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20/02/01 1 Examining the government budget and fiscal reserves from a macroeconomic perspective Paul Lau February 2001 2 Agenda l Facts and figures: Changing pattern of government budget & fiscal reserves l Lessons learnt l Summary 3 Figure 1: Budget balances from 1985/86 – 1999/2000 Facts & figures -100 0 100 200 300 400 500 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 Financial year (yr ending) HK$Bn Budget surplus / deficit Fiscal Reserves 4 Figure 2 - Government revenues & expenditure (as a % of GDP) Facts & figures 0% 5% 10% 15% 20% 25% 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 Financial year (yr ending) % of GDP Revenue Expenditure 5 Figure 3 – Changing pattern of major revenue items Facts & figures 0 10 20 30 40 50 60 70 80 96 97 98 99 00 Financial year (yr ending) % of GDP Profit Tax Salaries Tax Land Premium Investment Income 6 Is there a structural deficit in Hong Kong? l Structural deficit: – A measure of what the government deficit would be under existing tax & spending rules, if GDP were at its “natural” level – Also known as “full-employment” deficit, mid- cycle deficit, or cyclically adjusted deficit l Difficulty in assessment (at an early stage) – Technical and statistical issues – Extraordinary pattern in recent years Lessons learnt 7 Prudent fiscal management in an economy with huge fiscal reserves l Huge fiscal reserves (FR) in recent years – Investment income from FR is a major contributor to government revenue – Benefits: increased ability to cope with unforeseen events that may have adverse effects on government budget – Opportunity costs of maintaining a huge FR l A criterion of prudent fiscal management – At a given point of time -> optimal FR level – Growing economy -> optimal FR to GDP ratio Lessons learnt 8 Is prudent fiscal management equivalent to balancing the budget? l Intertemporal gov’t budget constraint – FRt – FR t-1 = r t FR t-1 + (R t – Gt) (1) – Headline vs. primary budget balance – FRt – FR t-1 = (rt - γt) FR t-1 + Rt – Gt (2) Yt Y t-1 Y t-1 Yt l Balanced budget: 2 interpretations – Zero headline budget surplus (over a cycle) Ø FR being roughly constant, but FR to GDP ratio falls over time – Zero primary surplus Ø FR to GDP ratio rises (provided that r > γ) Lessons learnt 9 Summary l Huge current fiscal reserves; As a result, investment income is significant l Difficult to determine (at this early stage) whether the budget deficit is structural l More importantly, establishing criteria of prudent fiscal management: FR to GDP ratio is an (macroeconomic) indicator; Optimal range of FR to GDP ratios? 10 Figure 4 – Budget balance and Fiscal Reserves (as a % of GDP) -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 Financial year (yr ending) % of GDP Budget surplus / deficit Fiscal Reserves Fiscal Reserves (including Land Fund)
