Management of Contingent Liabilities in Philippines-

Policies, Processes, Legal Framework,

and Institutional Arrangements

Tarun Das*,
Economic Adviser, Ministry of Finance, India.
And Consultant to the World Bank

March 2002

* The author is grateful to the World Bank to provide an

opportunity to prepare this report and the government of India
for granting necessary permission for that. Paper expresses personal
views of the author, which may not reflect views of the World Bank or the
Government of India.

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 Management of Contingent Liabilities in Philippines-
Policies, Processes, Legal Framework, and Institutional Arrangements

Tarun Das, Economic Adviser, Ministry of Finance, India.

And Consultant to the World Bank

1. Background and Objectives

1. This report is a part of a wider study on the Public Expenditure, Procurement and
Financial Management Review (PEPFMR) for the Philippines being prepared by the
World Bank. The objective of the PEPFMR exercise is to examine selected issues in
the allocation and management of public resources, which are of interest to the
Government of Philippines and the World Bank. In particular, the objectives of the
World Bank study are as follows:

(i) To help the authorities establish more effective and transparent mechanisms and
policies to allocate, utilize and manage available public resources so as to
promote economic growth, improve delivery of basic social services, and reduce
poverty; and

(ii) To fulfill the World Bank’s fiduciary responsibility and serve as the core
background analytical framework for future operations in Philippines. The
PEPFMR findings and recommendations will constitute part of the core analytical
work for a proposed Public Finance Strengthening Loan (PFSL), and attendant
programs and adjustment loans.

2. A key focus area of the PEPFMR is the identification and management of public
contingent liabilities, which pose threats to fiscal stability and overall macro-
economic stability and, therefore, require better monitoring and management. These
liabilities include exposures under obligations such as government guarantees on
loans; performance guarantees to BOT projects, guarantees on guarantee institutions
and deposit insurance, and fiduciary guarantees to public pension, provident and
insurance institutions. Certain other categories of government's contingent liabilities
include forward contracts for foreign exchange, various implicit obligations
associated with bank failures, and possible recapitalization of failing corporations.
These issues donot come under the purview of the PEPFMR.

2. Scope and Methodology

3. This report examines the largest components of contingent liabilities such as

exposures under government guarantees on loans, BOT projects, guarantees on
guarantee institutions, public pension institutions, deposit insurance, un-funded
liabilities of pension institutions and the increasing debt of the National Power
Corporation (Napocor). The report suggests systems for monitoring and

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 dissemination of information on outstanding guarantees of the government guarantee
institutions that are explicitly or implicitly backed by the national government.

4. The report examines the legal framework, policies, processes and institutional
arrangements for monitoring public contingent liabilities in the Philippine
government with special emphasis on state guarantees to Government Financial
Institutions (GFIs) and Government Owned and Controlled Corporations (GOCCs).
The report identifies the key issues and concerns, and describes, analyzes and
assesses the steps already taken by the authorities. In addition, it provides country-
specific recommendations in the short-, medium- and long term for the improvement
as per international sound practices.

5. The findings are based on examination of available reports on the subjects and
discussions with the concerned entities involved in receiving, issuing, approving,
managing and recording state contingent liabilities (focusing for the present on
explicit ones which are recognized under legal laws and contracts for both domestic
and external liabilities) during a mission to Manila during 17 February to 2 March
2002.

6. The consultant has worked under the continual guidance of the PEPFMR task team
leader (TTL) Mr. Amitabha Mukherjee who specified the broad objectives and scope
of the study and also indicated the key technical officials and policy makers in the
Philippines who are responsible for the approval, issue, recording, monitoring and
management of contingent liabilities.

7. During visit to Manila, the Consultant maintained close interactions with Mr. Lloyd
McKay, Lead Economist, World Bank Office at Manila (WBOM), Ms. Laura
Pascua, Under-Secretary, Department of Budget and Management (DBM) and the
Chairperson of the counterpart team (PER Working Group) established by the
Government of Philippines; Ms. Nieves Osorio, Undersecretary, Department of
Finance (DOF), Government of Philippines (GoPh), Ms. Soledad Emilia J. Cruz,
Director, Corporate Affairs Group, DOF, GoPh., and Ms. Xuelin Liu, Country
Economist, Philippines Country Office, Asian Development Bank.

8. The Consultant has also benefited greatly from detailed discussions with various
officials of the government of Philippines and GOCCs, who are responsible for
issuing, approval, monitoring and auditing of contingent liabilities and formulation of
policies. A list of key officials with whom detailed discussions were held in Manila is
given at Annexure-D.

3. Contingent liabilities- definitions and measurement

Contingent liabilities are defined by the System of National Accounts 1993 as contractual
financial arrangements that give rise to conditional requirements either to make payments
or to provide objects of value. A key characteristic of such financial arrangements, as
distinguished from the current financial liabilities, is that one or more conditions or
events must be fulfilled before a contingent liability takes place. A key characteristic that

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makes such liabilities different from normal financial transactions is that they are
uncertain.

Contingent liabilities represent potential claims against the government, which have not
yet materialized, but which could trigger a firm financial obligation or liability under
certain circumstances. Several studies have shown that contingent liabilities, once
materialized, can be a major factor in the build up of public sector debt and can pose
significant risks to the government’s balance sheet.

Contingent liabilities are of two main types- explicit and implicit. Explicit contingent
liabilities are based upon legal and contractual commitment or formal acknowledgement
of a potential claim, which can be realised in particular situations. Explicit contingent
liabilities include bonds or other liabilities contracted by the government with put options
for lenders, credit-related guarantees, performance guarantees, various types of
government insurance schemes (e.g., against banking deposits, crop failure, natural
disasters, etc.), or legal proceedings representing claims for tax refunds or against
government providers of services such as health care, education, defense, housing, etc.

Implicit contingent liabilities represent potential claims where the government does not
have a contractual obligation to provide financial support, but society expects the
government to provide assistance because of moral considerations. Implicit contingent
liabilities arise when the cost of not assuming them are considered to be very high in
terms of social and economic disruptions. For example, bailing out weak banks or failed
financial institutions or meeting the obligations of the subnational (state and local)
governments or the Central Bank in the event of default following systematic crisis may
be viewed as an implicit contingent liability of the central government.
Other implicit contingent liabilities include disaster relief, corporate sector bail outs,
municipal bankruptcy, defaults on non guaranteed debt issued by sub-nationals and state-
owned enterprises or government obligations under a fixed exchange rate regime to
defend its currency peg. These risks can be particularly significant in emerging market
countries undergoing financial sector and capital convertibility reforms and where the
regulatory and disclosure standards may be weak.

As for example of contingent liabilities, in the case of Philippines, the national

government assumed about US$7.5 billion (or P152 billion) of liabilities from the
Philippine National Bank (PNB) and the Development Bank of the Philippines (DBP) in
the process of rehabilitation of these GFIs. Most of these liabilities were due to the
default of private external borrowings, which were guaranteed by PNB and DBP. While
the national government had not extended counter-guarantees to PNB and DBP for these
external loans, it was constrained to assume these liabilities because of automatic
government guarantees provided for in these bank charters and to avoid adverse impact
on the credit rating of sovereign debt. Again in 1993, the Philippine government assumed
liability of US$8.1 billion or P331 billion of cumulative losses of the Central Bank of
Philippine (CBP). The losses of CBP was primarily due to mismatch between its assets
and liabilities caused by fluctuations of the exchange rate and also due to bearing the

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forward exchange losses of the oil companies during the oil crisis of the late 1970s and
rehabilitation of weak banks.

Contingent liabilities are complex and not easy to quantify. A single and uniform
framework for their measurement may not be appropriate. The choice of a technique
depends on the type of contingent liability being measured and the availability of
requisite data and information. It is well recognised that cash based accounting systems,
even supplemented by off-budget and off-balance sheet transactions, are not suited for
managing contingent liabilities. Only the accrual based accounting systems can capture
contingent liabilities as they are created. Within such systems, contingent liabilities can
be recorded at full face value or maximum potential loss as well as expected value and
expected present value of contracts.

Following Polackova (1998), contingent liabilities can be best described in terms of a

Fiscal Risk Matrix cross-classifying sources of potential risks on government finance by
two distinct characteristics: direct or contingent and explicit or implicit. Table-1 presents
a typical fiscal risk matrix for the Philippines government.

Table 1: Fiscal Risk Matrix for Philippines Government

Liabilities Direct: Obligation in Contingent: Obligation if a

Any event Particular event occurs

Explicit: • Sovereign debt (domestic and • Direct guarantees on obligations of GOCCs

Government external)
liability by law • Budgeted expenditures of
or by a contract different departments
• Expenditures – non-
discretionary and legally
binding in the long term (civil
service salaries and pensions)
• Guarantees on currency risks of GFIs' foreign
loans
• Guarantees on various types of risks
(including market, currency, regulatory,
political) in BOT contracts
• Umbrella guarantees for various types of loans
(agriculture, microenterprise, housing)
• Deposit insurance (P100k per account)
• Guarantees on benefits (unfunded liabilities)
of the social security system and GSIS
• Future health care financing
• Tax credit certificates

Implicit: • Future recurrent costs of • Bank failure (beyond state insurance)

A moral public investment projects • Possible default of the central bank
obligation of the • Possible need to further recapitalize
government government banks
which reflects
• Cleanup of the liabilities of privatised entities
public and
interest group • Support to enterprises (covering losses and
pressures assuming non-guaranteed obligations)
• Liabilities and other obligations of sub-
national governments

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 4. Practices of Managing Contingent Liabilities in Philippines

At present, the government of Philippines does not have a comprehensive Act to monitor
all contingent liabilities. It has only one tool to manage its contingent liabilities related to
external sector. Republic Act 4860 (Foreign Borrowings Act), as amended from time to
time, sets a ceiling of $7.5 million on outstanding government guarantees for foreign
loans of the government-owned and controlled corporations (GOCCs). Items, which are
required to be charged against this ceiling, are the guaranteed principal amounts (i.e.,
disbursements less repayments, excluding interest payments and other bank fees) of loans
incurred and bonds issued. The national government charges a fixed 1 per cent annual
guarantee fee regardless of the risk profile of the guaranteed loan or institution.

The Department of Finance (DoF) reviews and approves requests of GOCCs for
national government guarantees. After approval by the DoF, the Bureau of the Treasury
(BTr) is mandated to keep track of government guarantees issued and to ensure that total
outstanding guarantees at any time donot exceed the ceiling prescribed under RA 4860.
However, borrowings of certain GOCCs (e.g., LRTA, MWSS, NDC, NEA, NIA, NPC,
PNOC, and PNR etc.) are explicitly exempted in their charters from being charged
against this ceiling. These exemptions render the ceiling a less effective control
mechanism, especially since some of the exempted corporations are the giant GOCCs
with large outstanding loan balances.

A study by AGILE (Accelerating Growth Investment and Liberalisation with Equity- a

Consortium of the Development Alternatives Inc., Harvard Institute for international
Development, Cesar Virasta & Associates Inc. and PricewaterhouseCoopers) made an
analysis of contingent liabilities of the Philippines government for 30 GOCCs. The
AGILE study identified 15 GOCCs with automatic guarantees in their charters. However,
a more comprehensive study made by Bernardo and Tang (2001) indicates that 22
GOCCs, out of 32 GOCCs, enjoy automatic guarantees in their charters (Annexure-A).

Except guaranteed GOCC loans; other types of government contingent liabilities

are largely unmonitored. There are efforts in the DoF and BTr to monitor government
guarantees for various types of risks under BOT contracts but these are still in the initial
stages. The government also does not monitor exposures related to foreign exchange
cover for loans of government financial institutions secured by the Land Bank and the
Development Bank of the Philippines from official creditors in foreign exchange and
relent to accredited private financial institutions in pesos. Likewise, the unfunded
liabilities of the pension institutions (Social Security System, Government Service
Insurance System, Home Development Mutual Fund), also guaranteed by the
government, are not monitored and managed. In addition, there is currently no system
for bringing together information on outstanding guarantees of government guarantee
institutions that are explicitly or implicitly backed by the national government.

