Fiscal Costs of Hidden Deficits: Beware—When It Rains, It Pours
IMF Blog, February 9, 2016
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Bibliographic details
- Authors: Elva Bova, Marta Ruiz-Arranz, Frederik Toscani, Elif Ture
- Published: February 9, 2016
Dataset and scope
- New dataset documents over 200 episodes covering 80 countries over the period 1990–2014.
- Focus: episodes involving the materialization of contingent liabilities (so-called hidden deficits).
Definition and mechanisms ("How it works")
- A contingent fiscal liability is a potential obligation for the government that depends on a possible future event.
- Example mechanism: a government guarantee on a public or private company loan—if the company fails to pay, the lender calls the guarantee and the government takes the loan onto its books.
- Contingent liabilities can be:
- Explicit (embedded in contracts, e.g., loan guarantees).
- Implicit (expectations that governments will cover debts of local authorities or state-owned enterprises).
- Common realizations include financial sector bailouts and assumed debts of subnational governments or state-owned enterprises.
Key findings on fiscal costs ("Costly deficits")
- The fiscal cost of realized contingent liabilities is large:
- The cost averages 6 percent of Gross Domestic Product (GDP).
- In some cases, costs exceed 20 percent of GDP.
- Frequency and annualized potential cost:
- These events happen every 12 years in the average country.
- Potential cost is about half percent of GDP per year.
- Cross-country variation:
- Brazil: occurred on average every 5–6 years and cost 8.3 percent of GDP.
- Incidence much lower in countries like Canada, Hong Kong and Israel.
- Major sources of costs:
- Support to the financial sector, including bailouts, accounts for the largest share of unexpected costs (examples: Indonesia, Thailand and Korea during the Asian Crisis; Iceland and Ireland during the Global Financial Crisis).
- Subnational government bailouts, support to state-owned enterprises, and legal liabilities also produce substantial costs (examples: Argentina 2001–2004; Greece 2007–2010; Macedonia starting in 1999).
- Timing and correlation with macro conditions:
- Liabilities tend to materialize after periods of high growth, coincide with low growth periods and banking crises, and tend to happen simultaneously—exacerbating strain on government finances (illustrated by the Asian Crisis and the Global Financial Crisis).
- Institutional mitigation:
- Countries with stronger institutions and lower growth volatility tend to suffer less from contingent liability realizations.
- Specifically, countries with strong public institutions could face a cost which is 30 percent lower than the average.
Policy implications and recommendations ("Avoiding bad surprises")
- Build stronger institutions to prevent emergence and accumulation of contingent liabilities:
- Better governance at the local government level.
- Improved governance in state-owned enterprises and public-private partnerships.
- Stronger supervision and better resolution regimes for financial sector institutions to reduce the likelihood and cost of taxpayer-funded bailouts.
- Increase transparency, disclosure, and monitoring of contingent liabilities:
- Strengthen fiscal frameworks to enhance discipline and limit excessive growth of contingent liabilities.
- Emphasize disclosure and monitoring because hidden deficits tend to emerge in times of financial distress when public finances are weakest.
- Overall goal: avoid large, unexpected budgetary shocks—“needless to say that it is better to avoid bad surprises in the budget during these difficult times.”
Source: Fiscal Costs of Hidden Deficits: Beware—When It Rains, It Pours (Elva Bova, Marta Ruiz-Arranz, Frederik Toscani, Elif Ture), February 9, 2016.
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