I. INTRODUCTION
Several factors could either contribute to a significant deviation of fiscal variables compared to what was expected or reduce “fiscal space” over the medium or longer term. These factors could result from
• Shocks to macroeconomic variables (e.g. GDP growth, exchange rate) and natural disasters, which may affect government revenues, spending commitments or the value of debt.
• Medium-term expenditure commitments, such as those under public pension system, and public-private partnerships, and projected decline in some revenue sources in the medium-term.
• Contingent contractual/explicit liabilities such as guarantees under public-private partnerships, public and private pension systems, deposit insurance, and universal health coverage.
• Contingent implicit liabilities such as liabilities of subnational governments, public enterprises, development banks and commercial banking system that under some circumstances could become liabilities of the federal government.
• Cash flow risks
Analyzing and managing fiscal risks and contingent liabilities is clearly important, thought not always straightforward to implement. Disclosure is instrumental to management of risks, improving economic efficiency and reducing borrowing costs. Transparency also improves the quality of decisions on whether the government should take on risk in the first place. Best practice suggests, for example, that analysis of the sensitivity of budget estimates and public debt projections to key macroeconomic assumptions should be part of the budget documents. Also, risks and medium-term expenditure commitments should be taken into consideration in setting fiscal targets. Of course, some risks are more challenging to analyze than others. For example, risks related to macroeconomic shocks and some types of guarantees are easier to quantify than risks from other sources—for example, in the case of implicit guarantees.
Internationally, there is a trend toward greater disclosure of information on fiscal risks. This has been driven by the materialization of large fiscal costs driven by contingent liabilities associated to banking crises, natural disasters, state-owned enterprises, subnational governments, legal claims, and guarantees (Box 1). Other factors pushing for greater disclosure include international accounting and statistical reporting standards requiring disclosure of certain risks; the adoption of fiscal responsibility and/or public financial management legislation that enhances disclosure relative to those standards; and recent transparency initiatives, such as the IMF Code and Manual of Good Practices on Fiscal Transparency (2001, 2007) and the OECD Best Practices for Budget Transparency (2001).
Countries have increased the extent to which they analyze, manage and disclose fiscal risks. Risks associated with macroeconomic shocks are disclosed by many countries. Information on some contingent liabilities is also frequently disclosed, though the extent of disclosure varies (Appendix I). Typically, countries start by assessing a limited set of risks, and then expand the range of disclosed items, reflecting better information and ability to estimate risks. For example, Colombia gradually extended the coverage of contingent liability estimates from the central government to other parts of the public sector. In Chile, the government phased in the types of contingent liabilities disclosed—first reporting on minimum revenue guarantees under PPPs and minimum pension guarantees, later including loan guarantees to public enterprises in 2006, and finally adding information on student loan guarantees and lawsuits against the state in 2007 (Appendix II).
A few countries have consolidated information on fiscal risks in a single annual document. Australia and New Zealand report consistently and comprehensively on fiscal risks. These countries publish a Statement of Fiscal Risks, which is part of the documentation published jointly with the budget. Other countries—e.g. Brazil, Chile, Peru and Colombia—have also taken important steps. Chile publishes a stand-alone document on contingent liabilities.
Disclosure of fiscal risks in Mexico: A number of important pieces of information that are relevant to the analysis of fiscal risks are prepared and regularly published, but they are not presented or analyzed in an integrated manner (Box 2). Mexico does not currently systematically report, assess or register fiscal risks. For example, the only assessment of contingent liabilities is that associated to PIDIREGAS. The stream of payments committed under PPS-type arrangements are disclosed at the project level, but the associated fiscal risks are not assessed. The Mexican legal framework does not require the quantification, analysis or disclosure of contingent liabilities.
This project focuses on specific actions that would strengthen Mexico’s fiscal risk monitoring, analysis, disclosure and management. In particular, this background paper aims to develop an inventory and a general framework that will allow a better integration of the assessment of fiscal risks with the budget and medium- and long-term macrofiscal framework. The following section presents a list of sources of fiscal risk or medium-term expenditure commitments that, because of their relevance to Mexico, could be included in the Mexican overall risk assessment. The section also reviews how other countries disclose and analyze each of the sources of fiscal risk. Section III then looks at approaches to modeling multiple risks.
SOURCES OF FISCAL RISK
This section looks at the following five categories of fiscal risks in Mexico:
• A. Macroeconomic shocks (including natural disasters)
• B. Medium-term expenditure commitments, and possible decline in some revenue sources
• C. Contingent contractual liabilities
• D. Contingent implicit liabilities
• E. Cash flow risks
For each distinct source of fiscal risk, preliminary information and insights are organized along the following lines:
• Description. Nature of the risk.
• Relevance. Quantitative information that would eventually allow judge the magnitude and likelihood (and expected value) of the risk. Factors on which it depends, and whether it is likely to be correlated with other risks. History of past significance is also relevant.
• Disclosure in Mexico. Description of the current disclosure and methodology to assess the fiscal risk in Mexico.
• Approaches to modeling risk. How the risk is disclosed and modeled. Information that is needed to assess the risk.
• International experience. How other countries have monitored and attempted to analyze the risk.
• Feasibility. Feasibility of modeling the risk in the case of Mexico and likely time requirement.
A. Macroeconomic shocks (including natural disasters)
Description. Government revenues and expenditures are subject to shocks to various macroeconomic variables (economic growth, oil prices, interest rates, or exchange rates) and natural disasters.
