an additional source of financial instability and capital flight. They open up new prospects for arbitrage, speculation and windfall profits for a handful of operators in creditor and debtor countries, giving them an interest in persistence of the crisis".

Even if some of the mechanisms for debt rescheduling reduce outward transfers, they can be very costly in terms of increased financial instability and austerity and conflict with the prime objective of debt reduction, the report points out.

"Many governments have therefore been reluctant to agree to such operations as part of debt rescheduling deals. Nevertheless, creditor banks have acquired substantial rights to engage in them".

There could be little doubt that many of the debt-troubled countries need stabilisation involving considerable drop in inflation, moderation of public sector deficits, reduction in pace of domestic debt accumulation, substantial slowdown in monetary expansion and stabilisation of real interest rates, stabilisation of real exchange rates, and lessening of currency substitution and capital flight.

All these call for reconciliation of income-claims on the public budget of which reduction of public sector deficit is a part. Whether financed by monetary expansion or by unsustainable pace of domestic debt accumulation, they represent incompatibility of claims on the budget (by public employees, rentiers, foreign creditors, recipients of government subsidies and beneficiaries of public goods) with income transfers the private sector is willing to make to the public sector through taxation.

Many Third World countries are currently making renewed efforts at stabilisation with various combinations of orthodox and heterodox measures. But whatever the route chosen, success requires the raising of the rate of growth.

Debt reduction could help reconcile income claims and eliminate disorder, and lower public sectors interest payments and help reduce budget deficits.

While the need for debt reduction is now recognised, it has not been sufficiently appreciated that in a number of countries restoring stability, order and confidence, and eliminating uncertainties and imbalances, would inevitably take time even if substantial relief is provided and appropriate policies are pursued by the debtor country.

The crisis has been allowed to persist for so long that the cumulative damage is too deep rooted to be undone swiftly. Major OECD economies took almost half a decade to restore macro-economic disorder after the mid-70’s, even when their external environment had improved.

"It would therefore be unrealistic, even counterproductive, either to require debtor countries to achieve a significant reduction in internal imbalances before becoming eligible for debt reduction, or to expect a swift return to stable conditions", UNCTAD concludes.