Monday, May 17, 2010

Weekly Hurriyet Column: Fiscal Rule: Dead the day it was born

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. As for cheesy references, I am sticking to movies again, but it is not a classic this time around (see the text for the hyperlink).

As for the column, Yapi Kredi Research came up with the most original piece on the fiscal rule, coming up with a more efficient formula. Although they have a web site, I could not find the paper there. I will ask them to put it on the web, and if they agree, I will link to it as an addendum to the column.

BTW, loyal readers would know that the fiscal rule has got my attention since it first surfaced back in September. A blog post summarizes my views on the topic as well as providing links to all my articles/posts on it. More recently, I responded to a reader request, and was spectacularly proven wrong, claiming that given the political agenda, it'd be tough for the government to get the fiscal rule on the table by the end of June. Uppssss.......

Anyway, on to the column :

I was watching a Richard Gere movie last week, where one of the villains had a tattoo on his forehead in Cyrillic that read “I was dead the day I was born.

The expression seemed to ring some bells. First, I thought it was from a Beckett play, but I had given up on existentialism long ago. It all made sense a couple of days later when Economics tsar Ali Babacan unveiled the much-awaited fiscal rule, establishing that I had experienced some kind of premonition.

As Cornelius Tacitus once noted, viewed from a distance, everything is beautiful, and the Fiscal Rule is no exception. I was pleasantly surprised to learn that the rule will cover the general government, which includes social security institutions, local governments and extra-budgetary funds. The actual formula looks very appealing to the eye as well, especially after Babacan’s comments that the tightest formula had been chosen and that the adjustment coefficients ensured a three-year convergence period. Most of my esteemed colleagues rushed to hail the formula as too rigid.

I would argue that the growth side of the formula, with 5 percent penciled in as the long-term growth rate, is not cautious enough. You could counter me by pointing at Turkish growth performance after the 2001 crisis, which was, by the way, supported by extremely loose global financial conditions and arguably the best world growth spurt in history. A simple Excel exercise reveals that even with a respectable growth rate of 4-5 percent over the next few years, debt declines very slowly.

As for the three-year convergence, the coefficient of one-third means that the deficit will simply be reduced by one-third of the gap between current and targeted deficit, not that the target of 1 percent will be reached in three years. Plugging in my 2010 deficit-to-GDP and growth projections of 4.5 and 6 percent to the same Excel sheet and fixing growth at the neutral rate of 5 percent thereafter, I find that it takes almost a decade to reach the deficit target. I doubt such a modest trajectory is the right path for a country that suffers from CSD, or chronic savings deficiency.

But my biggest objections are on the rule’s implementation. A useful analogy could be made with inflation targeting: Having inflation targeting or even attaining the targets does not make a central bank credible; it is the institutions that come along that do. Similarly, without an independent and authoritative budget monitor or fiscal council, the fiscal rule is not likely to gain much ground. The Court of Accounts, the designated auditor, simply doesn’t have the know-how, political independence or sanctions power.

Similarly, without having been hammered into the Constitution, there will always be the risk that the rule will share the destiny of the ill-fated borrowing limits in the fiscal control law of 2003, being cropped or even nullified with subsequent laws. I find it extremely suspicious that in some places, the rule just looks like a repackaging of that law, which makes me wonder, “If it didn’t work last time, how come it’ll work this time?”

Last but not the least, experts have pointed at lack of full transparency and shenanigans in the general government accounts, which do not bode well for the implementation of a fiscal rule, where reporting will be done by the Ministry of Finance. Combine this with an in-house audit, and you have the recipe for disaster.

Despite last week’s display of prophecy, I am not sure whether I have sixth sense or not. I am definitely not seeing any dead people, but I think I may have just seen a dead fiscal rule.

I also know that with all the over-jubilation, I’ll probably suffer the fate of Cassandra, at least in the short-run.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

No comments: