Journal Issue

CHAPTER 3: Fiscal Risk Disclosure and Management: International Experience

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 analyzes the international experience with respect to fiscal risk disclosure and management. In the area of disclosure, the section reviews international standards and transparency initiatives that have fostered fiscal risk reporting, and then presents country experiences with respect to types of risks disclosed and reporting requirements and documentation.

Fiscal Risk Disclosure

Public disclosure of information on fiscal risks can help to manage risks, improve economic efficiency, and reduce borrowing costs. Making information on fiscal risks publicly available subjects the analysis to additional scrutiny, helping to ensure that risks are properly assessed and recognized. Transparency also promotes earlier and smoother policy responses; strengthens accountability for risk management; and improves the quality of decisions on whether the government should take on risks in the first place. Even when contingent expenditures imply low risks from a macroeconomic standpoint—because they are small or uncorrelated with each other—disclosure leads to more careful assessment of cost-effectiveness and inspection for implicit subsidies. Consistent with these benefits, cross-country evidence shown in Box 2 suggests that fiscal transparency is associated with better sovereign bond ratings and greater access to international capital markets (see also Glennerster and Shin, 2008; and Hameed, 2005).16 Moreover, fiscal transparency has been found to foster FDI (Drabek and Payne, 2002).

There is a trend toward greater disclosure of information on fiscal risks. This has been driven by international accounting or statistical standards requiring disclosure of certain risks; the adoption of fiscal responsibility and/or public financial management legislation that enhances disclosure relative to those standards; and recent transparency initiatives, such as the IMF Code and Manual of Good Practices on Fiscal Transparency (2001, 2007) and the OECD Best Practices for Budget Transparency (2001).

Box 2.Fiscal Risk Transparency and Credit Ratings

Research by the IMF’s Fiscal Affairs Department shows that fiscal transparency (and, in particular, fiscal risk disclosure) is associated with better sovereign bond ratings and greater access to international capital markets. Although fiscal transparency might proxy for other aspects of institutional quality, it may also be part of a package of mutually reinforcing reforms with clear benefits in terms of market access and lower borrowing costs.

Fiscal transparency indicators were developed from the fiscal transparency module of the Reports on Standards and Codes (“fiscal ROSCs”). “Overall fiscal transparency” is based on 20 attributes of good fiscal transparency practices; a narrower measure (“fiscal risk disclosure”) is based on a subset of four aspects of disclosure in budget documentation for contingent liabilities, quasi-fiscal activities, and other fiscal risks. Cross-country regressions show that these fiscal transparency variables are positively related to sovereign ratings, controlling for per capita income, inflation, default history, and political stability. The estimated coefficients are statistically and economically significant. The figure below illustrates the independent association of fiscal risk disclosure with ratings, after stripping away the effect of the above-mentioned controls from both variables. The estimated coefficient suggests that countries moving from no disclosure of macro-fiscal risks, contingent liabilities, or quasi-fiscal activities to providing some information on all these counts would improve their credit ratings, on average, by a full notch (e.g., from Baa1 to A3 on Moody’s ratings).

Fiscal Risk Disclosure and Sovereign Credit Ratings

(Scatter plot of orthogonal components)

Note: The sample consists of 56 countries, surveyed at different points during 1999—2007. The scatter plot reports the orthogonal components of sovereign bond ratings and fiscal risk disclosure to per capita income, GDP growth, inflation, fiscal balance, current account balance, external debt, default history, and political stability.

An alternative approach, based on a cross section of 62 emerging market/developing countries (of which only 24 have market access, that is, issue bonds internationally), explores the relationship of fiscal transparency to market access and then, given market access, to sovereign bond spreads, in a two-stage system. Greater transparency is found to be positively and significantly associated with market access, controlling for other factors such as trade openness and country size; the null hypothesis of no direct relationship between transparency and bond spreads cannot be rejected, however, likely because of the small number of countries for which spreads exist.

Note: This box was prepared by E. Cabezon, B. Gracia, A. Ivanova, and J. Shields.

International standards and transparency initiatives

Requirements to disclose certain fiscal risks are part of internationally accepted accounting and statistical standards (Box 3). The International Public Sector Accounting Standards (IPSAS) for accrual accounting require disclosure in notes to financial statements of contractual contingent liabilities when the possibility of payment is “not remote.”17 Under cash accounting, which remains widespread, disclosure similar to that under accrual standards is recommended, though not required. In addition, disclosure of key contingent liabilities is required as a memorandum item to the balance sheet under statistical reporting standards, such as the Government Finance Statistics Manual 2001. An international task force under the aegis of the OECD is studying the feasibility of harmonizing the different international government accounting and statistical standards.

