Allen Schick and Paulo Mauro Discuss Budgeting for Fiscal Risks

On September 17, at a well-attended FAD seminar, Professor Allen Schick and FAD Division Chief Paulo Mauro presented their views on "Budgeting for Fiscal Risks". Professor Schick is an acknowledged expert on the subject and, in 2002, wrote a path-breaking book with Hana Polackova Brixi and Sweder van Wijnbergen — "Government at Risk: Contingent Liabilities and Fiscal Risk"—published by the World Bank and Oxford University Press. This seminar was timely, given the fact that FAD has recently produced an IMF Board Paper on the subject "Fiscal Risks—Sources, Disclosure, and Management".

Professor Schick was quite complementary on the recent FAD paper and agrees with many of the recommendations contained in the Paper. Pr. Schick suggested that a clearer distinction between "fiscal risks" and "fiscal uncertainties" could be made:

- In the FAD paper fiscal risk is defined as the "possible deviation of fiscal outcomes from budget estimates or other projections";

- Pr. Schick provides an alternative definition which focuses on the "contingency of future revenues or expenditures on uncertain events";

In his analysis of the typical characteristics of a "Risk Taking State", Pr. Schick highlighted the following issues related to:

1) the macro-economic management by the state: the important issue here relates to the fact that it is more important to balance the economy than the budget; the use of automatic (built-in) stabilizers for fiscal policy; usually risks are taken in good times, which become due in bad times; and the treatment of economic shocks.

2) the existence of the "Entitlement state" where a shift of risks from households to the government takes place; the composition of national expenditure changes; the universalization of major income support schemes; moral government becomes more important than moral hazard; and the government is seen as payer or guarantor of last resort.

These characteristics are, however, mostly present in the more advanced economies.

Other main points of Pr. Schick's presentation included:

* a discussion of the incentives for governments to accumulate fiscal risks;

* identification of the problems with the control of contingent liabilities;

* the inadequacy of conventional budget procedures;

* the management of fiscal risks; and

* possible strategies that could reduce the shift of risk to government.

The full presentation is available here: Download budgeting_for_fiscal_risk_by_aschick.ppt .

(As an aside, Prof. Schick joked that until a few weeks ago, he would have advised governments to look towards the private sector for guidance on managing risks. Given the recent financial turmoil, this advice is clearly no longer relevant).

In response to the observations made by Pr. Schick, Mr. Paolo Mauro (FAD Division Chief and one of the main authors of the Board Paper), highlighted the findings of their study and the recommendations contained in the Board Paper. He mentioned that this topic has gained importance in many IMF member countries, as interest in promoting fiscal sustainability and transparency grows. The paper on which the discussion was based reviews the experience with fiscal risks in a wide range of countries and provides practical advice on risk identification, disclosure and management. This includes a set of Guidelines for Fiscal Risk Disclosure and Management, and a possible Statement of Fiscal Risks. The paper defines fiscal risks as deviations of fiscal outcomes from what was expected at the time of the budget or other forecast. On this basis, it explores the sources of fiscal risks—their nature and relative importance—which vary with country economic structure and level of development. —in addition to sound macroeconomic and public financial management policies—practices that require justification for taking on fiscal risks and risk-sharing with the private sector; and (iv) effective risk management is facilitated by a legal and administrative framework that clarifies the relationship between different levels of government and vis-à-vis the private sector.

Lessons drawn from the review of the international experience in these areas include: (i) the identification of all fiscal risks is a prerequisite for their disclosure and management, and contributes to a fully informed conduct of fiscal policy; (ii) comprehensive disclosure of all fiscal risks helps facilitate identification and management of risks, and reduce borrowing costs in the long run; (iii) fiscal risk mitigation includes

Finally, the paper proposes Guidelines for Fiscal Risk Disclosure and Management as a tool to help policymakers identify potential improvements to existing frameworks and to inform the IMF staff’s analysis of fiscal risks. Once finalized, the guidelines could be a helpful complement to the IMF’s Code and Manual of Good Practices on Fiscal Transparency and the Government Finance Statistics Manual.

Mr. Mauro also informed participants that this topic will be discussed at an upcoming high-level FAD seminar for European countries in Paris, planned for October 28-29, 2008.

Comments

[Carlos Delatorre]

I think that the comment made by Mr Shick (on the convenience of looking at the private sector for guidance on managing risks) may still be relevant if we are discussing "basic" risk techniques (such as sensitivity, scenario and, even, MonteCarlo analyses). Let me elaborate. When a government assesses the convenience of a public investment in roads or a PPP, where a traffic guarantee is given to the private sector, these techniques link risk variables (road traffic, for example) with economic NPV outcomes (whether probabilistic o not), and typically modeled in a spread-sheet. The problem with more elaborate risk methodologies could reside in the fact that there is not direct link between risk variables and outcomes, part of the reason that is unclear the extent of losses of some financial operations in the recent months.

I understand that some sections of the Manual of Fiscal Transparency refer to these basic techniques when looking at the convenience of assessing and/or presenting alternative fiscal scenarios.