October 1998 Many governments have faced serious fiscal instabilities as a result of their growing contingent liabilities. But conventional fiscal analysis and institutions fall short in addressing contingent fiscal risks. What approaches in fiscal analysis and standards for public sector management would foster sound fiscal performance? And how can policymakers be made accountable for recognizing the long-term costs of both direct and contingent forms of government activity in their decisions? Governments are increasingly exposed to fiscal risks and uncertainties for three main reasons: * The increasing volume and volatility of international flows of private capital. * The state's transformation from financing services to guaranteeing that the private sector will achieve particular outcomes. * Moral hazards arising in markets because the government is perceived to have residual responsibility for market outcomes. Sources of fiscal risk may be direct or contingent (a liability only if a particular event occurs). Whether direct or contingent, they are either explicit (recognized as a government liability by law or by contract) or implicit (a moral obligation reflecting public expectations and pressure from interest groups). The recent Asian crisis revealed that major moral hazards exist in markets and that sizable hidden fiscal risks may arise from contingent forms of government support. Governments must understand and know how to handle contingent liabilities if they are to avoid the danger of sudden fiscal instability and realize their long-term policy objectives. They can reduce fiscal risks by incorporating contingent liabilities into their analytical, policy, and institutional public finance frameworks. Governments can address fiscal risk through three channels in particular, says Polackova: * By including contingent and implicit financial risks in their fiscal analysis and (to deter moral hazard in the market) by publicly acknowledging the limits of state responsibilities. * By reflecting the cost of contingent liabilities in policy choices, budgeting, financial planning, reporting, and auditing. * By developing institutional capacity to evaluate, regulate, control, and prevent financial risk in both the public and private sectors. Given the increasingly serious implications of contingent government liabilities for the fiscal outlook of countries, Polackova argues that it is time for the World Bank, the International Monetary Fund, and others to: * Incorporate government contingent fiscal risks in their analysis of a country's fiscal sustainability, policies, and institutions. * Require countries to disclose information regarding their exposure to contingent fiscal risks. * Help countries embrace contingent liabilities in their analytical, policy, and institutional public finance frameworks. This paper-a product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region-is part of a larger effort in the region to enhance the Bank's analytical and operational work in public finance. The author may be contacted at [email protected].

Many governments have faced serious instability as a result of their contingent liabilities. But conventional public finance analysis and institutions fail to address such fiscal risks. This book aims to provide motivation and practical guidance to governments seeking to improve their management of fiscal risks. The book addresses some of the difficult analytical and institutional challenges that face reformers tooling up to manage government fiscal risks. It discusses the inadequacies of conventional practices as well as recent advances in dealing with fiscal risk.

Many governments have faced serious instability as a result of their contingent liabilities. But conventional public finance analysis and institutions fail to address such fiscal risks. This book aims to provide motivation and practical guidance to governments seeking to improve theirmanagement of fiscal risks. The book addresses some of the difficult analytical and institutional challenges that face reformers tooling up to manage government fiscal risks. It discusses the inadequacies of conventional practices as well as recent advances in dealing with fiscal risk.

Many governments have fac ...

Governments' contingent liabilities increase fiscal vulnerability, but are omitted in traditional measures of the current deficit. In the Czech Republic this omission may mean that fiscal adjustment has been overstated by 3 to 4 percent of annual GDP, with future budgets having to pay for past guarantees. The stock of existing contingent liabilities in Macedonia could add 2 to 4 percent of GDP to that country's future deficits.

Conventional fiscal accounting methodologies do not appropriately account for governments’ noncash policies, such as their contingent liabilities. When these liabilities are called, budget costs can be large, as evidenced by the United States’ saving and loan crisis. In general, deficit measures may underestimate the macroeconomic impact of government policies, promoting the substitution of noncash for cash expenditure and increasing future financing requirements. The paper describes extended deficit measures to address the problem, but notes their limited practical value. Nonetheless, some alternative methods of valuing contingent liabilities are proposed to gauge fiscal impact and facilitate budgetary control.

Contingent liabilities have gained prominence in the analysis of public finance. Indeed, history is full of episodes in which the financial position of the public sector is substantially altered-or its true nature uncovered-as a result of government bailouts of financial or nonfinancial entities, in both the private and the public sector. The paper discusses theoretical and practical issues raised by contingent liabilities, including the rationale for taking them on, how to safeguard against the fiscal risks associated with them, how to account and budget for them, and how to disclose them. Country experiences are used to illustrate ways these issues are addressed in practice and challenges faced. The paper also points to good practices related to the mitigation, management and disclosure of risks from contingent liabilities.

We construct the first comprehensive dataset of contingent liability realizations in advanced and emerging markets for the period 1990–2014. We find that contingent liability realizations are a major source of fiscal distress. The average fiscal cost of a contingent liability realization is 6 percent of GDP but costs can be as high as 40 percent for major financial sector bailouts. Contingent liability realizations are correlated among each other and tend to occur during periods of growth reversals and crises, accentuating pressure on the budget during already difficult times. Countries with stronger institutions are able to better control and address the underlying risks so that they are less exposed to contingent liability realizations.