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Contingent Liabilities and Debt Management Strategy . 6th UNCTAD Debt Management Conference Geneva November 19-21, 2007 Udaibir S. Das Division Chief Sovereign Asset and Liability Management Division Monetary and Capital Markets Department IMF . Contingent Liabilities. Significance

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Contingent liabilities and debt management strategy l.jpg

Contingent Liabilities and Debt Management Strategy

6th UNCTAD Debt Management Conference

Geneva

November 19-21, 2007

Udaibir S. Das

Division Chief

Sovereign Asset and Liability Management Division

Monetary and Capital Markets Department

IMF


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Contingent Liabilities

Significance

Disclosure: Good practices

Management and Debt Strategy

Conclusions


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Definition and Motivation

Key aspects

  • Timing and amount of obligations contingent on the occurrence of some uncertain future

  • Event outside the control of the government

  • Explicit or implicit


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Significance

  • Poses significant balance sheet risk

    • Governments increasingly assuming financial risks for society

    • Opportunistic use of CLs (guarantees)

    • Creative financing

  • Not just fiscal, but several often ignored negative spillovers

  • Often leads to large “hidden deficits”

    • fiscal balances and debt build up


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Significance of contingent liabilities?

Annual “Hidden” Deficits

(percent of GDP)


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Significance of contingent liabilities

  • Moral hazard

    • Transfer of risk to the government give rise to moral hazard

  • Particularly strong with implicit CLs

    • Expectations that government would intervene in the event of a crisis

      Past bailouts: Average cost 12.8% of GDP (40 sample episodes).


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Contingent liabilities: New Challenges

  • Changing macroeconomic, financial and capital market landscape

  • Role of sub-nationals, and private sector debt

  • Capital market more discerning

  • Strengthening of debt management capacity

  • Transparency and disclosure


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Disclosing CLs: Good Practices

  • Compiled and disclosed in budget documentation, fiscal reports and financial statements

    Exceptions:

    • Implicit CLs, to minimize moral hazard

    • Sensitive information

    • Implicit CLs should be made explicit if:

      • Strong prima facie evidence of a guarantee

      • A framework to avoid open-ended guarantees

      • Government is explicit when it will notstep in


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Disclosing CLs: Good Practices

  • Disclosure statements should include:

    • Classification by major category

    • Fiscal significance of government’s CLs

    • Information on the past calls on the government

    • Information about reserve assets set aside against specific contingencies

  • A good practice to collate information on all fiscal risks into a single Statement


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Managing CLs: Framework

  • CLs should be issued under the guidance of a well-articulated policy framework:

    • Justification

    • Design

    • Approval and Integration with Budget

    • Management and Analysis

  • A good example:“Guidelines for Issuing and Managing Indemnities, Guarantees, Warranties and Letters of Comfort”.


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    Managing CLs: Justification and Design

    When CLs are acceptable and preferable to other forms of support:

    • Market failure or administrative advantages

    • Risks borne by those best placed to manage them

    • Risk taken by government should be clearly identifiable

  • Risk sharing with private sector

  • Limiting scope and duration of CL


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    Managing CLs: Approval

    • Issuance of CLs (guarantees) integrated into the budget process and taken by parliament

      • Explicit CLs are similar to conventional debt

      • Budget for the cost of CLs, even if budget is cash-based

      • Legislature can set quantitative ceilings on CLs

      • Disclose CLs and risks in supporting budget documents to give parliament information

      • Sub national agencies?

    • Country Examples


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    Managing CLs: Budgeting

    • Fee reflecting the market cost of the guarantee should be charged ex-ante to the recipient

      • Prevents disguised expenditures

      • Recipient bears cost of the guarantee

      • State subsidy?

      • Margin over and above expected costs as a buffer for worse case scenario

    • Country Examples


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    Managing CLs: Budgeting

    • If subsidize, then market cost of guarantee charged against the budget

      • Acknowledges and internalizes cost of the decision

      • Ensures other expenditures are reduced

      • Removes bias in favor of guarantees

        • Guarantees often not the most efficient way to provide subsidies


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    Managing CLs: Contingency Funds

    • Resources should be set aside to meet future costs

      • Actual reserve funds: invest resources in managing these assets

      • Notional reserve funds: charges reduce gross debt if other spending is crowded out

    • Other financial tools to meet future costs (natural disasters):

      • Insurance and reinsurance

      • Calamity Funds/Contracting contingency credits

      • Allowing contingency margin in current budget


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    Managing CLs: Integration with DM

    • Risk management of entire stock of government debt, including contingent, should be centralized

      • Compilation and reporting of an inventory of CLs

      • If some debts are administered by specialized entities these should be reported to the DMO

      • Analysis and management of risk from contingent and non-contingent debts should be integrated


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    Managing CLs: Integration with DM

    • Limited role for debt managers in decisions to issue CLs .…

    • …. strong case for a bigger role

      • Price CLs

      • Separates the decision to issue guarantees from their pricing

      • Unbiased assessment of costs and risks

      • Specialized skills may be needed in project evaluation (PPPs)

      • Guidelines on contingent debts and principles for pricing


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    Managing CLs: Integration with DM

    • Expanding the management of public debt by integrating CL makes sense:

      • A latent form of public debt with a positive probability of becoming conventional debt;

      • Represents a potential claim on the Government’s balance sheet; and

      • Government’s overall fiscal/financial risks better assessed and managed


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    Managing CLs: Integration with DM

    Conventional debt portfolio

    “Potential” total public debt portfolio

    Explicit contingent debt portfolio

    Implicit contingent debt portfolio


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    Managing CLs: Integration with DM

    • But, some informational preconditions are needed:

      • Size (expected cost) of contingent liabilities

      • Financial risks associated with these contingent liabilities

    • “Easier” to quantify expected cost and risk associated with explicit than implicit ones


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    Conclusions

    • Increasingly important due to the implied vulnerabilities

    • Need to be properly identified and disclosed

    • Well managed, through:

      • Clear framework of CL instruments

      • Integration in the budget process

      • Integration with management of conventional debt


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    Four Issues Under Study

    • Systems for monitoring sub national and private sector debt and estimating its contingent nature

    • Use of financial derivatives to mitigate financial risks likely to arise from contingent debt

    • Role of debt audits and transparency

    • Managing CLs and its effects on CaR framework and debt strategies


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