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CHAPTER 5: Conclusions

Author(s):
Lusine Lusinyan, Aliona Cebotari, Ricardo Velloso, Jeffrey Davis, Amine Mati, Murray Petrie, and Paolo Mauro
Published Date:
January 2009
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Various types of shocks cause fiscal outcomes to deviate from budgets and expectations—often by large amounts. Evidence presented in this paper has shown that macroeconomic shocks and calls on contingent liabilities often have major implications for fiscal sustainability. Over the past few years, several member countries have increasingly disclosed fiscal risks, both to build public support for prudent fiscal policies and to improve financial market access at reasonable cost. The paper has documented a variety of approaches adopted by member countries with respect to mutually supporting identification, disclosure, and management of fiscal risks.

A number of broad messages emerge from the review of country experiences:

  • For effective identification of all fiscal risks—a prerequisite for disclosure, management, and a fully informed conduct of fiscal policy—procedures need to be in place to ensure that the entity that plays the key role in determining fiscal policy (typically, the ministry of finance) has access to all relevant data. This requires clear allocation of responsibilities for the various parts of the public sector in assessing and reporting fiscal risks they face or incur.

  • Comprehensive disclosure of all fiscal risks would seem desirable, to facilitate identification and management of risks, and to help reduce borrowing costs in the long run. Notwithstanding these advantages of disclosure, quantification may not always be feasible or desirable. For example, in the case of some implicit guarantees, the absence of contractual terms makes it difficult to disclose specific amounts. More generally, disclosure should avoid engendering moral hazard from a perception of an implicit blanket guarantee (e.g., in the banking system) and ensure that the state’s economic interests are not prejudiced (e.g., with respect to legal claims or public wage negotiations). In such cases, the government might decide to disclose the nature of the risks, without quantification. This said, fiscal policy objectives need to be set taking into account all risks, including those that may not be precisely quantified or disclosed. For risks that are disclosed, there is merit in reporting them in a single document, such as a statement of fiscal risks presented with the annual budget.

  • Cost-effective risk mitigation begins with sound macroeconomic and public financial management policies—areas on which policymakers should initially focus, especially in countries at relatively low levels of development. Beyond this, mitigation involves a combination of insurance and mechanisms providing for governments to commit to contingent expenditures only when there is sufficient justification, e.g., in terms of market failure. In practice, the use of insurance instruments remains limited, although it may increase as markets for innovative instruments develop further. For most countries, risk mitigation will thus mainly consist of practices that require justification for taking up fiscal risks, and that make it necessary for private sector agents to pay guarantee fees or to share in the risk (e.g., partial guarantees).

  • Fiscal risk management is also facilitated by a legal and administrative framework clarifying relationships between different levels of government and vis-à-vis the private sector—for example, by spelling out who can authorize government borrowing, investment, and the issuance of contingent obligations, and which entity is responsible for audits in these areas.

  • For fiscal risks to be properly incorporated in fiscal policy decision making, not only accurate information but also suitable procedures are required in the budget and contingent liability approval process. For example, contingent obligation proposals may need to be considered alongside competing instruments; and ceilings on broad categories of guarantees to be issued during the fiscal year may need to be subjected to parliamentary approval during the budget process.

Building on these considerations and informed by the international experience, a set of guidelines for fiscal risk disclosure and management has been presented (Box 7). This may be a useful resource for policymakers seeking to identify possible gaps in their current practices in that regard. The implications for the design of more specific measures will need to be traced against the background of individual country circumstances. More generally, the relative importance of various types of risks is likely to evolve over time: in that light, it would seem desirable for countries to continue to adapt to the times by learning from each other with respect to fiscal risk disclosure and management practices.

Box 7.Guidelines for Fiscal Risk Disclosure and Management

  • 1. Fiscal risks to which the government is exposed should be identified and disclosed, so as to facilitate an effective conduct of fiscal policy.

