As governments implement stimulus plans to get out of the crisis, we hear the media talking about how the fiscal deficit is skyrocketing. But, is this the only deficit that the State has? Let’s know the quasi-fiscal deficit!
In fact, reviewing and taking a walk through economics we see that it tells us no.
Well, there is another type of deficit, which we call quasi-fiscal, and that can be as or more important than the content in the budgets.
Let’s see it in our analysis!
What is the quasi-fiscal deficit?
«The result generated by the activity of central banks has an impact on the State’s assets, either for better or for worse.. »
The first thing we must bear in mind is that the financial balance of a State depends on many other factors, in addition to the income and expenses of a Government. One of them is the operations carried out by the central bank, which, too, can have a positive or negative impact on public finances. In some cases, as we will see below, with strong repercussions on the economy as a whole.
Let us remember that, today, a large part of central banks are public, which means that their profits and losses are part of the consolidated accounts of every State. In this sense, we can say that they have the same status as any other public company, despite their essentially financial nature. Therefore, the result generated by its activity has an impact on the State’s assets, either for better or for worse.
Suppose, for example, that a central bank buys a foreign currency at a very high price on international markets and subsequently resells that foreign currency. stock in the domestic market at lower prices. This, suffering a loss due to the difference in exchange rates.
In that case, we would be facing a negative result that would reduce the assets of the central bank and, by extension, of the State itself. These losses, therefore, would not be part of the fiscal deficit itself, since they have nothing to do with taxes or public spending, but they would enter the overall accounts of the State. This is why this type of deficit is often referred to as a “quasi-fiscal deficit”.
Of course, the opposite can also happen. In other words, that monetary policy generates benefits.
Suppose that the central bank agrees to a loan offered by international organizations at an interest rate of 3%. Using, later, that money to finance local business projects at 5%. In that case, the difference in interest rates would be favorable to the central bank, which would make its assets grow. It would be, in other words, a quasi-fiscal surplus.
Now, once we know this, we ask ourselves, what is the real effect of these policies? What impact can a central bank balance sheet have on a country’s deficit? Can it condition other public policies, such as government spending?
Let’s see some examples!
The Dominican experience
«The cost of repaying the debt generated by the quasi-fiscal deficit will be high, no less than 0.6% of GDP each year. »
Between 2002 and 2004, the Central Bank of the Dominican Republic (BCRD) carried out a very determined policy of monetary sterilization. That is, a series of market operations aimed at reducing the circulating amount of local currency. This, with the aim of containing its devaluation and the increase in prices. To achieve this, one of their preferred instruments was the issuance of debt, mostly in short-term securities and with interest rates that could reach up to 60%. This decision was also influenced by the rescue of some of the main banking entities in the country, which accentuated the resource needs of the Dominican monetary authorities.
The idea was simple: the BCRD issued debt securities for which investors gave local currency. In doing so, the monetary authorities put that money out of circulation, thus reducing the monetary base of the economy. The advantage of this strategy is that when these securities matured, the BCRD could always return them with new debt issues, using the technique of rollover that we have explained in previous posts.
In this way, the repayment of the debt could be done with money that was already circulating. Thanks to this, the money simply passed from one hand to another and the total volume of the monetary base did not grow again.
The problem with this policy is that although the return of the principal capital of these securities could be postponed indefinitely with the rollover, the interests did have to be paid every year. In fact, the total amount of interest payable by the BCRD generated a quasi-fiscal deficit of 4% of GDP in 2004.
Since then, the governments that have succeeded one another in the Caribbean country have tried different strategies to solve the problem. In 2007, a law was approved for the Treasury to contribute resources to the BCRD and thus gradually reduce its debt. However, the project failed, as the 2008 crisis hit the Dominican economy and led the government to run into a serious fiscal deficit. Reason why these capital contributions were not made in the estimated amount.
In 2020, the Dominican Government agreed with the monetary authorities a new strategy. The idea is to separate this debt from the BCRD’s balance sheet, creating a trust to manage it. In this period, of course, it is planned to restart money transfers from the Treasury, in order to guarantee the debt maturities that take place.
The cost of these government contributions is considerable, since they are estimated at 0.6% of GDP each year.
Argentina: A problem that is difficult to solve
«Lebac’s issuance reached such high levels that its total volume exceeded 100% of the monetary base in mid-2018. »
Something similar to what happened in the Dominican Republic has happened in Argentina, although this case may be more complex to analyze.
