## Fiscal Risks: Sources, Disclosure, and Management

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---

### Major findings on fiscal risks
- Definition: "the possibility of deviations in fiscal variables from what was expected at the time of the budget or other forecast."
- Typical horizon: risks often materialize over "a horizon of a few years."
- Principal sources identified:
  - Unexpected deviations of economic growth from expectations.
  - Terms of trade shocks.
  - Natural disasters.
  - Calls on government guarantees and contingent liabilities (banking system, state-owned enterprises, subnational governments).
  - Interactions with private sector agents, including public-private partnerships (PPPs).
- Empirical significance emphasized for:
  - Exchange rate depreciations, especially with large foreign currency debt.
  - Increases in interest rates.
  - Adverse terms of trade shocks.
  - Declines in economic growth.
- Consequences of failure to disclose or prepare:
  - Additional government obligations.
  - Larger public debts.
  - Refinancing difficulties and crises.
  - Disruptive ad hoc adjustments during the fiscal year.

### Principles for identification, disclosure, and management
- Mutual reinforcement:
  - Identification is a prerequisite for disclosure and management.
  - Disclosure creates public and market pressure to identify and manage risks.
  - Sound risk management facilitates fuller disclosure with less adverse reaction.
- Identification requirements:
  - Clear allocation of responsibilities for collection, transmission, and analysis of fiscal-risk information.
  - Procedures ensuring the ministry of finance has access to relevant data.
- Disclosure considerations:
  - Comprehensive disclosure is desirable.
  - Exceptions allowed when disclosure may engender moral hazard or prejudice the state's negotiating/legal position.
- Cost-effective mitigation measures:
  - Sound macroeconomic policies and public financial management practices.
  - Practices requiring justification for taking on fiscal risks.
  - Requiring private sector agents to pay guarantee fees or share in risk.
  - Use of insurance instruments where markets allow (noted as exceptional).
- Legal and administrative frameworks:
  - Clarify relationships among government levels and with the private sector.
  - Allocate roles and responsibilities for collection, commitment, and use of public funds.
- Integration into fiscal analysis and budgeting:
  - Account for possibility that risks may materialize when determining fiscal targets.
  - Consider contingent obligation proposals alongside competing instruments during the budget process.
  - Parliamentary approval may be required for ceilings on total issuance of guarantees.
  - Procedures include budgeting for expected calls on contingent obligations and establishing notional or actual contingency funds.

### Practical outputs and scope
- Paper provides:
  - A possible Statement of Fiscal Risks.
  - A set of Guidelines for Fiscal Risk Disclosure and Management.
- Exclusions:
  - Long-term expenditure commitments (e.g., pension systems) are largely outside scope, though disclosure is recognized as necessary.
  - "Policy risks" (possible future changes in government policies) are typically not disclosed in budget documents.

### Evidence base and consultation
- Data sources:
  - Questionnaire responses covering advanced, emerging market, and developing economies.
  - Countries in questionnaire: Algeria, Armenia, Bosnia and Herzegovina, Brazil, Chad, Czech Republic, Egypt, France, Gabon, Germany, Ghana, Honduras, Hungary, Indonesia, Italy, Japan, Jordan, Kenya, Lebanon, Mexico, the Netherlands, New Zealand, Nigeria, Norway, Peru, the Philippines, Russia, Saudi Arabia, South Africa, Tanzania, and the United Kingdom.
  - Supplemental secondary-source information for Australia, Chile, Colombia, the United States, and OECD countries more generally.
- Presented at an IMF Executive Board seminar in June 2008.

### High-level policy recommendations
- Assign clear responsibilities and ensure data access for fiscal-risk identification and analysis.
- Promote comprehensive disclosure with limited, well-justified exceptions.
- Require explicit justification and cost-sharing when contingent liabilities or guarantees are created.
- Integrate contingent liabilities and fiscal risks into budget processes, including parliamentary oversight where appropriate.
- Strengthen legal and administrative frameworks delineating central and subnational roles and private-sector interactions.
- Consider contingent funding mechanisms (budgeted reserves or contingency funds) and require guarantee issuance to compete with direct appropriations during project appraisal.

### Dimensions of fiscal risk and implications for policy
- Temporary vs. permanent:
  - Temporary deficits in low-debt contexts: allow automatic stabilizers to work.
  - Permanent shocks: greater implications for fiscal sustainability.
- Correlation:
  - Positively correlated or mutually reinforcing shocks warrant greater policy action.
- Forecasting:
  - Deviations may reflect weak forecasting capacity or strategic forecasts; accurate forecasts are important.
- Quantification:
  - Quantitative disclosure depends on ability to estimate fiscal cost and probability; easier for macroeconomic risks and explicit guarantees than for implicit guarantees.
- Sensitivity:
  - Major fiscal risks often involve areas where managing public expectations is critical (e.g., banking system problems, overvalued exchange rates).

### Key empirical measures and decompositions
- Forecast error sample and method:
  - Panel: 27 advanced economies for 1995–2007 and 131 emerging and developing countries for 2002–07.
  - Unexpected changes = difference between year t forecasts (WEO October vintage of year t-1) and outturns (WEO October vintage of year t+1).
- Percentile measures (10th percentile unexpected worsening):
  - 7.2 percentage points for the debt-to-GDP ratio.
  - 1.7 percentage points for the fiscal balance to GDP ratio.
- Box 1 decomposition (Worst 10th Percentile of Forecast Error Distribution; percentage points of GDP):
  - Debt-to-GDP (All countries): 7.3
  - Debt-to-GDP (Advanced): 6.9
  - Debt-to-GDP (All emerging market and developing economies): 7.4
  - Debt-to-GDP (Oil-exporting): 5.9
  - Debt-to-GDP (Non oil-exporting): 7.7
  - Balance-to-GDP: 1.7 (All countries); –1.7 (Advanced); –1.9 (All emerging market and developing economies); –1.9 (Oil-exporting); –1.9 (Non oil-exporting)
  - Growth contribution: –1.1 (All countries); –1.3 (Advanced); –0.7 (All emerging market and developing economies); 0.3 (Oil-exporting); –0.9 (Non oil-exporting)
  - Residual term: 7.7 (All countries); 5.9 (Advanced); 10.5 (All emerging market and developing economies); 16.2 (Oil-exporting); 10.4 (Non oil-exporting)
  - Number of observations: 415 (All countries); 261 (Advanced); 154 (All emerging market and developing economies); 27 (Oil-exporting); 127 (Non oil-exporting)
- Interpretation: residual term (exchange rate depreciation, recognition of previously unrecorded obligations, and contingent liabilities) accounts for the bulk of unexpected increases in debt-to-GDP.

### Forward-looking and ex post quantitative impacts
- Forward-looking standardized tests (sample info preserved):
  - A one-half standard deviation permanent shock to real growth increases the debt-to-GDP ratio five years later by 6.8 percent of GDP on average.
  - A one-half standard deviation shock to the primary deficit raises the debt-to-GDP ratio by 5.2 percentage points.
  - A one-half standard deviation shock to interest rates leads to somewhat smaller average increases but can be significant where debt is primarily floating-rate.
  - For developing countries (limited sample), a decline in economic growth has an especially notable effect on debt dynamics.
- Exchange rate shock:
  - A one-time 30 percent real depreciation increases the debt-to-GDP ratio by 8 percent in the year of the shock and 6.5 percent after five years (advanced and emerging economies sample).
- Commodity price shock:
  - A US$20 decline in oil prices would worsen the overall fiscal balance by 10 percentage points of GDP in a sample of oil-producing countries.

### Major ex post sources of large fiscal costs (contingent liabilities)
- Banking crises:
  - Sample: 117 banking crises in 93 countries during 1977–98.
  - 24 episodes with cumulative costs exceeding 5 percentage points of GDP.
  - Estimated costs: 30–55 percent of GDP in Argentina, Chile, and Uruguay (early 1980s); 25–50 percent of GDP in Indonesia, Korea, and Thailand (1997–98); about 20 percent of GDP in Japan (1990s).
- Natural disasters:
  - Direct economic losses often exceeded 10 percentage points of GDP in developing countries and amounted to a few percentage points of GDP in some advanced countries.
- State-owned enterprises (SOEs):
  - Political interference, mismanagement, or irresponsible borrowing have led to costly government bailouts (examples in power sector, airlines, railways/metro, water authorities).
- Subnational government bailouts (examples and magnitudes):
  - Brazil: 7 percent of GDP in 1993 and 12 percent of GDP in 1997.
  - Argentina: 1 percent of GDP cumulative in mid-1990s.
  - Mexico: 1 percent of GDP after the Tequila crisis.
- Legal claims:
  - Bosnia and Herzegovina: frozen foreign currency deposits, 12 percent of GDP.
  - Chad: litigation on domestic arrears, 9 percent of GDP.

### Sources of fiscal risk: guarantees and PPPs
- Guarantees:
  - Explicit guarantees amounted to 12 percent of GDP on average in a sample of then pre-EU accession countries as of end-2002 (European Commission, 2004).
  - For questionnaire countries, explicit guarantees amounted to 5 percent of GDP.
- PPPs:
  - PPPs are an important source of fiscal risk, especially for large transport and power investments.
  - Historical examples: Colombia calls on demand guarantees resulted in cumulative payments of 2 percent of GDP by 2004.
  - Gross costs for individual PPP projects in some countries often amounted to ½ percent of GDP.
  - Survey respondents identified guarantees, especially those linked to PPPs, as among the most important future fiscal risks.

### Fiscal risk disclosure: benefits, standards, and practices
- Benefits of disclosure:
  - Helps manage risks, improve economic efficiency, and reduce borrowing costs.
  - Subjects analysis to scrutiny, improving assessment and recognition of risks.
  - Promotes earlier and smoother policy responses and strengthens accountability.
  - Cross-country evidence suggests fiscal transparency is associated with better sovereign bond ratings and greater access to international capital markets.
- Box 2 empirical result:
  - Moving from no disclosure to providing some information on macro-fiscal risks, contingent liabilities, or quasi-fiscal activities would improve credit ratings, on average, by a full notch (example: from Baa1 to A3 on Moody’s).
  - Sample consists of 56 countries surveyed during 1999–2007; reported p-value: 0.04 for the plotted association.
- International standards and initiatives:
  - IPSAS requires disclosure in notes of contractual contingent liabilities when the possibility of payment is “not remote.”
  - GFSM2001 requires disclosure of key contingent liabilities as a memorandum item.
  - IMF Code and Manual of Good Practices on Fiscal Transparency (2001, 2007) and OECD Best Practices for Budget Transparency (2001) recommend budget documentation indicate major risks and include statements on contingent liabilities’ nature, duration, beneficiaries, guarantee fees received, gross exposure, and, where feasible, potential budgetary cost estimates.

### Country disclosure and institutional practices (selected examples)
- Macroeconomic shock disclosure:
  - All EU countries, most OECD members, and some emerging market economies disclose macro assumption risks via sensitivity analyses, alternative scenarios, or stress tests.
- Contingent liabilities disclosure:
  - Many advanced economies disclose total exposure measured by guarantees’ face value (examples: Brazil, the Czech Republic, Honduras, Jordan, Mexico, and Tanzania).
  - PPP disclosures are growing (Colombia, Chile, Indonesia, Japan, Peru, South Africa, United Kingdom).
  - A few countries disclose legal claims (Australia, Indonesia, New Zealand).
- Rules and legal requirements:
  - Australia materiality cut-off: possible impact > A$20 million in any one year or A$40 million over the forward estimates period (about 0.01 percent of 2007 expenditures).
  - New Zealand similar; exemptions when disclosure would prejudice substantial economic interests, security, negotiations, or cause material loss.
  - Laws in Canada, Chile, Colombia, Czech Republic, France, and Peru require disclosure of contingent liabilities in fiscal responsibility or public financial management legislation.
- Consolidated fiscal risk statements:
  - Seven advanced and emerging market economies report fiscal risks in a single annual document covering guarantees, litigation, PPPs, quasi-fiscal deficits, natural disasters, and macro sensitivity.

### Fiscal risk management — mitigation and institutional arrangements
- Efficient mitigation principles:
  - Modify activity to reduce risk; transfer or share risk with parties able to manage it; allocate risk to actors with best incentives.
  - Contingent liability instruments issued only for externalities/market failure or when government better placed to manage risk.
  - Ex ante controls may be justified (e.g., limits on subnational borrowing or guarantees).
- Risk sharing and pricing:
  - Partial guarantees used to increase private lender incentives (private lenders bear 15–20 percent of net loss in some Canada and EU arrangements).
  - Time limits, termination clauses, beneficiary collateral, and guarantee fees commonly used.
- Hedging and insurance:
  - Limited use; examples include commodity hedging (Mexico) and catastrophe bonds (Mexico’s earthquake bond in 2006).
  - International facilities: Caribbean Catastrophe Risk Insurance Facility; World Bank (2007).
- Institutional design:
  - A central monitoring unit within the ministry of finance is often desirable.
  - Line ministries should manage risks they create, keep contingent liability registers, and seek treasury concurrence for guarantees.
  - Supreme Auditing Institutions (SAIs) play roles in ex post monitoring and audit across contingent liabilities, SOEs, subnational governments, and extra-budgetary funds (country examples cited).
- Country institutional examples:
  - South Africa: National Treasury’s asset and liability management division monitors debt and contingent liabilities.
  - Indonesia: risk management unit within ministry of finance analyzing SOE risks, government support to infrastructure, and global risks.
  - Debt management units in Canada, Czech Republic, Colombia, Denmark, New Zealand, and Sweden monitor contingent liabilities.
  - PPP units exist in Czech Republic, Egypt, Honduras, Hungary, Mexico; SOE units in Brazil, Kenya; subnational units in Indonesia, Peru; legal-claims unit in Ghana.

### Budget integration and operational measures
- Incorporate fiscal risks into fiscal sustainability analysis and macro framework.
- Annual contingency appropriations:
  - A limited centralized contingency appropriation may reflect country-specific circumstances (example amounts: New Zealand general contingency NZ$200 million, equivalent to 0.4 percent of expenditures).
- Guarantees and contingent obligations should be decided within the annual budget cycle, with parliamentary oversight via ceilings or approvals.
- Statement of Fiscal Risks:
  - Structure: describe overall fiscal strategy, list risk sources (macroeconomic risks, public debt composition, contingent central government expenditures, PPPs, SOEs, subnational governments).
  - For each source: provide forward-looking expected cost estimates and historical quantitative information.
  - Progressive enhancement: expand coverage and improve quantification over time (sensitivity analyses → interacting scenarios; gross exposure → expected present value).

### Country case studies and frameworks (selected boxes and appendices)
- Box 4 (PPPs): Indonesia, South Africa, Hungary, Netherlands—processes for appraisal, approval, monitoring, and fiscal reporting; examples of integrating PPP support into budgets and fiscal risk statements.
- Box 6 (Sweden):
  - Parliamentary approval required to issue a guarantee.
  - Fee charged for all guarantees unless parliament decides otherwise; fee set to cover expected cost and paid by recipient.
  - Swedish National Debt Office (SNDO) solely responsible for pricing guarantees using rating analysis, option pricing, or simulation models.
  - Guarantee fees are paid into a notional contingency fund; called guarantees are covered by the contingency fund, not the budget; fund can be overdrawn without limit.
- Appendix 1 (New Zealand):
  - Legal framework: Public Finance Act (PFA) accrual accounting; Fiscal Responsibility Act (FRA) requirements to reduce debt and prudently manage fiscal risks.
  - Disclosure requirements: sensitivity statements and statements of specific fiscal risks in budget documents.
  - Operational practices: external review of macro forecasts; independent tax forecasts by IRD; within-year contingency mechanisms including NZ$200 million general contingency (0.4 percent of expenditures).
  - Centralized monitoring system: "Inspect a Risk" register and treasury monitoring.
- Appendix 2:
  - Treasury practices: fiscal reporting division generates Statement of Specific Risks; financial asset portfolios match liability risk characteristics; SOEs report quarterly to shareholding ministers; debt management office aggregates assets/liabilities and manages balance sheet risks.
  - External audit by the comptroller and auditor general on fiscal risk information.