    Identification of fiscal risks is a prerequisite for risk disclosure and management. Although risks may be adequately identified in the absence of disclosure, a commitment to making information on fiscal risks publicly available subjects the analysis to additional scrutiny, helping to ensure that risks are fully recognized and properly assessed. Moreover, disclosure may help to manage risks and reduce borrowing costs in the long run. Transparency also strengthens accountability for effective risk management; improves the quality of decisions on whether the government should take on risk in the first place; and promotes earlier and smoother policy responses.

    Availability of information on fiscal risks

    • A list of all material fiscal risks to which the government is exposed should be compiled, together with an indication of their relative importance; whenever possible, risks should be quantified in terms of amounts (point estimate and range) and probability of occurrence.

    • Each government unit should communicate to the risk monitoring agency (typically within the ministry of finance) all information it has on sources of fiscal risks; in particular, entities that issue government liability instruments (including contingent ones) should maintain and communicate a register with the details of all the instruments.

    • To reduce exposure to risks arising from nonfinancial public enterprises, public financial institutions, the central bank, and subnational governments, the ministry of finance should routinely monitor and report on the fiscal performance and financial position of these entities; the extent of monitoring should be commensurate with the degree of fiscal risk.

    • Procedures should be in place to provide independent assurance of the integrity and robustness of the assumptions underlying the budget, including the government’s macroeconomic forecasts.

    Legal/accounting framework regarding the disclosure of fiscal risks

    • There should be a presumption that information on fiscal risks should be published, with exceptions based on clearly defined criteria relating mainly to the materiality of fiscal risk exposure and the possibility that disclosure might engender moral hazard (e.g., through perceived blanket guarantees in the banking system) or prejudice the national interest (e.g., in wage negotiations or legal disputes). It would be desirable for the timely publication of information on fiscal risks to be a legal obligation of the government. The government’s accounting policies should be reviewed to ensure that, to the extent possible, they provide relevant information on fiscal risks, consistent with international accounting standards. Notably, the government’s accounting standards should require disclosure of information on contingent liabilities.

    Disclosure practices

    • The budget documentation should include:

      • —an assessment of fiscal sustainability;

      • —discussion of overall fiscal risk management strategy, including priority areas for risk mitigation;

      • —alternative macroeconomic scenarios or sensitivities of the fiscal aggregates to changes in assumptions;

      • —statements describing the nature and fiscal significance of quasi-fiscal activities, together with related fiscal risks;

      • —discussion of public debt management strategy, risks in the portfolio, and risk mitigation;

      • —information on contingent liabilities, including (see Manual on Fiscal Transparency): (i) a classification of outstanding contingent liabilities by major category; (ii) a description for each category of why and how the government takes on such risks; (iii) the fiscal significance of outstanding contingent liabilities by major category (quantification should include the total exposure under the liability and, where feasible, the expected value); (iv) information on major individual contingent liabilities, including a description of their nature, scope, and quantification; (v) past calls on the government to meet contingent liabilities; (vi) for each new contingent liability, its public policy purpose, duration, and the intended beneficiaries; and (vii) information about any assets set aside against specific contingencies.

    • Budget documentation could also include information on (i) PPPs (perhaps as a separate report in countries where the size of the PPP program warrants it), indicating for each project the government’s contingent liabilities and future contract payments; (ii) state-owned enterprises and subnational governments; and (iii) the objectives and operations of extrabudgetary funds—including any revenue or expenditure stabilization funds.

    • The government should publish information on realized risks, including annual ex post reviews of budget macroeconomic and fiscal forecasts against outcomes, with analysis of reasons for deviations.

    • Information on fiscal risks presented in the annual budget documents could usefully be compiled into a single Statement of Fiscal Risks (see Appendix 1).

  • Fiscal risks should be mitigated in a cost-effective manner.