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 Based on current practices, guarantee fees collected are treated as part of
government's general revenues and are not kept in a separate account to fund future
guarantee calls. Given government's cash-based accounting and budgeting frameworks,
government does not presently provide reserves for expected guarantee calls. The
corporations are also not required to conform to standard prudential norms in
provisioning and reserve policy for contingent liabilities. The GOCCs donot estimate and
disclose their off-balance sheet contingent liabilities in their annual reports. Only when a
guarantee is called does the government set up the needed budget to fund payments and
only for that portion due in the current year.

As in most countries, government budgets in the Philippines are done on a cash basis and
not on accrual basis. Non-cash expenditures such as depreciation of assets, taxes owed
but not yet paid, donot appear in the budget. Consequently, guarantees and other off-
budget arrangements are made liberally and there is no hard budget constraint. Although
it is possible to note guarantees and other non-cash items as memorandum items in the
cash-based budgets and accounts, complete incorporation of these liabilities requires a
shift from cash-based to accrual based budgeting and accounting.

5. Extent and Nature of government contingent liabilities

Total contingent liabilities of the Philippines government due to government guarantees

on loans, BOT projects, guarantees on guarantee institutions, public pension institutions
and deposit insurance are estimated to be Pesos 3.4 trillion, which is equivalent to 111 per
cent of public debt and 95 per cent of GDP. The most dominant component involves
exposures in unfunded liabilities of pension institutions, amounting to P1.8 trillion or 55
per cent of GDP or 64 per cent of national government debt. At the distant second
position come the government guarantees on loans (which account for 15 per cent of total
contingent liabilities, equivalent to around 15 per cent of GDP and 17 per cent of national
government debt), closely followed by government guarantees BOT projects (which
account for about 14 per cent of total contingent liabilities, equivalent to around 14 per
cent of GDP and 16 per cent of national government debt). Deposit insurance has also a
significant share (11 per cent) in total contingent liabilities, equivalent to 11 per cent of
GDP and 12 per cent of public debt. However, these contingent liabilities do not include
government's contingent liabilities under forward contracts for foreign exchange and
various implicit obligations associated with bank failures and possible recapitalization of
failing corporations.

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 Table-2: Summary of government contingent liabilities
Maximum exposure for each type as in October 2001

Type of contingent Amount Share in total As % of As % of

liability (P billions) contingent GDP public
liability (%) debt

Guarantees on loans 491 15.5 14.8 17.2

BOT Projects 455 14.3 13.7 16.0
Guarantee institutions 40 1.3 1.2 1.4
Public pension institutions 1,828 57.7 55.0 64.2
Deposit insurance 352 11.1 10.6 12.4

Total 3,166 100 95.2 111.3

Source: Bernardo and Tang (2001) and AGILE (2001) except for guarantees on loans,
which are updated by the author on the basis of, most recent data.

Table-3: Total Contingent liabilities (CLs) of the National Government

as of October 2001

Type Levels (Pbln) % Share in % of GDP % of total

Contingent NG debt
Liabilities

Domestic debt 15.3 3.1 0.5 0.5

Guaranteed 15.1 3.1 0.5 0.5
Assumed 0.2 0.0 0.0 0.0

External debt 476.1 96.9 14.3 16.7

Guaranteed 458.7 93.3 13.8 16.1
Assumed 17.4 3.5 0.5 0.6

Total CLs 491.4 100.0 14.8 17.2

Memo items
NG total debt 2844.0 85.6 100.0
 Domestic 1239.4 37.3 43.6
 External 1604.6 48.3 56.4

Source: Bureau of the Treasury

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 (a) Direct guarantees on loans

As per the data supplied by the Bureau of the Treasury, as of October 2001, total
contingent liabilities of the national government due to guaranteed loans amounted to
P491.4 billion, which is equivalent to 14.8 per cent of GDP or 17.2 per cent of national
government debt. This includes P17.6 billion in assumed guarantees of formerly
rehabilitated GOCCs (mainly Philippine National Bank and Development Bank of
Philippines). The bulk (97 per cent) of the contingent liabilities consist of guarantees on
foreign debts of GOCCs, including borrowings of GOCCs whose charters exempt them
from the ceiling provided under RA 4860. Domestic debts guaranteed include bond
issuances of the Home Development Mutual Fund and the National Development
Company as well as agrarian reform bonds of the Land Bank.

