Transparency and sovereign debt

Less transparency - a political advantage?

Politicians may be encouraged to prepare non-transparent budgets as a way to ‘hide’ taxes and liabilities. Two theoretical arguments support this behaviour. First, the fiscal illusion theory shows that voters typically overestimate benefits of public spending and underestimate current and future taxation costs. Lack of budget transparency can increase voters’ confusion and reduce politicians’ commitment to be fiscally responsible. Lack of transparency and voters’ confusion can interfere negatively with effective budget control, particularly when substantial fiscal adjustments are needed. Second, policy makers benefit of the strategic advantage they have against citizens, i.e., information asymmetry. The less the electorate knows and understands about the budget process, the more the politicians can act strategically and use fiscal deficits and overspending to achieve their goals.

Some literature finds that more transparent budget procedures are associated with macroeconomic figures, namely, lower deficits and debt. Furthermore, weak institutions are often associated with larger deficits, thus, the budget process can be a commitment tool for fiscal discipline in terms of deficit and debt over GDP.

Public sector initiatives for transparency

In recent years, some public-sector initiatives have promoted transparency in sovereign debt markets, for example, the IMF's Fiscal Transparency Code, the Institute of International Finance (IIF) or The International Budget Partnership (IBP)’s Open Budget Survey.

On the one hand, the Institute of International Finance (IIF) has been increasingly active in advancing good practices in sovereign investor relations (IR) and data dissemination. Many countries have made progress in enhancing IR and data dissemination practices, helping develop the investor base and build capital markets. However, transparency in respect of medium to long-term financing provided by the private sector to sovereign debtors could still be improved. Accordingly, the IIF issued a new set of voluntary Principles for Debt Transparency, focused on financial transactions with both sovereigns and sub-sovereigns. Robust implementation of such guidelines by both public and private sector creditors will be an essential element of the quest for better transparency in sovereign debt markets.

On the other hand, the IBP (International Budget Partnership) has been reporting its Open Budget Survey, based upon the idea that adequate fiscal performance needs proper instruments to lean on, i.e., transparency and accountability. The Open Budget Survey (OBS) assesses the three components of a budget accountability system: public availability of budget information; opportunities for the public to participate in the budget process; and the role and effectiveness of formal oversight institutions, including the legislature and the national audit office.

Debt to GDP-ratio and government influence

The larger the debt ratio over GDP is, the more important government’s influence on the economy is. Consequently, the demand for transparent and accurate government budget reports is higher. Furthermore, the appropriate recording of both deficit and debt would have a huge benefit in terms of transparency in the political and social debate, by showing the government's role in the economy.

The transparency of the budget is supposed to enhance the control of the budget process. Governments sometimes bypass this budget control and “hide” liabilities by either shifting them to future budgets or using “off the budget” financial resources. Another tool used by governments to influence taxpayers/voters is the strategic budget projections. For example, by inflating the ‘baseline’, politicians claim to be fiscally responsible without having to hurt key constituencies through budget trims. Thus, they create a ‘fiscal illusion’ by appearing ‘conservative’ to the taxpayers, who are worried about budget size. This mechanism delays the electorate’s realistic perception of the actual situation of public finance. Improvements in budgetary transparency and expenditure management and control can effectively remove practices such as budgetary “tricks” to circumvent tax and expenditure limitations.

Transparency and debt

Some literature points out that those countries with high levels of government debt present the least transparent budgets. The idea behind this hypothesis was explained above, i.e., hiding information to taxpayers and investors as a way to take advantage of the information asymmetry. Figure 1 plots the OBS data, as a measure of transparency, with the sovereign debt over GDP ratio. OBS is measured as a ranking between 1 (highest transparency) and 110 (lowest transparency). This correlation should be negative and significant. The Pearson correlation, on the one hand, meets our expectations, since it is negative (-0.1155), but it is not statistically significant (p-value 0.2230).

Table 1 shows the most transparent countries according to the OBS. Those countries ranking high in terms of public finance and budgetary transparency are not the ones with the high levels of debt over GDP.

Table 1: OBS ranking and sovereign debt over GDP

As an overall conclusion, countries should increase their levels of public finance transparency, as a way to reduce the information asymmetries that exist between politicians and citizens. Besides, the fiscal illusion practices could be curbed through this increased transparency.