What is the Fiscal Rule and why is it a concern in the reforms led by the Government?

September 13, 2023

The Fiscal Rule was created with the purpose of seeking a balance between the Nation’s expenditures and revenues. Its central idea is that structural expenses should not exceed structural revenues.

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The reforms led by the Government have had a difficult path in the Congress of the Republic. The concerns recently expressed by the Autonomous Committee of the Fiscal Rule regarding their financial viability introduce an additional obstacle to their implementation and limit their scope.

In recent weeks, in several pronouncements widely disseminated by the media, the Autonomous Committee of the Fiscal Rule has expressed concerns and recommendations on the reforms proposed by the government.

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According to statements made to El Espectador, the committee pointed out that the government’s proposals are at the limit of non-compliance with the Fiscal Rule and that events such as the drop in the price of oil, the increase in inflation or the depreciation of the peso may take away the margin for action.

In a recent pronouncement, the committee made strong objections to the government’s pension reform project. It made recommendations on the amount of income that should be contributed to Colpensiones and private funds, suggesting that only workers earning up to one minimum wage should contribute to the public fund.

The cost of the health reform, on which there are no precise government estimates, has also been a cause for concern on the part of the Autonomous Committee of the Fiscal Rule.

These opinions become a new pressure on the government to bring its proposals in line with the goals and assumptions established in the Medium Term Fiscal Framework (MTFF).

Fiscal Rule: limits to government action

Law 1473 of 2011 created the Fiscal Rule, which establishes the creation of a framework that reduces the fiscal deficit within targets set by the MFMP.

Structural revenues are those that do not depend on the economic cycle, such as the mining and energy activity or the occasional profits of the Banco de la República, which depend on cyclical circumstances.

For the Fiscal Rule, structural revenues are predictable revenues, while structural expenditures are those that are not due to extraordinary circumstances, such as the sudden massive influx of Venezuelan migrants or the Covid-19 epidemic.

The Medium-Term Fiscal Framework was established by Law 819 of 2003. It establishes the macroeconomic outlook for the next 10 years. The last of these was issued in July 2023.

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The MFMP establishes the outlook for the economy and projects expenditures and collection revenues, the debt margin and tax revenues, based on assumptions about oil revenues, exchange rates and other economic variables.

Fiscal Rules have been generalized

Compliance with a Fiscal Rule that ensures macroeconomic stability without abrupt variations has been a permanent recommendation of the OECD and the IMF.

Many countries around the world have fiscal rules or various types of legislation that seek to achieve a balanced budget and stable management of public finances, regardless of changes in government.

In the study that led to the establishment of the Fiscal Rule, Banco de la República pointed out that the vast majority of Latin American and Caribbean countries have balanced budget rules. These have different modalities, but all of them seek to balance revenues and expenditures, increase economic growth and improve the sustainability and transparency of fiscal policy.

Several countries require the Executive to explain any deviation from the Fiscal Rule. In others, such as Brazil, sanctions are established in case of non-compliance and others do not have corrective mechanisms in case of non-compliance.

According to the Banco de la República de Colombia, fiscal rules are designed to be permanent and enforced regardless of changes in government. Therefore, they can help prioritize government policies and keep public debt at reasonable levels.

The Bank notes that fiscal rules act as a safeguard to restrict the accumulation of excessive deficits resulting from distorted political incentives. However, strict fiscal rules may reduce the room for maneuver to adjust policy in case of unexpected shocks.

Who monitors the Fiscal Rule

In Colombia, monitoring and surveillance of compliance with the Fiscal Rule is carried out by the Autonomous Committee of the Fiscal Rule. According to the Ministry of Finance, this is a technical, autonomous and independent committee that makes non-binding recommendations.

The Autonomous Committee of the Fiscal Rule is composed of 7 members: 5 experts appointed by the Ministry of Finance for 4-year terms and the presidents of the economic commissions of the Congress of the Republic.

Although the opinions of the Fiscal Rule Committee are not binding, they are of great importance in view of what the IMF says about the government’s macroeconomic plans.

In turn, the IMF’s opinion is very much taken into account by international lenders and risk rating agencies to determine Colombia’s capacity to contract new credits and set interest rates.