Defining the Boundaries: Debt vs. Expenditure Ceilings
Over-indebtedness and over-spending are closely related concepts and often cause certain confusion, occasionally interchangeably misused, as both involve government actions that exceed planned financial limits. Understanding the distinction is important as one may directly affect the debt sustainability assessment of the country (i.e., over-indebtedness) while the other may primarily affect the allocation of funds within the annual budget for line ministries for the next fiscal year (i.e., over-spending).
Debt ceilings are established to set a cap on new internal and external borrowing and thereby mitigate the risk of over-indebtedness, while expenditure ceilings are intended to function as fiscal discipline instruments designed to control aggregate public spending and have a broader coverage of the government’s fiscal activities, particularly those related to line ministries spending.
Most sovereigns set expenditure ceilings in their budget, which is usually included in their annual borrowing plan. This is also approved, in most instances, by Congress or Parliament under a Budget law or an Appropriation Act.
The Mechanics of Fiscal Discipline
A problem that could arise between the annual budget limit and the expenditure ceilings relates to how they are measured as real and nominal values can affect the calculation. Real values are nominal values adjusted for inflation and show the purchasing power of the annual budget. Nominal values, by contrast, are not adjusted for inflation and can lose their real value over time. For that reason, it is crucial that budget ceilings set in nominal terms are not disconnected from the real value of expenditure if inflation is high or volatile, especially in countries with a history of inflationary problems. With this in mind and, given the possibility of unforeseen or uncertain macroeconomic shocks, some flexibility is needed to adjust spending needs.
Navigating Over-spending Risks
Over-spending is inevitable and although it should be extraordinary it is contemplated in most countries public finance management frameworks as an exceptional budgetary deviation, emphasizing that this should not bypass borrowing controls. It is common to consider that any expenditure exceeding the annual budget: (i) shall arise from unforeseen or urgent events (e.g., pandemic or a climate catastrophic event), (ii) must be approved or regularized by the legislature, as in most cases there is no automatic exception for emergency borrowing (e.g., incorporated in the annual or supplementary budget or through a contingent appropriation), and (iii) shall be subject to a quantitative cap (e.g., linked to annual domestic revenues[1]).
Moreover, some countries exclude certain categories of spending from expenditure ceilings and create a specific category of spending that are treated differently with respect to expenditure ceilings (e.g., health and social security funds) while others established an unallocated reserve or “margin” to meet unforeseen and exceptional contingencies.
As the justification for over-spending relies on urgent and unforeseen events that trigger the need for additional spending and are subject to a quantitative cap, they are often not defined with detailed qualitative specificity. The open interpretation of what constitutes urgent and unforeseen circumstances must be refined to avoid governance risks, strengthen transparency and accountability, and prevent the erosion of fiscal discipline. Limits and causes for such exceedances must therefore be carefully determined so as not to give rise to overly broad or imprecisely defined justifications, as over-spending is not a substitute for normal appropriations. The regulatory frameworks must safeguard against unplanned borrowing and unrecognized contingent liabilities, which can undermine fiscal transparency and be rapidly transformed into over-indebtedness.
Lastly, over-spending should not be regarded as a free ride or unwarranted burden for the line ministries but rather as a necessary measure when an extraordinary event arises that requires immediate economic attention and serious consequences. In some cases, upon an instance of overs-pending, the exceeded amounts are rolled over into the following year’s budget compromising the line Ministers’ budget for that year. Conversely, if over-spending is done on an arbitrary basis (e.g., authorization of an illegal payment), this could be illegal or declared null and void, as it would have been made in violation of regulations. The consequences can be criminal or at least give raise to an explicit sanction to the line ministry or head of the line ministry.
Impact on Debt Sustainability Analysis (DSA)
It is important to highlight that over-spending in itself does not directly enter into the DSA, as it is not considered to be under the borrowing category but rather as an expenditure-side deviation (e.g. contracting services without having allocated funds which will be paid in the future), unless it is financed through new debt. The key debt indicator of a debt sustainability assessment is indebtedness measured by the stock of debt and debt service relative to repayment capacity.
While over-spending is prone to happen due to the occurrence of a defined set of unexpected events and it is considered to be a permitted exception in public finance management, over-indebtedness is less likely to occur inadvertently because new borrowing usually requires a predetermined purpose and that is why it usually requires approval by the Legislature and/or the Minister of Finance. Borrowing undertaken without such authority would be ultra vires (i.e. exceeding the limits sets forth by the legislature and therefore exceeding the legal capacity to contract such debt). Consequently, a debt contracted beyond the limits set forth by the approved budget or without having followed the rules in place for exceptional situations could be considered invalid or unlawful, as it lacks authorization. Accordingly, so long as the requirement for over-spending is approved by the Legislature and does not result in an unauthorized increase in government borrowing, no over-indebtedness occurs (just an increase in borrowing beyond the set ceiling).
[1] For example Liberia’s Public Finance Management (PFM) Act establishes that over-spending shall not exceed 2% of total annual domestic revenues (Section 8.3 of the PFM Act) and Somalia’s PFM Act establishes that over-spending shall not exceed 5% of the total domestic revenues (Article 19 of the PFM Act).