Further risk disclosure recommendations are included in various fiscal transparency initiatives. The IMF Code and Manual and the OECD Best Practices stress that budget documentation, mid year reports of budget execution, and end-year financial statements should indicate the major risks, and should include statements indicating contingent liabilities’ nature and policy purpose, duration, and intended beneficiaries; the guarantee fees received; the government’s gross exposure and, where feasible, an estimate of the potential budgetary cost (net of possible loss recovery).

Country experiences

Risks associated with macroeconomic shocks are disclosed by many countries. All EU countries, most OECD members, and some emerging market economies (e.g., Brazil, Chile, and Indonesia) disclose risks associated with macroeconomic assumptions such as growth, inflation, interest rates, exchange rates, and international oil prices—through sensitivity analyses, alternative macroeconomic scenarios, or stress tests for fiscal aggregates. Uncertainty surrounding baseline projections is sometimes illustrated through a fan chart (e.g., the United States’ Budget and Economic Outlook).

Box 3.Disclosure of Contingent Liabilities: International Accounting and Statistical Standards

Accounting Standards (IPSAS). Under accrual accounting, contingent liabilities (in the accounting sense of possible payments linked to events that are less than likely to occur) are not recognized as liabilities and expenses in government accounts. However, for each class of contingent liability the government is required to disclose in notes to financial statements (except when the possibility of any payment is remote) a description of the nature of the contingent liability and, where practicable: (i) an estimate of the financial effect, e.g., the present value of any payments; (ii) an indication of the uncertainties about amounts or timing; and (iii) possible reimbursement. On the other hand, if the probability that payments would have to be made is more than 50 percent, and the payments can be reliably estimated, then the government is required to recognize in its accounts a liability (referred to as provision) and a corresponding expense. Disclosure requirements include: (i) stocks at the beginning and end of the period; (ii) breakdown of the flows during the period; (iii) description of the nature of the obligation and the timing of payments; (iv) indication of uncertainties regarding amount and timing; and (v) the amount of any reimbursement.1 Under cash accounting, standards allow, but do not require, disclosure of information about contingent liabilities along the lines set out above.

Statistical Reporting Standards (GFSM2001). A contingent liability is recognized as a liability only when the contingency materializes and the payment is due, primarily to ensure a consistent set of national accounts with no overlap between liabilities recorded in the public and private sector balance sheets. However, statistical standards require disclosing all contingent liabilities as a memorandum item to the balance sheet, including a description of the nature of the various contingencies and the present value of expected government payments or other indication of their value.2

Note: Draws on International Financial Reporting Standards, 2003, International Accounting Standards Board (IASB).1 Exemptions from disclosure requirements are allowed when disclosure may prejudice the government’s position in a dispute with other parties. In such cases, the general nature of the dispute and the reason for nondisclosure should be reported.2 The IASB is considering changes to the treatment of contingent liabilities: the term “contingent liability” may no longer be used and provisions may have to be made for all items currently treated as “contingent liabilities;” the uncertainty about whether a payment is required would cease to be a recognition criterion and, instead, would be reflected in the measurement of the liability.

Information on some contingent liabilities—loan guarantees in particular—is also frequently disclosed, though the extent of disclosure varies. Countries disclosing such information include most advanced economies, the majority of EU acceding states, a third of the remaining emerging and transition economies, and a handful of developing countries.18 Reported information usually consists of total exposure measured by the guarantees’ face value (Brazil, the Czech Republic, Honduras, Jordan, Mexico, and Tanzania), complemented in some cases by the expected cost of outstanding guarantees (Colombia and Chile), guarantees that are likely to be called (Hungary), the flow of new guarantees (Japan), calls on guarantees (South Africa), or revenues from guarantee premiums (Netherlands).

Disclosure is less frequent for types of risk that have become sizable more recently or for which quantification is more difficult. Fiscal risks due to PPPs are disclosed by a growing but still limited number of countries (Colombia, Chile, Indonesia, Japan, Peru, South Africa, and the United Kingdom). The information usually consists of a description of the government guarantees granted under PPP contracts, the projects’ total value, and expected cash flow payments or their net present value (Budina and others, 2007; Irwin, 2007). For risks that are especially difficult to quantify (e.g., legal claims against the state), information on the nature and scope of such “unquantifiable” risks is provided by only a few countries (Australia, Indonesia, and New Zealand). Prospective amounts related to legal claims are seldom disclosed, though Brazil and New Zealand sometimes report the gross amount together with a disclaimer that this does not represent an acknowledgement of the government’s liability. A few selected “policy risks” associated with government policy changes under consideration are disclosed by New Zealand, whereas other countries’ disclosure practices take all government policies as given.

