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Introduction

Recent months have shown that global crises such as the COVID-19 pandemic create pressures on public finances that are difficult to anticipate and prepare for. Across OECD countries, most governments have decided to play the role of “insurer of last resort” for firms and households well beyond what they had done a little more than a decade ago, when the world economy was hit by the 2008 global financial crisis. Fiscal plans have derailed as large risks crystallised, despite the fiscal reforms of the last decade. As the worst case scenario for public finances seems to have already materialised, should governments and Ministries of Finance still try to manage their fiscal risks? This article takes the view that recent events should not discourage policy makers from building expertise and developing processes for managing fiscal risks, which will be all the more important in the coming years for several reasons:
- With a highly uncertain economic environment, forecasting the economy and public finances will become increasingly challenging. Having a clear understanding of existing and new risks to the fiscal forecast will be crucial for decision makers to draw realistic spending plans.
- With fiscal risks at an all-time high, managing them will be a core task of decision makers, e.g. monitoring the stock of guarantees, credit risk on government loans, commercial value of equities held by the government, and taking timely and appropriate decisions in relation to the management of related risks.
- With unprecedented fragile public finances, fiscal responsibility and discipline in ministries, departments and agencies will involve not only meeting their expenditure targets, but also managing existing and emerging risks linked to the amplification of both on- and off-balance government assets and liabilities, in the form of debt, acquisition of equity in strategic firms, loans, guarantees, etc.
- With difficult budgetary trade-offs ahead, the legislature will need comprehensive information on fiscal risks and their management to exercise oversight and conduct an effective debate over budgetary decisions, including reserves and “space” in fiscal plans. Therefore, although the identification and measurement of fiscal risks is challenging and Ministries of Finance know well that a fiscal risk may not always turn out as anticipated, this article aims to provide evidence that potential benefits in terms of awareness, anticipation and promotion of an informed debate about the resilience of public finances are likely to outweigh the time and resources required. The starting point for this article is the OECD Best Practices for Budget Transparency (OECD, 2002[1]) and the Recommendation of the Council on Budgetary Governance (OECD, 2015[2]). Based on five case studies including two pioneer countries in the management of fiscal risks (Australia and New Zealand) and three countries that developed their framework in the wake of the 2008 financial crisis (Finland, the Netherlands and the United Kingdom), this paper identifies practices to be considered by countries that wish to implement OECD recommendations in this area and strengthen their fiscal risks framework. It emphasises that the objective of such frameworks should go beyond mere disclosure to include the active management of fiscal risks and consider them in the formulation of fiscal policy. This paper does not aim to detail policy responses to specific risks, but rather makes the point that the starting point for resilient public finances is a smart definition of ever-changing and evolving fiscal risks (Section 2); a comprehensive framework for their identification, analysis and management (Section 3); and sound arrangements for operationalising the framework (Section 4). Finally, it summarises challenges and key lessons, and identifies future directions of the OECD’s work to advise member countries on managing fiscal risks.

Defining fiscal risks

Fiscal risks should be identified against fiscal forecasts The concept of fiscal risks is closely linked to the more general problem of the accuracy of fiscal forecasts that form the basis of medium-term expenditure frameworks.1 The 2008 financial crisis put an emphasis on better understanding uncertainty in forecasts. This includes accompanying the outlook with a fan chart reflecting uncertainty with forecasts; including more variables in the sensitivity analysis; and identifying where significant deviations could come from and what this means for the government’s fiscal mandate and longer term fiscal sustainability. Fiscal risks is the term used for describing these sources of potential large deviations from the fiscal forecast. They are defined as “the probability of significant differences between actual and expected fiscal performance” (Kopits, 2014[3]) or “the possibility of deviations of fiscal outcomes from what was expected at the time of the budget or other forecast” (IMF, 2008[4]) As deviations from forecasts, fiscal risks are not the same as fiscal pressures, which are phenomena generally integrated in the forecasts (e.g. ageing). The United Kingdom’s Office for Budget Responsibility (OBR) notes, for example, that “what constitutes a fiscal risk depends crucially on which potential developments in the public finances you choose to incorporate into the central projection and which you regard as potential deviations” (OBR, 2017[5]). The definition of fiscal risks may go further by specifying criteria for including or not, certain parameters in the forecasts. For example, in Australia, fiscal risks are defined as “matters not included in the fiscal forecasts because of uncertainty about their timing, magnitude or likelihood; and the realisation of contingent liabilities or assets” (Commonwealth of Australia, 2019[6]). The nature and number of fiscal risks identified by a given country also depends on the forecast against which they are considered. Risks over the short, medium and long term are not the same. For example, today’s natural disaster risks will become tomorrow’s climate change risks. In the United Kingdom, because fiscal risks are identified against both the medium-term and long-term fiscal forecasts, the last Fiscal Risks Report identified and discussed around 60 large risks to public finances.

