Tunisia - Country economic memorandum : the road to an outward oriented economy (Vol. 2 of 5) : Annex 1

Ibpot No. ""TUN Republic of Tunisia Country Economic Memorandum: The Road to an Outward-Oriented Economy (In Five Volumes) Volume II: Annex 1 Fiscal Aspects of External Debt and Options for Financing and Adjustment March 1990 Country Operations Division Country Department II Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This documnent has a restricted distribution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - .AL AE I FISCAL ASPECTS OF EXTERNAL DEBT AND OPTIONS FOR FINANCING AND ADJUSTIMET This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  REPUBLIC OF TUNISIA FISCAL ASPECTS OF EXTERNAL DEBT AND OPTIONS FOR FINANCING AND ADJUSTMENT TABLE OF CONTENTS PAGE I. FISCAL AND OTHER CAUSES OF EXTERNAL DEBT ACCUMULATION IN TUNISIA .1.... . . . . . . . . . . . . . . . . . I External shock hypothesis .1.. . . . . . . . . . . . . . . I General financing requirements . . . . . . . . . . . . . . 4 - As determined by aggregate demand . . . . . . . . . . . 4 - As expressed in borrowing requirements . . . . . . . . . 6 - As reflected in debt levels . . . . . . . . . . . . . . 12 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 14 II. THE FISCAL BURDEN OF EXTERNAL DEBT SERVICING. . . . 14 III. FISCAL CONSEQUENCES OF EXTERNAL DEBT . . . . . . . . . . . . . . 15 Debt-related Macroeconomic Developments . . . . . . . . . . 15 - A real devaluation in the exchange rate . . . . . . . . 15 - An increase in government domestic borrowing . . . . . . 16 - Monetary financing of the deficit and taxation of financial intermediation . . . . . . . . . . . . . . . 18 Effects of institutional arrangements . . . . . . . . . . . 20 IV. FISCAL OPTIONS. . . .......... 21 The sustainable deficit approach . . . . . . . . . . . . . 21 The desirable deficit approach . . . . . . . . . . . . . . 23 Revenue and expenditure options . . . . . . . . . . . . . . 28 APPENDIX Tunisia's Central Government Consolidated Budget 1972-88 . 29 BIBLIOGRAPHY  ANNEX 1 FISCAL ASPECTS OF EXTERNAL DEBT AND OPTIONS FOR FINANCING AND ADJUSTMENT 1. This case study investigates the fiscal aspects of external debt in Tur.isia. These aspects include the fiscal causes of external debt accumulation; the fiscal burden of external debt ervicing; the fiscal consequences of debt overhang; and the alternative policy options for fiscal adjustment. As will become clear in what follows, structural adjustment in the face of heavy external debt typically entails a search for alternative sources of financing--in4luding internal debt and money creation--and a decision on the size of the overall fiscal deficit. Information on Tunisia has been gathered to permit an empirical estimate of the nature and magnitude of these linkages and their implications for the future. I. Fiscal and Other Causes of External Debt Accumulation in Tunisia 2. The evolution of the balance of payments, components of aggregate demand, and public and private borrowing requirements can be used to identify the major factors leading to excessive foreign debt accumulation in Tur.isia starting in the mid-1970's. A constant ratio to GDP over time is taken to imply neutrality; deviations from a constant ratio must be explained. In the case of the balance of payments, deviations in current account items are used to examine the hypothesis that high levels of foreign borrowing resulted from external shocks such as a deterioration in terms of trade or a drop in foreign demand. This hypothesis receives little support. Next, the role of excess domestic demand is investigated by looking at trends in the components of aggregate demand and in the borrowing requirements of the major economic agents: central government, public enterprises and the private sector. This analysis suggests that an increase in real consumption, associated with a higher fiscal deficit, was largely resronsible for the external debt build-up. The External Shock HvPothesis 3. In order to investigate the external shock hypothesis, the major balance of payments items for the period 1972-88 are expressed as a percent of GDP and presented in Table 1. Looking at deviations from trend in current account items, the following patterns can be distinguished. 4. Current price exports increased as a share of GDP over the period, from 25 percent of GDP in 1972 to a peak of 42 percent in 1988. Initially this was due to a rise in export receipts from oil, of which Tunisia is a minor exporter. Subsequently, increased textiles exports and tourist receipts maintained the momentum, as oil revenues declined. The ratio of current price imports to GDP also rose--from 27 percent in 1972 to 42 percent in 1988, with a peak of 50 percent in 1981. This can be explained by (i) an overall increase in aggregate demand, as discussed below; (ii) an increase in exports, and possibly in the import intensity of exports, over  wslpu "q ea^sSS /g US-M i * Id * Od es.oa: