Journal Issue

CHAPTER 4: Fiscal Risk Disclosure and Management: Lessons

Lusine Lusinyan, Aliona Cebotari, Ricardo Velloso, Jeffrey Davis, Amine Mati, Murray Petrie, and Paolo Mauro
Published Date:
January 2009
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This section draws some broad lessons from the international experience, recognizing that approaches differ on some issues. It then presents a more detailed set of Guidelines for Fiscal Risk Disclosure and Management, informed by the international experience presented in the previous sections, manuals or codes on transparency, and previous studies on specific aspects of fiscal risk. Broad lessons include the following:

Fiscal Risk Disclosure

  • Fiscal risks could be usefully presented in a single “Statement of Fiscal Risks.” This could be part of the budget documents submitted to parliament to help inform its fiscal policy decisions. It would include an analysis of the sensitivity of budget estimates and public debt projections to key macroeconomic assumptions, as well as a range of contingent liabilities as discussed above.26 A possible format for such statement is presented in Appendix I. For countries that already disclose all relevant risks in separate documents, there may be merit in consolidating the information in a single document, though the additional benefits may be limited.

  • Although it is desirable to disclose most fiscal risks, the need to minimize moral hazard or to avoid disadvantaging the country economically or in negotiations calls for clearly defined exemptions. For instance, reporting on implicit contingent liabilities might be inappropriate if it were perceived as an unconditional guarantee of financial assistance, thus resulting in moral hazard. Similarly, it might be detrimental to disclose information that would harm the government’s position in litigation or negotiations. This said, fiscal policy should be set taking into consideration all fiscal risks, including those that are not disclosed or explicitly quantified.

  • When the government is widely expected to assume an implicit liability if called upon, consideration could be given to establishing an appropriately-funded explicit, but limited, guarantee. This would be appropriate, for example—if market conditions are benign—when there are clear expectations that the government would bail out depositors despite the absence of an explicit banking deposit guarantee.

Fiscal Risk Management

  • Efficient risk mitigation involves risk sharing with other parties based on an assessment of which economic agents have the best ability and incentives to bear and manage risks. Risk sharing (through mechanisms such as partial guarantees) is especially desirable with those parties that are able to influence risk outcomes, so as to provide adequate incentives. To mitigate the demand for guarantees, fees (reflecting market values) could be also charged when there is no intention to subsidize the guarantees’ recipients.

  • A clear legal and administrative framework needs to guide the allocation of roles and responsibilities in risk management, both between the central government and other public sector entities, and between the ministry of finance and line ministries. Fiscal risk management may be facilitated by a central unit of government with the necessary authority and accountability for monitoring the overall level of fiscal risk and coordinating its management; this helps to take into account possible interactions among different sources of risk.27 At the same time, the desirable degree of centralization in risk management depends on country characteristics. It would seem appropriate for the center (the ministry of finance) to have significant control over risk-taking by line ministries when these have weak incentives to manage their portfolios prudently or when their actions can impose costs on others. On the other hand, excessive involvement of a central agency may be inefficient and may limit budgetary flexibility; in those circumstances, devolution of some functions to line ministries may be appropriate, depending on the extent to which spending ministries are held accountable for budget management, including risk management.

  • Making prudent budgetary allowance for contingent liabilities and emergencies requires allocating sufficient resources to a contingency appropriation to meet such expenditure during the budget year. The appropriation should be under the control of the ministry of finance, with access granted under stringent conditions, and with ex post reporting of the disposition of the contingencies appropriation. As noted above, in international practice the contingency reserve seldom exceeds 3 percent of total expenditures (a limit suggested by Potter and Diamond, 1999).

  • For fiscal risks to be properly incorporated in decision making, contingent obligation proposals need to be considered alongside competing instruments. While decisions to commit public resources should, in principle, be reflected in the budget at the time they are made, contingent obligations are characterized by uncertainties surrounding the timing and extent to which they may become due. This creates a possible “bias” in favor of guarantees under cash budgeting: grants, subsidies, and loans reflect their full cash impact, whereas guarantees may be viewed as “less expensive.” To address this issue, the following budgetary practices might be considered:

    • Under cash-based budgets, at least the expected cash cost of payouts to meet calls on guarantees in the budget year should be appropriated. This could take the form of either a general contingencies appropriation (see above) or a separate guarantees appropriation.

    • Alternatively, the full expected NPV cost of guarantees could be appropriated. This might reduce the bias in favor of guarantees, but would require reliable expected cost estimates and would introduce an element of accrual budgeting against a background—for most countries—of largely cash-based budgets.

    • An annual quantitative limit on guarantees could instill discipline in the allocation of guarantees among competing projects. The limit (on the outstanding stock or the annual flows) would be based on an assessment of sustainability. The total guarantees budget would then be allocated among individual agencies with competing priorities.

    • A fee-based guarantees fund could be set up to meet the cost of calls on guarantees. This might facilitate tracking the experience with guarantees and strengthen the government’s credibility as a contracting partner. An “origination fee” could also be imposed on the sponsoring ministry. Such fees, which could be higher for riskier projects, would establish a link to the budget process and would ensure that guarantees are not treated as free goods. Like other off-budget funds, however, a guarantees fund could introduce rigidities in cash management.

A more comprehensive set of Guidelines for Fiscal Risk Disclosure and Management (intended to complement the existing Fiscal Transparency Code) provides further suggestions aimed at helping policymakers identify potential improvements to an existing framework. The guidelines relate to: (i) identification and disclosure of fiscal risks; (ii) clarity of the legal and administrative framework; (iii) the framework for cost-effective risk management; and (iv) the implications of fiscal risks for the conduct of fiscal policy. In addressing these issues, the guidelines touch on more general features of sound fiscal policies that are especially relevant for keeping fiscal risks in check. The case of New Zealand provides a very good example of the application of some of these principles, their legal basis, and the evolution of practice over time (Appendix II).

The budgetary and debt implications of long-run developments such as population aging, health care, natural resource depletion, and climate change (see IMF, 2008), should also be assessed and disclosed—preferably in a separate report on long-term fiscal challenges.

The unit would usually be located within the ministry of finance. In countries where a risk management unit does not yet exist, a possible option is to extend the mandate of the debt management office (DMO) to cover management of contingent liabilities. This would build on the DMO’s expertise in managing the implications of a realization of contingent liabilities for a country’s debt level and on the DMO’s proximity to financial market reactions to issuance of contingent liabilities.

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