9.5 Necessary Condition: Macroeconomic Stabilization

9.5.1 What is macroeconomic stabilization? Why is it a necessary condition?
Macroeconomic stabilization is a condition in which a complex framework for monetary and fiscal institutions and policies is established to reduce volatility and encourage welfare-enhancing growth. Achieving this condition requires aligning currency to market levels, managing inflation, establishing foreign exchange facilities, developing a national budget, generating revenue, creating a transparent system of public expenditure, and preventing predatory actors from controlling the country’s resources.499 It also requires a framework of economic laws and regulations that govern budgetary processes, central bank operations, international trade, domestic commerce, and economic governance institutions. Stabilization of the economy is a prerequisite for economic growth. Empirical evidence shows that creating an environment that is conducive to higher rates of investment can reduce the likelihood of violence, while economic growth has a positive correlation with job creation and higher living standards.500

9.5.2 Guidance for Macroeconomic Stabilization

9.5.3 Approach: Monetary Stability
Monetary stability is a subjective approach as there are varying degrees to which people seek to achieve it. In the early phases of recovery, this approach may involve stabilizing the currency, bringing inflation and foreign-exchange rates to levels consistent with sustainable growth, promoting predictability and good management in the banking system, and managing foreign debt.501 The primary authority is usually an independent central bank that controls or stimulates the overall economy by manipulating the money supply and interest rates, within the parameters of monetary policy.502

9.5.4 Assess the state of monetary stability. An important step in achieving monetary stability is to assess current and past monetary conditions, including the state of the money supply and inflation, currency use, budget deficits, and debt. This assessment, typically performed by the International Monetary Fund (IMF) and World Bank, should also gauge the functionality of various government institutions and staff. Key questions to ask include the following:
  • What is causing inflation?
  • How much money is in circulation in both the formal and informal economies?
  • How deep are the financial markets?
  • Are interest rates realistic?
  • Are banking institutions intermediating effectively?
  • What is the effect of informal finance and remittances?
  • What is the condition of nonbank financial institutions?
9.5.5 Inform monetary decisions by setting up a system for collecting economic data. The ability to collect and analyze economic data is key to sound monetary policymaking process. Although statistics offces are often ignored in war-torn countries, the host nation government and international actors need to understand what is actually happening in the economy. In the emergency phase, assist the host nation government in establishing an interim mechanism to collect timely information on consumer prices, balance of payments, and other monetary statistics.503 Late attention to statistics offces could force finance ministries to conduct ad hoc statistical analyses to construct the consumer price index, GDP estimates, and national accounts.504

9.5.6 Address macroeconomic stabilization early on; it is an oft-overlooked priority.505 While no consensus exists on the exact sequencing of economic reforms, there is agreement that more attention must be paid to macroeconomic stabilization early on. This is critical for establishing a payment system, managing inflation, and laying down a basis for economic growth. S&R missions have typically prioritized emergency measures such as infrastructure rehabilitation, while postponing the reform of monetary and fiscal institutions and policies that are key to creating favorable conditions for growth.506 Some macroeconomic measures that may happen early on include opening up to trade, finding an appropriate exchange rate, managing inflation, and bringing the budget deficit to a manageable level.507

See Trade-off: Section 9.9.4, Macroeconomic reforms vs. political stability.

9.5.7 Build public confidence by stabilizing domestic currency. An unstable currency is bad for the economy because it is inflationary and can cause scarcity and depletion of resources. As a result, many people may convert their savings into foreign currencies during and after conflict, usually euros or dollars. Others will hoard cash in their homes.508 Suppressing this trend is often unsuccessful and may not be a priority—with time, domestic currency will eventually be used in local transactions and in paying taxes to the government.509 Host nation governments have a number of options for stabilizing their currencies, including using preexisting currency, introducing a new national currency, or borrowing foreign currency from another country.510 The most suitable approach will depend on the political situation but should seek to address supply bottlenecks, shore up reserves, strengthen institutions, and create a domestic market.
9.5.8 Stabilize the exchange rate through a foreign exchange market.511 An organized foreign exchange market that allows countries to buy and sell currency aids stabilization. Develop transparent policies for participation in foreign exchange auctions. Following violent conflict, the exchange rate is often overvalued because of restrictions on imports and other distortions that favor those with access to the foreign exchange at the official rate. There are several policy choices for foreign exchange. When the value of the currency is known, countries can either peg their currency to a major international currency or continue to let their currency float. By submitting to external discipline, pegging a currency foregoes autonomous monetary policy, which can be beneficial in countries trying to stabilize inflation and restore credibility after the conflict.512 An open exchange rate, however, may make sense for countries with insufficient reserves to maintain a fixed exchange rate.513