*Source: _dp0901 - Section II identifies the relative importance of various sources of fiscal risks, and related sections of the document.*

### 1.  Fiscal  policy.    2.  Budget—Forecasting.    3.  Risk  management.    4.  Disclosure  of

### Fiscal Risks: Sources, Disclosure, and Management

### Major findings on fiscal risks
- Fiscal risks are defined as "the possibility of deviations in fiscal variables from what was expected at the time of the budget or other forecast."
- Fiscal risks often materialize over "a horizon of a few years" and may arise from:
  - Unexpected deviations of economic growth from expectations.
  - Terms of trade shocks.
  - Natural disasters.
  - Calls on government guarantees and contingent liabilities (banking system, state-owned enterprises, subnational governments).
  - Interactions with private sector agents, including public-private partnerships (PPPs).
- Empirical evidence highlights the macroeconomic significance of:
  - Exchange rate depreciations, especially in countries with large foreign currency debt.
  - Increases in interest rates.
  - Adverse terms of trade shocks.
  - Declines in economic growth.
- Failure to disclose and prepare for fiscal risks has, in many instances, caused:
  - Additional government obligations.
  - Larger public debts.
  - Refinancing difficulties and crises.
  - Disruptive ad hoc adjustments during the fiscal year.

### Principles for identification, disclosure, and management
- Identification, disclosure, and management are mutually reinforcing:
  - Identification is a prerequisite for disclosure and management.
  - Disclosure creates public and market pressure to identify and manage risks.
  - Sound risk management facilitates fuller disclosure with less adverse reaction.
- Identification requires:
  - Clear allocation of responsibilities for collection, transmission, and analysis of fiscal-risk information.
  - Procedures ensuring that the entity setting fiscal policy (typically the ministry of finance) has access to relevant data.
- Disclosure considerations:
  - Comprehensive disclosure is desirable to facilitate identification and management.
  - Exceptions to disclosure may be warranted to avoid engendering moral hazard (for example, perception of an implicit blanket guarantee in the banking system) or to avoid prejudicing the state's economic interests in legal claims or negotiations.
- Cost-effective risk mitigation includes:
  - Sound macroeconomic policies and public financial management practices.
  - Practices that require justification for taking on fiscal risks.
  - Requiring private sector agents to pay guarantee fees or share in risk.
  - Use of insurance instruments where markets allow (noted as exceptional due to limited market development).
- Legal and administrative frameworks should:
  - Clarify relationships among different levels of government and with the private sector.
  - Allocate roles and responsibilities for collection, commitment, and use of public funds.
- Integration into fiscal analysis and budgeting:
  - The possibility that risks may materialize should be taken into account when determining fiscal targets.
  - Contingent obligation proposals should be considered alongside competing instruments during the budget process.
  - Ceilings on total issuance of guarantees may require parliamentary approval during the budget process.
  - Further procedures include budgeting for expected calls on contingent obligations and establishing notional or actual contingency funds.

### Practical suggestions and outputs developed in the paper
- The paper provides:
  - A possible Statement of Fiscal Risks.
  - A set of Guidelines for Fiscal Risk Disclosure and Management.
- The scope excludes:
  - Long-term expenditure commitments (e.g., pension systems) for which medium-term estimates are generally possible, though disclosure of such commitments is recognized as necessary.
  - "Policy risks" related to possible future changes in government policies, which are typically not disclosed in budget documents.

### Evidence base and consultation
- The analysis draws on:
  - Questionnaire responses covering several advanced, emerging market, and developing economies.
  - Countries covered in the questionnaire responses include Algeria, Armenia, Bosnia and Herzegovina, Brazil, Chad, Czech Republic, Egypt, France, Gabon, Germany, Ghana, Honduras, Hungary, Indonesia, Italy, Japan, Jordan, Kenya, Lebanon, Mexico, the Netherlands, New Zealand, Nigeria, Norway, Peru, the Philippines, Russia, Saudi Arabia, South Africa, Tanzania, and the United Kingdom.
  - Supplemental secondary-source information for countries including Australia, Chile, Colombia, the United States, and OECD countries more generally.
- The work was prepared in response to member-country interest and was presented at an IMF Executive Board seminar in June 2008.

### High-level policy recommendations
- Assign clear responsibilities and ensure data access for fiscal-risk identification and analysis.
- Promote comprehensive disclosure while allowing limited, well-justified exceptions to avoid moral hazard or prejudice to the state's negotiating/legal position.
- Require explicit justification and cost-sharing when contingent liabilities or guarantees are created.
- Integrate contingent liabilities and fiscal risks into budget processes, including parliamentary oversight where appropriate.
- Strengthen legal and administrative frameworks delineating central and subnational government roles and interactions with private sector agents.
- Consider contingent funding mechanisms (budgeted reserves or contingency funds) and require that guarantee issuance compete with direct appropriations during project appraisal.

*Prepared by the IMF Fiscal Affairs Department; paper presented at an IMF Executive Board seminar in June 2008.*

### Section II identifies the relative importance of various sources of fiscal risks,

### _dp0901 - Section II identifies the relative importance of various sources of fiscal risks,

### Overview
- Fiscal risks are deviations of fiscal outcomes from budget/forecast expectations and arise from macroeconomic shocks and realization of contingent liabilities.
- Contingent liabilities include:
  - Explicit liabilities: defined by law or contract (e.g., debt guarantees).
  - Implicit liabilities: moral or expected obligations (e.g., bailouts of banks or public sector entities).
- The paper distinguishes fiscal risks by features that affect disclosure and management: temporary vs. permanent, correlation, forecasting quality, quantification, and sensitivity.

### Dimensions of fiscal risk and implications for policy
- Temporary vs. permanent:
  - Temporary deficits from growth slowdowns in low-debt contexts may be managed by allowing automatic stabilizers to work.
  - Permanent shocks have more important implications for fiscal sustainability.
- Correlation:
  - Positively correlated or mutually reinforcing shocks (e.g., exchange rate, debt, banking crises) warrant greater policy action.
- Forecasting:
  - Deviations may reflect weak forecasting capacity or strategic forecasts (overly conservative or optimistic assumptions).
  - Highlights importance of accurate forecasts.
- Quantification:
  - Quantitative disclosure depends on ability to estimate fiscal cost and probability.
  - Easier for macroeconomic risks and explicit guarantees than for implicit guarantees.
- Sensitivity:
  - Major fiscal risks often relate to areas where managing public expectations is critical (e.g., banking system problems, overvalued exchange rates), affecting disclosure modalities.

### Macroeconomic significance of fiscal risks (empirical evidence)
- Comparison of WEO forecasts with outturns shows unexpected changes are often large and widely varying, with average near zero.
- Sample and measurement:
  - Panel: 27 advanced economies for 1995–2007 and 131 emerging and developing countries for 2002–07.
  - Unexpected changes computed as difference between year t forecasts (WEO October vintage of year t-1) and outturns (WEO October vintage of year t+1).
- Key empirical percentile measures:
  - 10th percentile unexpected worsening (10th worst realization in 100 observations):
    - 7.2 percentage points for the debt-to-GDP ratio.
    - 1.7 percentage points for the fiscal balance to GDP ratio.
  - Unexpected changes are somewhat larger in emerging/developing countries but substantial in advanced countries as well.
  - Large unexpected improvements observed for oil-exporting countries in years of oil price rises.