A breakdown of the above data by GOCCs is not readily available. Instead, information
culled from 1999 Commission on Audit reports indicate that National Power Corporation,
which enjoys automatic government guarantee on its bonds, has the largest share (42 per
cent) of outstanding foreign loans of GOCCs in 1999. Government financial institutions,
like Bangko Senetral ng Pilipinas (21 per cent) and Development Bank of Philippines
(15 per cent) also have large outstanding foreign loans.

There are some weak corporations, for which the risk of government being called to
service their loans is very high. A review of the financial performance on the basis of
Audit Reports indicate that LRTA and PNR had negative networth for the past three
years, and four others (NEA, NFA, NIA, NPC) had been registering losses leading to
declining networth.

Guarantees to GOCCs need to be more tightly managed and monitored. Decisions to

providing guarantees should be subject to the same process of appraisal as that for
providing loans. The recent decision of the DOF to make a provisioning in the budget by
one percentage of guarantees is a positive move. But, these charges are modest and the
uniform provisioning does not reflect an assessment of the differing risk characteristics of
the projects or loans being guaranteed.

In the short run, government should systematically assess the financial health of each of
GOCCs to ascertain their creditworthiness and the government's risk in guaranteeing their
debts. The existing guarantee limit under RA 4860 must be enforced for all GOCCs.
Based on this assessment, government may opt to impose more stringent criteria before
guaranteeing loans and adjust guarantee fees depending on credit rating of the
institutions.

In the medium term, the government should review and amend the charters of GOCCs as
necessary to ensure that the guarantee limits apply to all GOCCs. Where desirable and
possible, GOCCs could be privatised to avoid the risk. Weak GOCCs either need to be
strengthened with feasible capital and manpower restructuring or closed with legal
compensations to all stakeholders. In general, the process of auditing for the GOCCs

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needs to be strengthened with discloser of all contingent liabilities in their balance sheets.
In any case, there should be no automatic guarantee of contingent liabilities by the
national government and risk based fees be charged for all guarantees.

The government has already taken some steps in the right direction. The Investment
Coordination Committee of the DOF has created a Technical Working Group to help it
complete an inventory of all contingent liabilities, review the sources of contingent
liabilities, develop means for minimizing and sharing risks across government and quasi-
governmental organizations, monitor projects guarantees, and build institutional capacity
for effective management of contingent liabilities. The government has recognized the
complexity of issues relating to continent liabilities and is devoting resources to the
difficult task of measuring them.

(b) BOT Projects

In order to attract private sector participation and financing for critical infrastructure
projects in power, road, rail transport and water supply, the government of Philippines
issued guarantees for BOT projects for mitigating some of the risks posed by the political
and economic environment in the Philippines. Some of the risks assumed by the
government include currency, market, political and regulatory risks as well as force
majeure events (such as natural calamities, war, revolution, labour agitation and strikes,
changes of law, compulsory acquisition of assets by government in public interest etc.).

A recent study commissioned by AGILE (2001) attempted to estimate national

government exposure to BOT project-related risks for 40 power projects, six transport
projects and five other projects (on water supply, housing, tourism, information
technology, thermal coating and printing plant). The study assessed risks in the BOT
projects and computed the expected losses of the government from these projects using
Monte Carlo or stochastic simulation methods. The study estimated that the indicative
exposure in these projects amounted to P1412 billion and explicit exposure at P455
billion. The explicit exposure represents the maximum contractual obligation of the
national government that arises if all the contingencies, including force majeure, are
triggered in all the contracts. However, it may be mentioned here that the likelihood of
such happening is remote and the expected loss from some of these exposures (e.g., force
majeure) is zero.

The results indicate that the Sual and Pagbilao power projects and the MRT-III light rail
transit project have the highest risks for losses, and the main risk factors arise from
currency and demand risks and time-overruns in implementation of projects. However, it
may be noted that in the case of the power projects, neither the NPC nor the national
government assumes the costs of these risks as these costs are actually passed on to
consumers. For MRT-III on the other hand, the government already provided US$76
million in subsidy in 2000.