Relevance
• Table 1 compares the budget estimates and the outturn for several fiscal variables. Forecasting error (for example, oil prices) contributes to revenue deviations from the budget. Interest payments also seem to often be underestimated, but this may reflect shocks to interest rates.
• Oil revenue
o Risks related to oil price for the Mexican mix. Oil revenues reached 9.0 percent of GDP in 2007, compared to 8.4 percent of GDP in the Federal Budget. Oil price for the Mexican mix was US$61.7 bbl compared to US$42.8 bbl in the budget. In the current context, the oil price formula used for the Federal Budget is likely to generate a budget assumption that is below the outturn.
o Risks related to international oil price, since these lower PEMEX’s own source revenues (through higher cost of gasoline imports) and lower the fuel excise (since a longstanding pricing policy rule keeps fuel pump prices about constant in real terms).
o Risks related to volume of oil production. There have been downward revisions to the proven oil reserves. Hurricanes also affect the oil production platform.
• Non-oil tax revenues (mostly related with GDP growth but also with the process of formalization in the economy) were 10.7 percent of GDP in 2007, compared to 10.1 percent of GDP in the Federal Budget.
• Non-oil own source revenues of agencies and enterprises under direct budgetary control (e.g. CFE, LFC, IMSS, ISSSTE). These revenues can be affected by shocks to formal employment, energy prices, epidemics, and legal reforms. In 2007, the Federal Budget expected the non-oil revenues of the federal parastatal entities under direct budgetary control to be 3.4 percent of GDP. However, a total of 3.8 percent of GDP was collected.
• Extraordinary expenditures can be triggered by natural disasters (e.g., hurricanes, flooding, earthquakes). The Federal Fiscal Responsibility Law (article 37) establishes that the budget should allocate resources to the “Fondo para la Prevención de Desastres”, “Fondo de Desastres”, and “Fondo para Atender a la Población Rural Afectada por Contingencias Climatológicas”. The minimum size of the funds (jointly) equals 0.4 percent of programmable expenditures.
Disclosure in Mexico
The 2008 mid-year fiscal report indicates the sensitivity of revenues and interest payments to changes in oil prices, GDP growth, interest rate and inflation (see Table 2).
Table 2. Mexico—Sensitivity of fiscal projections, 2009
Source. Documento relativo al Cumplimiento de las Disposiciones Contenidas en el Artículo 42, fracción I, de la Ley Federal de Presupuesto y Responsabilidad Hacendaria, SHCP, April 2008.
Approaches to modeling risk
Most OECD members, and some emerging market economies (e.g., Brazil, Chile, Indonesia) disclose fiscal risks associated with macroeconomic assumptions such as growth, inflation, interest rates, exchange rates and international oil prices. Approaches include sensitivity analyses, alternative macroeconomic scenarios, and stress tests for fiscal aggregates, as well as probabilistic approaches such as the value-at-risk (VaR) approach. Uncertainty surrounding baseline projections is sometimes illustrated through a fan chart (e.g., the United States’ The Budget and Economic Outlook: Fiscal Years 2007-2016).
Fan charts
Based on the forecasting track record, this approach illustrates the uncertainty for the projection of the fiscal variable of interest (for example, the overall balance) as a fan of probabilities around the baseline projection. The central line represents the baseline scenario of the forecast, and the bands around this line illustrate the uncertainty surrounding the forecast. Confidence intervals are constructed with reference to the errors of previous forecasts for the relevant variable. Thus, a disadvantage of this approach is that in the event of changing conditions and economic shock strengths, the past prediction errors may not capture the size of the uncertainty going forward.
The U.S. presents the baseline projection of the budget using the fan-chart approach (Figure 1). The forecasting track record of revenues and expenditures over the current fiscal year and the next five-year projection horizon is used to estimate the likelihood of alternative budget projections for the next five years under current policies. The analysis removes the effects of changes in legislation from the discrepancies between projections and actual figures, and separates inaccuracies correlated with the business cycle from those that are not. The approach requires information on the discrepancies in the revenues and expenditures mid-term projections, effects of legislation passed during the fiscal year on revenues and expenditures, and revisions to the GDP gap.
Figure 1. U.S. Fan chart for budget projections (in percent of GDP)
Source: United States’ The Budget and Economic Outlook: Fiscal Years 2007-2016
Sensitivity analysis
This analysis shows the fiscal impact of changes to key macroeconomic variables, but do not provide guidance on the probability that these changes materialize. The correlation between these changes is ignored. This approach involves estimating the sensitivity of key fiscal variables (such as revenues, expenditures, interest payments, debt) to variations in each of the key macroeconomic variables, with an explanation of underlying mechanisms.
Australia publishes the impact of changes to economic parameters in the current fiscal year on medium-term expenditures and revenues. The set of economic parameters include inflation, wage and salary growth, minimum wages, unemployment benefit recipients, employment, profits, domestic demand. The Statement of Fiscal Risks mentions specific risks to the projections.
New Zealand presents a table summarizing the sensitivity of the fiscal position over the next five years to changes in specific macroeconomic variables—in particular, lower GDP growth, lower growth rates of wages, salaries and profits, and lower interest rates (Table 2)
Indonesia reports the sensitivity of revenue, expenditure and overall balance to changes in economic growth, inflation, interest rate, exchange rate, crude oil price, and oil production. The impact on government debt posed by a currency depreciation and increase in the interest rate are estimated too.