In 2002, the Central Bank of the Argentine Republic (BCRA) tried to stabilize the price of the peso. To do this, it sought to reduce the monetary base through the issuance of debt securities called Lebac. This instrument was used intensively between 2002 and 2003, although in the period between 2004 and 2016, its use was much more specific.
So far we have a case very similar to that of the Dominican Republic.
Faced with a context of devaluation and price increases, the central bank issues debt and withdraws the money it receives from it from the economic circuit. In this way, the excess supply in the money market is reduced and, at least temporarily, the markets calm down. The problem is that, from this point on, the story becomes much more complicated.
As we can see in the graph above, the Lebac had been used little until 2016. First because there was a boom in raw materials. In this sense, Argentina exported much more than it imported, and with this, the BCRA’s reserves did not stop growing. With these resources, there were not too many problems to pay the interest that these titles demanded each year.
In 2008, the upward cycle of raw materials came to an end and, from then on, reserves began to shrink. Inflation grew again and the peso was devalued, but the Government did not consider tackling these problems by applying monetary sterilization. Instead, it applied alternative policies, such as price controls and restrictions on foreign exchange markets; which, in general, had very little success.
The change of government at the end of 2015 brought with it a shift in monetary policy, once again giving priority to the accumulation of reserves and the fight against inflation. For this reason, the BCRA once again made intensive use of Lebac, since between 2016 and 2017 there was a massive influx of dollars into the country which, when converted into pesos, once again made the monetary base grow.
Lebac’s issuance reached such high levels that its total volume exceeded 100% of the monetary base in mid-2018. The reality is that its use did not result in Argentina returning to low inflation rates, but we must not forget that Other factors, such as the fiscal deficit, have also influenced this. In any case, it is difficult to estimate what the level of inflation would have been if this policy had not been carried out.
In 2018, the international scene darkened. Mainly due to the fall in the price of raw materials, but also due to the rise in interest rates in the United States. All of this reduced the inflow of foreign currency and led to capital flight, while at the same time causing the peso to depreciate again, so there was no longer an excess of dollars to deal with with the Lebacs.
It was decided, then, to put an end to them. The reason was very simple: the cost of maintaining that debt, with interest rates reaching 57%, and very short-term maturities, was too high for the State.
However, the chosen strategy was to replace these titles with similar ones, called Leliq.
The truth is that, since then, the stock BCRA debt has not only not been reduced, but it has almost tripled since the end of 2018. The main reason is that, with a fiscal deficit financed, in part, with monetary issuance, the markets have an excess of pesos that are try to absorb with these titles.
What can we learn from all of this?
“Sometimes, poor monetary policy decisions can end up reinforcing the problems that, precisely, they sought to solve. »
The accumulated cost derived from the interests of the Lebac, Leliq and other debt securities issued by the central bank in Argentina has been so high in recent years that to face it it has been necessary to resort to printing money, thus contradicting the purpose for the one they were created to reduce the monetary base.
In addition, they represent an immense opportunity cost for the country’s economy, since they absorb a part of the savings that, otherwise, would have made it possible to finance consumption and investment in the private sector. This effect of displacement of private investment, called in economics «crowding out«, Has reached levels never seen in Argentina since the 2001 crisis.
In fact, as we can see in the graph above, in July of this year the public sector absorbed 59.56% of the total credit in the economy. If we compare these numbers with December 2020, the figures are even worse, since of the new credit generated this year, 75.90% is aimed at financing the State.
The main lesson that we can draw from what happened in the Dominican Republic and Argentina is that poor monetary policy decisions can end up enhancing the problems that they were precisely seeking to solve. Well, let’s not underestimate the cobra effect and the words of Thomas Sowell, in which he alluded to the measurement of politics by its impact on society and not by the intentionality with which said policy was applied. But not only that, but also these decisions could strangle credit to the private sector, hindering investment and weighing down productivity.
We can say, therefore, that the quasi-fiscal deficit, although accounting separately from the one presented by the Government, may end up conditioning the economy as a whole. The reason is that if the quasi-fiscal deficit is too high and central banks begin to see that their reserves are in jeopardy, governments are forced to take charge of the problem.
Naturally, this may involve unpopular decisions such as raising taxes or diverting resources from other areas of the state to cover that deficit.
For this reason, it is especially important that when we analyze the economic prospects of a country, we not only pay attention to what its government does. Sometimes, as we have seen repeatedly, the mistakes of a central bank can destabilize the economy, even if the government keeps its accounts in order. In the same way that we have heard so many times about the importance of fiscal discipline, perhaps we should remember that monetary discipline is just as important to our economies and their well-being.