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Hana Brixi - Government Contingent Liabilities and Fiscal Risk
 

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Hana Brixi - Government Contingent Liabilities and Fiscal Risk Hana Brixi - Government Contingent Liabilities and Fiscal Risk Presentation Transcript

  • GOVERNMENT CONTINGENT LIABILITIES AND FISCAL RISK World Bank Washington, DC May 2, 2006 Hana Brixi
  • Summary
    • Why government contingent liabilities need to be taken into account?
    • What are the current risk exposures?
    • Public risk in private infrastructure
    • Local government risk
    • Fiscal institutions for managing contingent liabilities and fiscal risk
  • Why contingent liabilities need to be taken into account?
    • Government contingent liabilities tend to arise from:
      • addressing the cost of needed investment (infrastructure) and structural reforms (banking sector)
      • privatization of state functions (pension guarantees)
      • short-term emphasis on fiscal adjustment and deficit targets
      • expanding developmental role and autonomy of local governments
    • Contingent liabilities tend to be a result of:
      • an effort to find more efficient ways to achieve policy objectives
      • neglect of moral hazard in the behavior in the markets
      • fiscal opportunism
    • They tend to be costly when they surface - in the medium to long term
    • Issues in capturing contingent liabilities in fiscal analysis
      • complexity (different forms of contingent liabilities, different parts of government and the public sector)
      • “ invisibility” – sometimes even to policymakers
    • Issues in managing contingent liabilities
      • information
      • incentives (rewarding transparency, enforcement?)
      • capacity
  • What are the current exposures to risk?
    • explicit contingent liabilities –
    • government liability created by a law or contract
    • implicit contingent liabilities –
    • a “political” obligation of government that reflects public and interest-group pressures
  • Explicit contingent liabilities
    • State guarantees for borrowing of enterprises
      • Cyprus, Czech Republic, Malta, Poland and Slovenia - credit guarantees mainly to state-controlled companies
    • Statutory guarantees on liabilities and other obligations of various entities (including financial institutions such as state-owned banks, pension funds, infrastructure development funds)
      • Czech Republic - Czech Consolidation Agency, Ceska Inkasni, Czech Land Fund, Railway Transport Infrastructure Administration, Agriculture Guarantee and Credit Support Fund
      • Hungary - State Development Bank, EXIM Bank, Export Credit Insurance Company, Pension Reserve Fund to cover private pension annuity, Deposit Insurance Fund, Credit Guarantee Fund, Rural Credit Guarantee Foundation, Office of Agricultural Market Regime, and environment guarantees of the Privatization Agency
      • Estonia, Latvia, Lithuania, Poland and Slovakia -Guarantee/Reserve Funds and the related minimum pension/ relative rate of return guarantees, deposit guarantee, investor protection, and credit/export guarantees
  • Explicit contingent liabilities (cont.)
    • State guarantees on service purchase contracts
      • Poland (possible obligations arising from the past power-purchase agreements)
    • Other state guarantees issued to private investors and service providers
      • Hungary (guarantees related to the privatization of Postabank)
    • State guarantees on debt and other obligations of local gov’ts
    • State insurance programs
    • Litigation
      • Poland (legal claims against the government with respect to weak copyright protection and 1944-1962 property losses)
      • Lithuania (legal claims for savings compensation and real estate restitution)
      • Slovakia (legal claims by CSOB and the Slovak Gas Company)
  • Implicit contingent liabilities
    • Claims by public sector entities to assist in covering their losses, arrears, deferred maintenance, debt and guarantees
      • Poland (obligations of state-owned companies – some arising during the restructuring of railways and mines; obligations of hospitals and state agencies)
      • Hungary and Malta (obligations of state-owned companies and the related cost of restructuring)
      • Czech Republic (environment guarantees issued by the National Property Fund; losses, arrears and debt of the Czech Railways)
    • Claims by local governments to assist in covering their own debt, guarantees, arrears, letters of comfort and similar
      • Poland (local government debt and guarantees related to regional development)
      • Lithuania (municipal budget arrears)
      • Czech Republic (bail-outs related to hospital arrears)
  • Implicit contingent liabilities (cont.)