Table 2. New Zealand: Sensitivity analysis
Source. Half Year Economic and Fiscal Update 2006. New Zeland.
Stress tests to the baseline projection
The fiscal variable of interest (for example, gross debt) is decomposed into several variables to explain its dynamics. The analysis consists of a set of stress tests in which one key variable at a time is hit by an adverse shock. (Alternatively, several such shocks can be considered together). The behavior of the fiscal variable of interest under less favorable conditions is projected, and then a subjective assessment is made as to weather the outcome is uncomfortably high (for a level of debt) or generally signifies excessive vulnerability. Standardized tests include lower growth, higher interest rates, a lower primary balance, and exogenous debt increases, such as those resulting from exchange rate depreciation or the recognition of off-budget obligations. The choice of the stress tests is somewhat arbitrary. In particular, the calibration of the shocks generally uses the unconditional variance of the underlying series, and the correlation among the shocks is ignored (or, if multiple shocks are considered to happen together, the packaging of these shocks is not systematic). Fiscal policy is assumed not to react. Further, each individual test formally has a near-zero probability of occurrence, making any meaningful quantification of risk impossible (Celasum, 2006).
Alternative macroeconomic scenarios
This approach takes into consideration the sensitivity of the fiscal variables to macroeconomic shocks and interlinks these. There is discretion in the choice of the alternative scenario, which may not represent upper or lower bounds to the baseline path.
New Zealand illustrates, in addition to the sensitivity analysis mentioned above, the paths of the operating balance and sovereign-issued debt over the next five years for two alternative macroeconomic scenarios—one of stronger domestic demand and the other of lower demand for New Zealand dollar assets (Table 3). Each of these scenarios interlinks underlying macroeconomic variables. The report indicates that these scenarios do not represent upper or lower bounds to the central forecast.
The macro-economic fiscal framework published by Peru projects the overall and primary fiscal balance during the next 3 years under two alternative scenarios—one of lower domestic growth and the other of lower global demand. The document also presents a debt sustainability analysis of the debt during 10 years under three scenarios: the first of no policy change; the second of higher interest rate (associated to an exchange rate devaluation and lower economic growth); and the third lower economic growth.
Table 3. New Zealand: Fiscal scenarios
Source. Half Year Economic and Fiscal Update 2006. New Zeland.
Value-at-Risk (VaR) Approach
This technique is used to calculate the probability distribution of the variable of interest, for example, the debt-to-GDP ratio. After identifying the risk factors that help explain the evolution of the variable of interest, historical data is used to assess the interrelationship between these risk factors. The probabilistic distribution of the variable of interest is computed through simulation using the probability distribution of the underlying risks, their covariance matrix, and a function describing the relationship between the risks and the variable of interest. The approach is not without drawbacks since it is based on historical data.
Peru complements its traditional debt analysis with a Value at Risk approach to calculate the probability distribution of the ratio of public debt to GDP for the next three years. Based on historical information of domestic debt, foreign debt, domestic interest rates, external interest rates, primary fiscal balance and exchange rate, probability distributions are assumed for each of these variables and the correlation among these factors is calculated. The probability distribution of the debt ratio is computed from running simulations.
Natural disasters
As a result of the frequency of natural disasters in Indonesia, the annual budget allocates resources to disaster alleviation and mitigation.
Required information
• Choice of the fiscal variable (balance, gross debt, net debt) and coverage of the public sector, as well as the approach to depict fiscal risks. Each of the approached described above has limitations, hence, there are advantages of using several models.
• Required data differs across models. For example,
o Fan chart approach. Data on projected revenues, expenditures, traditional fiscal balance and augmented fiscal balance over a five-year horizon. When did Mexico start making 5-year baseline projections? Information is also needed on the effects of legislation passed during the fiscal year on revenues and expenditures. If information on the projected and revised output gap is available, it would be possible to correct for cyclical inaccuracies.
o Sensitivity analysis. This approach requires a row-by-row analysis of each line in the fiscal table.
o VaR approach. Choice of relevant fiscal risk factors and historical data on these to determine the correlation matrix of these risks. The framework also builds on assumptions of the distribution of the risk factors. For example, a normal distribution could be assumed for GDP growth and primary spending; and log-normal distribution for the interest rate.
• Choice of macroeconomic shocks (GDP growth, interest rates, exchange rate, and oil price assumptions) and alternative macroeconomic scenarios.
• Risks to the oil production platform.
• Other: tax base estimates; estimates of formalization rates; costs of medical treatments by epidemics; costs estimates and probabilities of disasters by type.
Feasibility
• Very high
B. Medium-term expenditure commitments, and projected decline in some revenue sources
Description. Off-budget schemes to finance infrastructure investment (PIDIREGAS, PPSs, investment through off-budget funds), federal public pensions, wage negotiations. Expected decline in the oil production platform.