9.5.9 Set realistic targets for inflation rates. Inflation is often high in war-torn economies. This may be the case because the government resorted to printing money to fund its military costs, among other factors. Stabilizing inflation is important to restore public confidence in the value of domestic currency, invite greater investment, and provide businesses with a guide for what to produce and in what quantities.514 However, it is important not to go too far. Focusing on managing reserves and debt may be more realistic and effective. Imposing traditional economic reform agendas used in ordinary developing countries may not be appropriate for a country that has just undergone violent conflict. The effect could be to exacerbate social polarization and political disintegration.515 Neither actors nor institutions in these countries tend to respond to traditional policy prescriptions the way one might expect in a country that is already on a strong path to development.

9.5.10 Build the institutional capacity of an independent and credible monetary authority. A credible monetary authority typically exists in the form of a central bank that is able to implement monetary policy decisions without political influence. In cases where it is necessary to develop a central bank, think about reducing the printing of money, replenishing foreign currency, jumpstarting foreign exchange operations and setting up accounting and statistical systems. Training and technical assistance are also important for both high-level offcials and central bank staff.516 The primary functions of a central bank include the following:
  • Controlling the emission of domestic currency
  • Restoring the payments system
  • Facilitating or serving as a market for foreign exchange
  • Supervising commercial banks.
9.5.11 Strive for relevance, transparency, and effectiveness when developing a banking system. In the early stages, focus on creating a relevant, transparent, and effective banking regime that is capable of mediating between savers and investors. Do not focus too heavily on creating a sophisticated financial sector. Banking policies should focus on establishing rules for transparency, preventing bad loans, and avoiding political lending.

9.5.12 Approach: Fiscal Management
Effective fiscal management requires building a transparent and accountable system for collecting revenue, spending public funds, and managing domestic debt. Fiscal policy is the use of the state budget to affect an economy through revenue collection and payments for goods and services and must be established early. A fiscal authority is needed to implement policy and manage fiscal operations, all of which will be a challenge when there is very limited administrative capacity. See Section 8.6 for a discussion on the stewardship of state resources.

See Gap/Challenge: Section 9.10.6, Public finance management.
See Trade-off: Section 8.9.4, Responsible fiscal management vs. the need to provide immediate services.
9.5.13 The fiscal authority should be effective and transparent. A finance ministry is typically the authority responsible for managing fiscal operations. While the precise institutional structure, powers, and responsibilities of that authority will vary depending on the country, the goals are often the same: ensuring that fiscal decisions are made in a predictable rather than ad hoc manner, establishing transparency in fiscal operations, collecting revenue, and ensuring that public spending matches the national priorities. These are fundamental for stabilization. Given weak administrative and technical capacity, simplicity is key. The fiscal authority usually includes four departments with the following functions:517
  • A budget department to coordinate the spending program and create the budget
  • A treasury to control spending, ensure funds are accounted for, transfer state revenues into bank accounts, and record transactions transparently;
  • Customs and domestic tax departments for implementing tax policy and collecting tax revenues.
Donors should coordinate a technical assistance strategy at the outset and provide long-term advisers to account for weak capacity.518

See Gap/Challenge: Section 8.10.4, Oversight and accountability.

9.5.14 Do not ignore revenue generation strategies to meet urgent needs in these environments. After violent conflict, the government will need revenue to resume the provision of basic goods and services, finance key reconstruction projects, and address large macroeconomic imbalances. Significant revenue mobilization, however, will be challenging because of a shrunken tax base, complex or discriminatory tax policies, weak institutional capacity, and competing illicit economies. One of the primary means for collecting revenue is getting the tax system up and running by securing the necessary infrastructure, technical assistance, and monitoring or oversight mechanisms. Another means for generating revenue quickly is through transparent and accountable management of natural resource wealth. Natural resource wealth management is also discussed in Sections 8.6.25 and 9.6.11.
9.5.15 Stress simplicity in developing tax systems and policies, given limited administrative capacity. In these environments, there typically is limited capacity to administer a complex tax system. Rather than imposing direct taxes on personal income that could be diffcult to implement, taxation could start with simple, indirect taxes on sales at hotels or restaurants. Simple taxes on international trade—sales taxes on exports and excise taxes on imports—may also be relatively easy sources of revenue. The concept of simplicity should be applied to tax administration as well, focusing primarily on the most basic aspects of operation in early phases, such as procedures for filing and paying taxes and registration checks. With time, the focus of attention should shift toward improving the capacity for tax efforts and broadening the tax base.

