Fiscal Transparency and Public Contingent Liabilities Lessons from Cross-Country Experiences Sudarshan Gooptu Lead Economist Poverty Reduction and Economic Management Sector Unit East Asia and Pacific Region World Bank Presentation at World Bank Workshop on Fiscal Transparency and Data Management, Washington, DC. December 4-7, 2006.
Contingent Liabilities Definition Obligations for the government that materialize if a particular event occurs e.g. financial guarantees on borrowings by sub-national entities. The risks involved in on-lending are very much like risks involved with government guarantees Contingent claims Moral Hazard: The willingness to take risks on the part of the borrower can be excessive The risks involved must be controlled Guarantees are often off-budget
Why worry about Contingent Liabilities? Governments face increasing risks and uncertainties Trends toward greater fiscal vulnerability: increasing volatility of international capital flows transformation of the state from financing public service delivery to guaranteeing private sector provision Fiscal opportunism under deficit targets: conceal state support and its fiscal cost Moral hazard in the markets: markets expect government support in cases of failure
Fiscal risks in emerging-market economies are particularly large and costly Market institutions are weak Inadequate information disclosure - investors do not fully understand the risks Disciplining effect of financial markets is weak Governments have history of bail-outs Moral hazard and possible failures in the markets are large Government has limited access to borrowing
Fiscal Risk Matrix to identify future financing pressures on Central Government Liabilities Explicit Recognized by government law or contract Implicit Government m oral obligation, public expectation, interest group pressure Direct (predictable) Contingent (if a particular event occurs)
Cataloguing the various types of fiscal risks is not an end in itself, but a means of enabling governments to manage the risks they take.
Direct and Explicit xxxxxxxxxxxxxx xxxxxxxxxxxxxx xxxxxxxxxxxxxx Sovereign borrowing (foreign and domestic loans contracted and securities issued by central government) - amounts and risk structure (currency, maturity, floating rate, link to assets) Budgetary expenditures Expenditures legally binding in the long term (civil service salaries, civil service pensions)
Direct and Implicit xxxxxxxxxxxxxx xxxxxxxxxxxxxx xxxxxxxxxxxxxx Future public pensions if not required by law (implicit pension debt) Social security schemes if not required by law Future health care financing Future recurrent cost of public investment projects
Contingent and Explicit xxxxxxxxxxxxxx xxxxxxxxxxxxxx xxxxxxxxxxxxxx State guarantees for borrowing and obligations of subnational governments and public/private entities Umbrella guarantees for various loans (mortgage loans, student loans, agriculture loans, small business loans) State guarantees on private investments, trade, exchange rate State insurance schemes (deposit insurance, minimum returns from private pension funds, crop insurance, flood insurance, war-risk insurance)
Contingent and Implicit xxxxxxxxxxxxxx xxxxxxxxxxxxxx xxxxxxxxxxxxxx Default of a sub-national government and public/ private entity on non-guaranteed debt/obligations Bank failure (support beyond state insurance) Clean-up of liabilities in entities being privatized Failure of non-guaranteed pension/social security funds Default of central bank on its obligations (foreign exchange contracts, currency defense, BOP) Collapses due to sudden capital outflows Environmental recovery, disaster relief, war/military,...
International experience of effective risk disclosure Australia s State of Victoria Canada s Ontario Province India s State Tripura United Kingdom s England and Wales - publish a list of the sources of their risk exposure - discuss the nature, sensitivities and possible financial implications of the risks - provide face value and/or estimates of future possible fiscal cost. At the central government level, good practice is pursued particularly by Australia, Canada, Czech Republic, Netherlands, New Zealand, South Africa, United Kingdom, and the United States. The IMF s Manual on Fiscal Transparency sets a good model.
Some Examples of fiscal risk matrices in East Asian Countries
Fiscal Risk Matrix for the Philippines Liabilities Explicit Govt. liability by law or contact Implicit A moral obligation of the govt. due to public or interest group pressures Direct (obligation in any event Sovereign debt Expenditures approved in the Budget Future legally-binding expenditures (pensions and provident funds) Future cost overruns or recurrent costs of public investment projects Contingent (obligation if a particular event occurs) Govt. guarantees for GOCC loans Govt. guarantees given to the operators of the BOT projects Umbrella guarantees for loans given to the priority sectors Guarantees on benefits of the social security system Bail out of failed banks Possible default of the central bank Support to public enterprises for covering losses or assuming non-guaranteed obligations
INDONESIA Sources of Fiscal Risk Exposure Guarantees to protect depositors in and creditors to the banking system Sovereign guarantees on insured credits to private infrastructure providers, for instance, in the provision of Toll Roads and with IPPs in the Power sector Obligations of minimum pension payments, and Guarantee schemes to the private sector (some of which were instituted since the crisis to restore the flow of credit) Off-balance sheet obligations of public sector corporations, which ultimately are the obligations of the Government
THAILAND Sources of Fiscal Risk Exposure Guaranteed debt of state-owned enterprises Obligations of FIDF and future recapitalization needs in the banking sector Financing needs under programs of price support and price control (SOEs, EBFs) Losses, non-guaranteed obligations, arrears and deferred maintenance of SOEs Possibly negative net worth of BOT Future possible commitments and obligations of sub-national government
THAILAND Other Sources of Fiscal Risks Example: State Railway of Thailand operating losses (4 billion expected in 2000) reported liabilities (35 billion in 1999) deferred maintenance (20 billion remaining track rehabilitation) arrears (fuel cost to PTT) total obligations to be covered are over 60 billion baht (on top of future losses) Therefore, the guaranteed debt is not all.
