Fiscal Risk managment in Latvia Nils Sakss Direktor of fiscal policy department Ministry of Finance of Latvia

Latvia’s perception of fiscal risk Fiscal risk is defined as the possibility of short- to medium-term deviations in fiscal variables compared with what was anticipated in the government budget or other fiscal forecasts (IMF, 2008) Fiscal risks are classified as: general economic risks, (e.g., lower economic growth than predicated resulting in loss of government revenues); or specific risks (e.g., potential cost of natural disasters). Fiscal risks from contingent and other opaque liabilities (e.g., government guarantees) can cause serious fiscal instability if left unchecked. But under conventional cashbasis government budgeting and accounting, the treatment of contingent liabilities is often inadequate and their fiscal consequences frequently overlooked in the standard fiscal analysis

Taxonomy Hana Brixi and Allen Schick, Government at Risk: Contingent Liabilities and Fiscal Risks, 2002.

Narrow (operational) definition Section 16. General Management of Fiscal Risks   (1) The Cabinet shall ensure the general management of fiscal risks. The objective of the general management of fiscal risks is to ensure the stability of indicators laid down in Section 5, Paragraph three, Clauses 1, 3, 4, 5 and 7 of this Law (hereinafter – fiscal indicators) in the medium-term regardless of the changes caused by external factors, as well as to reduce impact of changes caused by external factors in fiscal indicators in each year of the framework law period. Key Fiscal indicator: General Government Deficit

Incorporating Risks In The Budget Contingency reserves Fiscal Safety Reserves

Statistical implications on fiscal risk managment in Latvia: General government and accrual accounting

Concept of general government (1) The general government sector by convention includes all the public corporations that are not able to cover at least 50 % of their costs by sales, and, therefore, are considered non-market producers. It has four subsectors: central government state government local government social security funds

Examples: Latvia Passenger railway company; Universities; Hospitals; Theaters; Municipal utility companies; Special economic zones;

SoE Outside GG Inside GG Are free in managment decisions Unless: 1. They ensure projected amount of dividends in the state budget; 2. They unexpectedly not ask for government «support» All what they do falls on GG accounts: Borrow money in financial markets - increase of state debt; Build something – full construction costs recognized as GG expenditure at the moment of construction – falls on state deficit.

If GG SoE are not taken into account in State budget preparation, they very likely fill produce «negative surprise» in General Government accounts !!! This is high fiscal risk. If GG SoE are included in fiscal projections produced for State budget, risk has been reduced or even mitigated. Residual risks relates only to deviation from projections.

Incorporation of GG SoE in fiscal projections Projections of Revenue – adjusted expenditure (balance of SoE) ( adjustment :+ gross fixed capital formation – depreciation). The aggregate GG SoE balance is included in GG balance projections as a balance under no change policy scenario. Then the issue is about «absorption capacity of budget» of GG SoE deficits. If there is no absorption capacity, MoF should intervene and propose to government to take action. this is not a fiscal risk. But can be if we not incorporate the GG SOE accounts into GG fiscal projections. If process is implemented, the risk is that SoE deficits are significantly higher, than projected.

GG SoE net borrowing/net lending: Projections and outcome

Accrual accounting The term “accrual” refers to a fundamental accounting concept concerning the timing of recognition of economic events in financial reports. Accrual accounting is a system of accounting in which transactions and other flows between institutional units are recognized when economic value is transferred, increased, or lost, regardless of the timing of the related cash receipts or payments. This contrasts with the cash basis under which transactions and other events are recognized only when the related cash is received or paid. Accrual accounting is basic method for IMF, OECD, Eurostat reports.

Fiscal risk management as defined in Fiscal Discipline Law Regular identification, disclosure and mitigation; Declaration of fiscal risks annexed to MTBFL; Fiscal safety reserve: ( expenditure ceiling in MTBFL – expenditure in Budget Law) depending of fiscal risks, at least 0,1% of GDP.

Regulation of General Management of Fiscal Risks

Terminology Specific risks Individual risk Risk event Sorce of fiscal risk

Insitutional set up General management of Fiscal Risks Ministry of Finance Maintaining register of Fiscal Risks Monitoring and assistance to central gov bodies in managment of specific fiscal risks Proposals to CGB of additional measures in risk managment. Calculation of size of fiscal safety reserve. Drafting the declaration of Fiscal Risks

Register of Fiscal Risks Nr. of fiscal risk Source of fiscal risk Description of fiscal risk Assessment of fiscal impact and fiscal indicator which is affected by the fiscal risk Assessmenet of fiscal risk probability Description of current management of fiscal risk Additional necessary actions (measures) to reduce fiscal risk   Additional necessary actions to eliminate the consequencesof fiscal risk Institution which is responsible for fiscal risk management

Central Government Body (CGB) Insitutional set up Management of specific risk related to assigned government funtion Central Government Body (CGB) Management of Specific Risk and imrovement of managment Assesment of impact of specific risk Assesment of probability Accumulation of information of individual risk Supervision of managment of individual risks by public agencies.

Project implementing body (PIB) Insitutional set up Government Agency Managment of indicidual risk; Assesment of impact Ssesment of probability Accumulation of information Management of individual risk and Project implementing body (PIB)

Requests and reporting Issue reguests Ministry of Finance Fiscal risks managment report CGB Submission of information Government Agency and PIB Including the task to include risks maagment tasks in PPP projects

Fiscal risk management report

Fiscal risks managment report Ministry of finance assesses Whether the proposal for exclusion or inclusion of specific risk into the register has been justified Whether the risk reduction measures are sufficient to accept residual risk, If necessary, makes its own assesment of impact and probability If necessary, proposes additional measures to CGB If no agreement between MoF and CGB – issue to be discussed and decided by government.

Probability and fiscal impact Quantifiable and non –quantifiable risks Calibration of probability probability Closer to 0% Closer to 10% Closer to 30% Closer to 60% Closer to 100% value 1 2 3 4 5 ignored Fully included as expenditure in budget

Non –quantifiable fiscal risks Calibrationn of impact impact More than 0,5% GDP Between 0,01 and 0,5 Less than 0,01% of GDP significant medium insignificant

Fiscal Risks and Fiscal Safety Reserve Not included Included in Declaration nonquantified quantified Escape clause FNR Above 0,1% IKP Below 0,1% IKP Compensatory measures No immediate compensation No compensation No compensation No ex post correction in long term Ex- post correction ( if having impact on structural balance) Ex- post correction

Fiscal risk declarations Example: Australia (1)

Declaration of Fiscal Risks

Report of Fiscal Discipline Council