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 Issues Revealed by the Crisis Unreported Deficits SoEs & PPPs 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 Arrears Macroeconomic Risks 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 Contingent Liabilities Stimulus / Consolidation 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
II. Importance of Fiscal Risks Iceland hit by financial sector liabilities 120 100 General government gross debt, per cent GDP 80 70 60 Contribution to unexpected increase in general government debt between 2007-2010, 80 50 Other 60 40 20 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 40 30 20 10 Bank bail outs Revisions to debt including for arrears Forecast debt, 2007 Actual debt, 2013 0 1000 900 800 700 600 500 400 300 200 100 0 Bank assets as a share of GDP, 2007/08 Iceland UK Greece Japan USA 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 5
II. Importance of Fiscal Risks Half the increase in Portugal s debt due to risks 160 160 Arrears 140 General Government Gross Debt 140 120 100 80 SOE & PPP debt outside the General Government sector General Government debt excluding reclassified SOEs, PPPs or financial sector* Financial sector bailouts SOE & PPP reclassifications post Dec 2009 GG Gross debt reported in Dec 2009 Fin Sector SOE & PPP reclassification Debt dynamics 120 100 80 60 60 40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014(f) 40
III. Managing Fiscal Risks Identify and Quantify Analyze and Assess Mitigation Build fiscal buffers Monitor and Report 7
III. Managing Fiscal Risks: Identify and Quantify Results from FTEs Contingent liabilities can be very large And public corps pose significant risks 140 Portugal: Quantified Contingent Liabilities (Percent of GDP) Russia: Equity Purchases and Subsidies (Percent of GG Expenditure) 120 100 80 60 40 20 0 Guarantees Monitored PPPs Unmonitored Concessions Callable Capital in ESM Deposit Guarantee Scheme Others 8
III. Managing Fiscal Risks Analyze and Assess 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 9
III. Managing Fiscal Risks Analyze and Assess Philippines Philippines Fiscal Risk Statement: Interest and Exchange Rate Sensitivity 10
III. Managing Fiscal Risks Mitigation For each risk the government, in theory, faces the following choices: 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 Decision will be influenced by type of risk size, degree of uncertainty, degree of govt. control and ability of govt. to bear risk 11
III. Managing Fiscal Risks Building Fiscal Buffers Buffers Low debt / Stabilization funds Contingency reserves / Margins Budget flexibility Public sector fiscal planning Virements Supplementary budgets Include SOE flows and stocks within fiscal projections, plans and objectives Caps Create budget ceilings for contingent liabilities such as guarantees, PPPs etc 12
III. Managing Fiscal Risks Reporting and monitoring Macroeconomic uncertainty: forecast fan charts (percent of GDP) Budgetary Central Govt Non-com Parastatals Sub-Nat govt Assets and liabilities: Public sector balance sheet Reported Unreported (percent of GDP) Less than half of public sector liabilities reported General Government Significant macro and fiscal forecast uncertainty Central Bank Com Parastatals Consolidation Liabilities Assets Public Sector Net Worth -150-100 -50 0 50 100 150 Contingent liabilities: guarantees to the financial sector 100 80 60 40 Large exposure to the financial sector (percent of GDP) Sub-national risks: Municipal government liabilities 800 600 400 Percent of income Liabilities to Income (LHS) Cumulative liablities to GDP (RHS) Percent of GDP Small number of municipalities with large liabilities, but small overall risk 8 6 4 20 0 200 2 0 Municipalities, Cities and Provinces, (ordered by liabilities to income) 0
III. Tools and Diagnostics 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 14
V. Conclusions 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 15