block reforms. IMF (2004) gives examples of countries which are moving towards debt tolerance in spite of “bad” histories, including Chile, Israel, Mexico and Poland.

# **Box 8.  Turkey—Strengthening Institutions for Fiscal Management**

Turkey’s volatile economic performance in the 1990s may be attributed in part to its coalition politics, which were compounded by weaknesses in the institutional arrangements for aggregate fiscal management. The seeming inability of a number of governments to restrain fiscal commitments within a sustainable policy framework created a credibility problem with domestic and international debt markets.

The weaknesses included (a) a non-comprehensive budget and lack of transparency in fiscal reporting, (b) fragmented responsibility and poor coordination of fiscal management among the three central agencies of government (Finance, Planning and Treasury), and (c) a failure to control and to incorporate the effect on fiscal risk of quasi-fiscal policies and guarantees which created unrecorded “hidden” liabilities, both explicit and contingent. Differences in the perspectives of coalition partners exacerbated these problems.

As a result, fiscal risk was underestimated. In 1999, the reported consolidated central government budget suggested expenditure equivalent to 36 percent of GDP, but a comprehensive assessment would have revealed general government expenditure closer to 46 percent of GDP. Including the costs of quasi-fiscal policies, such as directed credit programs, would have increased this further. For much of the period up to 1999, such costs were disguised as growing liabilities of the government to the banking sector (the socalled duty losses) that were not explicitly recognized. While estimates of these costs vary, in 1999, the public sector’s financing requirement (including the costs of quasi-fiscal programs) of almost 24 percent of GDP was double the reported consolidated budget deficit of 12 percent.

The government has taken steps to address these institutional weaknesses. The Public Finance Management and Control (PFMC) Law that was passed by Parliament in December 2003 puts in place a comprehensive fiscal framework encompassing the general government. The new law sharply reduces the scope for extra-budgetary and revolving funds, which are being eliminated or integrated into the budget. Explicit appropriations are provided to compensate for “duty” obligations of state enterprises and banks and that this is now accounted for in the budget. Thus while quasi-fiscal policies still exist, their costs are now provided for in the budget. Longer term reforms that will modernize the financial control arrangements and allow greater scope for managerial authority to improve public sector performance are also being initiated.

Looking forward, the law provides for the preparation of a medium term fiscal strategy that will be endorsed by the Council of Ministers and which will inform the preparation of a medium term budget. This will start with the preparation of the 2006 budget. Defining and adhering to the medium term fiscal strategy will be key in building the credibility of government.

_Box contributed by Anand Rajaram_ .

Box 9 summarizes recent studies which identify debt thresholds for MACs. The vast majority of MACs exceed the identified thresholds.

# **Box 9.  Debt Thresholds Identified By Recent Studies**

Three studies done at the IMF examine the difficult issue of debt thresholds:

- Based on a country’s fiscal track record over 1985-2002, namely, its past ability to generate primary fiscal surpluses which are then discounted by the difference between a market-based interest rate and past average growth performance, IMF (2003, page 130) computes a sustainable level of debt for the median MAC to be 25 percent of GDP based on a sample of 21 MACs.  The actual median level of public debt-to-GDP in these MACs was a huge two-and-a-half times the benchmark median level of 25 <u>percent, indicating substantial over-borrowing.</u>

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