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 stateowned 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
Explicit & implicit
contingent & direct
obligations
Local
Governments
Banks
Nonbank
SFIs
Economic
enterprises
Utility
companies
Service
providers
Explicit &
implicit
contingent
& direct
obligations
Private
sector
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
Toll roads
min. rev.
or other
guarantees
Other roads
Shadow tolls
Availability
payments
Power gen.
Wholesale
water
Wastewater
treatment
Electricity and
Water
distribution
Schools
Hospitals
Prisons
SOE Utilities
provide
availability
payments
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
Public borrowing to finance Entering into PPP with longan investment
term purchase contract
Get asset without having to
raise taxes immediately
Get asset without having to
raise taxes immediately
Must repay debt whether you
need the asset or not
Must make availability
payments whether you need
the asset or not
Have a liability that you must
report
Have a liability that you might
not have to report
A guarantee of revenue
$million
Forecast revenue
200
Guaranteed
revenue
150
100
50
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Payments can be large: The Incheon airport
expressway in Korea
300
200
150
100
50
19
20
17
20
15
20
13
20
11
20
09
20
07
20
05
20
03
20
01
0
20
Billion 1999 won
250
Year
Forecast revenue
Guaranteed revenue
Actual revenue
A possible good outcome
$ million
Payment
Forecast revenue
Actual revenue
Guaranteed revenue
200
150
100
50
0
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
A possible bad outcome
$ million
Payment
Forecast revenue
Actual revenue
Guaranteed revenue
200
150
100
50
0
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
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.
Obligations
Explicit
Government
obligation
created by law
or contract
Implicit
A moral
obligation of
government
that reflects
public and
interest-group
pressure
Direct
Contingent
Obligation in any event
Obligation only if a particular event occurs
Local government debt
Local government guarantees for debt and other
Arrears (if legally binding)
obligations of public sector and non-public
Non-discretionary
sector entities
budgetary spending
Local government guarantees on private
investments (infrastructure)
Local government insurance schemes
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
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 nonguaranteed 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,...)
Sources of
financial
safety
Explicit
Under direct
control of local
government
(ownership, taxing
power)
Implicit
Not under direct
local government
control
Direct
Contingent
Based on existing assets
Dependent on future events
Local government-owned
assets available for
possible sale or lease
Existing funds that are
under indirect local
government control (local
social security funds)
Local tax revenues less tax
expenditures
Transfer income from the central
government
Recovery of loans made by the local
government (on-lending)
Future profits of enterprises and
agencies under some local
government control
Contingent credit lines and financing
commitments from official creditors
to the local government
For both matrices, items and their classification vary according
to the local conditions.
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
Risk awareness
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 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.)
Risk awareness - questions
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?
Disclosure
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
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)
Disclosure - questions
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”)
Fiscal planning
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 - questions
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?
Accounting for fiscal risk
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.
Budgeting 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
Principles in budgeting for fiscal risk

apply a joint ceiling to the cost of budgetary and offbudget/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)
Accounting and budgeting – questions
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?
Fiscal risk management
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
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
Fiscal risk management – questions
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?
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
Goal
Options
Risk
awareness
Collect and centralize information on fiscal risks
Discuss risks and long-term fiscal cost as part of decision-making
Employ useful analytical frameworks and valuation of risks and obligations
Disclosure
Disclose past fiscal cost of contingent liabilities and other sources of risk
Disclose outstanding risk exposures
Disclose government analysis the possible fiscal cost of its risk exposures
Disclose draft contracts and government analysis of possible fiscal cost
Disclose long-term fiscal scenarios reflecting the future fiscal effect of risks
Enhance the system of financial reporting standards to require disclosure of
fiscal risk
Accounting,
budgeting,
and fiscal
planning
Reflect the net present value of expected fiscal cost of fiscal risks in
government deficit and debt when government obligation originates
Reflect the future possible fiscal effect of fiscal risks in fiscal planning
Set overall limits on government risk exposure—either as simple ceilings on
the face value of government guarantees or as part of joint ceilings
Consider reducing deficit/debt ceilings by risk-adjusted values of contingent
liabilities issued/outstanding and/or establishing contingent liability fund
Enhance the accounting & budgeting standards to address fiscal risk
Risk mgmt.
Centralize government risk-taking authority
Separately, analyze and monitor government risk exposures and obligations
Audit government risk analysis and risk management
Build capacity to evaluate and manage risk
Develop extended assets and liabilities management framework