Macro I Introduction to Financial Programming Part 2

Macro - I Introduction to Financial Programming Part 2 1

Outline of the session • - Monetary and Banking Sector • - Government Sector • - Few words on debt sustainability analysis 2

Monetary Sector Structure of the Financial System (Financial Survey) Banking System (Monetary Survey) Monetary Authorities (Balance Sheet of the MA) Other Financial Institutions (Consolidated Balance Sheet of OFI) Commercial Banks (Consolidated Balance Sheets of Commercial Banks) 3

Monetary Sector Monetary Authorities Functions: • Issue currency • Hold the country’s foreign reserves • Oversee the monetary system, supervise banks and monitor financial stability • Serve as lender of last resort to the system Balance Sheet: 4

Monetary Sector Commercial Banks Functions • Provide financial intermediation to savers and investors/borrowers. • Affect money supply and liquidity in the economy (through their deposit taking and lending behaviors). • Help transmit monetary policy from the monetary authorities to the economy Balance Sheet 5

Monetary Sector The Monetary Survey is the consolidated balance sheet for the entire banking system (Commercial Banks and Monetary Authorities). Present, in a timely fashion, data on monetary and credit developments for the entire banking system. Data are available at quite high frequency (monthly). 6

Monetary Sector Balance of payments and Money supply In the Monetary Survey : D M 2 = D NFA - D NDA The change in money supply is equal to the change in the net foreign assets in the banking sector minus the change in net domestic credit. In the Bo. P : Change in FX reserves = CAB + CFAB = D NFA The external sector (through changes in foreign exchange reserves) has an impact on Money Supply. 7

Monetary Sector • Monetary aggregates • Mo (Monetary base= currency in circulation + reserves of commercial banks at the CB ); • M 1 (currency, checkable (or demand) deposits); • M 2 (M 1 + savings deposits, time deposits, money market funds); • M 3 (M 2 + special time deposits) The Monetary base is controlled by the Central Bank M 1, M 2, and M 3 are not fully controlled by the CB Money Multiplier = M 2/Mo Money Velocity = GDP/M 2 8

Monetary Sector Cambodia, Monetary survey Source: IMF, 2016, Article IV report, Cambodia 9

Monetary Sector Cambodia, Monetary survey Source: IMF, 2016, Article IV report, Cambodia 10

Monetary Sector Ghana, Monetary survey Source: IMF, 2016, Program Review, Ghana 11

Main linkages between sectors (not exhaustive) 12

Government Sector • General government comprises all government units • Central government • State governments (in federal countries) • Local governments • The public sector also includes corporations and quasi-corporations controlled by the government units. These corporations are not part of the Government sector (but there can be public liabilities for the Government). 13

Outline of the session • - Monetary and Banking Sector • - Government Sector • - Few words on debt sustainability analysis 14

Government Sector Source: Government Finance Statistics (GFS). IMF 15

Government Sector Source: GFS Manual, IMF, 16 2001

Foreign Aid in the Gov. Operations n n Aid Grants are registered “above the line” Foreign Loans are registered as Foreign financing 17

Government Sector Government Expenditures have a direct impact on the production sector in the short run - Government consumption: (Wages and Salaries, Consumption of Good and services) - Government investment (transaction in non-financial assets) -Y = C + GI + (X – M) However, Government consumption and investment can partially crowd out private consumption and investment. This is the fiscal “multiplier” debate: -If multiplier = 1; 1 euro of gov. expenditure translate (one the short run) into 1 euro of additional GDP -If multiplier is below 1, the effect is smaller (crowding out) -If multiplier is above 1, …. well, GDP increase by more than & euro. - The long run impact of government expenditures depends on the 18 nature of expenditure

Government Sector Government financing operations also have an impact on the economy in the short run: - Taxes (more or less the same discussion that about fiscal multiplier) - Deficits: - Financed by the domestic banking sector = increase in Net Domestic Assets …. . so it has an impact on money supply, unless the banking sector reduces credit to the private sector (less private sector investment and consumption) - Financed by the domestic private sector : total impact depends on the behavior of private sector (less consumption and more saving ? Less investment ? ) - Financed by external borrowing increase long term external vulnerability …but has less impact in the short run A good financial programming framework must take these constraints 19 and potential impacts into account.

Government Sector In the longer run: § Budget deficit and borrowing add to pubic debt. § Public debt sustainability needs to be assessed. 20

Cambodia: Fiscal Balance Government Sector 21 Source: IMF, 2016, Article IV report, Cambodia

Government Sector Ghana, Government sector Source: IMF, 2016, Program Review, Ghana 22

Government Sector Ghana, Government sector Source: IMF, 2016, Program Review, Ghana 23

Main linkages between sectors (not exhaustive) 24

Outline of the session • - Monetary and Banking Sector • - Government Sector • - Few words on debt sustainability analysis 25

Debt sustainability Sustainability of different types of debt need to be assessed • - External Debt (to assess Balance of Payment sustainability / “External sector”) • - Public Debt (to assess public finance sustainability / “Government sector”) 26

Debt sustainability The IMF and the WB DSA (Debt Sustainability Analysis) for Low Income Countries usually focus on the sustainability • PPG (public and publicly guaranteed debt) external debt • Total public debt 27

Public Debt Dynamics In the simplest case, the dynamic of the ratio of pubic debt to GDP can be summarized by the following equation d = debt-to-GDP ratio r = real interest rate on domestic debt g = real GDP growth rate p = primary balance as a share of GDP 28

Public Debt sustainability The public debt sustainability is assessed by looking at the evolution of public debt at a 20 -year horizon. Public debt is sustainable when d does not explode (or breach a given level) over the forecast horizon 29

Debt sustainability ……more on debt sustainability in Macro II course 30

Thank you 31