Disclosed amounts for explicit contingent liabilities are assessed using a variety of approaches. Although most governments disclose only gross exposures, a few also report expected cost estimates. Information on guaranteed amounts and the probability that guarantees will be called is analyzed and presented in different ways, including stochastic simulations or option pricing models (Chile, Colombia, Peru, and Sweden). Risks from contingent liabilities are sometimes assessed using a risk ratings approach.19

Disclosure varies considerably across countries in the areas of state-owned enterprises, subnational governments, and off-budget accounts. These often represent significant fiscal risks both to the budget of the central government, which might be called upon in the event of difficulties, and to the sustainability of the public sector more generally—thus highlighting the importance of broader coverage of the fiscal accounts to reduce fiscal risks. Several countries publish general government accounts or comprehensive public sector accounts, and two-thirds of the sampled countries publish significant information in these areas. Nevertheless, gaps in coverage remain in many countries.

Few countries follow well-defined rules in choosing what fiscal risks should not be disclosed. Australia and New Zealand have translated the principle of materiality into specific cut-off points for disclosing individual contingent liabilities, with values below a certain threshold not requiring separate disclosure.20 New Zealand exempts from disclosure information that is likely to prejudice substantial economic interests of the country; harm the security or defence of the country or the international relationships of its government; compromise the government in a material way in negotiation, litigation, or commercial activity; or result in material loss of value to the government.

Several countries have adopted laws that require risk reporting. Beyond accounting standards, some countries have introduced risk reporting requirements in their fiscal responsibility laws or legislation covering public financial management. These often call for disclosure of government contingent liabilities (Canada, Chile, Colombia, the Czech Republic, France, and Peru); in some cases, they also entail comprehensive reporting of all risks that could affect the fiscal outlook. Beyond contingent liabilities, these also include sensitivity to economic conditions, and long-term risks associated with demographic changes (Australia, Brazil, New Zealand, and the United Kingdom).21

A few countries have consolidated information on fiscal risks in a single annual document. Seven advanced and emerging market economies currently report information on fiscal risks in a single document, which often also discusses efforts to manage fiscal risks through contingency reserves or guarantee funds. (Appendix Table A1 provides the list of countries and a description of disclosed risks.) Risks covered include explicit government guarantees; contingent liabilities from litigation; guarantees to infrastructure operators; the quasi-fiscal deficit of the central bank; natural disasters; and the fiscal outlook’s sensitivity to macroeconomic shocks. Some countries also discuss SOE performance and emphasize the need to monitor related implicit contingent liabilities.

Countries have gradually increased the coverage of risks disclosed. While fiscal risk statements may initially have focused on a limited set of risks, the range of disclosed items has subsequently been expanded, reflecting better information and improved ability to estimate risks. Colombia, for example, gradually extended the coverage of contingent liability estimates from the central government to other parts of the public sector. In Chile, the government phased in the types of contingent liabilities disclosed—first reporting on minimum revenue guarantees under PPPs and minimum pension guarantees, later including loan guarantees to public enterprises, and finally adding information on student loan guarantees and lawsuits against the state. In Indonesia, the 2009 fiscal risk statement is expected to deepen the assessment of the public enterprise sector.

Fiscal Risk Management

Turning to fiscal risk management, this section considers whether countries (a) mitigate fiscal risks in a cost-effective manner; (b) have in place a legal, regulatory, and administrative framework facilitating effective fiscal risk management; and (c) integrate fiscal risk management into fiscal analysis and the budget process.

Mitigation of fiscal risks

Are fiscal risks mitigated in a cost-effective manner? Risk mitigation starts with sound macroeconomic policies and appropriate debt management strategies. Beyond this, a clear policy framework helps to assess whether proposals to take on new risks are justified (e.g., in terms of market failure). Mitigation of fiscal risks should be guided by an assessment of which economic agents have the best ability and incentives to manage risk and who is best placed to bear risk. Further measures include modifying activities to reduce risks; transferring risks to, or sharing them with, other parties. Decisions on whether mitigation is needed also hinge on the extent to which various risks are correlated or mutually offsetting.

