Fiscal Risks

Sources, Disclosure and Management

Ricardo Velloso
Fiscal Affairs Department, IMF
Presentation at 2009 ICGFM Miami Conference
May 21, 2009
 Introduction
• Fiscal Risks could be defined as deviations of
fiscal outturns (deficits, debt/GDP) from
expectations at the time of the budget and/or
other fiscal forecasts.
• How large are fiscal risks for different groups of
countries?
• What are the most important sources of risk?
• What can policy makers do about fiscal risks?
 Context
• Increasing interest in fiscal risk disclosure and
management: more countries are preparing
fiscal risk statements.
• Presentation draws on recent FAD paper
discussed at IMF’s Executive Board.
• Extension of IMF’s ongoing work on fiscal
transparency (revised Code and Manual on
Fiscal Transparency).
• Preliminary Guidelines: tool for policymakers
that will evolve with experience.
• More requests for advisory services in this area.
 Outline of Presentation

• How large are fiscal risks?

• What are the main sources of fiscal risks?
• How do countries disclose fiscal risks in
practice?
• Preliminary guidelines for identification,
disclosure and management of fiscal risks.
• A possible statement of fiscal risks
 How Large Are Fiscal Risks?
Surprise Deviations in Debt/GDP

Deviations of Debt/GDP--All Countries

-5sd -4sd -3sd -2sd -1sd mean +1sd +2sd +3sd +4sd +5sd
120 140
80 100

10th Percentile
Frequency
60 40
20
0

-30 -20 -10 0 10 20 30

In percent of GDP; positive deviation if actual > forecast
Total obs. 398; mean=-0.77; sd=6.78; skewness=0.21; kurtosis=6.96
 How Large Are Fiscal Risks?
Surprise Deviations in Balance/GDP
Deviations of Balance/GDP--All Countries
-6sd -5sd -4sd -3sd -2sd -1sd mean +1sd +2sd +3sd +4sd +5sd +6sd
80 120 160 200 240 280 320

10th Percentile
Frequency
40
0

-20 -15 -10 -5 0 5 10 15 20

In percent of GDP; positive deviation if actual > forecast
Total obs. 1397; mean=-0.36; sd=3.21; skewness=-0.47; kurtosis=8.96
 Surprise Deviations in Balance/GDP

Advanced Countries Emerging Countries Developing Countries

-5sd -4sd -3sd -2sd -1sd mean+1sd +2sd +3sd +4sd +5sd -6sd-5sd-4sd-3sd-2sd-1sdmean1sd 2sd 3sd 4sd 5sd 6sd -5sd -4sd -3sd -2sd -1sd mean+1sd +2sd +3sd +4sd +5sd
100

140

160
90

140
120
80

10th percentile

120
10th Percentile 10th Percentile

100
70

100
60

80
Frequency

Frequency

Frequency
50

80
60
40

60
30

40

40
20

20

20
10
0

0
-10 -5 0 5 10 -20 -15 -10 -5 0 5 10 15 20 -15 -10 -5 0 5 10 15
In percent of GDP; positive deviation if actual > forecast In percent of GDP; positive deviation if actual > forecast In percent of GDP; positive deviation if actual > forecast
Total obs. 378; mean=0.02; sd=2.20; skewness=-0.42; kurtosis=6.80 Total obs. 388; mean=-0.57; sd=3.52; skewness=-0.66; kurtosis=10.34 Total obs. 631; mean=-0.45; sd=3.49; skewness=-0.21; kurtosis=6.86
 Sources of Fiscal Risk
• Fiscal risks arise from macroeconomic shocks
and the realization of contingent liabilities.
• Sources of macroeconomic shocks include real
GDP growth, inflation, commodity prices, and
interest and exchange rates.
• Contingent liabilities are obligations triggered
by uncertain events and can be:
– Explicit: defined by law or contract, e.g., debt
guarantees.
– Implicit: arising from government ownership
of SOEs, expectations that the government
will provide assistance (e.g., following
natural disasters, to depositors in event of
bank failures, etc).
 Currency Crises
(depreciation by at least 25 p.p. and at least 10 p.p. greater than the previous year)

