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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

Contingent Liabilities and Debt Management Strategy

6th UNCTAD Debt Management Conference


November 19-21, 2007

Udaibir S. Das

Division Chief

Sovereign Asset and Liability Management Division

Monetary and Capital Markets Department


contingent liabilities

Contingent Liabilities


Disclosure: Good practices

Management and Debt Strategy


definition and motivation
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
  • 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
significance of contingent liabilities
Significance of contingent liabilities?

Annual “Hidden” Deficits

(percent of GDP)

significance of contingent liabilities6
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).

contingent liabilities new challenges
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
disclosing cls good practices
Disclosing CLs: Good Practices
  • Compiled and disclosed in budget documentation, fiscal reports and financial statements


      • 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
disclosing cls good practices9
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
managing cls framework
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”.
managing cls justification and design
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
managing cls approval
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
managing cls budgeting
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
managing cls budgeting14
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
managing cls contingency funds
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
managing cls integration with dm
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
managing cls integration with dm17
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
managing cls integration with dm18
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
managing cls integration with dm19
Managing CLs: Integration with DM

Conventional debt portfolio

“Potential” total public debt portfolio

Explicit contingent debt portfolio

Implicit contingent debt portfolio

managing cls integration with dm20
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
  • 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
four issues under study
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