### Decomposition of unexpected increases in debt-to-GDP ratio (Box 1)
- Unexpected increases decomposed into:
  - Unexpected rises in deficits.
  - Contribution from unexpected economic growth slowdowns.
  - Residual term including exchange rate depreciation and calls on contingent liabilities.
- Empirical findings (Worst 10th Percentile of Forecast Error Distribution; percentage points of GDP):
  - Debt-to-GDP (All countries): 7.3
  - Debt-to-GDP (Advanced): 6.9
  - Debt-to-GDP (All emerging market and developing economies): 7.4
  - Debt-to-GDP (Oil-exporting): 5.9
  - Debt-to-GDP (Non oil-exporting): 7.7
  - Balance-to-GDP: 1.7 (All countries); –1.7 (Advanced); –1.9 (All emerging market and developing economies); –1.9 (Oil-exporting); –1.9 (Non oil-exporting)
  - Growth contribution: –1.1 (All countries); –1.3 (Advanced); –0.7 (All emerging market and developing economies); 0.3 (Oil-exporting); –0.9 (Non oil-exporting)
  - Residual term: 7.7 (All countries); 5.9 (Advanced); 10.5 (All emerging market and developing economies); 16.2 (Oil-exporting); 10.4 (Non oil-exporting)
  - Number of observations: 415 (All countries); 261 (Advanced); 154 (All emerging market and developing economies); 27 (Oil-exporting); 127 (Non oil-exporting)
- Variance decomposition (set equal to 100) indicates the residual term accounts for the bulk of unexpected changes in debt-to-GDP; surprises in the deficit or growth play smaller roles.

### Quantitative impacts from forward-looking and ex post estimates
- Forward-looking standardized tests (IMF debt sustainability templates; sample of 19 advanced and emerging market countries; seven developing countries for some shocks):
  - A one-half standard deviation permanent shock to real growth increases the debt-to-GDP ratio five years later by 6.8 percent of GDP on average.
  - A one-half standard deviation shock to the primary deficit raises the debt-to-GDP ratio by 5.2 percentage points.
  - A one-half standard deviation shock to interest rates leads to somewhat smaller average increases but can be more significant where debt is primarily floating-rate.
  - For developing countries (limited sample), a decline in economic growth has an especially notable effect on debt dynamics.
- Exchange rate shock:
  - A one-time 30 percent real depreciation increases the debt-to-GDP ratio by 8 percent in the year of the shock and 6.5 percent after five years in the advanced and emerging economies sample.
- Commodity price shock:
  - A US$20 decline in oil prices would worsen the overall fiscal balance by 10 percentage points of GDP in a sample of oil-producing countries.
- Combined shocks and ranges (Table 1 summary statistics retained in source):
  - Reported measures include Mean, Median, Minimum, Maximum, Standard deviation for impacts of shocks on debt-to-GDP for Advanced and Emerging Market Economies and Developing Countries (exact tabular entries preserved in source).

### Major ex post sources of large fiscal costs (contingent liabilities)
- Banking crises:
  - Sample: 117 banking crises in 93 countries during 1977–98.
  - 24 episodes with cumulative costs exceeding 5 percentage points of GDP.
  - Estimated costs: 30–55 percent of GDP in Argentina, Chile, and Uruguay (early 1980s); 25–50 percent of GDP in Indonesia, Korea, and Thailand (1997–98); about 20 percent of GDP in Japan (1990s).
  - Costs arise from depositor and debtor bailouts, open-ended liquidity support, repeated recapitalizations; often larger after years of implicitly subsidized lending by state-owned financial institutions.
- Natural disasters:
  - Direct economic losses often exceeded 10 percentage points of GDP in developing countries and amounted to a few percentage points of GDP in some advanced countries.
  - Losses are unevenly distributed geographically; fiscal deficits have risen substantially after disasters in some Latin American and Caribbean episodes.
- State-owned enterprises (SOEs):
  - Political interference, mismanagement, or irresponsible borrowing have led to costly government bailouts.
  - Examples in power sector, airlines, railways/metro, water authorities with fiscal impacts cited in source (percent-of-GDP examples preserved in source).
- Subnational government bailouts:
  - Central government rescue packages have had large costs in some cases:
    - Brazil: 7 percent of GDP in 1993 and 12 percent of GDP in 1997.
    - Argentina: 1 percent of GDP cumulative in mid-1990s.
    - Mexico: 1 percent of GDP after the Tequila crisis.
- Legal claims:
  - Governments have paid sizable compensations in various legal cases; examples include:
    - Bosnia and Herzegovina: frozen foreign currency deposits, 12 percent of GDP.
    - Chad: litigation on domestic arrears, 9 percent of GDP.
    - Other instances include claims related to privatization, liquidation of SOEs, personnel management, property compensation, tax refunds, bank restructuring guarantees, and environmental cleanup.

### Key implications emphasized in the section
- The residual term (exchange rate depreciation, recognition of previously unrecorded obligations, and contingent liabilities) is a key determinant of unexpected increases in debt-to-GDP.
- Large fiscal costs often originate from contingent liabilities rather than from predictable variations in deficits or growth alone.
- Accurate forecasting, quantitative disclosure where feasible, and management strategies targeted to the nature of the risk (temporary vs. permanent; correlated vs. idiosyncratic; explicit vs. implicit liabilities) are essential for fiscal risk mitigation.

*Source: _dp0901 - Section II identifies the relative importance of various sources of fiscal risks,*

### 0.6 percent of GDP yearly over the past five years.

### _dp0901 - 0.6 percent of GDP yearly over the past five years.

### Sources of Fiscal Risk
- Guarantees:
  - Explicit guarantees legally binding the government amounted to 12 percent of GDP on average in a sample of then pre-EU accession countries as of end-2002 (European Commission, 2004).
  - For countries with questionnaire responses, explicit guarantees amounted to 5 percent of GDP.
  - Systematic information on actual calls on guarantees is limited, but potential risks from guarantees are substantial.
- Public-private partnerships (PPPs):
  - PPPs have gained importance as a source of fiscal risks, particularly for large investment projects in transportation infrastructure and the power sector (Hemming and others, 2006).
  - PPPs often entail fiscal obligations not captured in fiscal accounts (for example, state guarantees for concessionaire borrowing, minimum revenues, or exchange rate losses).
  - Anecdotal evidence exists of costly PPP failures due to unrealistic demand projections or shortcomings in project planning and management.
  - Historical examples:
    - During the 1990s, calls on demand guarantees related to PPPs in power, telecoms, and toll roads in Colombia resulted in cumulative payments of 2 percent of GDP by 2004.
    - Substantial obligations on PPP contracts in power plants and roads also became due in Indonesia, Malaysia, and Thailand during the Asian crisis.
    - More recently, governments provided new state guarantees, equity contributions, operating subsidies, or full bailouts and renationalization in transportation infrastructure in countries including Australia, Hungary, Mexico, and the United Kingdom (OECD/ITF, 2008), with gross costs for individual projects often amounting to ½ percent of GDP.
- Outlook:
  - Survey respondents identified guarantees, especially those linked to PPPs, as among the most important sources of fiscal risks in the future.
  - Many PPP contracts involve even larger fiscal risks for the long term than for the medium term.

