Transcript Budgeting for Fiscal Risk

Budgeting for Fiscal Risk
Allen Schick
Presented to the Fiscal Affairs Division
International Monetary Fund
17 September 2008
What Are Fiscal Risks?
IMF Report
The possible deviation of fiscal outcomes from
budget estimates or other projections
Alternative Definitions
The contingency of future revenues or expenditures
on uncertain future events
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The Risk-Taking State
Macro-Economic Management
More important to balance the economy than the budget
Automatic (built-in) stabilizers
Taking risks in good times, which become due in bad times
Economic shocks
The Entitlement State
Shift of risks from households to government
The changed composition of national expenditure
Universalization of major income support schemes
Moral government more important than moral hazard
Government as payer or guarantor of last resort
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Incentives for Governments to
Accumulate Fiscal Risks
Inadequate Accounting Rules
The cash basis does not recognize liabilities for no payment has been made or is due:
the accrual basis does not recognize liabilities that are contingent on “unlikely” events
Weak Budget Constraints
Contingent liabilities are not expensed in the budget until payment is made
Guarantees are Treated as Costless Substitutes for State Ownership and
Direct Expenditures
In some countries, upfront fees for guarantees are booked as current revenues, thus
showing a “profit” from risk-taking programs
Inadequate Insurance Arrangements and Weak Capital Markets Impel
Governments in Less Developed Countries to Guarantee Private
Transactions
IFIs require state guarantees as a condition for lending funds for sectoral programs
and other purposes
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Why it is Hard to Control Contingent Liabilities
Risk typically is underestimated when it is taken: the true cost is only known
later when it is too late to do much about it.
Risk taken in good time often becomes due in bad times
There is no such thing as a risk-less guarantee or a cost-less risk: if there were
no risk or cost, there would be no incentive to seek government guarantees
Risk taken in one fiscal year becomes due in later years
When government issues guarantees, affected parties have incentives to behave
in ways that transfer risk from themselves to the state
If government hides the cost in one budget, the true cost will be higher in later
budgets
Risk begets risk: the more guarantees government accepts, the more
guarantees it will be pressured to accept
When government issues guarantees, economic agents assess the quality of the
guarantee rather than the soundness of the transaction
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The Inadequacy of Conventional
Budget Procedures
Cash basis of budgeting
Short or medium-term fiscal horizon
Incentive to underestimate future costs
Opportunistic politicians
Perverse effects of fiscal rules
Lack of budget constraint on total risk
Risk taking by extra-budgetary entities
No effective limit on payouts from past risks
Implicit liabilities do not exist until government makes them
explicit
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Managing Fiscal Risks Requires an
Extended Time Horizon
The Problem
Contingent liabilities entered into one year typically come due in future
years
Annual budgets do not recognize the downstream costs of contingent
(and other liabilities)
MTEF does not cover risks beyond the usual 3-5 year horizon
Lengthening the Time Frame
Long-term sustainability estimates that project future liabilities over a
30-50 year time frame
Publications of detailed schedules of all contingent liabilities, including
the amount of risk, the period during which the risk is extant, and events
that may trigger calls
Recognizing the present value of future calls on the balance sheet or
budget
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Managing Fiscal Risk
Separation of risk assessment responsibility from risk
commitment function
Prudential assessment of risk before commitments are made
Limit on the volume of contingent liabilities outstanding or
undertaken in a fiscal period
Expensing the estimated present value of future payments in
the budget or MTEF
Contingent liabilities reported in the budget or supplemental
financial statements
Vesting responsibility for managing the portfolio of risks in a
central agency or independent authority
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Strategies that Reduce the
Shift of Risk to Government
Risk-adjusted premiums for guarantees and other
contingent liabilities
Through co-pays and deductions, risk is shared with
enterprises and households
Government indemnifies last (rather than first) loss
Government exposure limited to amount provisioned
Government purchases reinsurance from private firms
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Draft IMF Guidelines for Fiscal Risks (1)
Fiscal Risks Should be Identified and Disclosed
The government should compile a list of the material fiscal risks to
which it is exposed: where possible, the amounts and probability of
occurrence should be quantified
The government’s accounting standards should require disclosure of
contingent liabilities
It would be useful to include a consolidated statement of fiscal risks
in the budget documents. The statement would address sources of
fiscal risk, including the budget’s sensitivity to macroeconomic risks,
public debt, contingent liabilities, the fiscal impact of natural
disasters, public-private partnerships, state-owned enterprises, and
sub-national governments
The guidelines do not recommend disclosure of implicit liabilities
when doing so would generate moral hazard, or prejudice the
government’s legal or bargaining position
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Draft IMF Guidelines for Fiscal Risks (2)
Fiscal Risks Should be Mitigated in a Cost-Effective Manner
Government should have a clear policy framework for assessing
whether to take assume a particular risk
Risks should be allocated to economic actors on the basis of ability
and incentives to manage them
When economic actors transfer risk to government they should either
pay a fee for reduced exposure or bear a portion of the risk
Government should issue contingent liabilities only in case of market
inadequacy or only when it is better positioned to manage the risks
Guarantee proposals should be subject to scrutiny and prioritization
to appropriately balance insurance and incentives, through fees,
partial guarantees, quantitative limits, termination provisions or
collateral
It may be appropriate for government to ex ante control risk taking
by actors who impose possible costs upon it
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Draft IMF Guidelines for Fiscal Risks (3)
There Should be a Clear Legal and Administrative Framework
to Manage Fiscal Risk
The entity with primary responsibility for managing finances should
have the necessary authority to monitor and manage fiscal risks
It may be desirable for line agencies to have clearly specified
responsibilities and capacity to prudently manage the risks to which
they are exposed
Risks should be assessed before the government enters into
contractual arrangements. These arrangements should be clear about
the apportionment of risk: they should be reflected in government
accounts, and should be publicly accessible
Responsibility for taking on risks should be separated from
responsibility for estimating potential costs
Fiscal activities that create risk should be subject to internal audit
and audit by the supreme auditing institution
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Draft IMF Guidelines for Fiscal Risks (4)
Fiscal Risks Should be Systematically Incorporated into Fiscal
Analysis and the Budget Process
Exposure to fiscal risk should be incorporated into fiscal sustainability
analysis
The risk of uncertain expenditures may be handled through
contingency appropriations whose magnitude reflects the country’s
specific circumstances
Decisions on guarantees and other contingent obligations should be
integrated with the budget and considered alongside alternative
instruments intended to achieve similar objectives
Parliamentary approval should be required for issuance of
guarantees, through an aggregate ceiling on guarantees, a ceiling on
categories of guarantees, or approval of individual guarantees
An annual appropriation should be made to cover expected calls on
guarantees during the fiscal year
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