Relevance
• Off-budget infrastructure investment schemes. Infrastructure projects entail different types of risks, for example, construction risk (design problems, and cost and schedule overruns), demand risk (the possibility that the demand for the services provided declines), and availability risk (the possible lack of continuity and low quality of service provision). Investment risks may be exacerbated in the case of off-budget schemes since these support increases in infrastructure investment without immediately adding to government borrowing. Thus, governments are tempted to use these schemes without an adequate assessment of the associated fiscal costs that the government will bear over the medium to long term. Off-budget investment schemes often involve the creation of government liabilities that could be firm (i.e. occur in any event) or contingent (e.d. triggered by a particular event). This section focuses on the firm liabilities while next section covers contingent contractual liabilities.
o PIDIREGAS lead to a significant future stream of government payments that reduce fiscal space. The financial obligations of PIDIREGAS receive priority treatment in the annual Federal Government budget. In 2007, the amount invested in PIDIREGAS amounted to 1.7 percent of GDP. It is expected that PEMEX’s total financed investments will increase 1.1 percentage points of GDP between 2000 and 2008, and CFE’s financed investments are expected to increase from 0.25 percent of GDP in 2000 to 0.34 percent of GDP in 2008. [Indebtedness if impacts the interest bill, interest rates, or roll-over issues.]
o PPSs: 8 projects in transportation, health and education areas have been awarded since 2005-2007. Under these 8 contracts, the private sector will invest US$1.2 billion (Table 4). NPV of the government obligations amount to 0.3 percent of 2007 GDP (staff’s calculation using a discount rate of 8 percent).
Table 4. Mexico: Federal government PPS projects
o Under the recently announced Programa Nacional de Infrastructura 2007-2012, the government plans to invest US$230 billion over the next five years, equivalent to 4 percent of GDP per year—it is not clear the financing mechanisms that will be used for these projects—but most likely as PPPs.
o Fondo Nacional de Infrastructura (FONADIN). The fund was created in 2008; its initial resources amount to US$4 billion. Over the next five years, it is expected this fund finances infrastructure investment of US$25 billion through the provision of guarantees and extending recoverable and non-recoverable loans. The distribution of the infrastructure projects is as follows: 45 percent in ports, railroads and airports, 30 percent in highways, 20 percent in hydraulic infrastructure, and 5 percent in other sectors. It is estimated that the private sector also participates in those projects so that total investment is US$75-100 billion, of which US$25 is public investment channeled through the fund.
o A Banobras trust fund (FINFRA) is involved in the financing of infrastructure—including PPS. FINFRA was recently incorporated into the FONADIN.
• Federal public pension schemes. ISSSTE for the Federal Government. Public enterprises that are included in the budget documents (PEMEX, CFE, LFC) have their own pension systems. The IMSS workers have also their own pension scheme, which is known as Régimen de Jubilación y Pensiones (RJP).
• Wage negotiations
• Oil production platform. Proven oil reserves of less than 10 years of production at current production rates.
Disclosure in Mexico
• Firm commitments under PIDIREGAS, PPS, off-budget funds. The annex to the budget has information on medium-term amortizations and interest payments associated to PIDIREGAS, as well as information on programmed investment (Tables 5 and 6). [PPSs (stream of payments) are also disclosed in the budget document (Table 7)].
Table 5a. Firm commitments under Pemex’s PIDIREGAS
Source. PEF, 2008
Table 5b. Firm commitments under CFE’s PIDIREGAS
Source. PEF, 2008
• Public pensions. Criterios publishes the expected pension outlays for the current and next 5-years (Figure 2a). Information on the actuarial deficit of the federal public pensions is not disclosed in budget documents. The Unit of Pensions at SHCP estimated that the actuarial deficit of ISSSTE (with 10 million of beneficiaries and 2.5 millions of workers) was about 60 percent of GDP, in NPV terms, before the ISSSTE Reform. The reform led to a deficit reduction of approximately 22 percent of GDP (Figure 2b). Which is the methodology used by the Unit of Pensions to estimate the actuarial deficit? According to information from the public enterprises, the pensions of PEMEX, CFE and LFC) amount to about 15 percent of GDP. According to information from IMSS, the actuarial deficit of RJP exceeds 10 percent of GDP. The figures of the actuarial liabilities of public enterprises and from RJP-IMSS have been provided by the Unit of Pensions at SHCP.
Table 6. PIDIREGAS investment
Source. PEF, 2008
Table 7. PPS in budget documents
Figure 2. Mexico. Federal public pensions
Source. First panel from Criterios, the second from the Unit of Pensions, SHCP.
• Expected decline in the oil production platform, oil exports and oil revenues is disclosed in Criterios (Figure 3).
Figure 3. Oil production and revenues
Source.Criterios, 2008.
Approaches to modeling risk
Medium-term non-contingent expenditure commitments as well as any anticipated decline in revenues pose a risk on fiscal finances since they increase budget rigidity and reduce fiscal space for discretionary spending. The risk to fiscal sustainability could be reduced by disclosing these operations in the medium-term fiscal framework and keeping a centralized registry of the commitments. Disclosure also facilitates policy analysis and reduces current spending pressures.
Special vehicles which are used to bypass budgetary procedures, such as off-budget funds, should be consolidated with the fiscal sector because of their impact on the borrowing requirements of the total public sector.
Pension liability
Colombia reports the pension liability in NPV terms. The calculation assumes a 50 year time horizon and a discount rate of 6 percent.
Indonesia publishes the expected annual cash payments of pensions for civil servants for the next 4 years. The report also indicates the share of the pension outlays that will be paid from the state budget, reflecting the liquidity problems that the pension fund faces.
Concessions
Peru reports the annual non-contingent cash payments for each PPP project during the next 3 years.
Required information.
• Future stream of government firm payments under the PIDIREGAS and PPS schemes (This information is already published in Mexico budgetary documents).
• Describe the methodology and information used by the Unit of Pensions to calculate the actuarial deficit.
• Estimates of newborns; type of disease (and associated treatment cost) and probability by age.