Fiscal risks are virtually infinite and criteria are needed for their identification and disclosure

Even within these boundaries, fiscal risks are potentially infinite and some countries explicitly acknowledge that within the definition and criteria for identifying fiscal risks, it may not be possible to cover all potential fiscal risks faced by governments in a single report. The United Kingdom argues that any definition of fiscal risks should aim to cover significant potential developments in the public finances “that might require a policy response – either before or after the event” (OBR, 2017[5]). New Zealand’s legislation states that fiscal risks should be disclosed “to the fullest extent possible” (Parliamentary Counsel Office, 2020[7]). In other words, a definition of fiscal risks should not aim at comprehensive coverage of potentially infinite fiscal risks, but rather at supporting policy decision making and facilitating oversight and accountability. In addition to the concept of fiscal risks, the terms “stress” or “shocks” is sometimes used. Stress or shock can be defined as an event potentially triggering several risks at the same time or successively, and exerting the largest costs on public finances. Typically, a large economic crisis, whatever its source (e.g. financial crisis, trade war, natural resources shortage, etc.) will trigger fiscal risks in the form of reduced government receipts and additional spending to support the economy and households. Pandemics or large natural disasters are other events that could trigger shocks, with comparable spillover effects from the economy to government revenue and spending. The identification and measurement of these shocks is further discussed below.

How to classify fiscal risks?

The OECD Recommendation of the Council on Budgetary Governance (OECD, 2015[2]) calls upon governments to “classify by type” their fiscal risks, with proposals formulated in the past on how such classification could be done, for example depending on the methodological approach to estimating them (Kopits, 2014[3]). Such a classification is important because a long list of fiscal risks would not be easy to understand for decision making. Case studies show that classification of fiscal risks is a shared feature of fiscal risks frameworks and classification by nature is the most common approach. Beyond risks to the reliability of the forecasts linked to “technical errors” of forecasters, four main categories of risks can be identified in most countries, although the terms or detailed classifications used vary (see Table 1). These categories are: 1. Macroeconomic risks, which emanate from either cyclical or structural changes in the economy that would directly affect the government revenue forecast and potentially indirectly influence its spending forecast. Risks in relation to macroeconomic variables include especially growth, natural resources prices, as well as the financial sector, which may, however, be identified separately from other macroeconomic risks.
2. Government policy or programmes risks, which are risks that tax collection or spending controls won’t happen as planned, generating revenue losses or additional spending. Spending and revenue risks are discussed, for example, in the United Kingdom’s Fiscal Risks Report, such as risks in relation to welfare or health spending. Similarly, Finland identifies so-called internal risks, which are risks “associated with the implementation of the government programme”.
3. Uncertain budgetary claims (also called contingent liabilities) risks, which encompass all commitments that the government has formally entered into or obligations that the government would not be able to avoid but that are not included in the fiscal forecast because they are uncertain or impossible to measure. In Australia, uncertain budgetary claims comprise guarantees (where one party promises to be responsible for the obligations of another party if that party defaults), indemnities (a legally binding promise whereby a party undertakes to accept the risk of loss or damage another party may suffer) or other types of claims (e.g. legal claims, tax disputes, uncalled capital subscriptions).
4. Balance sheet risks, which are mainly risks associated with assets and liabilities owned by the government, such as equity shareholdings or loans. New Zealand, for example, defines balance sheet risks as “risks affecting the Crown’s financial position through changes in the value of its assets or liabilities”.