Deviations of Balance/GDP--All Countries

-3sd -2sd -1sd mean +1sd +2sd +3sd
15

10th percentile
10
Frequency
5 0

-10 -5 0 5 10
In percent of GDP; positive deviation if actual > forecast
Total obs. 46; mean=-2.22; sd=3.33; skewness=-0.91; kurtosis=3.12
 Oil Exporters: Years of Oil Price increase

Deviations of Debt/GDP--Fuel Exporters Deviations of Balance/GDP--Fuel Exporters

-4sd -3sd -2sd -1sd mean +1sd +2sd +3sd 4sd -3sd -2sd -1sd mean +1sd +2sd +3sd
20

18
15
15

12
Frequency

Frequency
10

96
5

3
0

-30 -20 -10 0 10 20 30 40 -15 -10 -5 0 5 10 15 20

In percent of GDP; positive deviation if actual > forecast In percent of GDP; positive deviation if actual > forecast
Total obs. 27; mean=-6.07; sd=10.23; skewness=-0.70; kurtosis=2.94 Total obs. 26; mean=3.16; sd=5.18; skewness=-0.41; kurtosis=5.69
 Sources of Fiscal Risks
Results

• Really big, immediate, unexpected increases in

debt/GDP ratio: banking crises; exchange rate
crises (especially when large share of debt is
denominated in foreign currency); assumptions
of debts.
• More common risks to the fiscal deficit:
economic growth slowdowns, adverse terms of
trade changes.
Fiscal Costs of Banking Crises

Gross costs vs. Net costs

Recovery rates: fiscal risks on the asset
side
 Ar
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(in percent of GDP)

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Banking Crises: Net Fiscal Costs

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Banking Crises: Recovery rate

C 982
(recovery as a share of gross fiscal costs)

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 Benefits of Disclosure
• Strengthens incentives to ensure that key risks
are identified, estimated and carefully managed.
• Promotes earlier, smoother policy responses.
• Increases confidence amongst stakeholders in
the quality of fiscal management.
• Reduces uncertainty for investors and
taxpayers.
• Improves access to international capital
markets.
• International trend toward greater disclosure.
 Macroeconomic Shocks

• Fiscal risks from macro shocks are disclosed

by many countries, including all EU countries,
most OECD members and some emerging
market countries (Brazil, Chile, Indonesia).
• Modalities:
– Sensitivity analysis (e.g., minimum wage in Brazil).
– Full-fledged alternative macroeconomic scenarios
(New Zealand).
– Uncertainty surrounding baseline projections is
sometimes illustrated through a fan chart (US).

16
 New Zealand
• Clear responsibilities for macro and fiscal
forecasting to help ensure realistic budgets.
• Independent experts assess macro and fiscal
forecasts.
• Sensitivity of budget and medium-term fiscal
forecasts to variations in the key assumptions.
• Full-fledged alternative macroeconomic and
fiscal scenarios are considered alongside
baseline scenario.
• This approach provides policy-makers with a
better feel for the likely path of fiscal
aggregates, and improve their ability to judge
whether the effects of fiscal shocks are likely to
be temporary or permanent.
17
 Contingent Liabilities
General definition
- Obligations that have been entered into, but
the timing and amount of which are contingent
on the occurrence of some uncertain future
event outside the control of the Government.
Other definition
- Off-balance sheet contingent obligations
(accounting).

18
 Contingent Liabilities
Contingent Liabilities

Explicit Implicit
(obligations based on contracts, laws, (political or moral obligations,
or clear policy commitments). rather than contractual)

Guarantees Bailouts
(loan; trade and exchange rate; minimum pension; (of public enterprises, financial institutions,
income, profit and rate of return guarantees under PPPs) subnational governments, strategic private firms)

Natural disaster spending Natural disaster relief

Legal claims against the state

Environmental cleanup

Other
e.g. ideminities; insurance programs; uncalled capital

19
 Contingent Liabilities
• Disclosure practices driven by accounting, reporting and
transparency standards.
– Accounting Standards (IPSAS):
Likelihood and Loss more likely than not Loss less than likely but Loss remote
measurability of loss (probability > 50%) more than remote

Record in financial statements

Disclose nature of No
Loss can be measured and disclose nature of
contingency and amount Disclosure
contingency

Loss cannot be Disclose nature of No

Disclose nature of contingency
reasonably measured contingency Disclosure

– Statistical Standards (GFSM 2001).