    • Claims by financial institutions , such as state-owned banks, social security funds, and credit and guarantee funds)
      • Latvia (pension and social security funds)
      • Slovenia (Small Business Development Fund, regional guarantee schemes)
    • Non-contractual claims arising from private investment , for instance in infrastructure
      • Hungary (possible claims arising from motorway construction concessions – partly implemented through the Road Construction Corporation of the State Development Bank)
      • Poland (claims arising from expressway construction concessions)
    • Other possible obligations , such as environment commitments for still unknown damages and nuclear and toxic waste
      • Lithuania (decommissioning of the Ignalina nuclear power plant)
      • Cyprus (reunification cost)
  • Fiscal risk map SOEs/SFIs Central Government Local Governments Utility companies Economic enterprises Nonbank SFIs Private sector Service providers Banks Explicit & implicit contingent & direct obligations Explicit & implicit contingent & direct obligations
  • Fiscal risk map: The Czech Republic Financial Flows Guarantees Ministry of Finance National Property Fund (NPF) Bonds Issued Ceska Inkasni (CI) Purchase of bad loans CSOB Refinancing Konsolidacni Banka (KOB) Borrowings and bonds issued Financial Market Corporate Sector Special Institutions Banks, enterprises, hospitals and other entities qualified for support Czech National Bank Ceska Financni (CF) Bad assets Payment for bad assets Refinancing Credit Government Redistribution credit Corporate & environment liabilities
  • Public risk in private infrastructure
    • Public-private partnerships, or PPPs, are privately financed projects in which the government
      • is the main purchaser of the output under a long-term purchase contract (with availability payments)
      • supplements user fees with subsidies or guarantees (motorways)
    • Governments seek private finance for infrastructure to:
      • close the infrastructure gap
      • improve efficiency
      • reduce the fiscal burden
    • Private investors seek government guarantees and other disguised subsidies - which create contingent liabilities for the government
  • The different types of government obligations under PPPs Public-Private Partnerships Transport Power gen. Wholesale water Wastewater treatment Schools Hospitals Prisons Toll roads min. rev. or other guarantees Other roads Shadow tolls Availability payments SOE Utilities provide availability payments Electricity and Water distribution Making public assets available at no charge G. Provides availability payments
    • Implicit government liabilities in PPPs tend to be high –
    • the provision of infrastructure services is politically sensitive
    • PPPs create fiscal obligations that are not captured by traditional measures of government debt.
    • Only improvements in efficiency allow for fiscal saving
    • Disguising subsidies generates fiscal cost later – and may mask the need for structural reforms in infrastructure
    • Accurate fiscal monitoring and good use and design of PPPs require the fiscal costs and risks of the major contractual obligations to be identified and quantified.
  • The accounting appeal of public-private partnerships with availability payments Have a liability that you might not have to report Have a liability that you must report Must make availability payments whether you need the asset or not Must repay debt whether you need the asset or not Get asset without having to raise taxes immediately Get asset without having to raise taxes immediately Entering into PPP with long-term purchase contract Public borrowing to finance an investment
  • A guarantee of revenue
  • Payments can be large: The Incheon airport expressway in Korea
  • A possible good outcome 0 50 100 150 200 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 $ million Payment Forecast revenue Actual revenue Guaranteed revenue
  • A possible bad outcome 0 50 100 150 200 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 $ million Payment Forecast revenue Actual revenue Guaranteed revenue
    • The forms of government contingent support to infrastructure:
      • guarantees to cover policy risk and/or nonpolicy risk, service purchase agreements, and letters of comforts
      • signed by the central government, local governments, or state utilities
    • Policy risk – relates to unpredictability of government policy (prices, taxes, quantity/quality of output, competition rules)
    • Nonpolicy risk – relates to areas that are outside government control (construction cost, future demand for services, exchange rate, debt repayment
    • Service purchase agreements – relate to the government obligation to purchase the output on a take-or-pay basis
    • Reducing the need for providing contingent support to infrastructure:
      • government policy toward competition and ownership
      • Investment climate for all firms
    • The value of transparency and simplicity
      • explicit cash subsidy to infrastructure firm or its customers
      • capital in the form of equity or debt
    • Effort to examine contingent liabilities under fiscal surveillance would reduce the attractiveness of disguising fiscal support to infrastructure.
  • Local government risk
    • Local government risk – a source of financial stress that could face a local government in the future
    • Fiscal risk matrix helps identify the sources of future possible financing pressures facing local government.
    • Fiscal hedge matrix illustrates the different financial sources that can serve local governments to cover their obligations.
  • Claims related to local government letters of comfort Claims by failing local financial institutions and other entities Claims by various entities to assist on their non-guaranteed debt, their own guarantees, arrears, letters of comfort and other possible obligations Claims related to enterprise restructuring and privatization Claims by beneficiaries of failed social security or other funds – beyond any guaranteed limits Claims related to local crisis management (public health, environment, disaster relief,...) Remaining capital and future recurrent cost of local public investment projects The cost of future benefits under the local social security schemes Future spending on goods and services that the local government is expected to deliver Implicit A moral obligation of government that reflects public and interest-group pressure Local government guarantees for debt and other obligations of public sector and non-public sector entities Local government guarantees on private investments (infrastructure) Local government insurance schemes Local government debt Arrears (if legally binding) Non-discretionary budgetary spending Explicit Government obligation created by law or contract Contingent Obligation only if a particular event occurs Direct Obligation in any event Obligations
  • For both matrices, items and their classification vary according to the local conditions. Sources of financial safety Direct Based on existing assets Contingent Dependent on future events Explicit Under direct control of local government (ownership, taxing power) Local government-owned assets available for possible sale or lease Local tax revenues less tax expenditures Transfer income from the central government Recovery of loans made by the local government (on-lending) Implicit Not under direct local government control Existing funds that are under indirect local government control (local social security funds)   Future profits of enterprises and agencies under some local government control Contingent credit lines and financing commitments from official creditors to the local government
    • The two matrices represent an extended balance sheet of the local government.
    • Compared to the standard balance sheet, the extended balance sheet
      • provides information about contingent and direct implicit items that may affect future net worth
      • helps understand which local government actions imply progress or regress toward local government long-term fiscal stability
      • illustrates how the local government’s long-term finances will evolve if certain assumptions hold (such as assumptions in calculating the local implicit pension debt and the value of land).
    • Conventional fiscal surveillance covers local government debt service burden, deficit, debt level, and cash balances.
    • This is not sufficient in countries where local government budgets fail to cover all fiscal activities and contingent liabilities are significant.
  • Addressing fiscal opportunism at the local level
    • Substitution – contingent instead of direct – to avoid difficult adjustment and painful structural reforms, to escape fiscal discipline, or to implement low-priority programs
    • Moral hazard – the reliance on central government bailout influences the behavior of:
      • local government officials (who may tend to over-borrow, issue too many guarantees, establish and provide backing to local insurance programs, and take on financial risk through commercial activity) and
      • the creditors (who may expose themselves to excessive credit risk vis-à-vis local governments)
    • An effort to examine local government risk as part of fiscal surveillance would help reduce fiscal opportunism at the local level.
  • Fiscal institutions for managing government contingent liabilities and fiscal risk
    • Risk awareness
    • Disclosure of fiscal risk
    • Fiscal planning, accounting and budgeting for fiscal risk
    • Fiscal risk management
    • International mechanisms
    • Fiscal institutions – conventionally defined as institutional arrangements and management practices that relate to public resource allocation, resource use and financial management
      • government budget management
      • management of government liabilities
      • management of government financial assets
      • fiscal reporting, planning, accounting, budgeting, measuring debt, measuring fiscal savings and fiscal adjustment, accountability with respect to fiscal performance, …
    • Fiscal institutions affect the extent and type of government fiscal support (the amount and design of government programs, on budget & off budget)
    • They affect the extent to which governments:
      • use off-budget support as opposed to traditional public financing and
      • accept risk exposures as opposed to providing cash subsidies
    • Fiscal institutions directly affect government incentives, information and capacity
    • a) Incentives
    • Conventional fiscal institutions devote weaker scrutiny to non-cash fiscal support and long-term obligations, compared to cash-based support and immediate outlays
    • Hence, they tend to promote incentives to:
      • favor off-budget support even when public spending would deliver equal results at a lower cost in the long term
      • accept risks rather than providing cash subsidies
      • let the public sector accept risks that the private sector is more suited to bear
    • b) Information
    • Good information on the sources of government fiscal risks and good understanding of the long-term fiscal cost of off-budget government support is important to:
      • promote risk awareness within government (that is, an open discussion and acknowledgement of risks and government risk exposures)
      • enable policy analysts to assess the long-term fiscal cost of government support programs
      • promote public scrutiny and pressure on policy makers toward fiscal prudence
    • Conventional fiscal institutions do not call for much information on fiscal risks. Therefore, the long-term fiscal cost of contingent liabilities goes underestimated.
    • c) Capacity
    • Capacity to evaluate risk, mitigate risk at source, create risk-sharing arrangements, and manage any residual risk enables governments to:
      • well design programs of government support
      • make efficient risk allocation
      • rationalize their risk exposures
    • Conventional fiscal institutions neglect the need to build government fiscal risk management capacity
    • An open discussion of fiscal risks and government risk exposures enhances government’s dealing with contingent liabilities and long-term fiscal obligations – and hence it enhances the use and design of government programs
    • Credible valuation of risks and assessment of long-term obligations contribute to risk awareness.
