Page 93 - ES 2020-21_Volume-1-2 [28-01-21]

76 Economic Survey 2020-21 Volume 1

Figure 27: Potential for long-term impact of COViD-19 crisis on growth

Source: IMF World Economic Outlook, October 2020

Box 8: Fiscal rules for counter-cyclical fiscal policy

Fiscal rules are quantitative targets with respect to budgetary aggregates such as deficits,
debt, expenditure or revenue, which impose a long-lasting constraint on the fiscal policy. Broadly
they are referred to as “budgetary institutions” (Alesina and Perotti, 1999), i.e. a set of rules and
regulations according to which budgets are prepared, approved and implemented. As per IMF, 78
countries had adopted some form of national fiscal rule by the year 2015, as part of the significant
reforms in the fiscal framework. However, it is important to be cautious since some of these rules
may entail a pro-cyclical stance in bad economic times.
In this context, the Chilean experience with fiscal rules that enable counter-cyclical fiscal
policy provides important learnings. In 2000, Chilean Government adopted the structural surplus
rule that targeted the overall central government’s structural balance to be a surplus of 1 per
cent of GDP every year. This target was subsequently revised to 0.5 per cent of GDP in 2007,
and further to a simple balanced budget in 2009 (when the debt was almost paid off). Unlike the
effective budget balance, which indicates the current fiscal position, structural balance reflects
the medium-term fiscal outlook. The structural balance for Chile is estimated in the budget
using forward-looking estimates of potential GDP and copper prices (since copper is the key
driver of revenue in Chile-the largest exporter of copper). It therefore gives an estimate for the
total maximum spending level allowed in the budget for the year. If the economy grows at a
rate higher than the estimated potential GDP or if there is an increase in the copper prices over
the medium term, more revenues are collected. However, since the government expenditure is
capped for the fiscal year, the Government runs a surplus during economic booms. Similarly, in
years when the output and revenues are below potential, the government runs a deficit since the
fiscal rule does not allow spending cuts. Thus, the Chilean rule allows the automatic stabilizers
to operate, and the overall budget balance to adjust with the state of the economy. This would
thereby imply that with economic growth, the debt-to-GDP ratio should gradually fall.

The Chilean economy has benefited hugely from this budget rule, as the national savings
rose from 20.6 per cent to 23.6 per cent between 2000 and 2005, leading to a sharp fall in central