Issues in Fiscal Accounting: an Update

Adrienne Cheasty

Fiscal Affairs Department

IMF Santiago, January 2003

GFSM 2001—the lead-in

CEPAL 2000 New financial architecture—emphasis on

transparency... ... though fiscal transparency does not require a particular standard.

New sense of market demands for standards and independent access/comment (post-Enron?)

Official launch in January 2002

One objective of new GFS

To preclude investors’ unhelpful focus on a single deficit number...

... which may lead to inappropriate fiscal policies and creative accounting.

Instead, see government accounts as a corporate balance sheet + income statement (with various different indicators, each relevant to answer different questions)—net worth, financing needs, net investment, indebtedness, leverage...

Introduction of the new GFS will be gradual ... an ongoing project ...

Countries will move gradually (though many have balance sheets already)

The IMF is providing training A compilation guide will be prepared, after we gain

enough experience to anticipate countries’ difficulties

A working group in the IMF will explore the implications for policy (e.g., in IMF programs)

One policy decision already made:

Keep the IMF’s ‘overall balance’ The overall balance differs from ‘net lending/

borrowing’ (= the basic financial balance in the new GFS) because: It records all privatization receipts below the line (the new

GFS puts the sale of fixed assets above the line—which could create incentives for selling enterprises piecemeal rather than as going concerns).

It keeps ‘lending minus repayments for policy purposes’ above the line – useful for capturing (intertemporally) any subsidy inherent in policy lending.

New policy issues continue to surface:

The fiscal treatment of public enterprises Valuation of debt Accrued pension liabilities BOTs and concessions The fiscal treatment of the central bank

1. Public enterprises in the new GFS

The new GFS recognizes that many countries appropriately cover a wider public sector than general government in their fiscal accounts.

Last year: a movement to exclude “truly arms-length” public enterprises from the coverage of fiscal statistics...

... due to concerns that targeting a broad deficit measure put inappropriate pressure on governments to restrict public enterprise investment.

Argument: more positive operating balances of public enterprises tend to be associated with worse overall balances, since the most profitable enterprises (a) have the highest rate of return to investment and (b) have easiest access to borrowing.

1. Public enterprises in the new GFS, (cont.)

But... ... governments like fiscal reporting for public enterprises, including the

capacity to put an overall limit on them—since the government, as owner, has portfolio-balance and aggregate investment choices to make;

... investors raise questions if governments drop public enterprises (transparency matters);

... anyway, it has proven difficult to define operational criteria which distinguish ‘arms-length’ public enterprises from those which are tools of government policy: Quasi-fiscal activities (e.g., petroleum price subsidies) Impact of NPE profits/dividends on fiscal accounts Bail-outs of NPEs are more likely NPEs are slow to respond to indirect instruments of demand

management (e, i, ...)

1. Public enterprises in the new GFS, (concl.)

Nonetheless, the concerns expressed are valid. Hence: We will use the new GFS to facilitate a more nuanced analysis of public

enterprises Current and capital expenditure are shown in two separate accounts (as in

corporate accounts).... ... so there are two relevant balances (change in net worth and net

lending/borrowing)—i.e., before and after investment Accrual accounting is more accurate for investment Balance sheets allow more complete consideration of NPE’s financial options

(look at total change in net worth) Also, stress that there is no necessary link between breadth of coverage

and inappropriately restrictive fiscal policies (e.g., Mexico protects its public enterprises)

2. Valuation of debt

GFS does not take a categoric stance on valuation methods for assets and liabilities (there are various standards and anyway, more work is needed), but most of us assumed debt would be marked to market: The new GFS shows valuation changes in ‘other economic flows’—a helpful

addition to policy tools (e.g., Brazil has conservative government policy choices but rotten valuation changes)

However, marking to market implies an anomaly: The worse-off is a government (i.e., the less capable of paying its debt), the

lower the market tends to value the debt—so the debt burden drops E.g., how to explain Argentina’s current debt difficulties, given the low debt

burden when marked to market? So, we will probably keep records of nominal debt, as well as records

where it is marked to market.

3. Accrued pension liabilities

The only pension liabilities recorded in the 2001 GFS are for civil servants’ pensions.

A proposal was put to the December 2002 IFAC meetings to include already accrued pension liabilities to the rest of the population. This is part of an effort to get a fuller picture of long-run pressures on governments.

3. Accrued pension liabilities (cont.)

The proposal is controversial.

Objection: Pensions are not liabilities in the same sense as debt—the government can change policy and thereby reduce them.

Response: (1) it is difficult for a government to renege on accrued liabilities—it usually grandfathers; (2) the balance sheet is meant to be a snapshot of the present situation—policies won’t be changed unless the cost of current policies is clear.

Objection: There is moral hazard to recognizing these liabilities. Response: (1) The balance sheet needs to be seen as an analytical tool, not a legal

document. (2) Anyway, some countries (Chile) have taken a related step by creating/reporting recognition bonds.

Objection: It is a misrepresentation to show the liabilities without showing what offsets them on the asset side (=the power to tax).

Response: Good idea. Identify (part of net worth) either (1) assets equivalent to liabilities, or (2) assets equivalent to best-estimate power to raise taxes.

