Currencies

[thepennyking]

Unpleasant surprises waiting to happen
By ROMEO BERNARDO

There is, quite rightly, increasing concern over government's mounting debt. In all the talk about the risks, consequences and possible solutions to government's debt problem however, one critical dimension to the problem seems to have been overlooked--government's contingent liabilities.

This is surprising as past fiscal crises in the country were triggered by the realization of some of these extra-budgetary activities. Reported budget deficits have in fact been found to contribute much less to increases in the country's debt-to-output ratio than extra-budgetary items (the decomposition of the debt-to-output ratio by Homi Kharas and Deepak Mishra revealed that from 1980-97, reported deficits contributed only 34% while extra-budgetary items contributed 133% to the change in the debt-output ratio).

A study on government performance jointly published by the Philippine government, the World Bank, and the Asian Development Bank reports estimates of government's contingent liabilities running to about PhP3.1 trillion, which is nearly of the same magnitude as government's direct debt outstanding (PhP3.4 billion as of November 2003). What is worrisome about these contingent liabilities is that nobody knows when the additional fund demands will arise and how much government will need to put up at any point. Obviously, such unwelcome surprises can be very destabilizing.

Going through the list of government's contingent liabilities which includes the unfunded liabilities of pension institutions--Social Security System (SSS), Government Service Insurance System (GSIS), Retirement and Separation Benefits System (RSBS)--direct guarantees on obligations of state enterprises--e.g., National Power Corp. (NPC), National Food Authority (NFA)--guarantees on various types of risks (including market, currency, regulatory, political) under built-operate-transfer or BOT contracts, deposit insurance, implicit guarantee on the banking sector, umbrella guarantees for various types of loans in the agriculture, microenterprise and housing sectors, among others, government guarantees to NPC appear to require the most urgent attention.

The national government's exposure to NPC has become virtually real with government having had to incur debts directly to finance NPC's deficits, which have been rising at an alarming rate. From around PhP8 billion in 2000, NPC's losses, arising largely from inadequate power rate adjustments and the costs of take-or-pay contracts, rose steeply to an estimated PhP73 billion in 2003 and are reportedly, expected to reach PhP113 billion this year. Thus, unless rate increases are implemented and kinks in the privatization of the power sector are ironed out, the risk to government of absorbing an increasing portion of NPC's losses is very real.

Another threat to government's fiscal sustainability is the SSS' unfunded pension liabilities (estimated at around PhP1.3 trillion in 1999). Despite much ado over SSS' investment decisions, the accumulation of the pension fund's unfunded obligations is largely due to increases in pension benefits over the years (usually, as part of government's Labor Day concessions) without matching increases in contribution rates. Already, annual benefits being paid out exceed members' contributions and SSS' reserves are estimated to run out by 2011. Last year's 1% increase in the contribution rate is mere band-aid for a gaping wound. A larger adjustment is needed right away, without which the bleeding will increase by the day.

Then there is the banking sector, which because of public expectations, benefits from an implicit government guarantee. This implicit guarantee carries even more weight today as banks, lacking alternative investment outlets, have been parking a large share of investment funds in government securities. Any problem on the fiscal side will thus translate directly into banking sector stress. This underscores the need for government to come to grips with the sector's bad asset problem and recapitalization requirements to allow banks, in time, to carry out their intermediation function.

There are many, many other contingent obligations that government is potentially exposed to, some significantly smaller (e.g., directed credit programs), others with less likelihood of being triggered (e.g., force majeure events under build-operate-transfer contracts). In many cases, particularly with public enterprises, the need for government to take over the corporations' loan servicing results from operating inefficiencies and subsidized price structures due to the highly politicized environment for rate adjustment. Thus, in cases where the private sector is willing to take over, government should privatize and concentrate instead on strengthening its regulatory function.

As to the rest of government's contingent liabilities, the crucial first step is to set up a monitoring system to enable government to keep track of all the financial risks it is exposed to in any given period. In time, government needs to develop practical tools to better manage these off-budget risks.

http://www.bworld.com.ph/current/B&F/executive.html