Fiscal Fatigue, Public Debt Structure and Sustainability: A DSGE Model for West African Economic and Monetary Union

Abstract

The present paper simulates several financing schemes for scaling-up public investment while stabilizing debt in WAEMU countries experiencing fiscal fatigue. We construct a DSGE model of a small open economy that incorporates the behaviour of four types of agents: firms, households, government, and the Central Bank. The analysis assumes that when the government faces fiscal fatigue, it can turn to debt to finance the scaling-up of public investment. To ensure long-term debt sustainability, fiscal adjustments are consistently implemented through transfers and/or taxes, subject to respective caps and floors. Simulations indicate that, in the presence of natural resource revenues, scaling up public investment is feasible using concessional borrowing only or by incorporating additional external commercial or domestic borrowing while maintaining debt sustainability. Otherwise, external commercial debt appears to carry more risk.

Keywords:

• Fiscal fatigue
• debt structure
• debt sustainability
• DSGE
• WAEMU

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 On 18 May 2021, a summit on the financing of African economies was held in Paris, bringing together nearly 30 African and European leaders (including 15 heads of state), numerous representatives of international organizations such as the African Union and the United Nations, as well as many multilateral donors, notably the International Monetary Fund, the World Bank, the European Investment Bank, the African Development Bank and the French Development Agency. The purpose of this event was to catalyse the financial responses that can be provided to African countries. It was also an opportunity to assess the financing needs and the possibilities of meeting them. Finally, the implementation of a common framework for dealing with the public debt of countries experiencing difficulties has also been discussed.

2 WAEMU is an economic and monetary union of 8 West African countries, which share a single currency (CFA franc) and a common issuing Central Bank called BCEAO. In accordance with Article 8 of its statutes, the Central Bank implements a common monetary policy for all Member States with the priority objective of price stability. Fiscal policies are the responsibility of each Member State but are regulated by the Convergence, Stability, Growth and Solidarity Pact (CSGSP) with a certain number of fiscal rules including those: the minimum tax revenue to $20\mathrm{\%}$ of GDP, public deficits to $3\mathrm{\%}$ of GDP and public debt to $70\mathrm{\%}$ of GDP.

3 According to Dembélé (2015), the extraction and trade of mineral resources is the main economic activity of the member countries of the ECOWAS, a Zone to which all the WAEMU countries belong. For example, West Africa produces more than $27\mathrm{\%}$ of Africa's mineral production. Many countries in WAEMU are producers of very high grade gold (Burkina Faso, Côte d'Ivoire, Mali, etc.). In 2006 gold mining in Mali accounted for $15\mathrm{\%}$ of GDP and $70\mathrm{\%}$ of export earnings. In Burkina Faso, gold exports reached 180 billion CFA francs in 2009, putting this sector ahead of cotton, which accounted for 120 billion CFA francs. More than $34\mathrm{\%}$ of Africa's manganese is produced in West Africa. As regards oil, four African countries have significant reserves under exploitation, two of which are in the WAEMU, such as Côte d'Ivoire and Niger. Oil is the main item in the region's trade transactions.

4 From a technical point of view, the portfolio coast also ensure the stationarity of $b_t^{s\ast }$. See, Schmitt-Grohé and Uribe (2003) for alternative methods to ensure stationarity of net foreign assets.

5 In the simulations, the values of the parameters of public capital at and off steady state $\overline{s}$ and s are both set to 0.6, in line with the calibrations for LICs (Buffie et al., 2012) or for Sierra Leone (Balma & Ncube, 2015).

6 The reason is that in such countries, resource production arises only from negotiations between foreign multinational firms and public authorities. It is also assumed that the WAEMU countries cannot control resource prices but rather bear the prevailing international market prices.

7 We are using the values in the literature on SSA because we did not have access to the social accounting matrices of the WAEMU countries which are our primary concern. However, the mismatch bias of the values set is negligible given that WAEMU countries are developing or emerging economies and in the macroeconomic data comparisons are most of the time in the average of SSA countries.

8 In alternative runs, Buffie et al. (2012) have allowed for learning effects and have set the capital learning externalities ${\varsigma }_x$ and ${\varsigma }_n$ to 0.08 so that the return of capital in the the traded sector is about $30\mathrm{\%}$ higher than the private return. The steady value of the net social return to capital is given by $(r+\delta )(1+{\varsigma }_j/\varphi j)-\delta$. To set ${\varsigma }_j$ such that the social return is equal to $30\mathrm{\%}$ above the private one, the problem that should be solved is $(r+\delta )(1+{\varsigma }_j/\varphi j)-\delta =(1.30)r$ for ${\varsigma }_j$.

9 Buffie et al. (2012) affirm that the results do not change significantly when Ω takes a value between 1 and 10.

10 The parameters $\theta x$ and $\theta n$ in the production function that drive $R_o$ are given by the calibration of $R_o$ knowing the other parameters in the model. Looking at the World Bank's Circa 2001 projects, this rate has a median value of $20\mathrm{\%}$ in SSA and would range from 15 to $29\mathrm{\%}$ for several sub-categories of investment in infrastructure. There are also estimates in the literature that indicate that the rate of return on infrastructure ranges from $15\mathrm{\%}$ to $30\mathrm{\%}$, depending on the sectors in which the infrastructure investments have been made, including irrigation, water and sanitation, electricity and roads (see among them Dalgaard & Hansen, 2005; Foster & Briceño-Garmendia, 2010)

11 For example Dembélé (2015) shows that gold mining production in 2006 accounted for $15\mathrm{\%}$ of GDP in Mali.

12 The HIPC program is known as the Heavily Indebted Poor Countries debt reduction initiative, which was initially launched in late 1996 by Bretton Woods Institutions (World Bank, IMF) and the Paris Club (bilateral official creditors) with the aim of making debt of heavily indebted LICs sustainable. By the first quarter of 2011, the WAEMU countries had reached their completion point under the HIPC Initiative and will be joined by Cote d'Ivoire in 2012. This initiative has enabled them to considerably reduce debt burden, which was becoming unsustainable.

Additional information

Funding

This work was supported by the Agence Nationale de la Recherche of the French government through the program ‘Investissements d'avenir’ ANR-10-LABX-1401.