Country experiences

Fiscal risk management is embedded within countries’ efforts to undertake sound macroeconomic policies. Sound policies such as fiscal deficit/debt reduction and structural reforms—including privatization and public financial management reforms—play a key role in reducing fiscal risks. One area traditionally seen as key to fiscal risk mitigation is public debt management.22 Many countries have a debt management strategy in place, though the extent to which it is made explicit varies. Several countries have adopted a formal debt management strategy (Armenia, Egypt, Hungary, Indonesia, Italy, Japan, and Mexico), and some countries employ explicit targets for debt duration, the maturity profile of debt service, and the shares of floating-rate debt and foreign currency denominated debt (South Africa). Debt management techniques—such as swap instruments used to reduce exposure to foreign exchange or interest rate risks—are also fairly common, especially in countries that are highly integrated in global financial markets.

In several countries, risk mitigation has been pursued by requiring the private sector to bear a share of the risk from contingent liabilities.23 Risk sharing has been achieved, for example, by providing only partial guarantees, which increase private sector lenders’ incentives to assess the creditworthiness of projects and borrowers (e.g., Canada and EU countries, where private sector lenders bear 15—20 percent of the net loss associated with any default). Other risk-sharing arrangements include time limits for contingent claims; clauses allowing the government to terminate the arrangement when it is no longer needed; and requirements for beneficiaries to post collateral (Australia).

Risk allocation usually aims at having risks be borne by the economic agent best placed to manage them. Notably, in PPPs, most governments transfer project-specific risks (such as construction, operating, and design/technical risks) to the private sector, while accepting some economy-wide risks (such as force majeure, regulatory, and political risks). For risks where neither the public nor private partner has an obvious advantage, approaches have varied.24

Few countries make use of financial hedging or insurance instruments to mitigate the potential impact of shocks on their fiscal accounts. Most countries have been reluctant to engage in hedging operations, perhaps because of accountability implications, cost considerations, or an emphasis on self-insurance (Borensztein and others, 2004; and Becker and others, 2007). Nevertheless, some commodity producers use financial instruments to hedge against commodity price fluctuations (e.g., Mexico for oil price shocks), and a few sovereigns have recently issued catastrophe bonds (e.g., Mexico’s earthquake bond in 2006).25 As markets for such instruments develop further, they may gain prominence in countries’ risk mitigation efforts.

Legal and administrative framework

Do countries have in place a clear legal and administrative framework to guide fiscal management and the government’s exposure to fiscal risks? In particular, effective risk management is facilitated by a clear allocation of roles and responsibilities—notably between the central government and the rest of the public sector—with respect to the collection, investment, and use of public funds. Fiscal risk management may be facilitated by a single government unit with the necessary authority and accountability for monitoring and coordinating the management of the overall level of fiscal risk; this helps take into account possible interactions among different sources of risk. To ensure that fiscal risk management is an integral part of overall fiscal management, such unit could be within the ministry of finance. At the same time, depending on their capacity, it may be desirable for line ministries, departments, and agencies to have some responsibility for managing those fiscal risks to which they are exposed.

Country experiences

While a special institutional unit is responsible for the overall management of most fiscal risks in few of the sampled countries, dedicated government units are responsible for managing specific fiscal risks in several countries. The monitoring of most fiscal risks is concentrated in a single central unit in South Africa. A recently established risk management unit analyzes most fiscal risks in Indonesia (a separate unit is responsible for debt management). Specialized units for debt management exist in many countries at all levels of development. Over the past few years, several countries have also extended the scope of their debt management offices to monitor and manage risks from contingent liabilities (Currie, 2002). In addition, some countries have established specialized units for SOEs; subnational governments; PPPs; and risks from legal claims against the state (Table 2).

Table 2.Role of Specific Risk Management Unit, Line Ministries, and Supreme Auditing Institution—Selected Country Experiences
Specific Risk Management UnitLine MinistriesSupreme Auditing Institution (SAI)
For many fiscal risks

South Africa: National Treasury’s asset and liability management division monitors and manages risks associated with government debt and contingent liabilities.

Indonesia: recently established risk management unit within the ministry of finance analyzes fiscal risks of SOEs, government support to infrastructure projects, and global economic risks; separate units are responsible for debt management and subnational governments.

For specific fiscal risks

Debt management: many countries; moreover, some debt management offices have extended their scope to monitor and manage risks from contingent liabilities (Canada, Czech Republic, Colombia, Denmark, New Zealand, and Sweden).

PPPs: Czech Republic, Egypt, Honduras, Hungary; and Mexico (in context of broader investment unit).