Feasibility
• High
C. Contingent contractual liabilities
Description. PIDIREGAS, PPSs, minimum pension guarantees of public and private pensions, and other government guarantees such as bank deposit insurance and net lending and extension of guarantees by development banks. Universal health insurance.
Relevance
• PIDIREGAS and PPSs. Bailout-precedent: the poor quality of feasibility studies for the 1980s toll road concession program and lower-than-expected traffic volumes resulted in the government bailout of private operators and takeover of the physical infrastructure—the government estimates that the total cost of the bailout reached US$7-8 billion.
• Banobras is involved in supporting infrastructure—including PPPs.
• Minimum pension guarantee. Guaranteed minimum pensions were established when reforming the private and ISSSTE pensions systems, in 1997 and 2007, respectively, in order to address the concern of those workers affected by the new schemes in case pension payments were to be too low at the time of retirement.
o Private pensions (IMSS-AFORE system)—the federal government guarantees a minimum pension (equal to the minimum salary—indexed to inflation—in the Federal District) to every beneficiary of the social security system that is 65 y/o and that has contributed at least 1,250 weeks. In 2005, this minimum pension was equivalent to 1.3 minimum salaries. IMSS has 45 million of beneficiaries and 13 million workers.
o ISSSTE reform—government guarantees a minimum pension of two minimum salaries after 25 years of contribution and starting at age 65. The number of ISSSTE workers under the new scheme is not yet known.
• Bank deposit insurance. One of the most generous in the world (about US$120,000 compared to US$100,000 in the U.S) and unfunded.
• Development banks. Net lending (first and second tier) is planned at about 0.5 percent of GDP a year during 2007-13, and it is transparently reflected in the augmented fiscal balance. Mandates of DBs have been reviewed and there are plans to gradually increase guarantees. In the past, quasi-fiscal activities of development banks led to large costs for the government.
• Universal health insurance (Seguro Universal de Salud) introduced in 2007 and covering all new-born children. Impact of new common diseases (cardiovascular, diabetes, cancer, etc.).
Disclosure in Mexico
• PIDIREGAS and PPSs. The budget includes information on the estimated cost of contingent liabilities associated to PIDIREGAS condicionada (Table 8). [how is this calculated?] Does the unit of investment assess the risks associated to PIDIREGAS or PPSs.?
• Minimum pension guarantee. [Does SHCP estimate the exposure to this guarantee?]
o Minimum pensions are low compared to average wages.
o In order to be entitled to the minimum pension, a worker must have contributed for at least 1,250 weeks –about 24 years–, a condition satisfied by a low percentage of workers. Therefore, the risk that these minimum pensions may bring to the Federal fiscal finances is limited, assuming no important changes in workers’ behavior and no renegotiation of terms (e.g., indexation).
• Development banks. Development banks’ risk exposure is appropriately measured according to commercial banks methodology. The same sounded practices applicable to commercial banks are used by development banks in order to measure their risk-exposure. Financial indicators such as capitalization, coverage and delinquency indexes are used to closely monitor risk-exposure of each institution. Total lending to the private sector accounted for 2.3 percent of GDP in 2007; only 0.7 percent of GDP was direct lending. [Do we have any indicators of risk exposure?] [Table 9. Net lending figures (Criterios) and stock of guarantees (SHCP quarterly report). Does Public Credit has any additional information on the total stock? Any estimate of exposure?]
Table 8. Expected budgetary cost associated to PIDIREGAS condicionadas
Source. PEF, 2008.
Table 9. Development banks
Aproaches to modeling risk
Reported information on explicit contingent liabilities usually consists of total exposure measured by the guarantees’ face value (e.g. government’s gross exposure), complemented in some cases by the expected value of all outstanding guarantees (Colombia, Chile). In the case of PPPs, countries report cumulative overall and expected exposure from guarantees and similar instruments.
Minimum pension guarantees
Chile estimates the risk associated to the minimum pension guarantee using an actuarial model. Required information includes population by age, gender and income groups (low, medium, high) since these groups differ in their contribution to their individual accounts. Based on mortality tables, the number of years during which pensions could be paid out from the individual accounts is calculated, and the pensions for the remaining life span are to be paid with the minimum pension guarantee. Factors such as the pension fund return does not seem to be included in the model (?). Chile projects the annual expected cash payments for the next 12 years and also reports the expected cash payments in NPV terms (using a real discount rate of 4 percent).
Guarantees associated to PPPs
Fiscal risks due to public-private partnerships (PPPs) are disclosed by a growing but still limited number of countries (e.g., Colombia, Chile, Indonesia, Japan, Peru, South Africa, United Kingdom). The information usually consists of a description of the government guarantees granted under PPP contracts, the projects’ total value, and expected cash flow payments or their net present value.
Chile quantifies the risk associated to minimum revenues guarantee extended in the context of road and airport concessions. The maximum loss exposure in case of no traffic (for each project, the maximum exposure, its NPV in local currency and in percent of GDP) is reported. In addition to this calculation, Chile uses a Montecarlo simulation model to estimate the expected cash payments under 5, 50, and 95 percentiles of the probability distribution for entire portfolio of concessions over the next 20 years; and (ii) the NPV of these payments for each project.
Colombia also reports the NPV of the contingent liability associated to infrastructure concessions that could materialize during the next 10 years. The expected value (assuming 50 percent likelihood that the payment is triggered) and the maximum loss exposure (assuming 99 percent likelihood that the payment is triggered) are presented. The report does not mention the methodology being used.
