Dag Detter is an investment adviser and former president of Stattum, the Swedish government holding company. Hanan Salem is a director in the Public Sector Group at Citi and a former deputy finance minister of Egypt. In this post they propose several policies that governments, in the context of rising sovereign debt levels, can use to help reform their public finance operations post-coronavirus.
The national lockdowns imposed by governments around the world to stop the spread of Covid-19 and protect lives have had a profound impact on both businesses and households. The necessary rush to implement fiscal stimulus measures to cushion the socio-economic impact is also leading to worries about an upsurge in sovereign debt.
These developments are reflected in a wave of sovereign credit rating downgrades. So far this has affected mainly emerging and frontier market countries, but as many developed economy governments face the prospect of wider fiscal deficits — and perhaps the need to step in to directly support public sector enterprises and even private sector companies — their debt burdens too will rise significantly.
There may yet be second and third waves of the pandemic, which pose the very real risk that sovereign debt could reach World War II levels before we know it. Yet this crisis could also be a catalyst to induce governments to look at their finances differently, particularly as a way to climb out of this dire economic situation.
Governments willing and able to strengthen how they manage their finances will be better positioned to bring about a faster and more sustainable recovery — or at the least, to kickstart growth without excessive austerity. Understanding how much spending is needed will also be important to avoid waste and minimise public borrowing, which today is a more critical consideration than ever before.
Developing a robust public financial management capacity is essential, and this includes the adoption of proper budget accounting methods and a strong audit function. For instance, shifting from cash to accrual accounting as the basis for the public financial management system would, for many governments, be a start toward this objective. In our view, accrual accounting would help shift the mindset to recognise spending on vital infrastructure — from health to education — as investments, and not merely as costs. This would also provide critical information, for governments as well as sovereign debt investors, to facilitate efficient capital allocation.
Better management of public sector assets is also an important tool to optimise value generated from public resources. If these assets were managed in a professional and transparent manner, ideally run by independent managers at arm’s length from political interference, they’d be able to contribute more to rebuilding a government’s fiscal strength.
In the aftermath of the crisis, the public sector — as well as the private sector — will need to use every available resource to get back on its feet. Governments with a complete view of their balance sheet, of what they own as well as what they owe, should have a better handle on managing both their assets as well as their liabilities. Yet most governments are not fully aware of their assets, especially land and buildings. Here too, proper accounting would help, enabling governments to “sweat their balance sheet” to derive maximum utility from their assets, much like a corporation or household needing to rebuild after hardship.
Better management of public assets could also eventually generate new income streams for the government’s budget and reduce net operating costs, in turn enabling an improved delivery of public goods and services and faster growth. Additional revenues could also be used to reduce existing debt, offset the need for new borrowing, or build the government’s net worth, outcomes that could potentially improve sovereign credit ratings down the road.
The historical record indicates economies with stronger balance sheets generally experience shallower recessions and recover quicker from downturns. This faster return to growth can be explained by the greater space for countercyclical fiscal policies. Also, there is usually less need for governments to resort to ad hoc fiscal actions that would be more likely to induce uncertainty and dampen incentives to consume and invest.
Governments at every level could navigate out of the crisis better by embracing the opportunity to implement a well-functioning public financial management system, based on audited accrual information and recognising the crucial role that better information plays in facilitating fiscal decision-making. Such a system encompasses all elements of the public sector balance sheet, including net worth as the most comprehensive summary measure of the fiscal position.
The benefits to society from better management of public finances — and the public sector balance sheet as a whole — are clear.