Fiscal Risks: Sources, Disclosure and Management

Fiscal Risks Sources, Disclosure and Management

Ricardo VellosoFiscal Affairs Department, IMF

Presentation at 2009 ICGFM Miami Conference May 21, 2009

Introduction

• Fiscal Risks could be defined as deviations of fiscal outturns (deficits, debt/GDP) from expectations at the time of the budget and/or other fiscal forecasts.

• How large are fiscal risks for different groups of countries?

• What are the most important sources of risk?• What can policy makers do about fiscal risks?

Context• Increasing interest in fiscal risk disclosure and

management: more countries are preparing fiscal risk statements.

• Presentation draws on recent FAD paper discussed at IMF’s Executive Board.

• Extension of IMF’s ongoing work on fiscal transparency (revised Code and Manual on Fiscal Transparency).

• Preliminary Guidelines: tool for policymakers that will evolve with experience.

• More requests for advisory services in this area.

Outline of Presentation

• How large are fiscal risks?• What are the main sources of fiscal risks?• How do countries disclose fiscal risks in

practice?• Preliminary guidelines for identification,

disclosure and management of fiscal risks.• A possible statement of fiscal risks

How Large Are Fiscal Risks? Surprise Deviations in Debt/GDP

10th Percentile

02

04

06

08

01

001

201

40F

req

uenc

y

mean-1sd +1sd-2sd +2sd-3sd +3sd-4sd +4sd-5sd +5sd

-30 -20 -10 0 10 20 30In percent of GDP; positive deviation if actual > forecast

Total obs. 398; mean=-0.77; sd=6.78; skewness=0.21; kurtosis=6.96

Deviations of Debt/GDP--All Countries

How Large Are Fiscal Risks? Surprise Deviations in Balance/GDP

10th Percentile

04

08

01

201

602

002

402

803

20F

req

uenc

y

mean-1sd +1sd-2sd +2sd-3sd +3sd-4sd +4sd-5sd +5sd-6sd +6sd

-20 -15 -10 -5 0 5 10 15 20In percent of GDP; positive deviation if actual > forecast

Total obs. 1397; mean=-0.36; sd=3.21; skewness=-0.47; kurtosis=8.96

Deviations of Balance/GDP--All Countries

Surprise Deviations in Balance/GDP

10th Percentile

01

02

03

04

05

06

07

08

09

01

00

Fre

qu

en

cy


-10 -5 0 5 10In percent of GDP; positive deviation if actual > forecast

Total obs. 378; mean=0.02; sd=2.20; skewness=-0.42; kurtosis=6.80

Advanced Countries

10th percentile

02

04

06

08

01

00

12

01

40

Fre

qu

en

cy

mean-1sd 1sd-2sd 2sd-3sd 3sd-4sd 4sd-5sd 5sd-6sd 6sd

-20 -15 -10 -5 0 5 10 15 20In percent of GDP; positive deviation if actual > forecastTotal obs. 388; mean=-0.57; sd=3.52; skewness=-0.66; kurtosis=10.34

Emerging Countries

10th Percentile

02

04

06

08

01

00

12

01

40

16

0F

req

ue

ncy


-15 -10 -5 0 5 10 15In percent of GDP; positive deviation if actual > forecast


Developing Countries

Sources of Fiscal Risk• Fiscal risks arise from macroeconomic shocks

and the realization of contingent liabilities.• Sources of macroeconomic shocks include real

GDP growth, inflation, commodity prices, and interest and exchange rates.

• Contingent liabilities are obligations triggered by uncertain events and can be:– Explicit: defined by law or contract, e.g., debt

guarantees.– Implicit: arising from government ownership

of SOEs, expectations that the government will provide assistance (e.g., following natural disasters, to depositors in event of bank failures, etc).

Currency Crises(depreciation by at least 25 p.p. and at least 10 p.p. greater than the previous year)

10th percentile

05

10

15

Fre

que

ncy

mean-1sd +1sd-2sd +2sd-3sd +3sd

-10 -5 0 5 10In percent of GDP; positive deviation if actual > forecast


Deviations of Balance/GDP--All Countries

Oil Exporters: Years of Oil Price increase0

510

1520

Fre

que

ncy

mean-1sd +1sd-2sd +2sd-3sd +3sd-4sd 4sd

-30 -20 -10 0 10 20 30 40In percent of GDP; positive deviation if actual > forecastTotal obs. 27; mean=-6.07; sd=10.23; skewness=-0.70; kurtosis=2.94

Deviations of Debt/GDP--Fuel Exporters

03

69

1215

18F

req

uenc

y

mean-1sd +1sd-2sd +2sd-3sd +3sd

-15 -10 -5 0 5 10 15 20In percent of GDP; positive deviation if actual > forecastTotal obs. 26; mean=3.16; sd=5.18; skewness=-0.41; kurtosis=5.69

Deviations of Balance/GDP--Fuel Exporters

Sources of Fiscal RisksResults

• Really big, immediate, unexpected increases in debt/GDP ratio: banking crises; exchange rate crises (especially when large share of debt is denominated in foreign currency); assumptions of debts.