The Indonesian report explains for each infrastructure PPP project (three projects in total) the associated government liability. One of these projects includes a guarantee for a short-fall in passenger demand and the report indicates the annual maximum exposure to this guarantee.
Peru publishes the maximum loss annual exposure during the next 3 years for each PPP project. In addition, Peru estimates, using a Montecarlo simulation, the expected fiscal cost (under a 50 percent probability) for the PPP portfolio in NPV terms.
Sovereign guarantees
Chile reports the total amount of guarantees that the government could extend to public enterprises. The total amounts are approved in legal documents. The Chile report indicates the amount of the guarantees that have been used, indicating the currency and type of debt instrument.
Colombia estimates the sovereign loan guarantees (expected value assuming 50 percent probability and maximum loss exposure) over the next 10 years in NPV terms.
Deposit insurance guarantee
Chile reports the maximum risk exposure to the government guarantee to bank deposits and a table on the credit rating for each financial institution. The guarantee covers 90 percent of the personal deposits across all financial institutions, with a ceiling of UF120. Chile calculates the maximum exposure, but indicates that it is indeed smaller than that amount since their calculation does not correct for a person having deposits exceeding the UF120 ceiling in different institutions.
Indonesia has a government backed deposit guarantee program. The deposit guarantee program is implemented by a Deposit Guarantee Institution. The maximum deposit that is guaranteed is Rp 100 million per customer in a bank. Indonesia publishes historical information on the total amount on deposits guaranteed and the reserves in the Deposit Guarantee Institution.
Required information
• Identification of guarantees included in the contract for each infrastructure project. Estimates of income streams and probability that each type of guarantee is triggered.
• Number of workers in the new pensions system and their demographics (age, gender, income). Estimated returns on pensions accounts and final pension. Labor dynamics in private and public sector
• Net lending and extension of guarantees by development banks
• Assets classification by market and credit risks for both developments and commercial banks. Bank deposit insurance reserves. Number of bank accounts exceeding US$120,000; deposits in bank accounts with deposits under the guarantee ceiling.
Feasibility
• Medium
D. Contingent implicit liabilities
Description. Pension schemes of subnational governments, subnational government enterprises, and of development banks; borrowing by subnational governments.
Relevance
• Subnational governments
o Debt
- Relatively low, partly reflecting the 1995 bailout, but increased 5 percent in real terms to 1.8 percent of GDP in 2006 (while the federal debt declined). 7 states have debt levels exceeding 2 percent of GDP, and 3 states account for 58 percent of total SNG debt.
- As a percentage of participaciones, debt reached 53 ½ in 2006. The percentage exceeds 100 for Federal District and Nuevo León.
- Debt registry at UCEF is not comprehensive since registry is only required if the debt is guaranteed with federal government transfers (art. 9 LCF). SNGs could voluntarily register other liabilities (art. 10 LCF). Hence, there may be underreporting of certain types of debt, including floating debt.
- New instruments include securitization for example of own revenues—such as the pledge of the payroll tax in the 2002 bond issued by State of Mexico. Trust-funds are also used as a device to borrow, for example, to finance projects and securitize future cash flows generated by the project—these trust-funds are off-budget.
- Absence of standardized debt limits.
o PPS—Several SNGs have adapted their regulatory framework to undertake PPSs and other SNGs are moving in this direction. Absence of standardized limits.
o Pensions—in 1998, the actuarial deficits amounted to about 25 percent of GDP. State governments’ pensions also represent a risk: most of them are unfunded.
Disclosure in Mexico
The implicit liabilities are not disclosed.
Figure 4. Actuarial deficits of subnational government and development banks (this figures should only show the acturial deficits of the states, and development banks—since these are the implicit liability from the point of view of the budgetary public sector)
Source: ISSSTE: SHCP; States: Hewitt; Public Sector Companies: CFE LyFC, PEMEX; RJP: IMSS; and Development Banks: Hewitt. ISSSTE information is for december 2002; for States is a proyection to 2003 from the estimation made in 1998, for Public Sector Companies, RJP and Development Banks the information is for december 2003.
Approaches to modeling risk
A broad coverage of the fiscal accounts (off-budget funds, public enterprises and subnational governments) helps to reduce fiscal risks by ensuring a better monitoring of the fiscal operations of all levels of government.
The quantification and monitoring of the contingent implicit liabilities associated to other levels of governments is also important even if the accounts of these are not consolidated with the federal government fiscal accounts.
Assessing the sustainability of ratios of subnational debt (and debt service) to a decline in central/federal government transfers if subnational governments are heavily dependant on transfers. This could be modeled with the traditional debt sustainability framework. Debt sustainability would also depend on the states’ capacity to raise own source revenues.
Required information
• For each state: information on total debt (including off-budget obligations), amortization schedule, debt maturity, federal government transfers, own-source revenues, and GDP.
• Pensions’ data: for each of the various pension systems mentioned above, information is required on pensions payments, contributions, number of current workers and beneficiaries, worker’s labor profile, reserves. In the case of state government workers, the World Bank has a project to assess states’ pension liabilities.
Feasibility
• Medium
E. Cash flow
Description. Short-term financing needs (roll-over of short-term debt, risks related to debt that is indexed), cash management to minimize debt issuance, debt management (integration of all types of federal debt, including IPAB).
Relevance
• Gross public debt to GDP (augmented government coverage) is 43.8 percent of GDP (27 percent of the total is external debt) at end-2007.
