Essential conditions for the performance of fiscal rules: lessons for Kazakhstan

Fiscal rules are restrictions that are imposed by legislation on the parameters of fiscal policy in order to ensure debt and fiscal sustainability. The main types of fiscal rules in the world, according to the IMF (January 2022), are budget balance rules, debt rules, expenditure rules and revenue rules. 

Budget balance rules constrain the fiscal aggregate, which primarily affects the debt ratio and is largely under the control of the government. Such rules provide clear operating limitations and can be defined as restrictions on the overall balance, primary balance, structural balance or cyclically adjusted balance. Usually in practice the ratio of balance to GDP is used.

Debt rules set an anchor or ceiling on government debt, often expressed as a percentage of GDP. The goal of this type of rule is to achieve sustainable debt levels.

Expenditure rules set limits on general, primary or current government expenditures. These rules are not directly related to the goal of debt sustainability, since they do not limit the income side. However, they can be an operational tool to initiate the necessary fiscal consolidation consistent with sustainability principles if they are accompanied by debt rules. Such rules can help limit expenses during times of unexpected income.

Revenue rules set an upper or lower limit on revenues and are aimed at increasing revenue collection and/or preventing excessive tax burdens. Most of these rules are not directly related to the national debt or spending. Additionally, putting an upper or lower limit on earnings is difficult because earnings are highly cyclical. The exception is those rules that restrict certain uses of windfall income. Revenue rules can lead to pro-cyclical fiscal policy, since lower limits generally do not take into account the operation of automatic stabilizers during recessions (recoveries).

In the Concept for the formation and use of funds from the National Fund of the Republic of Kazakhstan from 2016, the first two types of budget rules were applied. Budget balance rules required the national budget deficit be reduced to 1% of GDP as of 2018. In addition, the rules required that the non-oil budget deficit be subject to annual reduction restrictions established until 2025. The debt rule required that government debt remain at a level below the revenues to the National Fund of the Republic of Kazakhstan (NF RK) from the oil sector. It also limited debt servicing of the national budget, which was below 15% of budget revenues. In 2020, the government debt limit was set at 27% of GDP. In addition, the 2016 Concept established two existing rules on annual guaranteed transfers of the NF RK to the government budget. The decree required a reduction in the maximum annual amount of NF RK transfers for 2017-2019 with the subsequent establishment of an annual limit of 2 trillion tenge, starting in 2020. Also, according to this decree, targeted transfers could be allocated only by decision of the President to finance anti-crisis programs during a period of economic recession or slowdown in economic growth.

In 2020, the Budget Code of the Republic of Kazakhstan enshrined a budget rule regulating the amount of a guaranteed transfer from the NF RK. According to the rule, the guaranteed transfer from the NF RK should not exceed the volume of receipts to the NF RK from oil sector organizations predicted at the oil price, which is called the “cut-off” price. However, this budget rule did not contain any precise explanations, which appeared only in 2022 in the Concept of Public Finance Management of the Republic of Kazakhstan until 2030 , which specified that the budget rule begins to operate in 2023. At the same time, the “cut-off” price is adjusted when exceeding the forecast volume of oil production above 90.5 million tons for the reporting year, which is the maximum historical level of production in Kazakhstan, achieved in 2019. If for the forecast year the volume of production exceeds this threshold value, then the “cut-off” price will decrease in proportion to the excess. In other words, the budget rule does not allow increasing withdrawals from the NF RK even if oil production volumes increase. Thus, this makes it possible to create a financial reserve, which can subsequently be used to stimulate the economy during periods of crisis, and also helps reduce the non-oil deficit.

In addition, the Concept mentions the introduction of a budget rule on expenditures of the national budget. Thanks to it, the volume of expenditures will not outpace the growth rate of real GDP and/or inflation and will be limited during the period of economic growth. However, more accurate data has not yet been provided, despite the fact that, according to the same Concept, this rule is also enshrined in the Budget Code of the Republic of Kazakhstan and begins to operate in 2023.

It is worth mentioning that in addition to the two main budget rules, the Concept mentions the presence of auxiliary rules in Kazakhstan, such as the rule on the non-oil budget deficit, the rule on net assets of the state, the rule on debt. However, no structural explanations were given about their performance. Thus, the Concept has created a rather vague set of fiscal rules. Moreover, they are not very suitable for smoothing out economic cycles that arise in the event of changes in oil prices or other shocks. The Concept provides a significant amount of information on international experience in the implementation of fiscal rules and on the results that Kazakhstan plans to achieve using budget restrictions, but does not take into account the important features of fiscal rules for small open and undiversified economies with a focus on commodity exports.  

Based on all this, it can be noted that the conclusion in the IMF report (December 2022) is correct. Here is a conclusion that effectiveness of Kazakhstan’s fiscal policy and budgetary processes are hampered by unsystematic decisions of the Government and dispersed areas of budgetary responsibility. According to the report, Kazakhstan needs a clear strengthening of budget constraints and a revision of the Budget Code, which will help establish stronger institutional responsibilities and a rules-based fiscal policy that will strengthen its credibility.

Currently, external shocks dictate the choice of the optimal model of fiscal rules for the Kazakhstan economy. In the work (Kudrin et al., 2023), the authors examined the impact of budget rules on the economy and assessed how budget rules affect the cyclicality of non-interest income, that is, that part of budget revenues that is not used to finance public debt. Data from both developed and developing countries from 1995 to 2019 were selected for analysis.