### Fiscal Risk Disclosure (benefits and trends)
- Benefits of public disclosure:
  - Helps manage risks, improve economic efficiency, and reduce borrowing costs.
  - Subjects analysis to additional scrutiny, improving assessment and recognition of risks.
  - Promotes earlier and smoother policy responses and strengthens accountability for risk management.
  - Encourages careful assessment of cost-effectiveness and inspection for implicit subsidies even when contingent expenditures imply low macroeconomic risks.
  - Cross-country evidence (Box 2) suggests fiscal transparency is associated with better sovereign bond ratings and greater access to international capital markets (see also Glennerster and Shin, 2008; and Hameed, 2005).
  - Fiscal transparency has been found to foster FDI (Drabek and Payne, 2002).
- Trend:
  - There is a trend toward greater disclosure of information on fiscal risks driven by international accounting/statistical standards, fiscal responsibility/public financial management legislation, and transparency initiatives (IMF Code and Manual of Good Practices on Fiscal Transparency (2001, 2007); OECD Best Practices for Budget Transparency (2001)).

### Box 2: Fiscal Risk Transparency and Credit Ratings (key findings)
- Fiscal transparency measures:
  - “Overall fiscal transparency” based on 20 attributes of good fiscal transparency practices.
  - “Fiscal risk disclosure” based on a subset of four aspects of disclosure in budget documentation for contingent liabilities, quasi-fiscal activities, and other fiscal risks.
- Empirical results:
  - Cross-country regressions show fiscal transparency variables are positively related to sovereign ratings, controlling for per capita income, inflation, default history, and political stability; estimated coefficients are statistically and economically significant.
  - The estimated coefficient suggests countries moving from no disclosure of macro-fiscal risks, contingent liabilities, or quasi-fiscal activities to providing some information on all these counts would improve their credit ratings, on average, by a full notch (e.g., from Baa1 to A3 on Moody’s ratings).
  - Sample and statistical notes:
    - Sample consists of 56 countries, surveyed at different points during 1999–2007.
    - Reported p-value: 0.04 for the plotted association.
  - An alternative two-stage approach on a cross section of 62 emerging market/developing countries (of which only 24 have market access, i.e., issue bonds internationally) finds:
    - Greater transparency is positively and significantly associated with market access, controlling for trade openness and country size.
    - The null hypothesis of no direct relationship between transparency and bond spreads cannot be rejected, likely because of the small number of countries for which spreads exist.

### International standards and transparency initiatives
- Accounting and statistical standards:
  - IPSAS (International Public Sector Accounting Standards) for accrual accounting require disclosure in notes to financial statements of contractual contingent liabilities when the possibility of payment is “not remote.”
  - Under cash accounting, disclosure similar to accrual standards is recommended, though not required.
  - Government Finance Statistics Manual 2001 requires disclosure of key contingent liabilities as a memorandum item to the balance sheet.
  - An international OECD task force is studying the feasibility of harmonizing different international government accounting and statistical standards.
- Further recommendations from fiscal transparency initiatives:
  - IMF Code and Manual and OECD Best Practices recommend budget documentation, mid-year reports of budget execution, and end-year financial statements should:
    - Indicate the major risks.
    - Include statements on contingent liabilities’ nature and policy purpose, duration, intended beneficiaries, guarantee fees received, the government’s gross exposure, and, where feasible, an estimate of the potential budgetary cost (net of possible loss recovery).

### Country experiences (disclosure practices)
- Macroeconomic shock risks:
  - All EU countries, most OECD members, and some emerging market economies (e.g., Brazil, Chile, and Indonesia) disclose risks associated with macroeconomic assumptions (growth, inflation, interest rates, exchange rates, international oil prices) through sensitivity analyses, alternative macroeconomic scenarios, or stress tests for fiscal aggregates.
  - Uncertainty around baseline projections is sometimes illustrated through a fan chart (example: the United States’ Budget and Economic Outlook).
- Contingent liabilities:
  - Information on some contingent liabilities—loan guarantees in particular—is frequently disclosed, though the extent of disclosure varies.
  - Countries disclosing such information include most advanced economies, the majority of EU acceding states, a third of the remaining emerging and transition economies, and a handful of developing countries.
  - Reported information usually consists of total exposure measured by the guarantees’ face value (examples: Brazil, the Czech Republic, Honduras, Jordan, Mexico, and Tanzania), sometimes complemented by additional detail.

*Source: _dp0901 - 0.6 percent of GDP yearly over the past five years.*

### Box 3. Disclosure of Contingent Liabilities: International Accounting and

### Box 3. Disclosure of Contingent Liabilities: International Accounting and

### Accounting Standards (IPSAS)
- Under accrual accounting, contingent liabilities (in the accounting sense of possible payments linked to events that are less than likely to occur) are not recognized as liabilities and expenses in government accounts.
- For each class of contingent liability the government is required to disclose in notes to financial statements (except when the possibility of any payment is remote):
  - (i) a description of the nature of the contingent liability;
  - (ii) where practicable, an estimate of the financial effect, e.g., the present value of any payments;
  - (iii) an indication of the uncertainties about amounts or timing; and
  - (iv) possible reimbursement.
- If the probability that payments would have to be made is more than 50 percent, and the payments can be reliably estimated, the government is required to recognize in its accounts a liability (referred to as provision) and a corresponding expense.
- Disclosure requirements for provisions include:
  - (i) stocks at the beginning and end of the period;
  - (ii) breakdown of the flows during the period;
  - (iii) description of the nature of the obligation and the timing of payments;
  - (iv) indication of uncertainties regarding amount and timing; and
  - (v) the amount of any reimbursement.
- Under cash accounting, standards allow, but do not require, disclosure of information about contingent liabilities along the lines set out above.
- Exemptions from disclosure requirements are allowed when disclosure may prejudice the government’s position in a dispute; in such cases the general nature of the dispute and the reason for nondisclosure should be reported.
- Note in source: The IASB is considering changes to the treatment of contingent liabilities: the term “contingent liability” may no longer be used and provisions may have to be made for all items currently treated as “contingent liabilities;” the uncertainty about whether a payment is required would cease to be a recognition criterion and, instead, would be reflected in the measurement of the liability.

### Statistical Reporting Standards (GFSM2001)
- A contingent liability is recognized as a liability only when the contingency materializes and the payment is due, primarily to ensure consistency of national accounts with no overlap between public and private sector balance sheets.
- Statistical standards require disclosing all contingent liabilities as a memorandum item to the balance sheet, including:
  - a description of the nature of the various contingencies; and
  - the present value of expected government payments or other indication of their value.

### Disclosure Practices and Coverage across Countries
- Disclosure is more common for established explicit contingent liabilities such as guarantees; methods of disclosure include:
  - expected cost of outstanding guarantees (examples: Colombia and Chile);
  - guarantees likely to be called (Hungary);
  - flow of new guarantees (Japan);
  - calls on guarantees (South Africa);
  - revenues from guarantee premiums (Netherlands).
- Disclosure is less frequent for more recent or harder-to-quantify risks:
  - PPP-related fiscal risks disclosed by a growing but limited set of countries: Colombia, Chile, Indonesia, Japan, Peru, South Africa, and the United Kingdom.
  - Typical PPP disclosures: description of government guarantees under PPP contracts, projects’ total value, expected cash flow payments or their net present value.
  - Legal claims against the state: only a few countries provide information on nature and scope (Australia, Indonesia, and New Zealand); prospective amounts rarely disclosed (Brazil and New Zealand sometimes report gross amount with disclaimer).
  - A few countries disclose selected “policy risks” (New Zealand).
- Approaches to assessing disclosed amounts for explicit contingent liabilities:
  - Most governments disclose gross exposures; a few report expected cost estimates.
  - Some countries analyze guaranteed amounts and call probabilities using stochastic simulations or option pricing models (Chile, Colombia, Peru, and Sweden).
  - Some use a risk ratings approach (example: South Africa uses a 1 to 10 scale based on qualitative and quantitative criteria).
- Coverage gaps:
  - Disclosure varies for state-owned enterprises (SOEs), subnational governments, and off-budget accounts.
  - Several countries publish general government accounts or comprehensive public sector accounts; two-thirds of sampled countries publish significant information in these areas, but gaps remain.

