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GOVERNMENT CONTINGENT LIABILITIES: A HIDDEN RISK TO FISCAL STABILITY1
ABSTRACT. Governments are facing increasing fiscal risks. A string of years with a balanced budget and low public debt does not necessarily suggest either past fiscal prudence or a good fiscal outlook. Obligations that governments face are of four types: either direct or contingent, both of which are either explicit or implicit. Governments that want to maintain fiscal stability must know how to deal with both their contingent and direct liabilities. Specifically, governments need to (a) publicly recognize the limits of the state's responsibilities and deter moral hazard in the markets; (b) ensure that institutional arrangements and standards for public finance address both contingent and direct liabilities and promote fiscal prudence and equity in all contingent as well as directly financed public programs; and (c) evaluate and regulate financial risks in both the public and private sectors.
INTRODUCTION
Governments are facing increasing fiscal risks and uncertainties. Two of the reasons for this situation are: first, the international integration of financial markets, which has meant greater volumes and volatility of cross-border flows of private capital; and, second, the privatization of state functions, accompanied by implicit or explicit state guarantees. State guarantees and insurance schemes, as opposed to budgetary subsidies and direct provision and financing of public services, have become a common method of government support. These off-budget programs and obligations involve hidden fiscal costs, with implicit and contingent liabilities that may result in excessive requirements for public financing in the medium and long term.
The third reason is that policymakers pursuing a balanced budget or some deficit target tend to favor off-budget forms of state support that do not require immediate cash and that, at least for some time, hide the underlying fiscal cost. Fiscal adjustment that concentrates on deficit reduction may overlook or elevate the fiscal risks associated with structural policies affecting pensions and health care. Major fiscal risks outside the budget derive from explicit promises and implicit expectations that government will help when various failures occur. The subsequent emergence of moral hazard in the markets can exacerbate these risks. Usually the support governments offer to large weak banks, enterprises, and subnational governments in troubles is outside the budget.
Although it is impossible for...