See Trade-off: Section 9.9.2, Sophistication vs. simplicity in the income tax system.
9.5.16 Accept low tax rates on earned income in the emergency phase. Sustainable tax revenue requires long-term investment in nurturing the formal economy and fostering a culture of compliance in paying taxes.519 While revenue collection programs are necessary, they can also be counterproductive when pursued too aggressively in the immediate aftermath of violent conflict—raising taxes too heavily contradicts the central goal of economic recovery and can undermine the credibility of the government. Prepare to accept a prolonged period in which tax rates on earned income are low. The focus instead should be on jumpstarting economic activity by breaking down barriers, establishing new farms or businesses, and expanding operations. How the economy expands will shape the strategy for taxing different sectors.520

9.5.17 Consider debt relief programs to achieve debt sustainability. Many governments in countries emerging from violent conflict will have accumulated unsustainable debt burdens while immersed in the conflict. In these cases, debt service relief may be a critical element to recovery.521 The design and implementation of debt relief programs should be tailored to account for the unique complexities of each country’s political economy. These variations can include the speed of delivery, the scope of resources, performance triggers, and the exit strategy. Debt relief should be viewed as part of a long-term effort that includes a comprehensive and robust debt management strategy, and should address all conflict-era debts and forestall commercial borrowing.
9.5.18 Be prepared to fill the gap between revenue and government costs with funding from international actors. Inevitably, the host nation government will come up short on revenue in the emergency phases because stabilization costs are high and capacity is low. In these emergency stages, international actors should be prepared to serve as the primary source of funds. But as the host nation government begins to strengthen its taxation capacity, international actors should shift their role to filling funding gaps. Making this shift is challenging. International actors should help the host nation government in this transition by carefully assessing recurrent costs for both salaries and capital expenditure programs and establishing clear goals for achieving self-sufficiency.

9.5.19 Strengthen public expenditure management (PEM) of the host nation government.
Getting a PEM system up and running requires transparent processes and sound institutions, policies, and regulations. Strengthen budget execution by enhancing administrative and technical capacities of ministries. The ministries will have to draft budget documents and develop executive expenditure authorization procedures to monitor and control spending across the government. Audit capacities are essential and should be strengthened, alongside reforms in the fiscal conduct code, to limit corruption, waste, and misappropriation of public funds.522 Address bottlenecks in spending and generate controls within the executive branch, legislature, international community, and civil society, all of which play critical roles in ensuring accountability of public spending.523 Payment for government salaries and essential services (police, schools, clinics, or other operating units) should come from the finance ministry and should not be under the control of the heads of each operating unit.

9.5.20 Prioritize transparency in contracting and procurement practices to combat corruption. Contracting processes are one of the greatest sources of corruption in many countries. The best ways for curbing corruption in contracting processes are to establish simple and practical rules and procedures, accompanied by impartial and consistent decisions and a means for holding the contracting agency and contractors accountable for their actions. Implementing controls such as requiring dual authorization of expenditures and audits (i.e., from the manager and accounting clerk), can help restrict grafting practices.524 The World Bank has developed guidelines on how to standardize the establishment of open, transparent, and competitive contracting procedures.525 At stake are critical resources, necessary services, and the financial credibility of the operation, all of which outweigh the need to be more efficient. Other aspects of corruption are discussed in Sections 8.6.20 to 8.6.22 and 9.6.

9.5.21 Reflect national interests in budget and state spending. Although administrative capacity is weak, the host nation government should begin keeping budgetary records and ensuring that the national budget is aligned with citizens’ interests, including civil service pay and infrastructure investments.526 Before preparing a budget, the government needs a mechanism by which to execute the budget—a treasury system and spending information management system that allows the state to monitor all expenditures. The treasury should promote predictability, transparency, and timeliness in paying civil servants and procuring goods and services.527 Improving budget management can help prevent state funds from being siphoned off for illegitimate purposes and promote spending that is consistent with the offcial budget. Some budgetary execution challenges are rooted in inexperience and unrealistic estimates about the capacity to implement projects in the budget.

See Trade-off: Section 9.9.3, Creating donor trust funds vs. strengthening the host nation budget process.
9.5.22 Approach: Legislative and Regulatory Framework
A legal, institutional, and regulatory framework is necessary to guarantee proper operation of economic institutions to address stabilization challenges such as property rights.528 This framework must be simple, transparent, and easily enforceable, and it should address a range of laws governing commerce, labor, and property rights and mechanisms for institutional oversight and fiscal operations. Economic laws are worthless in this environment unless an effective legal system is capable of enforcing the law. This framework, together with broader economic recovery, can provide a foundation for greater investment and growth.529

9.5.23 Assess legal conditions and simplify wherever possible. In reviewing existing legislation, the goal should be to redress discriminatory practices linked to the conflict and simplify wherever possible to account for what will likely be weak administrative capacity. There is often a mismatch between the administrative capacity of host nation actors and the complexities of laws, particularly tax laws and administrative procedures. Consult widely in both the public and private sectors (informal and formal, on all sides of the conflict) to identify barriers to economic activity.530 As soon as possible, remove those barriers, including onerous business registration procedures or restrictions on who may apply for import licenses. Laws may need to be drafted or imported and must be understood by domestic courts and the population. See also Section 7.5 for more on assessing and reforming legal frameworks.