– OECD Best Practices (2001), IMF Fiscal Transparency Code and Manual (2007).

• Required also by PFM or fiscal transparency legislation

(Australia, Brazil, Canada, Chile, Colombia, France, New
Zealand, Nigeria, Pakistan, Peru, UK).

20
 Contingent Liabilities
• Disclosure venues:
– Financial statements (Australia, Canada, New Zealand, US).
– Budget documentation

– Medium-term fiscal framework (Chile, Colombia, Peru).

– Debt management reports (Japan, Czech Republic, Turkey).
– Statements of fiscal risks (Australia, Brazil, Chile, Colombia,
Indonesia, New Zealand).
21
 Contingent Liabilities
• Disclosure statements usually include:
1. Classification by major category.
2. Fiscal significance, nature and rationale.
– Total exposure, expected cost and “unexpected” loss.
– Explanations for changes in CLs between periods.
– When quantification hard, discussion of nature and scope.
– Public policy purpose, duration and intended beneficiaries
3. Major individual CLs: description of their nature,
scope and quantification (often face value).
4. Information on past calls on the government.
5. Information about reserve assets (e.g., deposit
insurance fund).

22
 Contingent Liabilities
• Exemptions from disclosure:
• Implicit CLs, to minimize moral hazard.
• Information that, if quantified, would
prejudice:
– Substantial economic interests of the country.
– Security or defense of the country.
– International relations of the government.
– Ongoing litigation and negotiation.

• Exemptions primarily apply to

quantification of CLs; existence, nature
and overall scope should still be
disclosed. 23
 CL Disclosure in Practice
What countries disclose
Loan Guarantees
Guarantee and Insurance Programs
Infrastructure Guarantees
Pension Guarantees
Lawsuits
Environmental
Liabilities
Quasi-fiscal deficit Central Bank
Callable Capital (International Org.)
Unquantifiable Liabilities
Implicit Liabilities
SELECTED COUNTRIES
Australia, Canada, Chile,
Colombia, New Zealand, South
Africa, US
Chile, Colombia
Chile, South Africa, US
Australia, Brazil, Canada, Chile,
Colombia, New Zealand, US
Canada, New Zealand, US
Australia, Chile
Australia, Canada, New
Zealand
Australia, Canada, New
Zealand
Chile, Pakistan, US
QUANTIFIABLE INFO
DISCLOSED
Maximum authorized, face value,
expected loss (annual & NPV),
unexpected loss (annual & NPV; 95% &
99% probability), details of guarantee
and guaranteed loan (maturity,
currency, interest)
Maximum loss, expected loss (annual
& NPV), unexpected loss (annual &
NPV; 5, 50, 95, 99% probability),
evolution of NPV expected costs
Face value, expected payments
(annual & NPV), calls on past
guarantees
Face value (amounts claimed),
expected losses (annual, NPV), range
of expected losses, unexpected losses
(99%), past success rates
Expected costs
Quasi-fiscal deficit and capital position
of CB; guaranteed CB liabilities
Face value
Description of liability
Fiscal cost of past banking crisis, past
costs of stabilizing fuel prices
24
 Guidelines for Fiscal Risk
Disclosure and Management
• Fiscal risks to which the government is exposed
should be identified and disclosed to facilitate an
effective fiscal policy.
• Risks should be mitigated in a cost-effective
manner.
• There should be a clear legal and administrative
framework to regulate overall fiscal management
and the government’s exposure to fiscal risks.
• Risks should be systematically incorporated in
fiscal analysis and the budget process.
 Guidelines
Identification & Disclosure
• Availability of information: compilation and
monitoring of all risks—importance, probability,
and where possible, quantification.
• Legislative/accounting framework for disclosure
of risks, with presumption of publication;
exceptions based on clear criteria (materiality,
moral hazard, prejudice of national interest).
• Full presentation of risks in budget
documentation, possibly in statement of fiscal
risks.
 Guidelines
Cost-Effective Risk Mitigation
• Efforts to address or reduce fiscal risks before
they are taken or materialize include a
combination of:
– Assessing if the government should take on a
particular risk.
– Modifying the activity to reduce risk.
– Taking up insurance or otherwise transfering or
sharing the risks particularly with those able to
influence outcomes.
– Allocating risks based on an assessment of best
ability to bear and manage risks.
 Guidelines
Legal/Administrative Framework
• Clear allocation of responsibilities between CG
and rest of public sector on use of public funds.
• Fiscal risk management may be facilitated by a
CG unit that can monitor and control overall risk
and consider interactions.
• Integration with overall fiscal management is
facilitated by location of unit within MOF.
• Ministries/agencies to have clearly specified
responsibilities for managing their risk exposure.
• Responsibility for taking on risks should be
separate from that of estimating potential costs.
 Guidelines
Incorporating Fiscal Risks in
Fiscal Policy & Budget Process
• Risk analysis should be incorporated in the
macroeconomic policy framework, with fiscal
targets allowing for the possibility that some
risks may materialize.
• Exposure to fiscal risks should be incorporated
in fiscal sustainability analysis.
 Guidelines
Incorporating Fiscal Risks in
Fiscal Policy & Budget Process
• Decisions over contingent liabilities should be
integrated with the annual budget cycle so that
proposals are considered alongside competing
instruments.
• A framework should be in place to require
parliamentary approval of contingent liabilities.
• An annual budget appropriation could be
included to cover the expected cost of
contingent liabilities (general, by main category,
or specific).
 Statement of Fiscal Risks