### Rules and Legal Requirements for Disclosure
- Few countries follow well-defined rules deciding which fiscal risks should not be disclosed.
  - Australia and New Zealand translate materiality into specific cut-off points for disclosing individual contingent liabilities.
  - Australia defines as material those fiscal risks with a possible impact on the forward estimates greater than A$20 million (about 0.01 percent of 2007 expenditures) in any one year, or A$40 million over the forward estimates period. New Zealand uses a similar definition.
  - New Zealand exempts from disclosure information likely to prejudice substantial economic interests, harm security or defence, compromise the government in negotiation/litigation/commercial activity, or result in material loss of value to the government.
- Some countries require risk reporting in fiscal responsibility or public financial management laws, often calling for disclosure of government contingent liabilities (examples: Canada, Chile, Colombia, the Czech Republic, France, and Peru).
  - In some cases these laws entail comprehensive reporting of all risks that could affect the fiscal outlook, including sensitivity to economic conditions and long-term demographic risks (examples: Australia, Brazil, New Zealand, and the United Kingdom).

### Consolidated Fiscal Risk Statements and Trends
- A few countries consolidate fiscal risk information in a single annual document; seven advanced and emerging market economies currently report fiscal risks in a single document.
  - Risks covered include explicit government guarantees; contingent liabilities from litigation; guarantees to infrastructure operators; quasi-fiscal deficit of the central bank; natural disasters; and sensitivity of the fiscal outlook to macroeconomic shocks.
  - Some countries discuss SOE performance and implicit contingent liabilities.
- Countries have gradually increased the coverage of disclosed risks over time:
  - Colombia extended contingent liability estimates from central government to other public sector parts.
  - Chile phased in disclosure types: first minimum revenue guarantees under PPPs and minimum pension guarantees, later loan guarantees to public enterprises, then student loan guarantees and lawsuits against the state.
  - Indonesia’s 2009 fiscal risk statement expected to deepen assessment of the public enterprise sector.

### Fiscal Risk Management — Mitigation
- Risk mitigation principles:
  - Sound macroeconomic policies and appropriate debt management strategies are first-order mitigants.
  - Clear policy frameworks help assess whether taking on new risks is justified.
  - Mitigation should allocate risks to economic agents best able and incentivized to manage them; options include modifying activities, transferring or sharing risks.
  - Decisions depend on correlation and offsetting properties of risks.
- Country practices:
  - Many countries have debt management strategies; some have formal strategies (Armenia, Egypt, Hungary, Indonesia, Italy, Japan, and Mexico).
  - Some countries set explicit targets for debt duration, maturity profile of debt service, shares of floating-rate debt and foreign currency debt (example: South Africa).
  - Debt management techniques such as swaps are common to reduce foreign exchange or interest rate exposure.
- Risk sharing with the private sector:
  - Partial guarantees used to increase private lenders’ incentives (example: Canada and EU countries, where private sector lenders bear 15–20 percent of the net loss associated with any default).
  - Other arrangements: time limits for contingent claims; termination clauses; beneficiary collateral requirements (example: Australia).
  - PPPs: project-specific risks typically transferred to private sector; governments accept economy-wide risks (force majeure, regulatory, political); approaches vary for demand risk (examples include full transfer, retention with availability payments, shared with traffic/revenue guarantees in Chile, Colombia, and Korea).
- Use of hedging and insurance:
  - Few countries use financial hedging or insurance widely; reluctance due to accountability, cost, or emphasis on self-insurance.
  - Some commodity producers hedge commodity price risk (example: Mexico for oil price shocks).
  - A few sovereigns have issued catastrophe bonds (example: Mexico’s earthquake bond in 2006).
  - International insurance facilities exist for natural disaster fiscal risks (example: Caribbean Catastrophe Risk Insurance Facility; World Bank, 2007).

### Legal and Administrative Framework; Institutional Arrangements
- Effective fiscal risk management is facilitated by:
  - Clear allocation of roles and responsibilities across central government and public sector entities for collection, investment, and use of public funds.
  - A single government unit with authority and accountability for monitoring and coordinating overall fiscal risk, often desirable within the ministry of finance.
  - Line ministries, departments, and agencies having responsibility for risks to which they are exposed, depending on capacity.
- Country experiences with institutional arrangements:
  - Few sampled countries have a special institutional unit responsible for overall fiscal risks; some have dedicated units for specific risks.
  - South Africa: a single central unit (National Treasury’s asset and liability management division) monitors and manages government debt and contingent liabilities.
  - Indonesia: recently established risk management unit within ministry of finance analyzing SOE risks, government support to infrastructure, and global economic risks; separate units for debt management and subnational governments.
  - Debt management units in many countries have extended scope to monitor contingent liabilities (examples: Canada, Czech Republic, Colombia, Denmark, New Zealand, and Sweden).
  - Specialized units exist for PPPs (Czech Republic, Egypt, Honduras, Hungary, Mexico), SOEs (Brazil, Kenya), subnational governments (Indonesia, Peru), and legal claims (Ghana); pensions/social security units in many countries.
- Role of line ministries:
  - In several countries line ministries are accountable for fiscal risk management, maintain registers of contingent liabilities, and manage issuance of guarantees (with government concurrence).
  - Examples: Netherlands delegates budget management to financial affairs directorates in line ministries; South Africa assigns internal control and contingent liability registers to accounting officers; France decentralized fiscal management; New Zealand departmental chief executives maintain contingent liability registers; Armenia holds line ministries accountable for fiscal risks of entities they established.
- Role of Supreme Auditing Institutions (SAIs):
  - SAIs play important roles in ex post monitoring, auditing, and certifying government accounts, including aspects of accounting and reporting of fiscal risks.
  - SAI involvement examples:
    - Contingent liabilities: Ghana, Russia.
    - SOEs: South Africa, Kenya, Indonesia, Japan, Hungary, Lebanon, Philippines.
    - Subnational governments: South Africa, Kenya, Japan, BIH.
    - Some extra-budgetary funds: Kenya, Indonesia, BIH.
    - Pension and petroleum funds: Norway.
  - Czech Republic: audit coverage includes all public institutions receiving state guarantees, foreign loans, or budget money.
  - Hungary: State Audit Office assesses credibility of expenditure and revenue estimates and monitors local government financial management.
  - Philippines: Audit Commission adopts remedial measures where internal controls are insufficient.
  - United Kingdom: National Audit Office audits key assumptions underlying budget projections (at least once every three years).
  - In a number of countries the SAI monitors all aspects of budget execution including fiscal risks (examples: Italy, France).

### Institutional Centralization and Decentralization
- Degree of centralization in management of PPPs, SOEs, and subnational governments varies:
  - Decentralization to line ministries is associated with greater institutional development.
  - Decentralization to subnational governments reflects historical and political factors.
- The text notes that country examples for PPPs and subnational governments are provided in Boxes 4 and 5 (not included here).

*Source: IMF staff compilation from the provided content.*

### Box 4. Public-Private Partnerships (PPPs) and Fiscal Risks in

### Box 4. Public-Private Partnerships (PPPs) and Fiscal Risks in Selected Countries

### Country arrangements for PPP appraisal, approval, monitoring, and fiscal reporting
- Indonesia
  - PPP proposals are submitted to the recently created PPP unit, which decides whether they meet technical and financial feasibility criteria.
  - The risk management unit of the ministry of finance evaluates costs that may arise from government support to PPPs and helps ensure that this support is transparent.
  - If the request for government support is approved by the minister of finance, an allocation of funds is then proposed in the draft annual budget.
  - A list of PPPs together with government support and gross exposure is presented in the fiscal risk statement.
- South Africa
  - The accounting officer or authority of the public institution involved in the PPP project is responsible for monitoring and managing it.
  - Fiscal costs of existing PPPs are captured in the budget review and the medium-term budget policy statement; a list of existing PPPs, together with government commitments, is published quarterly.
  - The accounting treatment of PPPs is currently under review. New standards are expected to require the recording of contingent liabilities from PPPs on the government’s balance sheet.
- Hungary
  - PPPs are handled by several government institutions: the promoting ministry or agency, an interministerial committee on PPPs, the council of ministers, and (for projects above a certain threshold) parliament.
  - The interministerial committee can propose amendments to existing regulations on PPPs, express its opinion on specific projects, and monitor and evaluate their implementation.
  - The ministry of finance proposes a ceiling on budget commitments associated with PPPs.
- Netherlands
  - Limited experience so far, but likely to gain importance.
  - PPPs are managed by line ministries, though the ministry of finance oversees project implementation.
  - The ministry of finance provides information on Eurostat rules and examines whether:
    - (i) the use of a PPP is preferable to traditional public investment forms;
    - (ii) PPP project costs are within the multiyear budget; and
    - (iii) PPP-related expenditures fit in the overall expenditure framework.
  - Current policy is to encourage specialized PPP knowledge centers in line ministries and decentralized development of simple PPP arrangements by municipalities.