    • Scenario analysis, for instance, can be useful to make policy makers aware of the potential fiscal impact of the worst possible outcomes under government off-budget (as well as on-budget) programs
    Risk awareness
    • Risk awareness through open discussion and acknowledgement of risks tends to be more effective than the actual results of sophisticated risk valuation
    • Simple analytical frameworks help enhance risk awareness (fiscal risk matrix in China, Czech Republic, India, South Africa and US)
    • Core subjects for government discussion:
      • sources of risk and financial safety
      • sensitivity of risk exposures
      • related moral hazard
      • possible fiscal implications (impact on future cash flows)
      • possible options to mitigate risk at source, transfer risk and deal with the residual risk
      • contingency plans (particularly for implicit contingent liab.)
    • What has been your experience in promoting open discussion of contingent liabilities and fiscal risks within government?
    • What is constraining open discussion of government contingent liabilities and fiscal risks in your country?
    • What is the capacity of your government to gather and analyze relevant information with respect to contingent liabilities and fiscal risk?
    • What analytical frameworks have you used or consider to use to promote risk awareness in government?
    Risk awareness - questions
    • Disclosure of fiscal risk raises scrutiny, fiscal prudence, and the contestability of resources
    • When disclosure rules have broad coverage they enable the government to better monitor lower-level governments & public sector units, and expand the share of government activities that is open to public scrutiny.
    • Scrutiny is likely to improve:
      • the use and design of government programs that give rise to fiscal risk (many are off-budget)
      • generate pressure for greater fiscal prudence applied by governments at both the central and local levels
    Disclosure
    • Good-practice financial reporting standards require the disclosure of commitments, contingent liabilities, and some other sources of fiscal risk.
    • Disclosure should not be constrained by the weaknesses in the existing financial-reporting standards or by slow progress in their improvement.
    • Central and local government can complement their existing reports with statements of government risk exposures (Australia – Victoria, Canada – Ontario, Chile, Czech Republic, Netherlands, New Zealand, South Africa, UK – England and Wales, and US – Government Accountability Office).
    • Government statement of contingent liabilities or analytical reports on fiscal risk can include:
      • a list of the sources of their risk exposure
      • discussion of the nature, sensitivities and possible financial implications of the risks
      • face value and/or estimates of future possible fiscal cost
    • Long-term fiscal projections and scenarios, and “fiscal” balance sheets that reflect fiscal risks
    • With respect to PPPs, publishing contracts/ licenses of private firms for the supply of public services, and/or summaries of the contracts, including descriptions of the government’s fiscal obligations (Australia , Argentina, Brazil, Chile, UK, and Peru)
    • Prerequisites for risk awareness and disclosure
      • a database of government direct and contingent obligations to form a basis for analysis
      • adequate institutional capacity, including the capacity to gather and analyze relevant information, evaluate risk exposures, and conduct revenue and expenditure projections
      • adequate enforcement mechanism, including a supportive political and legal environment (for instance, with respect to the reporting by local governments, public sector units, and public utilities to ensure compliance.
    • Disclosure of the limits of government responsibilities may help improve efficiency in the markets and reduce moral hazard in the market
      • consider making selected implicit liabilities explicit, while defining the limits of government responsibility in a way that is clear and sufficiently “non-attractive”
      • minimize remaining implicit liabilities by clear and credible announcements
      • act upon these announcements (not to bail out)
    • What has been your experience & considerations on:
    • promoting disclosure of government contingent liabilities and other sources of fiscal risk?
    • disclosing fiscal risk as part of long-term fiscal scenarios/analysis?
    • What are your considerations regarding the possible negative effects of revealing contingent liabilities and fiscal risk? (“the cost of transparency”)
    Disclosure - questions
    • Fiscal planning, to be meaningful, needs to reflect possible fiscal implications of off-budget obligations.
    • Fiscal targets may be complemented by ceilings on government risk exposures (Hungary, Latvia, Poland).
    • Better yet, fiscal targets can reflect the future likely fiscal cost of government off-budget obligations. The deficit and debt targets can be adjusted to reflect the PV of future fiscal cost of newly approved and outstanding off-budget government programs, respectively.
    Fiscal planning
    • What has been your experience & considerations on:
    • reflecting the future fiscal cost of government contingent liabilities and fiscal risk in fiscal planning?
    • implementing ceilings on government risk exposures?