9.5.24 Promote predictability, open markets, and fair competition through commercial laws.531 Having a strong national policy and regulatory environment that embraces these tenets is key to creating favorable conditions for a market economy. Stability and predictability are critical to markets, enterprises, and foreign direct investment. Remove ambiguities in the investment code to allow foreign firms to borrow locally, allow expatriates to get work permits, and avoid corruption and red tape. Create laws that govern contracts (pledges, loans, and mortgages), bankruptcy (for companies that reorganize or liquidate themselves), and commercial and financial transactions. Establish rules of the game by regulating quality standards in major industries and establishing processes for business license registration, whether for partnerships or corporations, domestic or foreign.532 The legal regime for commerce should also be perceived as favoring free and open markets and ensuring a level playing field for firms. Address market failures and prevent any special privileges or advantages for some sectors. These policies will likely contrast with the conflict-era or pre-conflict era environment in which the privileged few had access to economic opportunity. In cases where ownership was concentrated or state-held, privatization and competition laws are needed.

9.5.25 Develop a customs, tax, and budget legal framework to govern fiscal operations. Laws governing fiscal operations have two main sources: the constitution and tax and budget laws. The constitution typically specifies the division of government taxing powers while tax laws authorize the state to collect taxes and enforce the law when taxes are evaded. Financial regulations are also necessary to authorize the fiscal authority to manage public spending. The goal in creating tax regulations and laws should be to simplify them, make them more transparent, and make them easier to administer. A budget law should set out clear budget classification structures that establish guidelines for executing the budget, such as prohibiting unbudgeted spending, creating a framework for internal control and audit, and providing a means for financing budget deficits. New laws should also address how to deal with situations involving “off-budget transactions,” the absence of clear classification of budgetary spending, and the absence of procedures for managing foreign aid.

9.5.26 Prioritize dispute resolution mechanisms to address property and contract issues. Land and property rights disputes dominate in these scenarios. During violent conflict, the state often seizes property or other assets to support its efforts. People flee, land is abandoned, and others take control. The inflow of returnees looking to reclaim land creates a major problem. A national dialogue should commence as soon as possible over this issue of disputed or unclear property rights.533 The absence of a credible system for resolving property disputes and enforcing contracts will inflame conflict, especially when ethnic cleansing forced one group out and another took possession, or if unequal access to land was an issue that motivated the conflict. Ambiguity can also deter investors when potential investments involve land-intensive projects in areas where outstanding claims still persist. Resolution systems should not exclude customary laws that are already in place or alternative forums (e.g., local government or traditional institutions) that may be able to help manage conflicts within or between groups. These can resolve disputes that do not require a full court proceeding.534 For more on property dispute resolution, see Section 10.7.10.

9.5.27 Focus on laws to combat organized crime and other illicit economic activity. Laws that seek to combat predatory economic actors must be backed up by the means to investigate, prosecute, and convict those actors. This is a tall order. Laws should prevent money-laundering activity and provide ways for financial institutions and actors to report suspicious activity. Create a legal and administrative system to monitor and adjudicate such activity and seize assets when enforcing financial transaction laws. Legal safeguards should prevent predatory actors from capturing public entities when they are privatized. A transparency framework is needed to enable public posting of public property, bids and tenders for buying the property, identity of purchasers, financing of sales, and codicils on use of the property (the right of resale, restriction on use of assets) to ensure that sales are compliant with the transparency regime. The framework should also require public disclosure of transfers with the book and market values of the assets being transferred and the buyer of those assets. Also, state regulations and enforcement mechanisms are needed for enabling internal enterprise governance, maintaining relations with state entities, and reporting financial status and operations.

9.5.28 Engage the private sector on advocacy for policies and regulatory reform. Include the broader society in dialogue on policies and regulatory reform to achieve buy-in for economic recovery. But be cautious with regard to some business owners, who may have obtained their power and status during the conflict as a result of rent-seeking or predatory behavior. A public-private forum for dialogue on policies and regulations could benefit the private sector and jumpstart economic growth.535