Fiscal Adjustment and Contingent Government Liabilities: Case Studies of the Czech Republic and Macedonia

Abstract

Governments' contingent liabilities increase fiscal vulnerability, but are omitted in traditional measures of the current deficit. In the Czech Republic this omission may mean that fiscal adjustment has been overstated by 3 to 4 percent of annual GDP, with future budgets having to pay for past guarantees. The stock of existing contingent liabilities in Macedonia could add 2 to 4 percent of GDP to that country's future deficits. To control the expansion of government contingent liabilities and reduce fiscal vulnerability, one must be able to identify and measure them. Brixi, Ghanem, and Islam discuss how this may be done and demonstrate how the assessment of fiscal adjustment may change substantially when a broader picture of government liabilities is included. They base their analysis on experience in analyzing fiscal adjustment in the Czech Republic and Macedonia. Their work demonstrates the importance of including contingent liabilities when assessing the magnitude of the true fiscal adjustment and when analyzing fiscal sustainability. To the extent that explicit expenditures are shifted off-budget or replaced by guarantees, the achieved improvement in fiscal balances is overstated. For the Czech Republic, adjustment may have been overstated by some 3 to 4 percent of annual GDP. A stabilization program accompanied by a build[up of contingent liabilities, particularly state guarantees and obligations to cover liabilities emerging from directed credit, may not be sustainable. In Macedonia, the present fiscal equilibrium may be temporary because the stock of existing contingent liabilities could add 2 to 4 percent of GDP to future deficits. And methods used to reduce the traditional deficit are unlikely to be sustainable without further modification. Brixi, Ghanem, and Islam conclude that governments: - Must find better ways to identify and evaluate contingent liabilities arising from the banking system, nonbanking financial institutions, public enterprises, or the contingent and direct liabilities of subnational governments. - Need to better manage their risks - for example, building adequate reserve funds and hedging risk, where possible. - Should examine the implications of the bias toward adding contingent liabilities and develop administrative reform as part of analyzing budget management. This paper - a joint product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region, and the Office of the Senior Vice President and Chief Economist, Development Economics - is part of a larger effort in the Bank to support the quality of fiscal adjustment in its client countries. The authors may be contacted at hpolackova@worldbank.org, hghanem@worldbank.org, or rislam@worldbank.org.