1. Fiscal Risks Paolo Mauro Fiscal Affairs Department International Monetary Fund

2. Introduction Fiscal Risks: Deviations of fiscal outturns (deficits, debt/GDP) from expectations at the time of the budget or other fiscal forecasts. How large and frequent are the deviations for different groups of countries? What are the most important types of shocks? Does this depend on degree of integration in global financial markets? (Will rely on work on the correlates of output drops.) What can policy makers do about fiscal risks? (Identify, Disclose, Manage). Statements of Fiscal Risks.

3. Begin by looking at Output Drops Definition of output drop Frequencies Catalog of shocks Unconditional and conditional frequencies, expected cost Bivariate, then multivariate (probit) approach Causality (timing)

4. Currency crisis and Terms of trade shock

6. Table 2. Output Drops: Frequency, Duration and Loss, 1970-2001 Source: Authors’ calculations based on Maddison (2003) data. Notes: “All” output drops include concluded, ongoing and sub-events. Concluded drops are fully observed within the sample period whereas ongoing drops had not ended by 2001 and the duration and loss for these drops are calculated assuming that the drops ended in 2002.

8. Expected cost = =unconditional probability of a shock × probability of output drop given the shock × cost of the output drop when it occurs

9. Figure 2. Expected Cost of Shocks Based on Bivariate Estimates (in percent of pre-event GDP per capita)

10. Figure 2b. Ex-ante Cost of Shocks Based on Multivariate Estimates that are Statistically Significant (in percent of pre-event GDP per capita)

11. Output Drops and Shocks: Key Results 1900-2001 and four sub-periods: countries with lower initial p/c incomes have more output drops. 1970-2001: emerging markets have a drop every 16 years, duration 6 years, cumulative cost 40% of a year’s GDP; developing countries twice the costs Financial shocks matter more for emerging markets, real shocks for developing countries. For given output drop, decline in consumption is lower in countries that are at high level of financial development than in countries of medium and low levels of financial development.

12. Output Drops are All Unexpected: Forecast Error from October One Year Ahead

13. Now move to Fiscal Risks Fiscal Risks: Deviations of fiscal outturns (deficits, debt/GDP) from expectations at the time of the budget or other fiscal forecasts. Possible sources: macroeconomic shocks (exchange rate, cost of borrowing,..), contingent liabilities (guarantees, PPPs), legal claims against the government, bailouts of local governments, state-owned enterprises, banks, assumptions of debts.... How large and frequent Preliminary empirical work on sources of risks

14. All Countries-Surprise Deviations in Debt/GDP

15. Surprise Deviations in Debt/GDP

16. All Countries- Surprise Deviations in Balance/GDP

17. Surprise Deviations in Balance/GDP

18. Adverse Terms of Trade Shock (worsening of the terms of trade for goods by 10 percent or more)

19. Currency Crises (depreciation by at least 25 p.p. and at least 10 p.p. greater than the previous year)

20. Banking Crises (outbreak years of crises as identified in the literature)

21. Sudden Stops (worsening of financial balance by more than 5 p.p. of GDP)

22. Oil Exporters: Years of Oil Price increase

24. Lessons for Policy Makers Identify your risks, and analyze them in a comprehensive framework Sources can be macro shocks (exchange rates, interest rates,...), contingent liabilities (implicit— e.g. natural disasters, banking system) or explicit (guarantees, PPPs). Disclose them and manage them (more and more countries are doing fiscal risk statements). Disclosure imposes discipline to identify and manage fiscal risks, and may reduce long-run borrowing costs.

25. References Country Insurance: The Role of Domestic Policies, IMF Occasional Paper 260 Output Drops and the Shocks that Matter, IMF Working Paper No. 06/172 Fiscal Risks—Sources, Disclosure, and Management All available on www.imf.org or just google the titleswww.imf.org