Department of Country Economics — Uruguay, Barbados, Kyrgyz, Nicaragua, Vanuatu, Fiji, Indonesia, Luxembourg
The Fund recently released Article IV conclusion statements on the following countries.
Uruguay has had a good year in 2017, with growth estimated at above 3 percent and the rise in unemployment forecast to have come to a halt. A relatively tight monetary policy stance and an appreciating exchange rate have contributed to a notable decline in inflation — estimated at 6½ percent by year end — bringing it within the central bank’s target range for the first time in seven years.
The fiscal adjustment is on track. Fiscal policy has been countercyclical in 2017, with higher income tax receipts partly offset by rising pension and health care costs. The overall deficit is estimated to decline to 3.3 percent of GDP, and the government continues to be able to access international financial markets on favorable terms, including through global nominal-peso bonds.
Following the economic recovery in 2016, GDP growth is slowing reflecting increased pace of fiscal consolidation. Real growth reached 1.6 percent in 2016, as a result of continued robust long-stay tourism arrival and spending. It is projected to slow to 0.9 percent in 2017 and 0.5 percent in 2018 due to the ongoing fiscal adjustment and policy uncertainty related to the forthcoming elections. Inflation is projected to rise by year end to 5.5 percent as a result of recent tax increases but return to its historical norm in the medium term….
There has been progress with fiscal consolidation but the deficit and debt remain high. The fiscal deficit is estimated to have declined to 5.5 percent of GDP in FY2016/17 reflecting stronger revenue performance, including the introduction of the National Social Responsibility Levy (NSRL) and one-off factors. The government also reduced total expenditure, despite a large increase in debt service, reflecting efforts to contain spending across the board. Staff project further progress in reducing the fiscal deficit, to 4.1 percent of GDP in FY2017/18 without divestment proceeds. However, this is less than planned as a result of shortfalls in NSRL revenues and higher transfers to SOEs. Central government debt at end-FY2016/17 was 137 percent of GDP or 101 percent of GDP excluding securities held by the National Insurance Scheme (NIS).
“Economic growth exceeded expectations in 2017. GDP grew by 4.5 percent, with the recovery encompassing most sectors. Demand was supported by remittances, which surged 25 percent in dollar terms, and public spending, which grew by 4 percent of GDP. Headline inflation at 3.6 percent remained below the NBKR’s target range of 5–7 percent.
“The 2017 fiscal deficit was kept close to the 3.5 percent of GDP target, despite a significant fiscal expansion in the run-up to the October presidential elections and weak tax revenue collection. The economic recovery and efforts to tighten expenditures after the elections helped limit the deficit.
“The authorities should take fiscal and structural measures to limit the deficit to the targeted 2.5 percent of GDP in 2018. They should also improve revenue performance and refrain from introducing new or extending expiring tax exemptions, including the tax exemptions on ATM equipment and agricultural cooperatives. Preparatory work is underway to streamline the public sector wage bill, restore the energy sector’s sustainability by adjusting tariffs, and amend the law on universal child allowances to reintroduce targeting. The authorities should formulate amendments to the Budget Code to introduce a credible and enforceable fiscal rule and to close loopholes for extra-budgetary spending.
GDP is projected to grow in 2018 above potential, at 4.7 percent. Domestic demand is expected to strengthen, supported by a surge in public infrastructure investment projects. Exports are expected to respond favorably in the wake of the pickup in U.S. growth, partially cushioning the impact of higher oil prices. Inflation and the CA deficit are projected to increase to 6.3 percent and 7.7 percent of GDP, respectively. FDI and concessional loans are expected to continue financing the CA deficit. GIR are projected to grow to US$2.67 billion with the coverage declining to about 4 months of imports…
Risks to Nicaragua’s growth appear broadly balanced in the near term, but remain skewed to the downside over the medium term. On the upside, the firm up of the global recovery is expected to increase external demand. The stimulus of the U.S. activity, stemming from tax policy changes, is highly correlated with Nicaraguan GDP growth. On the downside, spillovers from the U.S. migration, trade and monetary policies continue to pose substantial risks. The latter coincides with the potential approval of the NICA Act by the U.S. Senate, while Venezuela’s oil cooperation no longer plays a substantial role. Therefore, the mission advises increasing fiscal space and maintaining a stronger international reserves position. Furthermore, financial institutions should continue to build financial buffers in case risks affecting economic growth materialize.
