30 The global financial crisis of 2008-2009 will provide an important test on the long-term commitment to fiscal sustainability. Governments throughout the world have loosened the fiscal rules as part of counter-cyclical packages. For example, in Brazil, The three-year Programs of Fiscal Adjustments between the National Treasury and the 25 states adjusted the primary balances and indebtedness targets and broadened the fiscal space for new borrowing. Through its development bank, the federal government created a credit line for SNGs that had suffered loss of federal transfers. Given that some states were not in compliance with the requirements of fiscal responsibility legislation, this operation is considered to be exceptional and allows all states to access the line of credit. In India, the central government allowed the states to raise additional market borrowings, thus increasing the limit of gross fiscal deficit to 3.5 percent of gross state domestic product in fiscal 2008/09, and to 4.0 percent in fiscal 2009/10, exceeding the FRL targets.<sup>26</sup> The challenge will be to manage the exit from fiscal stimulus and to resume a commitment to fiscal sustainability.

Some FRLs were enacted more to guide a fiscal adjustment process than to set a framework for fiscal policy for long-term. The global financial crisis of 2008-2009 brought to the fore the issues of fiscal policy over the economic cycles and the coordination of counter-cyclical fiscal policies across the different institutions of the government. It is not clear, however, the extent to which FRLs are suited to serve as the main legal basis for long-term fiscal management or are only one part of the overall institutional framework for long-term fiscal prudence.

# **C.** **_Subnational FRL in the context of national reform_**

Macroeconomic developments and nationwide reforms can provide an overall impetus. Consistency with other parts of the macro-fiscal system, subnational fiscal reform often unfolds in the broader macroeconomic context. In Canada, macroeconomic deterioration in the 1980s to early 1990s led to major changes in monetary and fiscal policy. After suffering from a lack of credibility, the Bank of Canada since the early 1990s committed to low and stable inflation. The attainment of inflation targeting overtime improved market and public confidence (Perrier and Armano 2000; Paulin 2000; OECD 2001). On the fiscal front, in the early 1990s, the importance of restoring sound public finances became increasingly clear at both the federal and provincial level. The fiscal framework adopted by the federal government and legislation by provinces were part of the move toward more sustainable public finances (Traclet 2004).

Establishing an FRL or other institution to constrain SNG debt and deficits works only if the governments in question start from or are brought to a position where they do not have extreme debt overhang. In other words, if the service on existing debt is already too large to pay realistically in the political economic situation, this attenuates greatly the incentive from an FRL to behave with fiscal responsibility. Consequently, a set of SNG fiscal adjustment and debt rescheduling programs often must complement or precede the implementation of an FRL. To work, the programs must strike a balance between being sufficient to eliminate the debt overhang and being so generous as to seem to reward fiscal irresponsibility of the past (or to fiscally hamstring the national government).

26 Government websites and World Bank country teams.