    Efficient risk mitigation—efforts to address or reduce potential fiscal risks before they are taken on or before they materialize—involves a combination of: modifying the activity to reduce risk; taking up insurance or otherwise transferring the risk to, or sharing the risk with, other parties, particularly those that are able to influence risk outcomes; allocating risks based on an assessment of which economic agents have the best ability and incentives to bear and manage risks. A clear policy framework on fiscal risk mitigation helps assess the justification for proposals to take on new risks; independent expert review is also helpful in this area.

    • A clear policy framework should be in place for assessing whether the government should take on a fiscal risk. The government’s priorities for mitigating fiscal risks should consider the expected net benefits from risk reduction while paying attention to: the possibility of extreme realizations imposing unacceptably large fiscal costs; the interactions between different risks; and scenarios in which a number of risks materialize at the same time. The specific rationale for taking on a risk (e.g., issuing a guarantee) should be documented and available for subsequent review.

    • Fiscal risks should be allocated based on which economic actor has the best ability and incentives to manage them, and who is best placed to bear them. For example, in PPP contracts or guarantees, the government should bear the risk of future changes to the policy or regulatory environment; private sector agents should bear risks over which they have some control, either in terms of reducing the probability of loss (e.g., construction risk) or their exposure to loss (e.g., foreign exchange risk).

    • The state should consider issuing contingent liability instruments only in cases of externalities/market failure (e.g., where markets are unable to take on large risks even though it is socially desirable to do so), or where the government is better placed than other parties to manage risks it finds necessary to take.

    • Economic actors that influence the government’s fiscal risk exposure could pay a charge for their reduced risk exposure, or bear at least some risk at the margin.

    • There may be policy justification for imposing ex ante controls on the risk-taking activities of economic actors that have weak incentives or impose costs on others through their actions (for example, limits on borrowing or on the issuance of guarantees by subnational governments, to minimize the macro/fiscal risk involved in their potential bailout).

    • When a risk materializes and the central government intervenes to absorb costs incurred by other entities, this should be done in a way that preserves or strengthens incentives for future risk management.

    • Guarantee proposals should be subject to scrutiny and appropriately designed prioritization, to balance insurance and incentive considerations. This could be attained, for example, through guarantee fees; partial guarantees; quantitative ceilings; termination clauses; or requirements for collateral.

  • There should be a clear legal and administrative framework to regulate overall fiscal management and the government’s exposure to fiscal risks.

    Effective management of fiscal risks that remain after mitigation efforts hinges on a clear allocation of roles and responsibilities—notably between the central government and the rest of the public sector (including subnational governments)—with respect to the collection, investment, commitment, and use of public funds. 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, taking into account possible interactions among different sources of risk. To ensure that fiscal risk management is an integral part of overall fiscal management, such a unit could be within the ministry of finance. At the same time, it may be desirable (subject to capacity constraints) for line ministries and agencies to have some clearly specified responsibilities for prudently managing fiscal risks to which they are exposed.

    Relationships among different levels of government

    • The entity with primary interest in managing the fiscal position (typically the ministry of finance) should be responsible for overall monitoring and management of fiscal risks and have the necessary authority to do so.

    • Fiscal risk responsibilities of different levels of government, and the relationships among them, should be clearly specified. In particular, the legal framework should be clear as to who may authorize borrowing, investment, and issuance of contingent obligations.

    • There should be a centralized technical capability for analysis and advice to government, and for technical support to line ministries and other public sector entities, on specific aspects of fiscal risk management (e.g., on PPPs, and in a PPP unit).

    • The government should fully and timely compensate public enterprises, the central bank, and public financial institutions, from the central government budget, for noncommercial obligations it requires them to undertake.

    Risk management

    • To the extent that departments/agencies are allowed to take on risks, each department/agency head should be responsible for the prudent management of such entity’s fiscal risks, and should be required to have a risk management strategy in place.

