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Managing Fiscal Risks
Teresa Ter-Minassian
Annual Meeting of the Spanish Economic Association
Zaragoza, December 12, 2008
Overview of presentation
Definition and sources of fiscal risks
Assessing and disclosing fiscal risks
Managing fiscal risks
Fiscal risks from public-private partnerships (PPPs)
Fiscal risks from financial crises
Definition and sources of
fiscal risks
What are fiscal risks, and
how significant are they?
Fiscal risks are defined here as factors outside government
control that can cause fiscal outturns to differ from their
initial forecasts.
Empirical analysis shows that such deviations can be large,
on both the upside and the downside. They are significant in
both advanced and developing countries, although on
average larger in the latter.
The materialization of large unexpected fiscal risks can
jeopardize macro-economic stability and longer-term fiscal
How Large Are Fiscal Risks?
Surprise Deviations in Debt/GDP
Deviations of Debt/GDP--All Countries
-1sd mean +1sd
10th Percentile
100 120 140
In percent of GDP; positive deviation if actual > forecast
Total obs. 398; mean=-0.77; sd=6.78; skewness=0.21; kurtosis=6.96
How Large Are Fiscal Risks?
Surprise Deviations in Balance/GDP
Deviations of Balance/GDP--All Countries
120 160 200 240 280 320
10th Percentile
-6sd -5sd -4sd -3sd -2sd -1sd mean +1sd +2sd +3sd +4sd +5sd +6sd
In percent of GDP; positive deviation if actual > forecast
Total obs. 1397; mean=-0.36; sd=3.21; skewness=-0.47; kurtosis=8.96
Sources of fiscal risks
Sources of fiscal risks can be grouped into
two main categories
 Unforeseen exogenous developments
 In real GDP growth and inflation
 In commodity prices
 In exchange rates and interest rates
 In external assistance flows to low-income countries
 Contingent liabilities
 Government obligations, whose amount and time of
realization depend on events outside the
government’s control
 Can be explicit or implicit
Contingent Liabilities
Contingent Liabilities
(obligations based on contracts, laws,
or clear policy commitments)
(political or moral obligations,
rather than contractual)
(loan; trade and ER; minimum pension; income,
profit and rate of return guarantees under PPPs)
(of PEs, financial institutions,
subnational govts., strategic private firms)
Natural disaster spending
Natural disaster relief
Legal claims against the state
Environmental cleanup
e.g. ideminities; insurance programs;
uncalled capital
Incentives for governments
to accumulate fiscal risks
 Incentives for optimistic bias in budget forecasts
 To facilitate budget approval
 To demonstrate ex-ante compliance with numerical fiscal
 To improve market perceptions of the country’s credit
 Incentives to provide guarantees, in lieu of direct
budget support
 To minimize explicit outlays in proposed budgets
 To show as revenues any fees received for guarantees
Assessing and Disclosing
Fiscal Risks
Assessing fiscal risks
Appropriate assessment methodologies vary with nature of
the risk.
To assess budgetary implications of unexpected macro-economic
developments, systematic use of sensitivity analysis of
budget baseline, and preparation of comprehensive, internally
consistent alternative scenarios are needed.
Assessment of contingent liabilities (CL) requires estimation
of their expected value, which may be difficult to quantify, if the
probability distribution of their realization is not well known (e.g.
for natural disasters). Monte-Carlo simulations used in some
instances (e.g. for guarantees included in PPP agreements).
Disclosing fiscal risks
 Benefits of disclosure requirements
 Reduce government incentives to accumulate risks
 Strengthen accountability for their identification and
 Promote earlier and smoother policy responses
 Can improve markets’ perception of a government’s
fiscal transparency and responsibility, and over time
moderate its financing costs
 Disclosure requirements should be embedded in a
robust legal framework, and underpinned by
adequate institutional capacity, to ensure
consistent compliance over time
International disclosure
Disclosure practices are shaped by international
accounting, statistical and transparency standards
The International Public Sector Accounting Standard (IPSAS)
requires inclusion of the expected fiscal cost of a CL in government’s
financial statement, if it can be measured and its probability of
realization exceeds 50%; disclosure in notes to the statement, if its
probability is less than 50%, but “not remote”
The IMF’s Government Fiscal Statistics Manual (GFSM 2001)
requires disclosure of key CLs as memorandum items in
governments’ balance sheets
The IMF’s Code and Manual of Fiscal Transparency, and the
OECD’s Best Practices for Budget Transparency recommend
inclusion of a comprehensive statement of fiscal risks in budget
Disclosure practices
Many countries include (more or less comprehensive) disclosure
requirements for fiscal risks in their national budget frameworks, fiscal
responsibility or fiscal transparency laws.
The range of risks disclosed has been increasing, and the detail and
quality of information provided are improving.
Many implicit contingent liabilities (e.g. risks of bailouts) are excluded
from disclosure, because of moral hazard concerns.
Best practices are generally found in advanced counties (e.g. New
Zealand, UK, Australia); but more recently also in some emerging
markets (e.g. Chile, Colombia, Brazil, Indonesia).
Managing Fiscal Risks
Mitigating fiscal risks
 Some useful approaches to mitigating fiscal risks
 Preparation by fiscal policy-makers of appropriate contingency
responses to the materialization of macro-economic risks to the
budget baseline.