SOEs: Brazil, Kenya.

Subnational governments: Indonesia, Peru.

Risks from legal claims against the state: Ghana.

Pensions/Social Security: many countries.
Netherlands: budget management is delegated to financial affairs directorates in the line ministries; each ministry has its own financial management system, but has to comply with its budget allocation and the overall expenditure ceilings.

South Africa: departments and public entities are responsible for risk management; internal control (including issuance of guarantees, with the concurrence of the Minister of Finance, and maintenance of a register of contingent liabilities) for a given unit is assigned to its accounting officer.

France: recent budgetary reforms have decentralized fiscal management and strengthened the role of program managers in internal control and risk management.

New Zealand: departmental chief executives are responsible for financial management and financial performance of their departments, including risk management; each department maintains a register of contingent liabilities.

Armenia: line ministries are accountable for the prudent management of fiscal risks of entities they established or to which they provide guarantees.

Direct involvement of line ministries in fiscal risk management also applies to: oversight and management of SOEs in Kenya and Hungary, examination of budgets and borrowing plans of major public institutions in japan; and monitoring of large infrastructure projects and PPPs in Saudi Arabia.
The SAI’s involvement in auditing and certifying the government accounts includes aspects of monitoring the accounting and reporting of fiscal risks. In particular, this applies to:

  • Contingent liabilities: Ghana, Russia,
  • SOEs: South Africa, Kenya, Indonesia, Japan, Hungary, Lebanon, Philippines;
  • Subnational governments: South Africa, Kenya, Japan, BIH;
  • Some extra-budgetary funds: Kenya, Indonesia, BIH;
  • Pension and petroleum funds: Norway.

Czech Republic: audit coverage includes all public institutions that receive state guarantees, foreign loans, or money from the budget.

Hungary. State Audit Office assesses credibility of expenditure and revenue estimates and monitors local government financial management.

Philippines: Audit Commission adopts remedial measures where internal control systems of audited agencies are deemed insufficient.

United Kingdom: national audit office audits key assumptions underlying budget projections (at least once every three years).

In a number of countries, the SAI monitors all aspects of the execution of the budget, including fiscal risks (Italy, France).
Sources: Questionnaire replies by IMF staff and country authorities.
Sources: Questionnaire replies by IMF staff and country authorities.

In several countries, line ministries have considerable responsibilities for fiscal risk management, and arrangements are in place to hold them accountable. In these countries (usually with advanced risk monitoring and management practices), line ministries or individual departments are responsible for their own budgets and financial management (including issuance of guarantees, typically with government concurrence and maintenance of a register of contingent liabilities). Direct involvement of line ministries in fiscal risk management includes oversight and management of SOEs; examination of budgets and borrowing plans of major public institutions; supervision of development funds; and monitoring of infrastructure projects and PPPs.

Box 4.Public-Private Partnerships (PPPs) and Fiscal Risks in Selected Countries

Indonesia. PPP proposals are submitted to the recently created PPP unit, which decides whether they meet technical and financial feasibility criteria. The risk management unit of the ministry of finance evaluates costs that may arise from government support to PPPs and helps ensure that this support is transparent. If the request for government support is approved by the minister of finance, an allocation of funds is then proposed in the draft annual budget. A list of PPPs together with government support and gross exposure is presented in the fiscal risk statement.

South Africa. The accounting officer or authority of the public institution involved in the PPP project is responsible for monitoring and managing it. Fiscal costs of existing PPPs are captured in the budget review and the medium-term budget policy statement; a list of existing PPPs, together with government commitments, is published quarterly. The accounting treatment of PPPs is currently under review. New standards are expected to require the recording of contingent liabilities from PPPs on the government’s balance sheet.

Hungary. PPPs are handled by several government institutions: the promoting ministry or agency, an interministerial committee on PPPs, the council of ministers, and (for projects above a certain threshold) parliament. The interministerial committee can propose amendments to existing regulations on PPPs, express its opinion on specific projects, and monitor and evaluate their implementation. The ministry of finance proposes a ceiling on budget commitments associated with PPPs.

Netherlands. Limited experience so far, but likely to gain importance. PPPs are managed by line ministries, though the ministry of finance oversees project implementation. The ministry of finance provides information on Eurostat rules and examines whether (i) the use of a PPP is preferable to traditional public investment forms; (ii) PPP project costs are within the multiyear budget; and (iii) PPP-related expenditures fit in the overall expenditure framework. The current policy is to encourage specialized PPP knowledge centers in line ministries and decentralized development of simple PPP arrangements by municipalities.