Contingent Liabilities in the Chinese Context EXAMPLE The use of specialized Municipal Corporations (MCs) or Urban Development Investment Corporations (UDICs) is common practice to finance infrastructure in China. These quasi-government entities are playing a primary role in the infrastructure-led growth of Chinese cities. The market borrowings of these entities may often carry the implied guarantee of the sponsoring government (local or national), even when the authorities make an explicit declaration that it will not honor the debt of the UDIC. The market perceives that the Government will step in and not let the UDIC default.
Other Sources of Fiscal Risks Exposure in China Banking Sector (Implicit liabilities, e.g. NPLs) Pension Liabilities (Implicit liabilities) Foreign public and publicly guaranteed debt (Explicit liabilities) Private participation in Infrastructure Projects (implicit liabilities, sometimes explicit at sub-national level.) Source: Krumm, Kathie and Christine Wong, Government Fiscal Risk Exposure in China. Chapter 10 in Government at Risk by Hana Brixi and Allen Schick (eds.), World Bank, Washington DC. 2002.
Lessons from International Experiences Need a Centralized Unit in Government for: -- Identification and measurement of CLs -- Policy formulation for issue of CLs -- Determination of guarantee fees -- Designing of CL instruments -- Monitoring risk exposures Some countries have established a Contingent Liability Redemption Fund (an on-budget item) DO NOT provide any automatic guarantees Prescribe limits on Sovereign guarantee issuance
Lessons from International Experiences (contd.) Establish sound risk sharing arrangements among government, operators, insurance companies Promote sound corporate governance Improve the supervision and regulation of SOEs Maintain macro-economic stability Establish/strengthen appropriate legal, regulatory and institutional set-up Set up an independent Public Debt Management Office Strengthen capability in Government for Contingent Liability Management
Institutions to Enhance Fiscal Transparency Formulate single strategy for all State agencies dealing with contingent external liabilities Ensure strong coordination between public debt management and monetary policy Standardize across all State agencies: Methods for the valuation of contingent risks Rules for the use of financial engineering tools Monitoring and evaluation procedures Transparency strengthens creditworthiness
Prerequisites for disclosure and adequate risk awareness at the local level a database of local government direct and contingent obligations adequate institutional capacity, including the capacity to gather relevant information and understand risk exposures for internal disclosure, an adequate enforcement mechanism, including supportive legal environment (for instance, with respect to local government reporting on their direct and contingent obligations to the central government) for public disclosure, local governments should agree (or the central government may need to issue rules) on what information the make public
Beyond transparency For contingent government liabilities consider expected fiscal effects and integrate with the medium-term fiscal outlook consider effectiveness in the context of policy priorities and budget allocations consider efficiency (as a form of government support and source of government risk exposure)
Some questions to ask: Before assuming an obligation What form of government involvement? (deregulation, subsidy, contingent support, benefits and risks of alternative forms) How to design the program to cover only justifiable risks and to minimize moral hazard? (fit with policy priorities) What is the most likely and maximum likely future fiscal cost?. DMO What would be the marginal risk added to the overall government risk exposure? (ALM approach, possible future fiscal effects) DMO
When obligation is held: How to disclose, budget, and account for the potential fiscal cost? (implicit subsidy) How to monitor the program risk factors? (moral hazard) How to manage the risk? (portfolio approach, reserve requirement, hedging possibilities, purchase of reinsurance). DMO How to manage reserves to ensure reserve adequacy and avoid misuse?.. DMO
After obligation falls due How to execute the obligation to minimize its fiscal cost and moral hazard implications? When to accept an implicit obligation? (the fit with policy priorities, moral hazard impact) How to build accountability for dealing with contingent liabilities? (the role of performance management and independent audit)
In Conclusion In the context of fiscal transparency, turn focus from level of contingent liabilities to risks associated with them. These Risks may entail fiscal, financial and political costs, among others. Contingent liabilities may not be preferable but are a reality that all Governments have had to face. Issue CLs to improve efficiency of service delivery not just financial cost minimization objectives. Try to understand the sources of risks but also incentives guarnatees/credit enhancements may create to those who get them and precedence it may cause.