Managing and Mitigating Contingent Liabilities

A well-designed framework for managing and disclosing CL, which puts in proper place safeguards against risks associated with CL, is critical in limiting the government’s risk exposure.  The specific institutional set up under which these safeguards operate is of secondary importance, but could have a bearing on the smooth functioning of the framework.  This set up includes the locations of responsibility for monitoring and managing CL, and the degree of its centralization” (Cebotari, 2008).

All CL cannot be eliminated but wherever possible, risk should be transferred or minimized to limit the government’s exposure to losses that result from CL. However, there are some practices that can limit risk associated with CL.

• Well established process for identifying, valuing, and managing CL
• Parliamentary approval of explicit CL and/or making the use of CL neutral in comparison to other financing mechanisms
• Identifying and including CL in the budget process and reporting CL in financial balance sheets
• Early and comprehensive attention to risks associated with CL
• In case of PPPs, comprehensive frameworks to ensure proper risk taking and allocation are more common
• Clearly defined reasons and objectives for taking on CL
• Examination of contingent debts and liabilities by the supreme audit institution to ensure discipline in taking on and managing CL
• Appropriate disclosure of CL but not in instances that will create moral hazard or impact the government’s position in litigation

At the core of any policy to manage and reduce exposure to CL must be the elimination of perverse incentives for policymakers to favor CL over other financing mechanisms.  Budgetary procedures, accounting practices, and statutory frameworks often create the environment in which CL become the financing tool of choice.  Until this changes, CL will continue to be a popular and inefficient means in which to pursue policy objectives.  “A key objective of reform is to promote neutrality: policy makers should be fully informed of the expected effects of contingent liabilities and treat proposals consistently whether they are for direct budgetary appropriations, guarantees or loans. Where neutrality is assured, policymakers will be more likely to implement their decisions in the most efficient and effective manner, rather than favoring one form of implementation (such as a guarantee) for convenience or to evade fiscal rules (or parliamentary scrutiny)” (Lindwall, 2013).  As all CL will not be eliminated, having an effective framework at the start of the process when explicit CL are issued, a reasonable understanding of sovereign exposure to implicit CL, and a coherent plan for mitigating all CL should they be triggered will limit losses and widespread financial and economic calamities.