The degree of centralization in risk management of PPPs, SOEs, and subnational governments reflects various factors. Decentralization to line ministries seems to be associated with a higher degree of institutional development, whereas decentralization to subnational governments reflects primarily historical and political factors. Country examples for PPPs and subnational governments are provided in Boxes 4 and 5, respectively.

In some countries, the supreme auditing institution (SAI) plays an important role in ex post monitoring of activities that create fiscal risks. This mostly involves auditing and certifying the government accounts, and includes monitoring the accounting and accurate reporting of activities that create fiscal risks. The SAI’s coverage depends on whether audited government accounts also cover contingent liabilities, SOEs, subnational governments, extrabudgetary funds, and public financial institutions. For example, in New Zealand, the Office of Controller and Auditor-General (OAG) audits the government’s financial statements, including statements of contingent liabilities. In addition, the OAG has initiated audits of specific risks, such as foreign exchange risks incurred by SOEs, the central government’s use of derivatives, and the effectiveness of the debt management office.

Box 5.Controlling Fiscal Risks from Subnational Levels of Government

In several sampled countries, the central government seeks to reduce fiscal risks from subnational governments through rules on their borrowing operations. For instance, local governments are not allowed to borrow, or are required to maintain low debt levels, in Armenia, Egypt, Ghana, Jordan, Lebanon, and Saudi Arabia. Local governments’ borrowing is subject to ceilings in Hungary and Japan and is only allowed for investment purposes in the Netherlands and France. Limits on subnational government borrowing are common in other advanced countries.

In case of default or noncompliance with rules, legislation in the countries considered permits the following actions:

  • Withholding of transfers. The central government can withhold transfers to subnational levels of government if these fail to meet debt service obligations (Bosnia and Herzegovina, Indonesia, and Russia). In Peru, noncompliance with fiscal rules would preclude regional and local governments from accessing the three main equalization funds available.
  • Further borrowing restrictions. Local governments might not be allowed to borrow if they breach debt ceilings, and bond issuance would be limited for local governments whose fiscal deficits are considered too high (Japan).
  • Asset liquidation. The minister of finance can order the liquidation of assets belonging to local authorities in default (Tanzania).
  • Restructuring plans. Local governments might be required to develop plans for restructuring and improving their finances to ensure that they can service their debt obligations (Indonesia and Japan).
  • Direct control by the center. In Russia, when local governments are in default, or their indebtedness exceeds 30 percent of revenues, a temporary financial administration (at the central level) may be set up to manage their operations. In Peru, the President can adopt fiscal measures deemed necessary to stabilize subnational governments’ fiscal operations.

Fiscal analysis and budget process

To what extent are fiscal risks systematically incorporated into the budget process and medium-term fiscal analysis? When determining fiscal targets, allowance needs to be made for the possibility that some risks will materialize. Likewise, budgetary mechanisms (such as contingencies appropriations) should provide adequate flexibility to handle risks that arise during budget implementation, while preserving the integrity of the original budget. In the case of government guarantees and other contingent liabilities, close integration of fiscal risk management and the budget process calls for decisions on such liabilities to be incorporated in the annual budget cycle. Moreover, given the medium- or long-term nature of many contingent liabilities, it is important to assess their implications for fiscal sustainability.

Country experiences

Contingency appropriations

Most countries include contingency appropriations for unforeseen spending needs in the budget. In some countries, contingency amounts proposed by the ministry of finance for parliamentary deliberation and inclusion in the budget are subject to ceilings set by law. The size of contingency appropriations is usually small—in the majority of cases, below 3 percent of total expenditure (Table 3).

