A. Why Does Fiscal Risk Pose a Danger? -
Fiscal risks—i.e., the threat of significant variations of fiscal outcomes from budgetary plans or forecasts—are widespread and constitute an intrinsic part of fiscal policymaking and budget planning. Cross-country experience reveals that fiscal risks are mostly related to macroeconomic shocks and the realization of contingent liabilities. The former include mostly shocks to GDP growth, exchange rates, interest rates, and oil prices. These can directly affect revenues, expenditures or the financing of the budget and public debt, as well as the operations and balance sheets of other parts of the public sector such as government-owned or controlled corporations and local government units. The latter includes both explicit and implicit contingent liabilities such as debt guarantees being called and bailouts of the banking sector.
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Notwithstanding their importance and prevalence, fiscal risks are often not comprehensively assessed, disclosed and actively managed. These shortcomings often result in larger fiscal costs and, sometimes, fiscal crises (IMF, 2008). When fiscal risks materialize, be it in the form of unexpected spending pressures or revenue losses, these often require ad-hoc and disruptive adjustments during the fiscal year. The global financial crisis and the widespread and costly bank bailouts is a recent reminder of the magnitude of fiscal risks outstanding and the disruptive impact it can have on public finances (e.g., Iceland). As a result, even in countries where debts and deficits are considered prudent, policymakers’ attention is turning toward risks—especially from contingent liabilities and off-balance sheet items. To address the challenges posed by fiscal risks, several countries have recently increased their disclosure of such risks, so as to foster fiscal sustainability and to reduce borrowing costs and the likelihood of crises.
B. Main Sources of Fiscal Risk in the Philippines -
A comprehensive assessment of fiscal risks in the Philippines was undertaken for the 2009 Philippines Development Report (World Bank, 20091). The assessment includes an overview of fiscal policy objectives and their relation to fiscal risks, and an analysis of the three main types of risks to public finances: (i) internal budget risks related to macro-economic risks and budget sensitivities; (ii) the public debt, in particular its structure and management; and (iii) contingent liabilities. The latter include risks stemming from Government-Owned and Controlled Corporations (GOCCs), Public-Private Partnerships (PPPs), the financial sector, Local Government Units (LGUs), tax credit certificates, and natural disasters. The key findings are:
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Large fiscal risks have materialized in the Philippines. These include two large banking bailout episodes (early 1980s and 1997/98—with an estimated fiscal cost exceeding 10 percent of GDP), the recapitalization of the former central bank in 1993 (cost of 22 percent of GDP), of the Development Bank of the Philippines in 1986 (cost of 10 percent of GDP), the repeated recapitalization of the Philippine National Bank before its complete privatization in 2007, and the government assumption of part of the National Power Corporation debt in 2002 (5 percent of GDP). The sheer size of these risks had previously reduced the available fiscal space and significantly increased the sovereign debt.
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Some previously large fiscal risks have decreased since the onset of the fiscal consolidation program in 2004. The fiscal consolidation program centered on revenue and expenditure measures but also on the privatization of GOCCs. Coupled with structural reforms and privatizations, this improved the primary fiscal balance, which contributed significantly to lowering public debt; GOCCs proved to be a large source of realized fiscal risk. Other key drivers of the debt-to-GDP ratio include the exchange rate, economic growth, and contingent liabilities.
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Fiscal risks remain sizeable, and their likelihood of realization has increased with the ongoing global financial crisis and recession. Notwithstanding the recent fiscal consolidation efforts, public debt remains high and sensitive to a growth slowdown and exchange rate shocks; rollover risks are also important given the large and rising gross financing requirements of the non-financial public sector; and contingent liabilities are large. All these risks have a higher likelihood of occurrence since the onset of the global financial crisis (e.g., through tightening of credit supply and increased risk premia) and the ensuing global recession.
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The largest fiscal risk exposure of the central government’s budget arises from its sensitivity to a few macroeconomic variables, namely economic growth, inflation, the interest rate, and the exchange rate.2 Analysis reveals no systematic bias in budget forecasts of the overall fiscal balance although biases do exist among its revenue and expenditure components.3 Macroeconomic forecasts used for the budget have been reasonably accurate. Given the specific type of fiscal risk exposure, policymakers would benefit from scenarios based on alternative macroeconomic assumptions—that would ask questions such as, “what if the global economic outlook is worse than assumed in the budget?”. To answer “what if” questions, some countries include alternative (yet plausible) scenarios in their budget documents.
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Fiscal risks related to the public debt are high and linked to a weak legal framework, a relatively high debt level, and a debt structure that can rapidly transmit shocks. The legal framework underpinning public debt management is fragmented and complex. Legal responsibility for public debt issuance, collection of information on public debt and guarantees, and debt management is devolved to several authorities and government entities.4 No formal debt management strategy exists in the Philippines so that public debt is managed with extensive executive discretion. While substantial progress was made in reducing public debt risks, these remain high.5 The average time to maturity is relatively short, requiring the government to raise large and rising amounts of debt each year; this exposes the budget to interest rate and rollover risks. The share of foreign-currency denominated public sector debt remains high (60 percent). As a result, public debt is broadly sustainable, but with significant upside risk. As the fan chart below reveals, while debt is projected to trend slightly downward over the medium-term under the assumption that the revenue effort improves (Figure 1, 50th percentile), large uncertainty surrounds the most likely outcome (darkest area) and debt has a much higher likelihood of increasing than decreasing.
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Fiscal risks stemming from contingent liabilities have been and remain large, mainly on account of GOCCs, PPPs, the financial sector, and natural disasters. The realization of contingent liabilities accounts for a large share of fiscal risks in the Philippines. GOCCs have been and remain a large source of fiscal risk, with contingent liabilities of 10 percent of GDP, mostly in (unhedged) foreign currencies. GOCCs have systematically required fiscal transfers far higher than budgeted. PPPs generate large—12 percent of GDP in contingent liabilities in 2005—and complex fiscal risks, yet no institutional setup exists to comprehensively monitor and manage these risks.6 Government guarantees on fixed contractual payments have a high likelihood of occurrence, as are risks from political/regulatory actions.7 The financial sector has generated the costliest source of fiscal risk but these have abated overall thanks to improved regulatory and supervisory controls and strengthened bank balance sheets. Natural disasters present a large and recurrent source of fiscal risk since the Philippines is one of the most disaster-prone countries in the world. For the past two decades, the average direct annual cost to the economy associated with disasters is estimated at about 0.5 percent of GDP (indirect costs are significantly higher). While the public sector has set up various contingency funds to address these fiscal needs, in practice, most of the fiscal cost has remained with the National Government and systematically exceeded the budgeted resources (only 0.03 percent of GDP was budgeted in the Calamity Fund in 2009).
Figure 1. Philippines: National Government Debt Sustainability Analysis 1/
Source: Philippines Quarterly Update (February 2010 issue), World Bank (2010a).
1/ The fan chart is constructed by taking a central forecast of NG debt (blackest line in the center) and calculating how this forecast would change if key variables such as inflation, the exchange rate and GDP growth differed from those assumed in the central scenario. The shocks introduced are those that have hit the Philippines in the past 10 years. The fan chart, therefore, provides a useful assessment of risks surrounding NG debt projections as it based on past Philippines shocks (magnitude and correlations). See Chapter 2 of World Bank (2009) for further details on the fan chart.
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