 Separation of the responsibility for risk assessment from that for
deciding on the assumption of the risk.
 Vesting of overall responsibility for managing the portfolio of fiscal
risks in a central authority, preferably the Ministry of Finance.
However, line ministries and agencies should also be responsible
for managing the specific risks relating to their activities.
Mitigating fiscal risks
Sharing of a risk between a government and other entities
should be guided by an assessment of which party is best
placed to bear that specific risk.
Risk-bearing by the government can be mitigated by capping
the amount of guarantees, and by levying risk-adjusted
premiums for their provision. Guarantees should have automatic
sunset (or at least periodic review) clauses.
For some risks, governments can purchase private reinsurance
(e.g. hedging for oil price changes; catastrophe bonds).
Decisions to do so require careful analysis of expected costs and
Integrating fiscal risks
into the budget
 Fiscal risks should be systematically incorporated
into fiscal analysis and the budget process
 Medium to long-term public debt sustainability analyses should
include stress tests of underlying assumptions, and incorporate the
expected value of significant contingent liabilities
 Annual budgets should include appropriations for expected calls on
guarantees, and adequate provision for the materialization of other
 Parliamentary approval should be sought for annual ceilings on
main categories of guarantees, or at least their aggregate amount
PPPs and Fiscal Risks
Types of fiscal risks in PPPs
 An appropriate sharing of risks between the
government and the private partner is crucial to promote
the realization of efficiency gains from PPPs (compared with
direct government procurement)
 Risks should be shared in line with each partner’s ability to
bear it
 The government should bear policy-related risks (e.g. risks of
expropriation, and of significant changes in legal or regulatory
 The private partner should bear normal commercial (construction
and supply) and financial (interest rate and exchange rate) risks
 Demand risk may need to be shared (on both the upside and the
Managing PPP-related risks
Governments need significant institutional capacity (robust legal
frameworks; trained manpower) to structure PPP projects
appropriately, evaluate bids, and monitor effectively project execution,
so as to minimize attendant fiscal risks and maximize value-for-money
There should be a central “gatekeeper” unit (preferably in the Ministry
of Finance) to review and approve all proposed PPP projects.
The choice between PPP and direct public procurement should be
based on a careful assessment of respective VFMs, not on their upfront budgetary cost.
Managing PPP-related risks
Appropriate budgeting and accounting rules are
essential to ensure that PPPs are entered into for
the right reasons
The annual expected value of guarantees and other contingent
liabilities should be provisioned for in the budget
The stream of expected service payments for PPPs and calls on
guarantees should be incorporated in medium-to-long term debt
sustainability analyses, with appropriate sensitivity tests
Some countries have found it useful to cap the total value of
government exposure under PPP projects, or the total projected
amount of PPP-related annual budget expenditures
Financial Crises and Fiscal
Types of fiscal risks
created by financial crises
 Financial crises give rise to different types of fiscal risks
 Revenue losses from declines in output and in asset prices
 Increases in cyclically-sensitive primary expenditures
 Increases in public debt and its service, reflecting increased sovereign
risk premiums, and/or exchange rate depreciation
 Increased rollover risk for the public debt
 Pressures for bailouts:
 Of state-owned enterprises
 Of sub-national governments
 Of financial institutions and non-financial private enterprises “too
big to fail”
 Available empirical estimates focus on the cost of bank bailouts
Main types of financial
sector bailouts
 Crisis containment
 Liquidity injections by central bank (CB).
 Deposit or loan guarantees
 Forbearance measures
 Administrative measures (e.g. deposit freezes; bank holidays)
 Bank restructuring
 Capital injections (grants, loans or equity)
 Purchases of troubled bank assets
 Other forms of support to asset values
 Take-over by governments of bank liabilities
 Some of these interventions result in immediate budget outlays; most
in CL (e.g. calls on guarantees; need to recapitalize the CB)
 Eventual fiscal cost depends on the extent of realization of CL, and on
the rate of recovery of assets taken over by government.
 The net costs of bank bailouts in last three decades have varied widely
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Banking Crises: Net Fiscal Costs
(in percent of GDP)
Fiscal costs of the current
financial crisis…
 ….are also likely to vary widely across countries,
but to be large for many
 The expected relatively deep recession will impact budgets
adversely through the operation of automatic stabilizers, and
through any discretionary fiscal stimulus
 The recent decline in commodity prices will affect adversely
countries dependent on natural resource revenues, but reduce
the fiscal burden of price subsidies
 Both advanced and emerging market countries have already
announced a panoply of measures to support financial
institutions, the cost of which is likely to increase in the short
term, as bank losses mount during the recession
 Pressures will also rise to support sub-national governments, and
to bailout large non-financial enterprises (both public and private)
Fiscal costs of the current
financial crisis…
 …as a result, public debt levels will rise to levels that may
prove unsustainable in the longer run (especially in light of
pressures from aging populations and climate change)
 To ensure medium-to-long term fiscal sustainability,
governments will need to credibly commit to fiscal
consolidation when the economy recovers
 Through fiscal rules or fiscal responsibility legislation, possibly coupled
with the creation of independent fiscal “watchdogs”
 By strengthening countercyclical features of their fiscal systems; and
 By implementing needed structural fiscal reforms, including reforms of
entitlement spending programs that adequately address the fiscal
cost of aging populations
Thank you!