• The annual (gross) augmented financing need—i.e, the augmented deficit, plus amortization and rollover needs on the existing augmented debt stock coming due in the next 12 months—is significant, and likely to be on the order of 10 percent of GDP.
• The Federal administration is advancing towards the implementation of a treasury single account (TSA). The TSA will only help minimize the borrowing requirement of the public sector if there is a good coordination between cash and debt management, which is lacking at the moment.
• There is a fragmentation of debt management. For example, IPAB’s significant debt is not managed by Public Credit.
Disclosure in Mexico
Approaches to modeling risk
• Adequate cash flow forecast of the borrowing requirement of the public sector. This requires the schedule amortizations (including those from the issuance of new debt) and information on debt duration
• Produce information on below-the-line operations and decide on the financing strategy that maximizes the risk-adjusted net worth of the public sector. This strategy also requires a good coordination between the institutional units responsible for the cash, budget, medium-term planning, and public credit.
Required information
Feasibility
• ??
II. APPROACHES TO MODELING MULTIPLE RISKS
A. Approaches
The assessment of fiscal risks should be incorporated in the medium-term fiscal framework and sustainability analysis.
• The sensitivity of fiscal aggregates to changes in economic conditions could be captured, as mentioned above, using different approaches. Some of these approaches allow for capturing the correlation between different fiscal risks.
• The baseline fiscal framework for the year and for the medium-term should include firm expenditure commitments and pressures, as well as the anticipated decline (or change) in revenues.
• The expected value of contractual contingent liabilities should be incorporated in an analysis of fiscal sustainability.
• Implicit contingent liabilities and a few contractual contingent liabilities are difficult to quantify. A stress test to account for the bulk of the non-quantifiable liabilities should be included in the analysis of fiscal sustainability.
[short summary of related literature, starting maybe with just 1-2 sentences to describe each paper]
What variable(s) to model? Recent literature calculates the probability distribution of the public debt/GDP ratio, with the idea of looking at sustainability. This approach would help draw conclusions regarding the augmented fiscal balance (and PSBR), which is not controlled by a policy rule. However, the focus may instead be on the need for policy adjustment to comply with the balanced budget rule. Hence, the probability distribution of the required adjustment of discretionary spending or tax policy could be the variable of interest.
Time horizon. Each framework has to be tailored to the time horizon under consideration, for example, budget year, one-year ahead, five-year horizon, or longer time horizon.
B. Way forward
The assessment of fiscal risks itself should be considered work in progress, where risk coverage would be extended and quantitative estimates improved gradually.
• On macroeconomic risks, a first step could include a sensitivity analysis to changes in individual macroeconomic parameters, and then, complement this analysis with alternative macroeconomic scenarios, a depiction of uncertainty with fan-charts or a VaR approach. Clearly, the meaningfulness of such probablistic analysis would depend in large part on the quality of the “baseline” scenario around which a distribution is defined. A careful review of medium-term baseline paths for key fiscal variables therefore would be a critical step.
• With regard to contingent expenditures, coverage could initially focus on the largest contingencies, but could gradually be extended to all government contingent liabilities. Moreover, quantification could be gradually improved, where feasible, by moving from gross exposure to the expected present value of expenditures.
III. REFERENCES
Adrogué, R. (2005) “Fiscal Sustainability: A Value-at-Risk Approach”. IMF Occasional paper.
IMF Board Paper: Fiscal Risks. Fiscal Affairs Department, IMF. 2008. [forthcoming, to be sent to IMF Executive Directors in May 2008]
IMF Board Paper: Government Guarantees and Fiscal Risk. Fiscal Affairs Department, IMF. 2005. SM/05/120.
IMF Board Paper: Public Enterprises and Fiscal Risk--Lessons from the Pilot II Country Studies. Fiscal Affairs Department, IMF. 2007. SM/07/368.
IMF Board Paper: Public-Private Partnerships and Fiscal Risk. Fiscal Affairs Department, IMF. 2007. SM/07/138.
Di Bella, G. (2008) “A Stochastic Framework for Public Debt Sustainability Analysis.
IMF Working Paper No. 08/58.
Celasun, O., Debrun, X., and Ostry, J. D. (2006) “Primary Surplus Behavior and Risks to Fiscal Sustainability in Emerging Market Countries: A "Fan-Chart" Approach.” IMF Working Paper No. 06/67.
Gray, D. F., Loukoianova, E., Malone, S.; and Lim, C. H. (2008) “A Risk-Based Debt Sustainability Framework: Incorporating Balance Sheets and Uncertainty” Working Paper No. 08/40.
Hemming, R (2006), “Public-Private Partnerships, Government Guarantees, and Fiscal Risk,” IMF Special Issues Paper.
Hostland, D., and Karam, P. D. (2006) “Specification of a Stochastic Simulation Model for Assessing Debt Sustainability in Emerging Market Economies” IMF Working Paper No. 06/268.
Hostland, D; Karam, P. D. (2005) “Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods” IMF Working Paper No. 05/226.
Tanner, E., and Samaké, I. (2006) “Probabilistic Sustainability of Public Debt: A Vector Autoregression Approach for Brazil, Mexico, and Turkey” IMF Working Paper No. 06/295
Published: December 1, 2006.
Reports prepared by country governments on their fiscal risks
Budget Strategy and Outlook 2007-08, Astralia Government.