Building fiscal buffers is essential to stave off potential shocks. The mission encourages the authorities to take advantage of the strong economic performance to complete the design and implementation of a tax reform aimed at creating additional fiscal space, as discussed in 2017 Article IV Staff Report. The mission welcomes the recent measures to better target electricity subsidies and eliminate some VAT exemptions,  and encourages the authorities to include the remaining recommendations of the Fiscal Affairs Department (FAD) of the IMF within their fiscal reform plan. The FAD proposals on subsidy rationalization, elimination of VAT exemptions, international taxation law implementation, and further strengthening of tax administration will help eliminate inequalities and increase fiscal resilience.
The Indonesian economy has continued to perform well. Real GDP growth accelerated slightly to 5.1 percent in Q3:2017 from 5 percent in 2016 and H1:2017, led by robust exports and fixed investment. The output gap is estimated at –0.5 percent of GDP. Inflation fell to 3.3 percent in November, at the lower half of the official target band (4±1 percent), due to the slightly negative output gap and stable food prices, which more than offset the increase in electricity prices earlier in the year due to improved targeting of subsidies. Core inflation has remained stable at around 3 percent. The current account deficit declined to 1.5 percent of GDP in Q1-Q3:2017 due to higher exports. However, credit growth remains slow reflecting both weak demand and banks’ tight lending standards.
The economic outlook is positive. Real GDP growth is projected at 5.1 percent in 2017, rising gradually to 5.6 percent over the medium term, led by robust domestic demand. Inflation is projected to remain around 3.5 percent, within the official target range, due to stable food and administered prices, and well anchored inflation expectations. The current account deficit is expected to remain contained at near 2 percent of GDP due to firm commodity prices and robust exports. Risks to the outlook remain tilted to the downside, including spikes in global financial volatility, uncertainty around U.S. economic policies, lower growth in China, and geopolitical tensions. Global growth and commodity prices could surprise on the upside. Domestic risks include tax revenue shortfalls and larger fiscal financing needs due to higher interest rates.
“Vanuatu is poised to fully recover from the extensive damages caused by Cyclone Pam in 2015, with several large infrastructure projects near completion and growth bouncing back. A recovery in tourism and agriculture combined with further ramping-up of infrastructure projects is expected to continue to propel real GDP growth to around 4 percent in 2017 and 2018. Inflation is estimated to pick up to 3.1 percent in 2017 driven by domestic demand, and rise further to 4.8 percent in 2018 mainly due to a temporary VAT increase, from 12.5 to 15 percent, before gradually reverting to modest levels in the medium term. The current account deficit is expected to widen to above 10 percent of GDP in 2017 and 2018, due to the high import content of infrastructure projects.
“The downside risks to this favorable outlook stem mainly from uncertainty in the rate of implementation of the public infrastructure projects. The delayed implementation of revenue mobilization measures, such as the introduction of the income tax, could put a strain on fiscal accounts. On the external front, while the withdrawal of correspondent banking and the negative impact of weaker-than-expected global growth have so far been limited, they pose non-negligible risks. The danger of natural disasters is ever-present.
“Looking further ahead, economic growth in Vanuatu needs to be stronger and more stable. In this regard, resilience to natural disasters should be at the core of any development strategy for the country to ensure sustainable and inclusive growth. It is in this context that diversification of economic activity is required. Tourism sector needs to be strategically segmented across locations, and efforts to diversify the economy into the agricultural sector need to be intensified. To facilitate diversification, supporting the private sector by improving the ease of doing business and reaching out to small businesses in need for credit is necessary.
The economy is recovering well after Tropical Cyclone Winston and is expected to record its eighth consecutive year of expansion in 2017. Growth is expected to pick up to about 4 percent in 2017, underpinned by reconstruction activities, a vibrant tourism sector, and the recovery of agriculture production. The growth momentum is projected to continue in the coming years. Inflation declined sharply in recent months as the supply of food items started to normalize and is projected to remain around 3 percent.
Risks to the economic outlook are largely related to external developments. The economy is vulnerable to natural disasters that weigh on growth. A tightening of global financial conditions could affect capital inflows. In addition, a possible growth slowdown in China could affect Fiji through its trading partners, especially Australia and New Zealand. On the domestic side, a stalling of structural reform momentum could discourage private sector development and investment.