• More common risks to the fiscal deficit: economic growth slowdowns, adverse terms of trade changes.

Fiscal Costs of Banking Crises

Gross costs vs. Net costs

Recovery rates: fiscal risks on the asset side

Banking Crises: Net Fiscal Costs(in percent of GDP)

0%

10%

20%

30%

40%

50%

60%

Argent

ina

1980

Indo

nesia

Jam

aica

Thailand

Turkey

Korea

Domini

can R

ep.

Mex

icoChil

e

Ecuad

or

Bulga

ria

Philip

pines

Nicara

gua

Venez

uela

Finlan

d

Urugu

ay

Brazil

Paragu

ay

Vietn

am

Argent

ina

2001

Croat

ia

Argent

ina

1989

Russia

Japa

n

Czech

Rep.

Mala

ysia

Colom

bia 198

2

Sri La

nka

Latvi

a

Lith

uania

Bolivi

a

Colom

bia 199

8

United

Sta

tes

Argent

ina

1995

Eston

ia

Norway

Banking Crises: Recovery rate(recovery as a share of gross fiscal costs)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Sweden

Norway

Mala

ysiaChil

e

Colom

bia 199

8

Japa

n

Bolivi

a

Urugu

ay

United

Sta

tes

Korea

Ecuad

or

Brazil

Paragu

ay

Thailand

Venez

uela

Czech

Rep.

Eston

ia

Finlan

d

Jam

aica

Indo

nesia

Nicara

gua

Mex

ico

Lith

uania

Domini

can R

ep.

Turkey

Bulga

ria

Argent

ina

1995

Argent

ina

1980

Argent

ina

1989

Argent

ina

2001

Colom

bia 198

2

Croat

ia

Latvi

a

Philip

pines

Russia

Sri La

nka

Vietn

am

Benefits of Disclosure

• Strengthens incentives to ensure that key risks are identified, estimated and carefully managed.

• Promotes earlier, smoother policy responses. • Increases confidence amongst stakeholders in the

quality of fiscal management.• Reduces uncertainty for investors and taxpayers.• Improves access to international capital markets.• International trend toward greater disclosure.

Macroeconomic Shocks

• Fiscal risks from macro shocks are disclosed by many countries, including all EU countries, most OECD members and some emerging market countries (Brazil, Chile, Indonesia).

• Modalities:– Sensitivity analysis (e.g., minimum wage in Brazil).– Full-fledged alternative macroeconomic scenarios

(New Zealand).– Uncertainty surrounding baseline projections is

sometimes illustrated through a fan chart (US).

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New Zealand• Clear responsibilities for macro and fiscal

forecasting to help ensure realistic budgets.• Independent experts assess macro and fiscal

forecasts.• Sensitivity of budget and medium-term fiscal

forecasts to variations in the key assumptions.• Full-fledged alternative macroeconomic and

fiscal scenarios are considered alongside baseline scenario.

• This approach provides policy-makers with a better feel for the likely path of fiscal aggregates, and improve their ability to judge whether the effects of fiscal shocks are likely to be temporary or permanent.

17

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General definition

- Obligations that have been entered into, but the timing and amount of which are contingent on the occurrence of some uncertain future event outside the control of the Government.

Other definition

- Off-balance sheet contingent obligations (accounting).

Contingent Liabilities



Explicit (obligations based on contracts, laws,

or clear policy commitments).

Implicit(political or moral obligations,

rather than contractual)

Guarantees(loan; trade and exchange rate; minimum pension;

income, profit and rate of return guarantees under PPPs)

Bailouts(of public enterprises, financial institutions,

subnational governments, strategic private firms)

Natural disaster spending

Legal claims against the state

Natural disaster relief

Othere.g. ideminities; insurance programs; uncalled capital

Environmental cleanup

19

20

• Disclosure practices driven by accounting, reporting and transparency standards.

– Accounting Standards (IPSAS):

– Statistical Standards (GFSM 2001).– OECD Best Practices (2001), IMF Fiscal Transparency Code and Manual (2007).

• Required also by PFM or fiscal transparency legislation (Australia, Brazil, Canada, Chile, Colombia, France, New Zealand, Nigeria, Pakistan, Peru, UK).

Loss can be measuredRecord in financial statements

and disclose nature of contingency

Disclose nature of contingency and amount

No Disclosure

Loss cannot be reasonably measured

Disclose nature of contingencyDisclose nature of

contingencyNo

Disclosure

Likelihood and measurability of loss

Loss more likely than not (probability > 50%)

Loss less than likely but more than remote

Loss remote


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• Disclosure venues:– Financial statements (Australia, Canada, New Zealand, US).

– Budget documentation

– Medium-term fiscal framework (Chile, Colombia, Peru).

– Debt management reports (Japan, Czech Republic, Turkey).

– Statements of fiscal risks (Australia, Brazil, Chile, Colombia, Indonesia, New Zealand).