Table 3.Contingency Reserves/Appropriations: Selected Country Experiences
CountrySize/limitPurpose of contingenciesOther features
ArmeniaMaximum 5 percent of total expenditures.General, mainly natural disasters; support for budget guarantees.A contingency reserve fund is included in the budget. Its use can be authorized by the executive branch.
Bosnia and HerzegovinaMaximum 3 percent (2.5 percent) of projected revenue from the State (Federation and Republic Srpska); equivalent to 3 percent of spending.Revenue shortfalls; international disputes/arbitration; financing new institutions; grants to non-profit organizations; exceptionally, for other purposes.Fixed limits on contingency spending are set by law. Use of the contingency reserve can otherwise be authorized by the executive branch.
Brazil0.5 percent of total expenditures.Guarantees; potential legal liabilities; subsidized loans (mainly agriculture) and liquidation of SOEs.The PPP law envisages creating a fund to cover any contractual guarantees under the rules specified in the law and regulations.
France0.15 percent reserve for wage bill; 5 percent reserve for other appropriations.Wage bill; other appropriations.The reserves are included in the budget to ensure that its execution falls under the ceiling established by the budget law. Fixed limits on contingency spending are set by law.
Honduras2 percent of projected current revenues (about 1.7 percent of total expenditures).Disasters; cofinancing of foreign investment projects; unfunded mandates; bridge loans for public entities to be repaid by fiscal-year end.The budget always includes a contingency fund of 2 percent of projected/budgeted current revenues. Fixed limits on contingency spending are set by law.
Hungary0.5—2 percent of central budget expenditure, for general reserve; 0.9 percent of GDP for both general and equilibrium reserves.General reserve is for unforeseen expenditures or to compensate for planned revenue; equilibrium reserve is to ensure compliance with deficit targets.Equilibrium reserves are included for line ministries and the central budget.
IndonesiaRp 2—3 trillion for natural disasters, Rp 2—4 trillion for infrastructure in 2007 (0.3-0.5 percent of total expenditures).Natural disasters; government support/guarantees related to infrastructure spending.The contingency for infrastructure guarantees is set up in a separate fund.
Japan0.05 percent of total expenditures.Natural disasters; nuclear damage.The budget also includes government guarantees (e.g., for deposit insurance).
Jordan1.8 percent of GDP (4.8 percent of total spending).Subsidies (e.g., fuel and food subsidies, social safety net, and scholarships).Main contingency expenditure item is a separate prog-within MoF budget. Other line ministries also have provisions for subsidies.
Nigeria2—5 percent of total expenditures.General.In addition, three extra-budgetary funds are used for contingency spending (natural disasters, stabilization objectives, and additional capital spending).
Philippines0.7 percent of GDP(3.9 percent of total expenditures).Disasters; support to public corporations or foreign-assisted projects; strategic government reforms; pensions and separation benefits.Includes a number of specialpurpose funds, such as Calamity Fund, Contingent Fund, and Unprogrammed Fund. Use of contingency reserve can be authorized by the executive branch.
RussiaMaximum 3 percent and 1 percent of total spending for general and presidential reserve funds, respectively.Loan guarantees; unforeseen expenditure.Starting with 2008 budget, additional reserve of 5 percent of total expenditure. The 2008—10 budget allows around 0.1 percent of GDP yearly for guarantee calls. Fixed limits on contingency spending are set by law. Use of the contingency reserve can otherwise be authorized by the executive branch.
South Africa0.5—2.5 percent of central budget expenditures.General; the reserve allows for unforeseen and unavoidable expenditure (e.g., natural disasters or programs announced in budget but not yet appropriated).Within the main budget, a contingency reserve is set aside for each of the next three years. In the outer years, the reserve is partly drawn down to fund new priorities.
Note: The size of the contingency reserve refers to the most recent year for which information is available.
Note: The size of the contingency reserve refers to the most recent year for which information is available.

In several countries, spending financed from the contingency appropriation requires parliamentary approval and/or can only be triggered by pre-specified factors. Triggers usually include natural disasters and called guarantees. In some instances, contingencies are triggered by changes in budgetary assumptions (e.g., international fuel prices) or the need to finance new laws passed during budget implementation. As documented in Table 3, country practices in using contingency funds vary regarding the purposes for which the contingency reserve can be spent and the degree of oversight or approval required from parliament.

Government guarantees

Several countries have integrated decisions on guarantees into the budget process. The main objective is to ensure that guarantee costs are internalized, thus reducing the bias in their favor compared to conventional expenditures. In cases where guarantees are not intended as subsidies, several countries charge the recipient a fee reflecting the guarantee’s market cost (Canada and EU countries—see Box 6 for Sweden’s approach to dealing with guarantees). In cases where guarantees are intended to provide a subsidy element, a number of countries charge fees against the budget of the sponsoring line ministry. These fees reflect the expected net present value of the guarantees’ lifetime costs (Canada, the Netherlands, Sweden, and the United States)—thus including a feature akin to “accrual budgeting” for guarantees—or the expected cost of the guarantees during the upcoming budget year (Colombia). Given the difficulties in calculating the expected value of guarantees, some countries charge line ministries “origination fees” equal to a small percentage of the guarantees’ face value.