    • An assessment of fiscal risks should be conducted before the government enters into contractual arrangements with public or private entities, including resource companies and operators of government concessions. Such arrangements should be: clear about the apportionment of fiscal risk; appropriately reflected in government accounts; and publicly accessible, to the extent possible.

    • The responsibility for taking on risks should be separate from the responsibility for estimating their potential fiscal costs: for example, line ministries responsible for issuing guarantees should not be tasked with assessing the expected cost of such guarantees without outside supervision; guidelines should be in place on how to “price” risks.

    • It is desirable to subject fiscal activities that create risk (including those undertaken off-budget) to internal audit as well as audit by the supreme auditing institution.

  • Fiscal risks should be systematically incorporated into fiscal analysis and the budget process.

    When determining fiscal targets, allowance needs to be made for the possibility that some risks will materialize. In the case of government guarantees and other contingent liabilities, a close integration of fiscal risk management and budget process calls for incorporating decisions over such liabilities to be into the annual budget cycle, and for analyzing the fiscal sustainability implications of the medium- or long-term nature of many contingent liabilities.

    Incorporating risk analysis into the macroeconomic policy framework

    • The government’s exposure to fiscal risks should be incorporated into fiscal sustainability analysis.

    • The government should have in place a fiscal policy strategy for unexpected changes in revenues or expenditures. For example, in situations of high revenue volatility, mechanisms (e.g., binding expenditure ceilings) should be in place to ensure that temporary revenue increases do not automatically result in excessive spending.

    • The general risk of uncertain expenditures in the budget year may be handled through a limited annual centralized contingency appropriation, whose magnitude reflects country-specific circumstances (e.g., the frequency and cost of natural disasters). This may provide adequate flexibility to manage risks that materialize during budget implementation, while preserving the integrity of the original budget.

    Guarantees and contingent obligations

    • Decisions over issuance of guarantees and other contingent obligations should be integrated with the annual budget cycle so that proposals are considered alongside competing instruments and programs intended to achieve similar objectives.

    • A framework should be in place to require parliamentary approval of guarantees to be issued, whether through an overall ceiling on guarantees, a ceiling on broad categories of guarantees, or approval of individual guarantees.

    • An annual budget appropriation could be included to cover expected calls on guarantees in the fiscal year, either in a general contingency appropriation or, where the likely costs are significant and can be estimated, in separate appropriations for anticipated calls on individual guarantee programs (e.g., a housing loan guarantee program).

APPENDIX 1: Possible Structure of Statement of Fiscal Risks

This appendix provides a possible structure of a statement of fiscal risks (Box A1), to be adapted depending on country characteristics—such as the relative importance of different types of shocks, institutional arrangements (e.g., the central government’s implicit or explicit responsibilities in the event of financial difficulties experienced by subnational governments), and the level of disclosure of long-term risks. The statement would typically begin with the government’s description of how its overall fiscal strategy has reduced fiscal risks, and an indication of the importance of greater fiscal transparency for the reliability and credibility of fiscal policy.

The statement could address sources of fiscal risks including (a) macroeconomic risks and budget sensitivity; (b) public debt composition; (c) contingent central government expenditures; (d) public-private partnerships; (e) state-owned enterprises; and (f) subnational governments. Further possible topics include future pension liabilities in the event these are not covered in a separate statement of long-term risks. For each source of risk, forward-looking expected cost estimates would be complemented by quantitative information on costs incurred as a result of past shocks.

The statement of fiscal risks itself should be considered a work in progress, where risk coverage would be extended and quantitative estimates improved each year. For example, on macroeconomic risks, a first issue of the statement could include a sensitivity analysis to individual parameter changes, but in subsequent years a full-fledged analysis of alternative macroeconomic scenarios (where various shocks interact) would be appropriate and helpful. Similarly, with regard to contingent expenditures, coverage could initially focus on the largest contingencies, but could gradually be extended to all government guarantees and guarantee-like instruments. Moreover, quantification could be gradually improved, where feasible, by moving from gross exposure to the expected present value of expenditures.