    • trying to adjust fiscal targets to reflect government fiscal risk exposures?
    Fiscal planning - questions
    • Accrual-based standards are helpful but neither necessary nor sufficient.
    • Cash flow accounting and budgeting
      • makes publicly financed projects and subsidies appear expensive, and neglects contingent form of support
    • Accrual-accounting standards
      • do not require all direct and contingent liabilities to be revealed and included on the balance sheet and in the calculations of budget deficits
    • The leading international standards are all converging toward more accurate accounting for risk.
    Accounting for fiscal risk
    • Accrual-budgeting standards are possibly effective in promoting cash neutrality and recognizing newly taken risk, particularly if implemented jointly with accrual-accounting standards.
    • Accounting and budgeting for risk can be done separately from the overall standards: Czech Republic, Colombia, Netherlands, and United States implement some accounting and budgeting for risk without fully adopting accrual-based standards
    Budgeting for fiscal risk
    • Principles in budgeting for fiscal risk
    • apply a joint ceiling to the cost of budgetary and off-budget/contingent support for each sector in a fiscal year, hence exposing the sources of fiscal risks to general budgetary scrutiny and limits (Canada, Netherlands)
    • have the budget immediately reflect the PV of future fiscal cost of contingent support when approved (US)
    • fit the likely fiscal cost in the deficit/debt ceilings, or reduce the deficit/debt ceilings accordingly (Hungary and South Africa in the context of MTEF)
    • create a contingent-liability fund that would benefit from budgetary transfers (Canada, Colombia and Netherlands) and/or fees (Sweden)
    • What has been your experience in:
    • trying to account and budget for fiscal risk and other off-budget obligations?
    • develop cash neutrality in government decision making?
    • internalizing fiscal risk and off-budget obligations in a medium-term budgetary framework?
    Accounting and budgeting – questions
    • Government’s risk appetite needs to be in line with its risk management capacity.
    • Fiscal risk management requires:
    • a) adequate information
      • a comprehensive database of all major risk exposures
      • capacity to gather relevant information
    • b) ability to understand
      • useful analytical frameworks
      • warning indicators (true fiscal deficit & debt, expected & maximum likely financing requirement)
      • contingency plans
    Fiscal risk management
    • c) incentives to act correctly
      • disclosure, accounting and budgeting (cash neutrality)
      • accountability for the adequacy of risk analysis and risk management (e.g., through the supreme audit institution)
      • risk management strategy (government)
      • centralized risk-taking authority (ministry of finance)
      • risk analysis and monitoring that are separate from risk taking (e.g., debt management office or treasury, and internal & external audit, as opposed to the budget/PPP office)
      • sound intergovernmental fiscal system (balance between revenues and responsibilities at each level of government)
    • Reducing government risk exposure entails three complementary tasks:
      • mitigate risk at source – adjusting market conditions to enable private-sector parties to better deal with risk (competition policy, tariff policies, investment climate,…)
      • transfer risk – creating risk-sharing arrangements
      • manage any residual risk that cannot be mitigated/transferred
        • hedging, reinsurance, catastrophe bonds
        • building contingent-liability funds
        • reducing debt and hope to use tax revenues and additional borrowing when needed
        • entering into a standby credit agreement
    • What has been your experience in:
    • building government capacity to analyze and manage contingent liabilities and other fiscal risks?
    • promoting accountability of policy makers for fiscal risk analysis and management?
    • centralizing risk-taking authority
    • separating risk analysis & monitoring from risk taking (perhaps by involving the debt management office and/or other entities in risk analysis and monitoring)?
    • involving supreme audit institutions (and local audit bureaus) in fiscal risk analysis and monitoring?
    Fiscal risk management – questions
    • What has been your experience in:
    • trying to mitigate risk at source (that is, enabling the private sector better deal with risk)?
    • in creating and implementing risk-sharing arrangements under government guarantees and PPP contracts?
    • in dealing with the residual risk (hedging, reinsurance, catastrophe bonds, contingent-liability funds, borrowing & ALM strategy, …)?
    • in protecting contingency fund against possible misuse?
  • International mechanisms
    • Risk awareness could be supported by expanding the framework of fiscal surveillance to involve a broad analysis of governments’ fiscal positions, supported by surveys of fiscal risks.
    • International mechanisms could do more to:
    • reward disclosure (”upgrade” for transparency rather than “downgrade” for the risks revealed)
    • punish opacity and excessive risk taking (establish early warning system, adjust fiscal targets, require adequate contingent liability fund, …)
    • assist in building fiscal risk management capacity
  •