### Integration of PPPs and contingent liabilities into fiscal risk management and the budget process
- Fiscal risk reporting
  - Indonesia: PPPs listed with government support and gross exposure in the fiscal risk statement.
  - South Africa: lists of PPPs and government commitments published quarterly; work underway to record contingent liabilities on the government balance sheet under new accounting standards.
- Budgetary decision points
  - Indonesia: government support approvals lead to proposed allocations in the draft annual budget.
  - Hungary: ministry of finance proposes ceilings on budget commitments linked to PPPs.
  - Netherlands: ministry of finance assesses PPP suitability relative to traditional investment and budget constraints before implementation.

### Key themes from broader fiscal risk disclosure and management context (excerpts relevant to PPPs)
- Fiscal analysis and budget process
  - When determining fiscal targets, allowance needs to be made for the possibility that some risks will materialize.
  - Budgetary mechanisms (such as contingency appropriations) should provide adequate flexibility to handle risks that arise during budget implementation, while preserving the integrity of the original budget.
  - Close integration of fiscal risk management and the budget process calls for decisions on contingent liabilities to be incorporated in the annual budget cycle.
  - Given the medium- or long-term nature of many contingent liabilities, it is important to assess their implications for fiscal sustainability.

*Source: Box 4. Public-Private Partnerships (PPPs) and Fiscal Risks in Selected Countries (excerpt).*

### Box 6. Sweden’s Framework for Guarantees

### Box 6. Sweden’s Framework for Guarantees

### Approval
- A guarantee can only be issued based on a decision by parliament.

### Guarantee fees and integration with the budget
- A fee must be charged for all guarantees, unless parliament decides otherwise.
- The fee is set to cover the guarantee’s expected cost and is paid directly to the state by the guarantee’s recipient.
- If parliament decides that a fee should not be charged (and this is allowed under state aid rules), then budget funds must cover the fee.
- A subsidized guarantee is treated in the budget process in a way akin to a direct subsidy.
- These rules ensure that subsidy elements in guarantees are recorded in the budget, and that the government either gets a payment from the guaranteed firm or, in the case of a subsidized guarantee, that other expenditures are reduced.

### Setting guarantee fees
- Once the conditions for the guarantee have been determined, the responsibility for pricing the guarantee rests solely with the Swedish National Debt Office (SNDO).
- Neither parliament nor the government has any direct say in pricing decisions.
- To determine the appropriate fee, the SNDO analyzes specific project risks covered by the guarantee, by reference to rating analysis, option pricing, or simulation models.

### Contingency Fund
- Guarantee fees are paid into a notional contingency fund.
- Fees paid thus reduce central government debt, but should leave more room to borrow if the guarantee is called upon.
- Called guarantees are covered by the contingency fund, not the budget.
- The contingency fund account can be overdrawn without limit, ensuring that the state cannot end up in technical default.

*Source: Box 6. Sweden’s Framework for Guarantees (draws on Hörngren (2003)).*

### 2.    Fiscal risks should be mitigated in a cost-effective manner.

### _dp0901 - 2.    Fiscal risks should be mitigated in a cost-effective manner.

### Efficient risk mitigation: principles and practices
- Efficient risk mitigation involves:
  - modifying the activity to reduce risk;
  - taking up insurance or otherwise transferring the risk to, or sharing the risk with, other parties, particularly those that are able to influence risk outcomes;
  - allocating risks based on an assessment of which economic agents have the best ability and incentives to bear and manage risks.
- A clear policy framework on fiscal risk mitigation helps assess the justification for proposals to take on new risks; independent expert review is also helpful.
- A clear policy framework should consider:
  - expected net benefits from risk reduction while attending to: the possibility of extreme realizations imposing unacceptably large fiscal costs; interactions between different risks; and scenarios in which a number of risks materialize at the same time;
  - the specific rationale for taking on a risk (e.g., issuing a guarantee) should be documented and available for subsequent review.
- Allocation of risks:
  - allocate risks to the economic actor best able and incentivized to manage and bear them (example: in PPP contracts or guarantees, government bears risk of future policy/regulatory changes; private sector bears construction risk or foreign exchange risk where they can control or mitigate these).
- Contingent liability instruments should be issued only in cases of externalities/market failure or where the government is better placed to manage necessary risks.
- Economic actors that influence the government’s fiscal risk exposure could pay a charge for their reduced risk exposure, or bear some risk at the margin.
- Ex ante controls may be justified on risk-taking activities of actors with weak incentives or that impose costs on others (example: limits on borrowing or issuance of guarantees by subnational governments to minimize macro/fiscal bailout risk).
- When a risk materializes and central government intervenes to absorb costs incurred by other entities, intervention should preserve or strengthen incentives for future risk management.
- Guarantee proposals should be subject to scrutiny and prioritization, balancing insurance and incentive considerations via mechanisms such as guarantee fees; partial guarantees; quantitative ceilings; termination clauses; or collateral requirements.

### Legal and administrative framework for fiscal risk management
- Effective management of residual fiscal risks depends on clear allocation of roles and responsibilities—especially between the central government and the rest of the public sector (including subnational governments)—for collection, investment, commitment, and use of public funds.
- A central unit with authority and accountability should monitor overall fiscal risk and coordinate management, considering interactions among different sources of risk; locating such a unit within the ministry of finance can help integrate risk management into overall fiscal management.
- Line ministries and agencies should have clearly specified responsibilities for prudently managing fiscal risks to which they are exposed, subject to capacity constraints.
- Relationships among levels of government:
  - the entity with primary interest in managing the fiscal position (typically the ministry of finance) should be responsible for overall monitoring and management of fiscal risks and have the necessary authority;
  - fiscal risk responsibilities across levels of government and their relationships should be clearly specified, including legal clarity on who may authorize borrowing, investment, and issuance of contingent obligations.
- Centralized technical capability:
  - there should be a centralized technical capability for analysis and advice to government and technical support to line ministries and other public sector entities on fiscal risk management aspects (e.g., PPPs, via a PPP unit).
- Compensation and clarity:
  - the government should fully and timely compensate public enterprises, the central bank, and public financial institutions from the central government budget for noncommercial obligations it requires them to undertake.

### Risk management responsibilities and controls
- Department/agency heads allowed to take on risks should be responsible for prudent management of their entity’s fiscal risks and required to have a risk management strategy.
- An assessment of fiscal risks should be conducted before the government enters contractual arrangements with public or private entities (including resource companies and concession operators); such arrangements should:
  - be clear about apportionment of fiscal risk;
  - be appropriately reflected in government accounts;
  - be publicly accessible to the extent possible.
- Separation of responsibilities:
  - responsibility for taking on risks should be separate from responsibility for estimating their potential fiscal costs (example: line ministries issuing guarantees should not assess expected cost of such guarantees without outside supervision);
  - guidelines should be in place on how to “price” risks.
- Audit: fiscal activities that create risk (including off-budget activities) should be subject to internal audit and audit by the supreme auditing institution.