Box A1.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. In conducting these exercises, it is desirable to take into account the correlations among different shocks.

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: projected statement of inflows, outflows, and balances; disposition of loan repayments and nonperforming loans.

Contingent Central Government Expenditure

Contingent Liabilities: 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 guarantees.

Banking sector: Deposit insurance scheme and—to the extent that the authorities feel this does not generate moral hazard—risks from the banking sector. Information on costs of past bailouts/recapitalizations/preemptive financial support.

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; infrastructure needs; public investment program; policy framework and rationale for PPPs.

Cumulative overall exposure from government’s current announced PPP program. Features of some signed 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.

Table AI.Statements of Fiscal Risks (FR) and Contingent Liabilities (CL), Selected Countries
AustraliaBrazilChileColombiaIndonesiaNew ZealandPakistan
Legal framework for FR reportingThe Charter of Budget Honesty Act 1998 requires fiscal risks be disclosed in a Statement of Risks in each budget and Midyear Economic and Fiscal Outlook.The Fiscal Responsibility Law (FRL) established that the annual budget directives law should include an annex with estimates of fiscal risks and contingent liabilities.The FRL requires the government to report annually on the amount and characteristics of government liabilities that arise from the extension of “fiscal guarantees.”The budget document justifies the need for disclosure of fiscal risks to enhance fiscal transparency and sustainability.The Public Finance Act 1989 requires disclosure of all government decisions and other circumstances that may put pressure on the forecast spending amounts, and/or have a material effect on the fiscal and economic outlook.The FRL states that some discussion of fiscal risks should be included in the Medium-Term Budget Framework of the Annual Budget, but this is yet to occur.
Type of documentStatement of the Annual Budget.Annex of the Annual Budget Directives Law.Report on Contingent Liabilities and Chapter of Annual Report on Government Finances.Chapter of the Medium-Term Fiscal Framework.Financial Notes to the Budget Document.Chapters of the Annual Budget Economic and Fiscal Update Document.Annex of the Annual Economic Survey.
Definition of FRChanges in economic and other parameters; matters not included in the fiscal forecasts because of uncertainty about their timing, magnitude and/or likelihood; and the realization of contingent liabilities.Risks that revenue and expenditure projected at the time of budget preparatio are not confirmed during budget execution, debt service and financing needs might be higher than projected due to the Impact of changes in interest rates, exchange rates, and inflation on maturing debt, and contingent liabilities might materialize.Government decisions and other circumstances that may put pressure on the forecast spending amounts, and/or have a material effect on the fiscal and economic outlook.
Definition of CLPossible costs to the government arising from past events that the outcome of future events not within the control of the government will confirm, including loan and nonloan guarantees, warranties, indemnities, uncalled capital, and letters of comfort.Classified according to the nature of their underlying factors, namely: (i) legal claims against the Union and against SOEs that are included in the annual budget; (ii) legal claims relating to government administration; (iii) debt in process of being recognized by the Union; (iv) operations involving endorsements and guarantees granted by the Union; and (v) legal claims against the central bank arising from out-of-court liquidation of financial institutions.Certain liabilities that the nation may have to honor at some time in the future because of their implicit or contingent nature.Costs that the Crown will have to face if a particular event occurs. Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and un-capital.Obligations triggered by a discrete but uncertain event. Explicit contingent liabilities are specific government obligations defined by a contract or a law (the government is legally mandated to settle such an obligation when it becomes due). Implicit contingent liabilities represent a moral obligation or expected burden for the government based on public expectations and political pressures.