Documento relativo al Cumplimiento de las Disposiciones Contenidas en el Artículo 42, fracción I, de la Ley Federal de Presupuesto y Responsabilidad Hacendaria, SHCP, April 2008.
Half Year Economic and Fiscal Update 2006. New Zeland.
Informe de Pasivos Contingentes 2007, Gobierno de Chile. November 2007.
Marco Fiscal de Mediano Plazo 2008, Gobierno de Colombia.
Marco Macroeconómico Multianual 2008-2010. Gobierno de Perú. Mayo 2007.
The Budget and Economic Outlook: Fiscal Years 2007-2016. U. S. Congressional Budget Office (January 2006).
The Uncertainty of Budget Projections: A Discussion of Data and Methods. A Supplement to the Budget and Economic Outlook: Fiscal Years 2006-2015. U. S. Congressional Budget Office (February 2005).
Indonesia.
Appendix I. Table 1. Disclosure of Fiscal Risks and Contingent Liabilities, Selected Countries
Australia Chile Colombia Indonesia New Zealand
Legal framework
FR reporting The Charter of Budget Honesty Act 1998 requires fiscal risks be disclosed. The FRL was amended in 2006 to establish the requirement of reporting annually on the amount and characteristics of government liabilities that arise from the extension of “fiscal guarantees.”
A law was passed in 2003 establishing the requirement of reporting the quantification and analysis of non-explicit debts (such as pension liabilities) and contingent liabilities (such as those from lawsuits, concessions and public credit operations) The budget document justifies the need for disclosure of fiscal risks to enhance fiscal transparency and sustainability. The Public Finance Act 1989 requires disclosure of all government decisions and other circumstances that may have a material effect on the fiscal and economic outlook.
Type of
Document Statement of Risks is a chapter of the Statement of the Annual Budget. Sensitivity of the budget to economic developments is included in the Fiscal Outlook chapter of the Statement of the Annual Budget. Stand-alone report on Contingent Liabilities. Chapter of the Medium-Term Fiscal Framework. Financial Notes to the Budget Document include a Fiscal Risk Statement. Chapters of the Annual Budget Economic and Fiscal Update Document
Specific risks:
Macroeconomic shocks √ √ √
Pension liabilities √ √
Minimum pension guarantee √
Bank deposit guarantee √ √
Concessions √ √ √
Loan guarantees √ √ √
Loan guarantee to SOE √
Lawsuits against the state √ √ √ √ √
Natural disasters √ √
Source: Board Paper on Fiscal Risks (2008)
Appendix II. Table. Chile’s Statement of Contingent Liabilities, 2007
Background Minimum Pension Guarantee Concessions Debt Guarantees to SOEs Legal Rulings Contingent liabilities: other Contingent Funds
The 2006 FRL requires the government to report annually on the amount and characteristics of government liabilities that arise from the extension of "fiscal guarantees." While the government was reporting on some of these guarantees since 2003 in its Annual Report on Government Finances, it first issued a comprehensive stand-alone report on contingent liabilities in November 2007. The reports explain that the state must come up with the difference between the legally-mandated minimum pension and one's pension at the moment of retirement, if the latter is lower than the former. Together with a brief description of the methodology, the reports present the annual expected cash payments over the next 12 years; the net present value of these payments and calls on past guarantees for pension fund bankruptcies. The reports discuss the existing minimum income guarantees to operators of public infrastructure concessions, including roads, airports, penitentiaries, and other. Their value is reported as: (i) expected cash payments under 5, 50, and 95 percentiles of the probability distribution for entire PPP system over the next 20 years; (ii) the NPV of these payments and its evolution over the past five years; and (iii) maximum loss exposure in case of no traffic (for each project, the maximum exposure, its NPV in local currency and in percent of GDP).The methodology used in the estimation (Monte Carlo simulations) is also discussed. For each law authorizing guarantees, the reports indicate the maximum amount authorized by the law, the amount actually guaranteed and the time of guarantee issuance (by loan and SOE). For each outstanding guaranteed loan, the details of the loans (amount issued, currency, interest, maturity, current stock at par value). Expected losses under these guarantees are not reported. The reports describe the main types of financial legal action against the state as well as the administrative framework for the defense of the interests of the state against those lawsuits. They report on the maximum amounts claimed in courts, by activity area, and past success rates at winning demands. Information is also reported on:
• Maximum risk exposure to the government guarantee to bank deposits;
• Guarantees to SMEs (share of NPLs in total loans to SME from the banking system, calls on guarantees as a share of the average guarantee portfolio of the Fund administering the guarantee; all as annual data for past 9 years);
• The reports describe the main elements of the (new) debt guarantee scheme for student loans and provides information on the total face value of guarantees granted. It also explains that no calls on these guarantees have been made given that it is a recent instrument.
• Quasi-fiscal deficit of the Central Bank (annual deficits and capital position of the bank, with a discussion of the factors affecting them);
• Other explicit contingent liabilities, such as unemployment programs and currency mismatches in SOEs;
• Implicit liabilities associated with potential interventions to stabilize domestic fuel prices.
The final section of the statement explains the purpose of, and provides financial information on, three funds that have been created to protect against specific contingent liabilities, namely: (i) the pension fund (which helps pay for the minimum pension guarantee); (ii) the guarantee fund for small businesses (which guarantees a certain share of bank loans to small businesses); and (iii) the fuel price stabilization funds (which collects/provides resources to stabilize the price of gasoline, diesel, and kerosene within price bands).
Source: Board Paper on Fiscal Risks (2008)
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