### Incorporating fiscal risks into fiscal analysis and the budget process
- When determining fiscal targets, allowance needs to be made for the possibility that some risks will materialize.
- For government guarantees and other contingent liabilities:
  - decisions should be integrated into the annual budget cycle;
  - analyze fiscal sustainability implications of the medium- or long-term nature of many contingent liabilities.
- Incorporating risk analysis into macroeconomic policy framework:
  - government exposure to fiscal risks should be incorporated into fiscal sustainability analysis;
  - the government should have a fiscal policy strategy for unexpected changes in revenues or expenditures (example: in high revenue volatility situations, mechanisms such as binding expenditure ceilings should be in place to prevent temporary revenue increases translating into excessive spending).
- Annual contingency appropriation:
  - the general risk of uncertain expenditures in the budget year may be handled through a limited annual centralized contingency appropriation, whose magnitude reflects country-specific circumstances (example: frequency and cost of natural disasters);
  - this can provide flexibility to manage risks materializing during budget implementation while preserving the integrity of the original budget.
- Guarantees and contingent obligations:
  - decisions over issuance of guarantees and other contingent obligations should be integrated with the annual budget cycle to consider them alongside competing instruments and programs;
  - a framework should require parliamentary approval of guarantees through an overall ceiling on guarantees, a ceiling on broad categories of guarantees, or approval of individual guarantees;
  - an annual budget appropriation could cover expected calls on guarantees in the fiscal year, either in a general contingency appropriation or, where likely costs are significant and estimable, in separate appropriations for anticipated calls on individual guarantee programs (example: a housing loan guarantee program).

### Statement of Fiscal Risks: structure and progressive development
- The statement of fiscal risks should begin with the government’s description of how its overall fiscal strategy has reduced fiscal risks and an indication of the importance of greater fiscal transparency for reliability and credibility.
- The statement could address sources of fiscal risks including:
  - (a) macroeconomic risks and budget sensitivity;
  - (b) public debt composition;
  - (c) contingent central government expenditures;
  - (d) public-private partnerships;
  - (e) state-owned enterprises; and
  - (f) subnational governments.
- For each source of risk, forward-looking expected cost estimates should be complemented by quantitative information on costs incurred from past shocks.
- The statement is a work in progress: risk coverage should be extended and quantitative estimates improved each year. Examples of progressive enhancement:
  - on macroeconomic risks, initial sensitivity analysis to individual parameter changes could evolve into full analyses of alternative macroeconomic scenarios with interacting shocks;
  - contingent expenditure coverage could start with largest contingencies and gradually extend to all guarantees and guarantee-like instruments;
  - quantification could move from gross exposure to the expected present value of expenditures where feasible.

*Source: _dp0901 - 2.    Fiscal risks should be mitigated in a cost-effective manner.*

### Appendix 1

### Appendix 1

### New Zealand’s approach to fiscal risk disclosure and management — background and legal framework
- Public financial management reforms of the 1980s created a legal framework assigning clear accountability for fiscal risk disclosure and management.
- Introduction of accrual accounting in the Public Finance Act (PFA) of 1989 and adoption in 1993 of Generally Accepted Accounting Practice (GAAP) for budgeting and reporting broadened coverage to include all assets and liabilities, including contingent liabilities.
- Fiscal Responsibility Act (FRA) of 1994 (subsequently incorporated, with some extensions, in the PFA) requires the government to:
  - reduce the debt to prudent levels by running operating surpluses, and then maintain the debt at prudent levels;
  - pursue policies consistent with a reasonable degree of predictability about the level and stability of tax rates for future years;
  - prudently manage the fiscal risks facing the state.
- Legislation requires budget documents to include:
  - a statement showing the sensitivity of fiscal aggregates to changes in economic conditions; and
  - a statement of specific fiscal risks, containing both policy risks and explicit contingent liabilities that may have a material effect on the fiscal and economic outlook.
- Disclosure exemptions apply only when disclosure is likely to:
  - prejudice the substantial interests of the country;
  - compromise the government in a material way in negotiation, litigation, or commercial activity; or
  - result in material loss of value to the government.
- Notes to financial statements discuss key risk management strategies across the government and SOEs, and provide data on concentrations of credit risk, foreign exchange risk, refinancing risk, use of derivatives, and fair value of financial instruments.

### Legal provisions limiting fiscal risk exposure (preserved wording)
- (i) only the minister of finance can authorize the Crown to borrow and enter into swaps or other financial arrangements;
- (ii) the minister of finance is allowed to issue government guarantees or indemnities only in the public interest;
- (iii) departments are forbidden to borrow (except from the Crown) and have limited authority to engage in derivative transactions (which are subject to Treasury oversight);
- (iv) the government’s financial asset portfolios must be invested on a prudent commercial basis;
- (v) subnational levels of government are also subject to high transparency and accountability standards;
- (vi) SOEs are required to act commercially, pay dividends on a basis comparable to private sector competitors, and negotiate an explicit full cost-recovery contract if the government wishes them to engage in noncommercial activities;
- (vii) the government’s financial statements fully consolidate SOEs, with separate segment reporting; and
- (viii) a Crown entity provides compulsory earthquake insurance for homeowners, with a maximum coverage ceiling per dwelling.

### Operational practices, disclosures, and fiscal risk management mechanisms
- Official macroeconomic forecasts underlying the budget are reviewed before finalization by an external panel of experts and full alternative macroeconomic scenarios are included in the budget documents.
- The budget includes a full set of independent tax forecasts by the Inland Revenue Department (IRD), with a discussion of the reasons for any differences between the IRD and official (treasury) forecasts.
- Fiscal forecasts in the annual budget include indicative amounts for new operating and capital initiatives in the second and third years, linked to the specific fiscal risks disclosed in the budget.
- Within-year spending pressures are accommodated by:
  - sectoral/departmental contingency appropriations (to meet likely and known cost pressures whose amounts are still subject to uncertainty at the time the budget is being finalized); or
  - a general contingency (of NZ$200 million, equivalent to 0.4 percent of expenditures, in the last few years) that is not appropriated at the time of the budget and functions more as a monitoring mechanism than a firm cap (the Treasury prepares monthly progress reports on decisions against this sum, and required funds are then appropriated in the May supplementary estimates).
- Contingent liabilities are managed by the relevant department and monitored by the treasury; policy initiatives that involve contingent liabilities are subject to scrutiny.
- The treasury operates a centralized system for monitoring and reporting on fiscal risks, called “Inspect a Risk,” which gathers information from:
  - discussions with departments and Crown entities;
  - the register of contingent liabilities maintained by departments; and
  - minutes of meetings of cabinet and cabinet committees.

*Source: Appendix 1 (New Zealand’s Approach to Fiscal Risk Disclosure and Management), FISCAL RISKS: SOURCES, DISCLOSURE, AND MANAGEMENT*

### Appendix 2

### Appendix 2

### Government fiscal risk practices
- “Risk” is then used by the fiscal reporting division of the treasury to generate the Statement of Specific Risks;
- the government has established a number of financial asset portfolios to match the risk characteristics of specific liabilities, such as a fund managed by the earthquake commission;
- SOEs report directly to shareholding ministers each quarter, and the performance of SOEs is monitored by the treasury, which provides ministers with a quarterly report on SOE performance; SOEs borrow without government guarantee (with one, historical, exception);
- the debt management office, a unit within the treasury, has responsibility for aggregating information on assets and liabilities across the government, and for managing risks to the government’s overall balance sheet;

### Institutional responsibilities and oversight
- external audit of information on fiscal risks is conducted by parliament’s office of the comptroller and auditor general, which has published reports on specific areas of fiscal risk in recent years (e.g., the use of derivatives and the performance of the debt management office).

*Source: _dp0901 - Appendix 2*

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