Minimum criteria for FR and CL reportingContingent liabilities and other fiscal risks with a possible impact on the forward estimates greater than AS $20 million in any one year, or AS $40 million over the forwan estimates period, are listed in this statement.Reasonable certainty (risks not included in fiscal forecasts because they reflect decisions or commitments with uncertain fiscal consequences or timing), materiality (impact on fiscal forecasts of NZ$10 million or more), and active consideration (policies considered by government or decisions that have been deferred).
Contingent fundsClaims of the Union that depend on judicial decision, such as debt receivables of the National Treasury or National Social Security Institute, and financial assets of the Union (i.e., loan operations originating from rural credit transferred to the Union).Pension fund: helps pay for minimum pension guarantee. Guarantee fund for small businesses: guarantees a share of bank loans to small businesses. Fuel price stabilization fund for gasoline, diesel, and kerosene.Contingency Disaster Fund and Guarantee Fund for Infrastructure.
Economic Risks: - alternative scenariosFiscal implications of two possible growth paths for the economy when key assumptions underlying the central forecast are altered.
- sensitivity analysisSensitivity of revenu nue and expenditure to changes in real GDP growth, inflation, exchange rate, nominal interest rate, and min imum wage. Sensitivity of the federal public debt to fluctuations in interest rate, exchange rate, and inflation.Sensitivity of revenue and expenditure to changes in economic growth, inflation rate, 3-month interest rate, exchange rate, crude oil price, and oil production.Sensitivity of the operating balance and sovereign-issued debt to changes in nominal GDP growth and interest rates.
AustraliaBrazilChileColombiaIndonesiaNew ZealandPakistan
Specific risks:
- pension schemes
- banking system
- regional funds
- debt guarantees
- nondebt guarantees V
- legal disputes
- uncalled capital
- central bank quasifiscal deficit
- natural disasters
Sources: Statement of Fiscal Risks, 2006/07 Budget (Australia); Fiscal Risks Annex of the 2007 Budget Directives Law (Brazil); Contingent Liabilities Chapter of the 2007 Report on Government Finances and Report on Contingent Liabilities, November 2007 (Chile); Implicit and Contingent Debts Chapter of the 2006 Medium-Term Fiscal Framework (Colombia); Financial Notes to the 2008 Budget Document (Indonesia); Fiscal Scenarios and Sensitivities, and Specific Fiscal Risks Chapters of the 2006 Budget Economic and Fiscal Update Document (New Zealand); and Statement of Contingent Liabilities Annex of the 2005/06 Economic Survey (Pakistan).
Sources: Statement of Fiscal Risks, 2006/07 Budget (Australia); Fiscal Risks Annex of the 2007 Budget Directives Law (Brazil); Contingent Liabilities Chapter of the 2007 Report on Government Finances and Report on Contingent Liabilities, November 2007 (Chile); Implicit and Contingent Debts Chapter of the 2006 Medium-Term Fiscal Framework (Colombia); Financial Notes to the 2008 Budget Document (Indonesia); Fiscal Scenarios and Sensitivities, and Specific Fiscal Risks Chapters of the 2006 Budget Economic and Fiscal Update Document (New Zealand); and Statement of Contingent Liabilities Annex of the 2005/06 Economic Survey (Pakistan).
APPENDIX 2: New Zealand’s Approach to Fiscal Risk Disclosure and Management