The issuance of government guarantees is often subject to further constraints. Issuance often requires parliamentary approval (France, Ghana, Japan, Kenya, and Sweden) or is subject to explicit limits (Czech Republic, Japan, the Netherlands, and Russia). While in some countries line ministries (or guarantee agencies) review guarantee applications and report on circumstances providing for payments under the guarantee, issuance often needs to be authorized by parliament (Armenia, Czech Republic, Hungary, and Tanzania), the government, or the ministry of finance (South Africa).

Box 6.Sweden’s Framework for Guarantees

Sweden has a well-developed framework governing the issuance of guarantees and their integration into the budget process, and for minimizing incentives and opportunities to provide subsidies through guarantees.

Approval. A guarantee can only be issued based on a decision by parliament.

Guarantee fees and integration with the budget. A fee must be charged for all guarantees, unless parliament decides otherwise. The fee is set to cover the guarantee’s expected cost and is paid directly to the state by the guarantee’s recipient. If parliament decides that a fee should not be charged (and this is allowed under state aid rules), then budget funds must cover the fee. As a result, a subsidized guarantee is treated in the budget process in a way akin to a direct subsidy. These rules ensure that subsidy elements in guarantees are recorded in the budget, and that the government either gets a payment from the guaranteed firm or, in the case of a subsidized guarantee, that other expenditures are reduced.

Setting guarantee fees. Once the conditions for the guarantee have been determined, the responsibility for pricing the guarantee rests solely with the Swedish National Debt Office (SNDO). Neither parliament nor the government has any direct say in pricing decisions. To determine the appropriate fee, the SNDO analyzes specific project risks covered by the guarantee, by reference to rating analysis, option pricing, or simulation models.

Contingency Fund. Guarantee fees are paid into a notional contingency fund. Fees paid thus reduce central government debt, but should leave more room to borrow if the guarantee is called upon.

Called guarantees are covered by the contingency fund, not the budget. The contingency fund account can be overdrawn without limit, ensuring that the state cannot end up in technical default.

Note: Draws on Hörngren (2003).

In a few countries, guarantee charges are set aside in contingency funds to meet future calls on guarantees. These funds can be notional, and thus track resources without accumulating them (Sweden and the United States), or actual, and thus invest resources in financial assets (Chile and Colombia). The resources set aside in contingency funds can be either pooled to meet calls on the entire guarantee portfolio (Sweden and the United States) or strictly earmarked for specific guarantees (Colombia).

16Although cross-country regression results point to a beneficial impact of transparency in the long run, disclosing hitherto unannounced contingent liabilities may initially worsen ratings and increase bond spreads (Polackova Brixi, 2004).
17In this paragraph and Box 3, “contingent liability” refers to the accounting definition, i.e., a possible payment that is linked to events that are less than likely to occur and thus not recognized on the balance sheet as a liability.
18See OECD (2007) and European Commission (2004).
19For example, in South Africa, risk ratings (on a 1 to 10 scale) pertaining to the credit worthiness of individual entities to which the government is financially exposed are based on both qualitative criteria (such as industry prospects, corporate governance, and quality of management) and quantitative criteria (financial ratios, such as return on equity, cost-to-income, debt-to-equity, profitability, and cash flow).
20Australia defines as material and requiring individual disclosure those fiscal risks with a possible impact on the forward estimates greater than A$20 million (about 0.01 percent of 2007 expenditures) in any one year, or A$40 million over the forward estimates period. New Zealand uses a similar definition.
21Several countries disclose long-term budgetary pressures, such as those related to demographic trends. Australia, New Zealand, the United Kingdom, and the United States, for example, publish stand-alone long-term fiscal sustainability reports, at an annual or multiyear frequency. All EU countries issue long-term public finance projections in their annual updates to stability/convergence programs. Other countries reporting on their long-term fiscal outlook include Brazil and Japan (pension and social security spending).
22See comprehensive studies in IMF and World Bank (2001, 2007) and IMF (2003).
23Some countries have formal guidelines for issuing and managing guarantees and other contingent liabilities (for example, Australia, Financial Management Guidance No. 6, September 2003).
24For example, demand risk in some cases has been fully transferred to the private partner, often resulting in costly renegotiations (OECD/ITF, 2008); in others it has been retained by the government, and concessionaire revenues have been derived from availability payments; elsewhere still (Chile, Colombia, and Korea) it has been shared, with a guarantee on either traffic or revenues, based on traffic bands that ensure risk sharing.
25In addition, international institutions have designed insurance facilities to manage fiscal risks from natural disasters (e.g., Caribbean Catastrophe Risk Insurance Facility; World Bank, 2007).

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