4 Some have argued that external grants and loans may also reduce the incentive

4 some have argued that external grants and loans may

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Some have argued that external grants and loans may also reduce the incentive of governments to improve their revenue mobilization efforts and may create dependency and rent-seeking effects within government bureaucracies (see Gupta et al (2004) or Moss et al (2005). Assessments of fiscal sustainability necessarily must gauge such disincentive effects, particularly given uncertainties on the long-term sustainability of external assistance inflows. In effect, the fiscal space created in the short term may have a negative impact on available fiscal space in the future if it reduces domestic resource mobilization efforts. Borrowing represents another option for the financing of additional expenditure. But borrowing, whether domestic or external, implies the need to repay, thus raising the question of whether the return on the expenditure justifies the cost of borrowing, and perhaps even more relevant, whether the spending will enhance future government revenues that can be used to finance the repayment of the loan. Governments may borrow to finance an overall fiscal deficit, rather than with regard to a specific project or expenditure program. But such borrowing must then be considered in the context of an assessment of the overall sustainability of a government’s debt obligations, in terms of its capacity to service interest and principal repayments. Such assessments typically need to consider inter alia, an economy’s prospective growth rate, its potential for exports and remittances, the prospective interest rate environment, the elasticity of revenue to growth, the composition of existing debt (in terms of interest rate, maturity, currencies of borrowing), and the terms of any new debt being considered (see IMF 2004a). Certainly, borrowing to finance the recurrent cost of programs, particularly in the health sector, is unlikely to be a reasonable strategy, since it would quickly build up the debt that would then need to be serviced, generating an increased interest burden on the budget. Domestic borrowing must be particularly managed with care, since it can quickly lead to government budgets being overburdened with debt service obligations. No possibility exists for such borrowing to be forgiven by external donors through debt cancellation initiatives. And, as can be illustrated in the cases of Malawi and Zambia, thin domestic 5
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capital markets can quickly result in high real interest rates that can prove a heavy burden on a government budget in terms of debt service. Thus, in Malawi and Zambia, domestic debt as a share of GDP has risen sharply in recent years to around 20-25 percent which, in view of the limited degree of monetization, has resulted in a high interest rates of around 20 percent In contrast, in Tanzania, domestic debt has halved in recent years, with a concomitant drop in the Treasury bill rate, thus creating fiscal space by the reduction in the overall interest bill.
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  • Spring '14
  • KevinP.Moenkhaus

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