Fundamental uncertainty, reserves, and fiscal policy rules in emerging financial markets

In the wake of the recent global economic crisis emerging financial markets, mainly the group of BRIC(S), have fared well compared to potential peers in North America and Western Europe. This economic performance is due to a number of factors, including relative exclusion from the volatile financial centers of the world but also a use of proactive fiscal (as in "done by the state") policy measures. This offers some intellectual foundation to discuss normalcy in the emerging economies development. Yet the fundamental uncertainty, characterizing modern financial markets, must be brought into discussion with all urgency. For an emerging market model this refers to unclear medium run outcomes, as the decoupling of the financial from the real sector in the economy has deep negative implications, despite some promise of growth. This paper is conceptual and builds on authors' earlier analysis of blended monetary and fiscal rules in a currency crisis-like situation. For concreteness the paper relates to the case of Russia, where such proactive blended policy is in place.

Following conceptual introduction on fundamental uncertainty, Section II of the paper builds on our earlier analysis of transition economies and fiscal policy potential, adopting that analysis to the case of Russia. After a brief review of fiscal sustainability test results, primarily based on econometric analysis of Bohn-test of fiscal sustainability Section III offers an analytical assessment of fiscal policy coordination. This is complemented via derivation of a fiscal net pool, similar to a sovereign wealth fund-like entity, with combined revenue pool and three scenarios analysis on post-crisis structure subject to redefined fundamental uncertainty considerations. The gist of the paper's argument is summarized in the concluding section.

On a more general level the paper models adaptable fiscal policy decision process within economic uncertainty and with multiple alternative revenue sources and set development projects' funding. A tight balance between the market and fiscal involvement backed by pragmatic revenue management is necessary. In this light the study briefly discusses three hypothetical economic scenarios relevant to emerging markets. Macro stability may be achieved under the proposed novel "fiscal net" framework described in this paper.