Macroeconomic Risks and Budget Sensitivity

- Discussion of the macroeconomic forecasting record in recent years,
comparing the assumptions used in budget forecasts against actual
outcomes.
-Sensitivity of aggregate revenues and expenditures to variations in
each of the key economic assumptions on which the budget is based
(e.g., impact of exchange rates and interest rates on revenues and
expenditures), with explanation of underlying mechanisms.
- Possible methods and presentational devices include alternative
scenarios or fan charts.
 Statement of Fiscal Risks
Public Debt
- Sensitivity of public debt levels and debt servicing costs to variations in
assumptions regarding e.g., exchange rates and interest rates. Impact of
debt management strategy on the government’s risk exposure.
- Policy and institutional framework for government borrowing and on-
lending.

Contingent Central Government Expenditure

- Expected value and government’s gross exposure to contingent
liabilities—especially central government guarantees (e.g., to public
enterprises); reporting to include broad groups of guarantees but also
any major individual guarantees. Rationale and criteria for the provision
of guarantee should be disclosed.
 Statement of Fiscal Risks

Contingent Central Government Expenditure (cont.)

- Banking sector: Deposit insurance scheme and—to the extent that the
authorities feel this does not generate moral hazard—risks from the
banking sector.
- Legal action against the central government: Past claims (including
amounts) and the face value of current claims, including a disclaimer that
reporting the risk does not indicate government acknowledgement of
liability.
- Natural disasters: Fiscal impact of disasters in recent years. Level and
operation of possible contingency reserve for natural disasters (if
applicable).

Public Private Partnerships

- Summary of the PPP program, including (i) how it fits with country’s
infrastructure and other investment needs, as well as (ii) policy
framework and rationale for PPPs.
 Statement of Fiscal Risks
Public Private Partnerships (cont.)
- Cumulative overall exposure from government’s existing PPPs, and gross
exposure from guarantees and similar instruments.

State-Owned Enterprises
- Policy framework for SOEs (pricing policy, dividend policy).
- Financial performance and position of the SOE sector and the largest
SOEs.
- Financial performance and position of state-owned banks.

Subnational Governments
- Legal framework for intergovernmental fiscal relations, and summary of
recent (aggregate) subnational government financial performance and
financial position.
Thank you!

35