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• Disclosure statements usually include:1. Classification by major category.

2. Fiscal significance, nature and rationale.– Total exposure, expected cost and “unexpected” loss.– Explanations for changes in CLs between periods.– When quantification hard, discussion of nature and scope.– Public policy purpose, duration and intended beneficiaries

3. Major individual CLs: description of their nature, scope and quantification (often face value).

4. Information on past calls on the government.

5. Information about reserve assets (e.g., deposit insurance fund).


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• Exemptions from disclosure:• Implicit CLs, to minimize moral hazard.• Information that, if quantified, would

prejudice:– Substantial economic interests of the country. – Security or defense of the country.– International relations of the government.– Ongoing litigation and negotiation.

• Exemptions primarily apply to quantification of CLs; existence, nature and overall scope should still be disclosed.


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What countries disclose

Loan GuaranteesGuarantee and Insurance Programs

Infrastructure Guarantees

Pension Guarantees

Lawsuits

Environmental Liabilities

Callable Capital (International Org.)

Quasi-fiscal deficit Central Bank

Implicit Liabilities

Unquantifiable Liabilities

Australia, Canada, Chile, Colombia, New Zealand, South Africa, US

Chile, Colombia

Chile, South Africa, US

Australia, Brazil, Canada, Chile, Colombia, New Zealand, US

Canada, New Zealand, US

Australia, Chile

Australia, Canada, New Zealand

Australia, Canada, New Zealand

Chile, Pakistan, US

Maximum authorized, face value, expected loss (annual & NPV), unexpected loss (annual & NPV; 95% & 99% probability), details of guarantee and guaranteed loan (maturity, currency, interest)

Face value

SELECTED COUNTRIES QUANTIFIABLE INFO DISCLOSED

Maximum loss, expected loss (annual & NPV), unexpected loss (annual & NPV; 5, 50, 95, 99% probability), evolution of NPV expected costs

Face value, expected payments (annual & NPV), calls on past guarantees

Face value (amounts claimed), expected losses (annual, NPV), range of expected losses, unexpected losses (99%), past success rates

Expected costs

Quasi-fiscal deficit and capital position of CB; guaranteed CB liabilities

Description of liability

Fiscal cost of past banking crisis, past costs of stabilizing fuel prices

CL Disclosure in Practice

Guidelines for Fiscal Risk Disclosure and Management

• Fiscal risks to which the government is exposed should be identified and disclosed to facilitate an effective fiscal policy.

• Risks should be mitigated in a cost-effective manner.

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

• Risks should be systematically incorporated in fiscal analysis and the budget process.

GuidelinesIdentification & Disclosure

• Availability of information: compilation and monitoring of all risks—importance, probability, and where possible, quantification.

• Legislative/accounting framework for disclosure of risks, with presumption of publication; exceptions based on clear criteria (materiality, moral hazard, prejudice of national interest).

• Full presentation of risks in budget documentation, possibly in statement of fiscal risks.

GuidelinesCost-Effective Risk Mitigation

• Efforts to address or reduce fiscal risks before they are taken or materialize include a combination of:– Assessing if the government should take on a

particular risk.– Modifying the activity to reduce risk.– Taking up insurance or otherwise transfering or

sharing the risks particularly with those able to influence outcomes.

– Allocating risks based on an assessment of best ability to bear and manage risks.

GuidelinesLegal/Administrative Framework

• Clear allocation of responsibilities between CG and rest of public sector on use of public funds.

• Fiscal risk management may be facilitated by a CG unit that can monitor and control overall risk and consider interactions.

• Integration with overall fiscal management is facilitated by location of unit within MOF.

• Ministries/agencies to have clearly specified responsibilities for managing their risk exposure.

• Responsibility for taking on risks should be separate from that of estimating potential costs.

GuidelinesIncorporating Fiscal Risks in

Fiscal Policy & Budget Process

• Risk analysis should be incorporated in the macroeconomic policy framework, with fiscal targets allowing for the possibility that some risks may materialize.

• Exposure to fiscal risks should be incorporated in fiscal sustainability analysis.

GuidelinesIncorporating Fiscal Risks in

Fiscal Policy & Budget Process

• Decisions over contingent liabilities should be integrated with the annual budget cycle so that proposals are considered alongside competing instruments.

• A framework should be in place to require parliamentary approval of contingent liabilities.

• An annual budget appropriation could be included to cover the expected cost of contingent liabilities (general, by main category, or specific).

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.

Statement of Fiscal Risks


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.

Contingent Central Government Expenditure

- 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 guarantee should be disclosed.


Contingent Central Government Expenditure (cont.)- Banking sector: Deposit insurance scheme and—to the extent that the authorities feel this does not generate moral hazard—risks from the banking sector.- 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, including (i) how it fits with country’s infrastructure and other investment needs, as well as (ii) policy framework and rationale for PPPs.


Public Private Partnerships (cont.)- Cumulative overall exposure from government’s existing 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.

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Thank you!

Economy & Finance

Fiscal Risks: Sources, Disclosure and Management