CHAPTER 1: Introduction
- Lusine Lusinyan, Aliona Cebotari, Ricardo Velloso, Jeffrey Davis, Amine Mati, Murray Petrie, and Paolo Mauro
- Published Date:
- January 2009
Fiscal outturns often differ substantially from budget or other fiscal projections, owing to shocks such as deviations of economic growth from expectations, terms of trade shocks, natural disasters, calls on government guarantees, or unexpected legal claims on the state. In many instances, failure to disclose and prepare for such risks has caused additional government obligations, larger public debts, and, occasionally, refinancing difficulties and crises. Moreover, unexpected spending pressures or revenue losses often require disruptive ad hoc adjustments during the fiscal year. Indeed, even in countries where debts and deficits have been reduced, policymakers’ attention is turning toward risks—especially from contingent liabilities and off-balance-sheet items—that may not be fully apparent in “headline” fiscal indicators. To address the challenges posed by fiscal risks, several countries have recently increased their disclosure of such risks, so as to foster fiscal sustainability and to reduce borrowing costs and the likelihood of crises.
A number of member countries have expressed interest in further work on disclosure and management of fiscal risks.1 Responding to such interest, this paper analyzes the main sources of fiscal risk and documents fiscal risk disclosure and management practices in a wide range of countries. A key source of information is questionnaire responses covering several advanced, emerging market, and developing economies.2 Building on an overview of existing practices and previous work on fiscal risks in specific spheres of activity (such as contingent liabilities, public enterprises, and public-private partnerships),3 the paper seeks to provide practical suggestions in this area—including a possible Statement of Fiscal Risks and a set of Guidelines for Fiscal Risk Disclosure and Management.
For the purpose of this paper, fiscal risks refers to the possibility of deviations in fiscal variables from what was expected at the time of the budget or other forecast. To keep the analysis manageable, the paper focuses on fiscal risks that have a reasonable chance of materializing during a horizon of a few years. It does not delve into expenditure commitments from longer-term challenges—such as those associated with pension systems—where spending pressures can usually be estimated fairly accurately into the medium term. At the same time, the paper recognizes the need to disclose such commitments as well: indeed, in some cases, past expenditure commitments in these areas had to be brought onto the government’s books with unexpected adverse consequences for the fiscal accounts. Similarly, the paper does not focus on “policy risks” related to possible changes in government policies (which in turn may stem from possible changes in government or public attitudes); these risks are seldom disclosed, as government policies are almost always taken as given in budget documents.
Empirical evidence presented in the paper highlights the macroeconomic significance of fiscal risks from various sources. Unexpected changes in macroeconomic variables often have major consequences for fiscal sustainability—most notably and immediately in the case of exchange rate depreciations in countries with large foreign currency debt. Increases in interest rates, adverse terms of trade shocks, and declining economic growth also have substantial fiscal implications. In addition, a key role is played by calls on explicit or implicit contingent liabilities—in the banking system or other parts of the public sector (such as state-owned enterprises or subnational governments), or through the government’s interactions with private sector agents (such as PPPs).
Identification, disclosure, and management of fiscal risks are mutually supporting activities. Just as identification is a prerequisite for disclosure and management, the public scrutiny that comes with disclosure creates pressure to ensure that risks are appropriately identified and managed. Moreover, disclosure requirements imply an obligation to face up to the fact that risks are being incurred and need to be considered in assessing public debt sustainability and setting fiscal targets. At the same time, sound risk management makes it easier for governments to disclose risks with little hesitation about possible adverse reactions on the part of citizens or international investors.
In analyzing the international experience and suggesting broad guidelines for fiscal risk disclosure and management, the paper concentrates on:
Identification and disclosure of fiscal risks. Identification of all relevant fiscal risks requires clearly established responsibilities for the collection, transmission, and analysis of information on such risks. Beyond the benefits of disclosure in the form of greater incentives for accurately identifying risks, transparency may also help reduce borrowing costs in the long run. This said, the paper outlines possible exceptions to a presumption of disclosure, where publishing information on risks might engender moral hazard (e.g., through the perception of an implicit blanket guarantee in the banking system) or prejudice the economic interests of the state with respect to legal claims or negotiating positions (e.g., over public wages).
Cost-effective mitigation of fiscal risks. Risk mitigation—that is, policy action that reduces potential fiscal risks before they are taken on or materialize—may involve taking up insurance or otherwise sharing risk with other parties. A clear policy framework on fiscal risk mitigation includes procedures to ensure that risks are taken on only if sufficient justification is provided.
Legal and administrative framework to manage fiscal risks. Successful management of fiscal risks that remain after mitigation efforts requires a clear allocation of roles and responsibilities—notably between the central government and other public sector entities—with respect to the collection, commitment, and use of public funds.
Integration of fiscal risks into fiscal analysis and the budget process. The possibility that risks may materialize needs to be taken into account when determining fiscal targets. Beyond this, integration of guarantee issuance decisions with the budget process helps to ensure that projects compete on a more equal footing regardless of whether they are financed through guarantees or expenditure appropriations. Further risk management procedures include, for example, budgeting for expected calls on contingent obligations, or establishing notional or actual contingency funds.
Section II identifies the relative importance of various sources of fiscal risks, including macroeconomic shocks and several types of contingent liabilities. Sections III and IV review country practices with respect to risk disclosure and management, respectively. Section V concludes, highlighting the potential benefits of a Statement of Fiscal Risks and a set of broad Guidelines for Fiscal Risk Disclosure and Management.
For example, the APEC Finance Ministers (14th Meeting, August 2007, Coolum, Australia) recently reaffirmed the importance of assessing and disclosing fiscal risks, and called on the IMF to provide further practical insights into best practices in managing such risks.
Responses were provided by FAD and desk economists, and by country authorities. The countries covered include Algeria, Armenia, Bosnia and Herzegovina, Brazil, Chad, Czech Republic, Egypt, France, Gabon, Germany, Ghana, Honduras, Hungary, Indonesia, Italy, Japan, Jordan, Kenya, Lebanon, Mexico, the Netherlands, New Zealand, Nigeria, Norway, Peru, the Philippines, Russia, Saudi Arabia, South Africa, Tanzania, and the United Kingdom. Further information was assembled from secondary sources for countries including Australia, Chile, Colombia, the United States, and OECD countries more generally.
Previous studies include Hemming and others (2006).