4. BOTs and concessions Build-Operate-Transfer schemes:

A private firm agrees to build an asset for government (e.g., road, prison), operate it for some years, and then transfer it to government. Government agrees to allow the private firm to control the asset until it is transferred, and to earn income on it, usually by charging government or the private sector for services (e.g., tolls, prison management).

Such schemes have been shown in the fiscal accounts only by recording an unrequited transfer from the private sector to government at the end of the contract period—i.e., essentially not at all, to date.

4. BOTs and concessions (cont.)

From an accounting perspective, and analytically, the lack of fiscal treatment creates problems.

Accounting: The government’s capital stock rises, with no recorded investment or payment. Some subset of the public may be paying user charges for public goods, without these showing in the budget.

Economics: Though the government succeeds in deferring payment for the investment, it still (1) makes the decision to invest; (2) usually keeps control of the specifications; and (3) produces the same public infrastructure as it would have under a traditional direct investment arrangement.

Conclusion: excluding BOTs from the fiscal accounts understates the role of government in the economy (size of the non-market sector, government aggregate demand, potential for crowding-out...)

4. BOTs and concessions (cont.) “The economic effect of the BOT scheme is very little different from the

situation where the public sector acquires [the investment] directly, using a private construction firm and vendor financing, and subsequently leases the asset to the same private sector corporation, using the lease income to pay off its debt service charges”. (IMF WP/02/167).

Counter-argument: No, it would be wrong to include these and other types of public-private partnership in the fiscal accounts because private sector involvement (a) changes the goods from “public” to “marketed” goods, and (b) imports market-economy efficiency to the public sector. I.e., the borders between the public and private sectors have become fuzzy.

Response (1): That was the plan, but: sketchy but increasing evidence (e.g., from Britain) suggests that public-private partnerships have been more expensive than plain vanilla government investments, both during operations and e.g., because of incentives to defer maintenance.

4. BOTs and concessions (cont.) Response (2):

Analytically: why would a private firm be willing to build something it has to give away unless it earns more than via a plain-vanilla private investment?

Because, (i) it gets access to government monopoly power (e.g., typically a BOT contract commits the government not to build another road/prison near by). Hence it can charge higher prices. The above-competitive prices have to be high enough to compensate for eventually ceding the asset to government (i.e., the exercise of state monopoly power pays for the asset).

Moreover, (ii) contracts usually minimize the risk to the private firm, by requiring government to guarantee a certain income, etc.

And (iii) typically the public sector retains most of the depreciation cost.

4. BOTs and concessions (cont.)

A proposal in an IMF working paper suggests showing the government’s role in the project more transparently (i.e., more accurately from an economic perspective).

The project is shown as government investment in the year(s) it is built.

The government finances it by a loan from the private construction company.

The government’s debt service to pay off the loan is: the income stream earned by the private company from operating the BOT (net of its costs).*

*The point here is that the government could have earned the same income stream (+/- differences in public/private efficiency), so in essence it is merely allowing the private sector act as its agent.

4. BOTs and concessions (cont.)

So, BOTs would increase the fiscal deficit in the year the resources are used to build the infrastructure.

However, the proposal does not envisage including the BOT liability as debt, because the debt service payments are already inherent (non-separable) in the arrangement.

4. BOTs and concessions (cont.)

The same insight—that the government can sell its monopoly power to the private sector—can also be applied to concessions (= like BOTs, but without the asset transfer).

Concessions are contracts defining private participation in the development and operation of public works.

4. BOTs and concessions (concl.)

When the concessionaire pays the government an upfront fee, it is because the concession is expected to be lucrative enough to cover costs and make a profit (i.e., reflecting use of monopoly power).

Hence, an IMF staff proposal is: to treat the upfront payment as the purchase price of an asset (= the right to use monopoly power). Effectively, this would mean eliminating the receipts from the sale of the concession from revenue—since government net worth does not increase. Its financing requirement is, however, reduced.

When the contract provides for the government to guarantee a minimum income to the concessionaire (e.g., to pay him if the volume of cars on a toll road falls short of projections), then any such payment should be treated as a subsidy—since (i) the payment depends on the quantity of services and (ii) is intended to close an operating gap in the remuneration of the concessionaire company.

When the contract provides for the concessionaire to transfer any excess profits to government (e.g., if car volume exceeds projections), these flow earnings are legitimate government revenue.

5. The fiscal treatment of the Central Bank

The shift to accrual also removes one of the main arguments against reporting a fiscal table for the central bank.

Reasons to include the central bank in the fiscal accounts are: To have a transparent record of quasi-fiscal activity. To track the aggregate demand impact of central bank operations (since central

bank losses are in effect financed by money creation). To monitor sustainability: if the central bank runs losses on its core activities

for a protracted period (so that it runs down its net worth), government will have to bail it out.

To remind people that there are real costs to monetary policy: an unsustainable policy (e.g., sterilization) will eventually have to be abandoned.

Problem (well, ... issue ...): the central bank tends to use its whole balance sheet more than a non-financial entity does. E.g., in Chile, the authorities can count on near-certain capital gains to finance their quasi-fiscal deficit.