Budget control as an aircraft cockpit III - Fiscal risk on the Attention Getter Panel

In addition to the primary flight display which we already presented, there is a whole range of other displays and control options in the aircraft cockpit that should also find an equivalent and be used in public financial management. In this article we will focus on fiscal risk management, symbolised by the Attention Getter Panel.

The Attention Getter Panel has a series of buttons and lamps which, by lighting up in orange or red, provide warnings and thus indicate potential system errors. The Fiscal Risk Management System serves a similar function in Public Financial Management, providing information on macroeconomic and specific fiscal risks. It also warns of possible system failures.

The financial crisis in particular has made the vulnerability of public finances to fiscal risks obvious. In order to prevent the recurrence of such a crisis, states need to gain a better and more comprehensive understanding of the risks that affect them and how to minimise them.

What are fiscal risks?

The World Bank defines fiscal risks as deviations from the budget outcomes expected at the time of budget preparation. Such deviations can have a significant impact on public finances and a government's ability to shape the economic situation through fiscal policy.

The vulnerability of a state to fiscal risks depends heavily on its individual circumstances, such as the structure of the economy, the organisation of the public sector and the interactions between the private and public sectors. In order to be able to respond well to risks, the abundance and quality of the related information is crucial. For example, the International Monetary Fund recommends collecting, disclosing and monitoring information on the following sources of fiscal risk: 

• Financial sector

• Legal rights and judgements

• Macroeconomic shocks

• Natural disasters

• Private non-financial companies

• Public-private partnerships (PPPs)

• Public or state-owned enterprises

• Subnational governments

   

Sources of further fiscal risks can be

• Government subsidy programmes

• Public debt

• State aid

• Other significant fiscal risks

It is important to keep in mind that events that result in negative fiscal impacts often do not occur alone, but sources of fiscal risks correlate with each other. Moreover, the effects of such events can be non-linear, i.e. have significantly more dramatic effects if they exceed a certain threshold. Therefore, all possible sources of risks as well as their correlations should be taken into account in public finance planning.

In Austria, the Fiscal Council plays an important role in the assessment of fiscal risks, regularly providing information on major risks and analyses (https://www.fiskalrat.at/). The European Union also provides analyses to the member states. The EU Debt Sustainability Monitor 2020 describes, for example, that the fiscal short-term risks of all member states have increased due to the pandemic, while in the medium term it is mainly the countries with high public debt that are at risk, and in the long term population ageing represents a significant risk for many states.

For Austria, the risk assessment was upgraded one category compared to the last report due to the strong increase in debt in relation to gross domestic product and is thus classified as medium risk.

How can the public sector mitigate fiscal risks?

To mitigate fiscal risks, they must first be identified. As a second step, quantitative data on the identified risks should be collected, which can then be analysed in terms of materiality. Scenario models are a helpful tool to discover correlations between different sources of risks as well as relevant thresholds. It is crucial to continuously collect and monitor data in order to detect and respond to changes at an early stage. 

In order to manage fiscal risks effectively, it is important to include them already when deciding on new political programs and measures. For example, liabilities for adopted projects should always be accounted for in order to limit risks in advance. In addition, mitigation measures can be taken for existing risks, for example by taking out appropriate insurance. 

Would you like to learn more about fiscal risks in public budgeting? Then please do not hesitate to contact our experts.