A series of reforms has forged New Zealand’s approach to fiscal risk disclosure and management. The public financial management reforms of the 1980s created a legal framework that assigns clear accountability for the different dimensions of fiscal risk disclosure and management. With the introduction of accrual accounting in the Public Finance Act (PFA) of 1989 and the adoption in 1993 of Generally Accepted Accounting Practice (GAAP) for budgeting and reporting, the coverage of fiscal statistics was broadened to include all assets and liabilities, including contingent liabilities. The emphasis on transparency in the conduct of government affairs culminated with the introduction of the Fiscal Responsibility Act (FRA) of 1994 and its subsequent incorporation (with some extensions) in the PFA. These acts require the government to reduce the debt to prudent levels by running operating surpluses, and then maintain the debt at prudent levels; pursue policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years; and prudently manage the fiscal risks facing the state.

The legislation requires that budget documents include both a statement showing the sensitivity of fiscal aggregates to changes in economic conditions and a statement of specific fiscal risks. The statement of specific fiscal risks contains both policy risks and explicit contingent liabilities that may have a material effect on the fiscal and economic outlook. All information must be disclosed, unless disclosure is likely to prejudice the substantial interests of the country, compromise the government in a material way in negotiation, litigation, or commercial activity, or result in material loss of value to the government. In practice, these exclusions are mainly applied to policy risks, rather than to existing legal obligations. The notes to the financial statements discuss key risk management strategies across the government and SOEs, and provide data on concentrations of credit risk, foreign exchange risk, refinancing risk, use of derivatives, and fair value of financial instruments.

Legal provisions designed to limit the government’s fiscal risk exposure include the following: (i) only the minister of finance can authorize the Crown to borrow and enter into swaps or other financial arrangements; (ii) the minister of finance is allowed to issue government guarantees or indemnities only in the public interest; (iii) departments are forbidden to borrow (except from the Crown) and have limited authority to engage in derivative transactions (which are subject to Treasury oversight); (iv) the government’s financial asset portfolios must be invested on a prudent commercial basis; (v) subnational levels of government are also subject to high transparency and accountability standards; (vi) SOEs are required to act commercially, pay dividends on a basis comparable to private sector competitors, and negotiate an explicit full cost-recovery contract if the government wishes them to engage in noncommercial activities; (vii) the government’s financial statements fully consolidate SOEs, with separate segment reporting; and (viii) a Crown entity provides compulsory earthquake insurance for homeowners, with a maximum coverage ceiling per dwelling.

Other key features of New Zealand’s fiscal risk disclosure and management framework include:

  • official macroeconomic forecasts underlying the budget are reviewed before finalization by an external panel of experts and full alternative macroeconomic scenarios are included in the budget documents;

  • the budget includes a full set of independent tax forecasts by the Inland Revenue Department (IRD), with a discussion of the reasons for any differences between the IRD and official (treasury) forecasts;

  • fiscal forecasts in the annual budget include indicative amounts for new operating and capital initiatives in the second and third years, which are linked to the specific fiscal risks disclosed in the budget;

  • within-year spending pressures are accommodated by (i) sectoral/departmental contingency appropriations (to meet likely and known cost pressures whose amounts are still subject to uncertainty at the time the budget is being finalized), or (ii) a general contingency (of NZ$200 million, equivalent to 0.4 percent of expenditures, in the last few years) that is not appropriated at the time of the budget and functions more as a monitoring mechanism than a firm cap (the Treasury prepares monthly progress reports on decisions against this sum, and required funds are then appropriated in the May supplementary estimates);

  • contingent liabilities are managed by the relevant department and monitored by the treasury; policy initiatives that involve contingent liabilities are subject to scrutiny;

  • the treasury operates a centralized system for monitoring and reporting on fiscal risks, called “Inspect a Risk,” which gathers information from discussions with departments and Crown entities, the register of contingent liabilities maintained by departments, and minutes of meetings of cabinet and cabinet committees; “Inspect a Risk” is then used by the fiscal reporting division of the treasury to generate the Statement of Specific Risks;

  • the government has established a number of financial asset portfolios to match the risk characteristics of specific liabilities, such as a fund managed by the earthquake commission;

  • SOEs report directly to shareholding ministers each quarter, and the performance of SOEs is monitored by the treasury, which provides ministers with a quarterly report on SOE performance; SOEs borrow without government guarantee (with one, historical, exception);

  • the debt management office, a unit within the treasury, has responsibility for aggregating information on assets and liabilities across the government, and for managing risks to the government’s overall balance sheet;

  • external audit of information on fiscal risks is conducted by parliament’s office of the comptroller and auditor general, which has published reports on specific areas of fiscal risk in recent years (e.g., the use of derivatives and the performance of the debt management office).

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