C. Key Institutional Weaknesses Contributing to Fiscal Risk

C. Key Institutional Weaknesses Contributing to Fiscal Risk

10. 
    Transparency and accountability of public finances are weak in the Philippines as information is not widely disseminated or aggregated. This complicates the assessment of fiscal risks (World Bank, 2010b). Basic assessments regarding the predictability of the budget are difficult to undertake due to (i) the difference in reporting budget plans and outturns; and (ii) extensive within-year reallocation of the approved budget between line agencies and special purpose funds. More generally, the budget document does not include a clear statement on off-budget operations that create a risk of becoming on-budget (e.g., contingent liabilities and quasi-fiscal operations). The reporting of GOCC operations and their fiscal impact could also be improved.
    
11. 
    The Philippines would benefit from disclosing fiscal risks in terms of improved transparency and accountability, risk management, economic efficiency, and reduced borrowing costs. Having to publicly disclose the extent to which ongoing projects or policies subject the budget to fiscal risks would greatly improve the overall transparency and accountability of public spending, and is likely to better internalize their potential future costs (be it at the executive decision-making, Congress approval, execution, or even at a later election stage). Transparency should thus lead to better risk management and/or to the modification of policies that entail too large a risk for the budget; it could also strengthen accountability for risk management. Consistent with these benefits, studies show that fiscal transparency is associated with better sovereign bond ratings and greater access to international capital markets in the long run. Box 1 presents emerging international best practices in fiscal risk disclosure.
    

D. Options for Strengthening Fiscal Risk Management

12. 
    In the short-term, publishing a fiscal risk statement is a quick win as the assessment behind the statement can be undertaken rapidly (given the preliminary work undertaken in World Bank, 2009). The statement should provide a comprehensive view of major risks that would impact public finances. This statement would send a strong signal of a government committed to (i) undertaking sustainable fiscal reforms;¹ and (ii) improving fiscal transparency and accountability, risk management, economic efficiency, and reduced borrowing costs. Having to publicly disclose the extent to which ongoing projects or policies subject the budget to fiscal risks would greatly improve the overall transparency and accountability of public spending, and is likely to better internalize their potential future costs. Transparency should thus lead to better risk management and/or to the modification of policies that entail too large a risk for the budget; it could also strengthen accountability for risk management.
    
13. 
    Over the medium-term, for the Philippines to improve its assessment and management of fiscal risks, the following set of key legal and institutional reforms are recommended (these specifically address weaknesses in assessing, approving, managing, and disclosing fiscal risks):
    

While a Debt and Risk Management Office is part of the new structure of the DoF under its rationalization plan, the plan has yet to be implemented.

Countries have found that establishing and publishing a debt management strategy, setting out the goals and objectives within which debt managers have to perform and are accountable to, helps to improve the overall risk structure of the portfolio and better understanding of the various trade-offs in structuring the debt portfolio. A strategy establishing key objectives and priorities for debt management is a founding stone for building capacity in public debt management. The strategy then enables a coherent approach to: (i) designing prudent risk management strategy and policy; (ii) allowing for the strengthening of middle office analytical capability; (iii) defining a framework for risk management; (iv) ensuring consistency with other macroeconomic policies and objectives; (v) establishing an organizational structure that ensures clear accountability and transparency of responsibilities; (vi) establishing a sound legal framework; and (vii) recruiting trained staff, and selecting and implementing effective management information systems. ²

Box 1. Emerging International Best Practices in Fiscal Risks Disclosure
A large number of countries have selectively disclosed, elaborated, and/or quantified fiscal risks. Among the most widely disclosed risks are those associated with (i) macroeconomic shocks; the impact of key macroeconomic variables on the budget are analyzed through a variety of methods, such as sensitivity analysis, macroeconomic scenarios, and/or stress tests; and (ii) contingent liabilities, especially explicit ones such as loan guarantees. Disclosure is less consistent across countries for other key sources of fiscal risks, namely state-owned enterprises, sub-national governments, quasi-fiscal activities, and off-budget entities. More recent types of risks are less commonly disclosed though the number of countries disclosing them is growing fast (e.g., public-private partnerships) as are risks that are difficult to quantify (e.g., legal claims), and “policy risks” such as potential changes in government or regulatory policies.
An emerging international best practice—including in the region—is for countries to disclose a comprehensive assessment of their fiscal risks. Starting with Australia and New Zealand’s pioneering fiscal risks statements, a few countries have introduced such self-contained statements, often as part of the annual budget document submitted to congress (see Table below). The context for these statements vary extensively, ranging from a legal requirement—as part of a broader approach to fiscal policy and disclosure found in Fiscal Responsibility Laws and/or public financial management legislations (e.g., New Zealand, Brazil)—or as the result of a discretionary decision of a Minister of Finance to foster the identification, disclosure, and management of fiscal risks (e.g., Indonesia in 2007). The practice of greater disclosure of fiscal risks is also driven by international accounting and statistical standards requiring the disclosure of certain material risks as well as recent transparency initiatives. Policymakers in the region are at the forefront of the push for better fiscal risk assessment, management and disclosure, as shown by the 2007 APEC Finance Ministers’ Meeting in which this topic was prominently discussed.
Scope of Existing Fiscal Risks Statements around the World

Source: World Bank (2009).

1/ Fiscal implications of two possible growth paths for the economy when key assumptions underlying the central forecast are altered.

2/ Sensitivity of revenues and expenditures to changes in real GDP growth, inflation, exchange rate, nominal interest rate, and minimum wage. Sensitivity of the federal public debt to changes in interest rate, exchange rate, and inflation.

3/ Sensitivity of revenues and expenditures to changes in economic growth, inflation rate, interest rate, exchange rate, crude oil price, and oil production.

4/ Sensitivity of the operating balance and sovereign-issued debt to changes in nominal GDP growth and interest rates.

World Bank, 2009, “Fiscal Risks: Assessment and Recommendations” chapter 2 of the 2009 Philippines Development Report.

World Bank, 2010a, “Philippines: Laying Out the Exit Strategies,” Philippines Quarterly Update, February issue, Manila.

World Bank, 2010b, Philippines: Public Expenditure and Financial Accountability, forthcoming Washington DC.

Note prepared by:

The World Bank