Managing Fiscal Risks

Gerd Schwartz

Tokyo Fiscal Forum

11 June 2015

Managing fiscal risks and uncertainties Outline of Presentation

I. Defining fiscal risks

II. Importance of fiscal risks

III. Managing fiscal risks

IV. Tools and diagnostics

V. Conclusion

I. Defining fiscal risks

Fiscal risks are factors that may cause fiscal outcomes to differ from forecasts or expectations

Macroeconomic Institutional Contingent liabilities

Explicit Implicit

Outside of immediate control

3

II. Importance of Fiscal Risks Financial crisis demonstrated impact of fiscal risks

Sources of Unexpected Increase in General Government Debt (percent of GDP, 2007-2010)

FRA DEU NLD ESP PRT GBR USA GRC IRL ISL AVE*

Underlying fiscal position 1.7 3.2 -2.4 1.8 11.3 3.7 8.1 16.3 1.3 10.9 6.0

Revisions to 2007 deficit & debt 1.7 1.8 -0.9 -0.1 0.1 1.5 7.1 2.5 1.6 4.0 4.7

Changes to government boundary -0.7 1.4 -0.2 0.6 9.4 1.9 0.9 11.2 -0.1 2.5 1.1

Cash-accrual adjustments 0.7 0.0 -1.3 1.3 1.7 0.3 0.0 2.6 -0.2 4.5 0.2

Exogenous shocks 8.4 12.8 14.2 15.4 8.1 17.0 6.3 40.0 60.2 39.5 9.8

Macroeconomic shocks 8.3 4.7 5.2 13.0 4.4 8.9 3.8 38.4 35.7 -3.3 6.0

Financial sector interventions 0.0 8.1 9.0 2.5 3.6 8.1 2.5 1.6 24.5 42.8 3.8

Policy changes 2.3 3.8 1.9 4.9 4.7 1.1 6.4 -8.0 -9.9 -4.3 4.7

Other factors 2.1 -0.3 6.5 1.9 3.7 6.2 8.3 -6.7 7.5 21.6 5.9

Total Unforecast Increase in Debt 14.4 19.5 20.2 24.0 27.8 28.0 29.1 41.7 59.1 67.7 26.4

* GDP-weighted average 4

Unreported Deficits

SoEs & PPPs

Arrears

Macroeconomic Risks

Contingent Liabilities

Stimulus / Consolidation

Issues Revealed by the Crisis

II. Importance of Fiscal Risks Iceland hit by financial sector liabilities

5

Increase in debt of around 70% GDP between 2007 and 2010:

• Mainly driven by cost of bank-bail outs – implicit contingent liabilities

• Also due to macroeconomic recession and build-up of arrears

0

20

40

60

80

100

120

2004 2005 2006 2007 2008 2009 2010 2011 2012

Forecast debt, 2007 Actual debt, 2013

General government gross debt, per cent GDP

0100200300400500600700800900

1000

Iceland UK Greece Japan USA

Bank assets as a share of GDP, 2007/08

0

10

20

30

40

50

60

70

80

Other

Bank bail outs

Revisions to debt including for arrears

Contribution to unexpected increase in general government debt between 2007-2010,

40

60

80

100

120

140

160

40

60

80

100

120

140

160

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014(f)

General Government debt excluding reclassified SOEs, PPPs or financial sector*

GG Gross debt reported in Dec 2009

SOE & PPP debt outside the General Government sector

SOE & PPP reclassifications post Dec 2009

Financial sector bailouts

General Government Gross Debt

Arrears

Fin Sector

SOE &

PPP reclassification

Debt

dynamics

II. Importance of Fiscal Risks Half the increase in Portugal’s debt due to risks

III. Managing Fiscal Risks

7

Identify and Quantify

Analyze and Assess

Mitigation

Build fiscal buffers

Monitor and Report

0

20

40

60

80

100

120

140

Guarantees Monitored PPPs

Unmonitored Concessions

Callable Capital in

ESM

Deposit Guarantee

Scheme

Others

III. Managing Fiscal Risks: Identify and Quantify – Results from FTEs

Contingent liabilities can be very large

Portugal: Quantified Contingent Liabilities (Percent of GDP)

8

Russia: Equity Purchases and Subsidies (Percent of GG Expenditure)

And public corps pose significant risks

III. Managing Fiscal Risks Analyze and Assess

9

Likelihood that fiscal risks will be realized Guarantees Financial sector assessments

Nature of the risk – what factors will determine Macroeconomic, exchange rate exposure,

business conditions, natural disaster, financial sector

Potential co-movement: are risks linked? When things go wrong, they go really wrong

Potential impact on public finances

10

III. Managing Fiscal Risks Analyze and Assess – Philippines

Philippines Fiscal Risk Statement: Interest and Exchange Rate Sensitivity

11

Whether to bear risk

• Pros: public policy benefits eg, automatic stabilizers for macro stability; guaranteeing bank deposits to discourage bank runs; guaranteeing student loans to encourage education

• Cons: moral hazard; disguised transfers; fiscal transparency; solvency

Whether to mitigate risk

• Deliberately not bearing all the risk, e.g. partial guarantees

• Regulating those benefiting from government risk-bearing, e.g. bank capital requirements

• Transferring risk to third parties, e.g. international reinsurance

How to absorb remaining risk

• Lower debt

• Stabilization funds / reserves

• Diversification eg widening tax base or financial asset investment strategy

For each risk the government, in theory, faces the following choices:

Decision will be influenced by type of risk – size, degree of uncertainty, degree of govt. control – and ability of govt. to bear risk

III. Managing Fiscal Risks Mitigation

12

• Low debt / Stabilization funds • Contingency reserves / Margins Buffers

• Virements • Supplementary budgets

Budget flexibility

• Include SOE flows and stocks within fiscal projections, plans and objectives

Public sector fiscal planning

• Create budget ceilings for contingent liabilities such as guarantees, PPPs etc Caps

III. Managing Fiscal Risks Building Fiscal Buffers

0

2

4

6

8

0

200

400

600

800

Liabilities to Income (LHS)

Cumulative liablities to GDP (RHS)

Municipalities, Cities and Provinces, (ordered by liabilities to income)

Percent of income Percent of GDP

-150 -100 -50 0 50 100 150

Net Worth

Public Sector

Consolidation

Com Parastatals

Central Bank

General Government

Sub-Nat govt

Non-com Parastatals

Budgetary Central Govt

ReportedUnreported

Liabilities Assets

0

20

40

60

80

100

Assets and liabilities: Public sector balance sheet (percent of GDP)

Large exposure to the financial

sector

Macroeconomic uncertainty: forecast fan charts (percent of GDP)

Significant macro and fiscal forecast

uncertainty

Contingent liabilities: guarantees to the financial sector (percent of GDP)

Sub-national risks: Municipal government liabilities

Less than half of public sector

liabilities reported

Small number of municipalities with

large liabilities, but small overall

risk

III. Managing Fiscal Risks Reporting and monitoring

III. Tools and Diagnostics

14

Fiscal Transparency Code provides a guide to managing fiscal risks

Fiscal Transparency Evaluations provides an assessment of risks

PPP Fiscal Risk Assessment Model helps design and assess PPP

V. Conclusions

15

• Dealing with risks and uncertainties is a key issue in fiscal management

• Global financial crisis clearly illustrates the dangers • Successful fiscal risk management involves

identification, analysis, mitigation, incorporation in budget, and reporting

• Fiscal Transparency Code and Evaluation provides a guide and assessment of risks