Documents - Andean Community - Macroeconomic Convergence Process in the Andean Community

Macroeconomic Convergence Process in the Andean Community*
Lima, June, 2001

The efforts to move ahead with the harmonization of macroeconomic policies have stepped up, especially in regard to monetary, fiscal, and financial policy, with a view to the future formation of an Andean Common Market. That harmonization will make it possible to build a more favorable climate for the trade and economic integration of the Subregion by creating a more stable –and hence a more promising—scenario for increasing trade and investment flows, while reducing distortions that can affect the decisions of economic agents.

This process is not only essential to the deepening of Andean integration, but also directly underpins national objectives by promoting greater economic stability.

The Subregion’s Treasury or Finance Ministers, Presidents of Central Banks, and Economic Planning Officers, meeting as the Andean Advisory Council, have been working on the matter since 1998. In May 1999, the first criterion for convergence was defined: the reduction of annual inflation to a single digit figure. This made the Andean Community (CAN) the first integration bloc to define community goals.1

Since then, all of the countries have witnessed a slow-down of their inflation (Ecuador since September 2000 because of its exchange, financial, and fiscal crisis of 1999) and to date three countries (Bolivia, Peru, and Colombia) have achieved single-digit annual inflation rates. Venezuela is very close to doing so and Ecuador has at last embarked on a rapid downward trend.

Chart No. 1
Evolution of Inflation
Rate for the last 12 months (%)

Source: IMACRO

Considering the rapid headway made by the countries in this area, the Andean Council at its last meeting, held in Caracas on June 21, 2001, agreed to set December 2002 as the target date for all Andean countries to reach single-digit inflation and agreed to announce a new Community goal for the years ahead in the fourth quarter of 2002. Andean countries like Peru have already announced 2 their intention of reaching and maintaining inflation rates similar to those of the developed countries.

The Council also made substantial progress at that meeting in defining a second criterion for convergence, in the fiscal area, which is composed of two elements: the adoption of two macrofiscal rules (permanent provisions) and the launching of a Community follow-up mechanism.

The first rule specifies that no Member Country will have fiscal deficits (at the non-financial public sector level) of more than 3% of GDP as of the year 2002; it does, however, incorporate a temporary provision establishing that said deficit may reach up to 4% of GDP during the period 2002-2004.

A comparison of the Community target with national targets, with those of the MERCOSUR, and with targets set by the European Union (EU) reveals the following:

Rule No. 1
Annual limit of the budget balance and date of effectiveness
Fiscal Deficit (as a % of GDP)

BO³ (Mercosur)	CO⁴	EC⁵	PE⁶	VE⁷	CAN	UE⁸
SPC⁹ 3%	(SPNF)¹⁰ l 3%	SPNF¹¹ 2.5%.	SPC¹² 1%	Multiannual Rule	SPNF 3%	3%.
2002	(proyect)	2000	2000		2002	1994

*SPC Consolidated Public Sector. SPNF: Non-financial Public Sector
Prepared by: Andean Community General Secretariat

The second rule approved by the Council sets the countries’ limit on both domestic and foreign borrowing at 50% of GDP and provides for a transition period in which to make the respective adjustment.

Rule No. 2
Borrowing (% of GDP)

BOMercosur	CO	EC	PE	VE	CAN	UE
Average net triennial SPC debt –deducting the NIRs--, no more than 40%	National government debt plus the guaranteed debt, no more than 40%		Triennial framework: the medium-term public debt is consistent with the principle of fiscal equality or surplus.	Triennial framework: maximum borrowing limit for each fiscal year	Balance of the SPC public debt at the end of each year, no more than 50%	Ratio of gross public debt to GDP should be under 60% at the end of the previous budget year.
2010	(proyect)				2015

*SPC Consolidated Public Sector. SPNF: Non-financial Public Sector
Prepared by: Andean Community General Secretariat

Only two countries are beyond the limit set in rule 2: Ecuador, which although it was able to make a sizeable reduction in its foreign debt in the past year by swapping Brady Bonds for global bonds, continues to be over indebted; and Bolivia. For that reason, the cited rule establishes a transition period in which those countries should adjust their borrowing to the set limit (up until 2015). It should be noted, however, that Bolivia could fulfill that criterion today if the net present value of its foreign debt were used 13 to calculate the indicator, instead of its nominal value, inasmuch as that debt was contracted for on soft terms and Bolivia has also been benefited by the Initiative for the Highly Indebted Poor Countries.

The following charts demonstrate the retrospective application of the two Community rules:

Rule No. 1
Economic Result of the SPNF
% of GDP

Source: IMACRO

Rule No. 2
Foreign and Domestic Public Debt: Dec. 2000
(% of GDP)

Source: IMACRO

But possibly what is most interesting in the definition of the criteria of convergence are not the two rules given above, but the follow-up mechanism. A Permanent Technical Group has been formally established, made up of officials of the Central Banks, Treasury Ministries, and economic planning institutions, who will periodically examine the progress toward reaching the goals. Transparency is possibly the most important element in the establishment of the convergence criteria, for it increases their credibility. This high-level body should periodically submit its reports to the Advisory Committee, which would then make a pronouncement regarding the fulfillment of the convergence criteria. In fact, the starting point for the entire exercise is the annual programs of convergence steps that each country will submit to this group and which will be used as reference material for evaluating compliance with the Community targets.

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1. The MERCOSUR defined its targets for convergence in December 2000 (inflation, fiscal deficit, and debt).
2. Multiannual Macroeconomic Framework, 2001-2004, El Peruano, June 4, 2001.
3. The rules referred to in this report are explained in detail in the Presidential Declaration on macroeconomic convergence targets and mechanisms. Meeting of the Mercosur, Bolivia, and Chile, Florianópolis, December 15, 2000.
4. The rules referred to in this report are set out in detail in Act 617 of October 2000. Bill on Fiscal Responsibility (under discussion). The rules based on this bill are in italics.
5. The rules referred to in this report are given in Ecuador’s Economic Transformation Act "Trolleybus Act," R.O. 34 of March 13, 2000.
6. The rules referred to in this report are stated in detail in Act No. 27245, Fiscal Prudence and Transfer, December 1999.
7. The rules referred to in this report are set out in detail in the Organizational Law of the Public Financial Administration, September 2000.
8. Treaty of Maastricht, February 7, 1992.
9. Corresponds to the variation of the consolidated public net fiscal debt (financing needs measured below the line).
10. General Government (GG) + public enterprises (PE), CG = Central Government (CG) + territorial governments + social security system. CG= Central Administration + national decentralized agencies.
11. SPNF = general government (GG) + decentralized entities (DE) + IESS + public enterprises (PE). DE = Universities + Port authorities + cultural institutions + Solca + Supervisory entities + Autonomous entities. IESS = Ecuadorian Social Security Institute.
12. SPNF = general government (GG) + public enterprises (PE). GG = ONP + Public institutions (within sector budgets) + Central Government (CG) + ESSALUD. FCR, FONHPU + CG Regulatory agencies = Public treasury + FONAVI-MIVIVIENDA.
13. The present net value of Bolivia’s debt is about 64% of its nominal value for 1999 (www.worldbank.org).

* The statistics used in the Economic Report come from the Macroeconomic Information System of the Andean Community General Secretariat (IMACRO) and are based on official sources in the CAN Member Countries, together with supplementary data published by international institutions, such as the World Bank, the IDB, ECLAC, and the IMF.