The authors, firstly, conclude that the presence of a fiscal rule is not a sufficient condition for a countercyclical fiscal policy, and a decrease in the procyclicality of budget expenditures does not mean their stabilization over time. It does not guarantee a solution to the problem of the debt burden. In addition, fiscal rules do not solve problems with servicing public debt or stabilizing budget expenditures. Thus, only 22 countries out of 49 that the authors studied exhibit countercyclical dynamics in non-interest spending (developed countries predominate), and only 7 of them managed to reduce their debt burden after the introduction of the fiscal rule. In some large economies (the USA, Japan, France, Canada), the application of fiscal rules failed to prevent the growth of non-interest expenses in such a way that this growth did not outpace the GDP growth rate and at the same time retained a countercyclical nature. A similar situation is possible when the total volume of additional expenses during periods of recession is not compensated by their savings at positive rates of economic growth. In other words, these countries do not pursue a medium-term balanced fiscal policy when fiscal revenues equal or exceed expenditures, resulting in accelerated debt growth.

Kazakhstan is a country with a stable national budget deficit, but the trend of expenditures exceeding revenues by more than 3% of GDP began in 2009 (see Chart 1). However, this dynamic is not constant. For example, in 2018, the budget deficit was only 1.5% of GDP (should be recalled the 2016 Concept, the goal of the budget limit was not achieved).  At the same time, in the USA the state budget deficit amounted to 5.8% of GDP, in Japan – 6.4% of GDP, in France – 4.7% of GDP. Thus, statistics indicate that the situation in Kazakhstan is developing according to a similar scenario to the developed countries discussed in the article, but on a much more limited scale, which does not yet threaten a rapid increase in the debt burden.

Table 1. Dynamics of the Republican Budget Deficit of the Republic of Kazakhstan 2009-2022

Source: Information and legal system of regulatory legal acts of the Republic of Kazakhstan

Secondly, the authors found that in developed countries, as well as in the developing ones, non-interest income is pro-cyclical. It means that they grow during periods of economic recovery and decrease during periods of recession. However, the presence of at least one fiscal rule in the country makes it possible to reduce their pro-cyclical nature. At the same time, the reaction of the economy to the introduced fiscal rule depends on institutional conditions, as well as on the nature of its implementation. If the budget rule changes frequently and is not enforced, this significantly reduces its effectiveness in reducing the procyclicality of non-interest income. To be most effective, budget constraints must have a certain degree of strictness and flexibility. Some of the countries considered, such as Germany, New Zealand, Denmark, etc., managed to reduce spending as a share of GDP after the introduction of the fiscal rule. According to the authors, it is a consequence of a more responsible fiscal policy. At the same time, budget rules became an instrument of self-restraint and tightening of financial discipline.

Thus, in the IMF staff report on Kazakhstan (February 2020), factors that influence the insufficient efficiency of fiscal rules were examined and recommendations were made to eliminate them. The IMF notes that one of the problems hindering the effectiveness of fiscal constraints in Kazakhstan is their low degree of flexibility, which does not contribute to the resilience of fiscal rules in relation to shocks and a changing environment. Lack of flexibility leads to the risk of breaking rules (especially during periods of shock) and, consequently, to a loss of confidence in them. In addition, it is noted that the institutional scope of fiscal rules in Kazakhstan is relatively narrow. Thus, the narrow scope of the rules may create incentives to shift spending to the rest of the public sector and weaken the objectives of the rules. Also, to improve the effectiveness of fiscal rules, Kazakhstan should increase the degree of transparency and legal enforcement in the fiscal sphere. Thus, it must be concluded that the problem of the unpreparedness of the institutional environment and political readiness to comply with budget rules, which are noted in the authors’ work, is relevant for Kazakhstan.  

The issue of the need for budget transparency for the most effective performance of fiscal rules is also studied in the article (Gootjes et al., 2022). Based on an analysis of 75 countries, the authors find that fiscal rules do not improve government budget balance when fiscal transparency is low. Fiscal rules also increase the likelihood that fiscal adjustments will occur and succeed, but only if fiscal transparency is sufficiently high. Thus, the effect of fiscal rules depends on the ability to control the government's actions in the area of fiscal policy, that is, on budget transparency. Greater transparency increases the costs of breaking rules, while its absence reduces financial discipline. However, the study shows that with a high degree of volatility of fiscal policy, fiscal rules, as well as a high degree of fiscal transparency, have little effect on positive changes in fiscal adjustments.

In addition, the authors examined the impact of media freedom and found that it enhances the effect of fiscal rules when the degree of budget transparency is low. Thus, when the functioning of fiscal rules is undermined by low budget transparency, media freedom can become an obstacle for the government to independently adjust budget revenues, expenditures, fiscal policy and other parameters.

As noted in the press release following the IMF staff visit to Kazakhstan (June 2023), high spending growth combined with increased transfers from the NF RK are undermining recently introduced fiscal rules, negatively impacting confidence in the Government's medium-term fiscal commitments. Kazakhstan's current system of fiscal rules is complex, characterized by redundancy and duplication, and does not lead to the desired results. Among other things, the country has serious problems with fiscal discipline and violation of budget rules. In the current environment, to improve the impact of fiscal constraints on the economy, Kazakhstan should consider the specific recommendations given by the IMF or the World Bank for organizing fiscal rules in the country.