Sustaining strong growth will depend on maintaining financial stability, rebuilding fiscal policy buffers, and boosting private sector development. Improving the business environment will propel private investment and growth as fiscal and monetary policy support is gradually withdrawn.
Luxembourg’s growth outlook re mains favorable, as the ongoing global recovery boosts near-term activity. Economic, fiscal and financial sector policies are generally sound and unemployment is on a declining path. Risks arise from the possible impact on the economy and tax revenue of changing international tax rules; financial volatility, possibly triggered by increased risk perceptions and higher global interest rates, reduced cross-border integration and policy collaboration, or geopolitical events; and Brexit. Closer to home, continuously rising real estate prices pose affordability problems and could lead to excessive indebtedness of some households, while the longer-term sustainability of the pension system is not assured.
Demand for housing continues to exceed supply. House prices are in line with fundamentals. However, they have risen faster than disposable income for years, largely because of structural supply constraints in the context of strong demand, in part reflecting immigration of workers and their families. Rigid zoning and administrative rules together with land hoarding prevent sufficient construction, while tax incentives and subsidies fuel demand. Reduced affordability has driven up household indebtedness.
Containing house price pressures requires a strong effort to expand the stock of affordable housing. In addition to pruning excessive red tape, coordinating local zoning decisions with a national spatial development plan and imposing effective taxation on unused land would lift bottlenecks. The reform of the distribution of municipal business taxes among municipalities is a step in the right direction as it reduces incentives favoring commercial over residential real estate zoning decisions. There is also scope to increase the very low provision of social housing. Government benefits for house purchases should become more means-tested.
Risks in the real estate market should continue to be closely monitored, and further actions taken as needed . Recent measures have appropriately built capital buffers in the banking system while discouraging riskier lending. However, household debt is relatively high and limits to debt-service-to-income ratios should be set if house prices continue to outpace disposable incomes.
Despite strong job creation, unemployment of young and low-skilled workers declines only gradually and activity rates of women and seniors remain low. While skills mismatches are a predominant factor in explaining structural unemployment, work disincentives inherent to the tax-benefits system are also important. High unemployment rates among the young and low-skilled reflect significant unemployment traps. The relatively low participation rate of women and the high gender-gap in part-time work mirror the high marginal effective tax rates for second-earners, especially at lower wages. Low participation of seniors is driven by inactivity traps generated by the generosity of the pension system.
For Discussion: In light of comments by Brian Pinto below, what suggestions will you give to improve the Fund Article IV country economic reviews? Should ‘country economics’ be in effect a separate branch of economics?
I made five discoveries as the result of being thrust into complicated country situations, each of which was unique. First, academic economics works. But applying it to specific countries requires getting your hands dirty for a prolonged period of time in the country itself. A desk exercise will not simply be insufficient but prone to serious error. Second, country economic analysis is, in effect, a separate branch of economics which is complementary to academic economics. You saturate yourself with information about a country, talk to people, lose sleep, keep winnowing your hypotheses down, and hope that things fall into place one day, with serendipity often playing a role. Anecdotes help. Box 1.1 provides an example from my early experience on Nigeria, which forever underlined the importance of intelligent listening to non-economists. Third, country economic analysis is integrative by nature. You cannot say, “Sorry, I’m a macroeconomist,” or “I’m a trade theorist,” or a specialist in labor markets, or something similar. Fourth, path dependence in countries is deeply entrenched. Bad policy habits and institutions die hard, and it could take a long time to turn things around — much longer than can be accommodated in the traditional regressions run by economists. Fifth, the hallmark of a good country economist is someone who questions the conventional wisdom and goes where the evidence leads. A good country economist will refrain from using as an excuse: “Oh, eminent economist X already figured that out, so we don’t need to worry about it.”
“Pinto argues that ‘country economics’ is in effect a separate branch of economics. Economic theory and the ‘conventional wisdom’ offer only starting points. He succeeds admirably in offering insights about what drives the growth experiences of developing countries, and points out the perils of conclusions drawn hastily from afar. Understanding the linkages between a country’s sovereign debt dynamics and its microfoundations of growth is the core of his investigation.” — Robert J. Shiller, Arthur M. Okun Professor of Economics, Yale University, 2013 Nobel Prize in Economics