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 Table 4: Indicative and Explicit NG Exposures
under BOT Projects* (In P billion)

Indicative* Explicit*

Power 1,210 253

Transport 167 167
Water 4 4
Others 31 31

Total 1,412 455

• Indicative exposures refer to the present value of future
payments by the national government to BOT operators and
their creditors;
• Explicit exposures refer to the financial cost of buyout or
termination payments as determined in contracts.
Source: AGILE (2001)

(c) Government guarantee institutions

In the Philippines, several corporations have been set up to guarantee loans in the
agriculture, small enterprise, housing and export sectors. The biggest among these is the
Home Guaranty Corporation (HGC). HGC is particularly noteworthy because it has an
authorized capital of P50 billion and an allowable guarantee limit of 20 times its
networth. Since all of HGC's obligations and loan guarantees are backed automatically
by sovereign guarantees, the government is potentially exposed to over P1 trillion in
contingent liabilities from HGC alone.

In addition to loan guarantees, HGC's bond issuances also carry sovereign guarantees.
These bonds are issued mainly to pay for calls on the corporation's loan guarantees,
payment of which are based on the total guaranteed amounts. Since the real estate slump
following the Asian crisis, guarantee calls on HGC have risen substantially and have
strained HGC's cash position. Reorienting HGC's guarantee scheme towards cashflow
guarantee may be needed to help HGC manage the guarantee calls. A further point of
concern would be pressure for it to do "formula lending" for low-income housing similar
to what NHMFC was doing (i.e., with no credit evaluation).

Aside from HGC, there are a host of much smaller government guarantee institutions
which include the Trade and Investment Development Corporation of the Philippines
(TIDCORP), the Guarantee Fund for Small and Medium Enterprises (GFSME), the Small
Business Guarantee Fund Corporation (SBGFC) and the Quedan and Rural Credit
Guarantee Corporation (Quedancor). Except for the SBGFC (which will be merged with
the GFSME), guarantees of the TIDCORP, Quedancor and GFSME are backed by the
national government.

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A 1998 study on the Quedancor, SBGFC and GFSME noted substantial losses in these
programs, with all three-guarantee institutions suffering negative net operating income
from 1992 to 1997. The study, moreover, observed that the number of loans guaranteed
by the programs is small and the additional number of loans that were stimulated by the
guarantee schemes is even smaller. Government decision to continue infusing hefty sums
into these institutions should thus take these factors into consideration.

(d) Public pension and provident fund institutions

Social Security System (SSS)

The most current audited balance sheet (2000) of the SSS shows a total reserve fund of
P170.4 billion comprising Pension Reserve Fund of P151.8 billion, Employees
compensation Fund P18.4 billion and Mortgagors’ Insurance Fund P0.2 billion.
However, this does not accurately represent the unfunded liabilities of the institution.

In 2000 the benefits of the SSS exceeded contributions by PhP3.5 billion. But, it
managed to overcome the gap by its earnings from investment. However, this may not be
feasible for all the years to come. According to estimates made by the Secretariat of the
Presidential Retirement Income Commission (PRIC) on the basis of the World Bank
PROST model, the implicit public debt in the case of termination of the program in 1999
would have amounted to P1.48 trillion or about 50% of GDP. The program's unfunded
liabilities were estimated at P1.3 trillion. The PRIC Secretariat further estimated that cash
flow will turn negative and the benefit payments will start dipping into reserves by 2003.
Actuarially it is headed for the morgue with reserves expected to run out by 2011. Office
of the Chief Actuary of the SSS also agrees with these estimates.

In fact, for a long period there had been deteriorating actuarial fund life of the social
security system and fund ratio due to the following factors:

(a) Benefit enhancements without increase in contribution rate since 1979,

(b) Subsidized interest rates on housing, development and member loans
(c) Decreasing interest rates in treasury bills in 1990s, and
(d) Increasing life expectancy.

The SSS has been experiencing contributions-to-benefits as well as contributions-to-

expenditures imbalances for the past several years, especially since 1993. The major
problem with the SSS is that for many years, benefits have been increasing without
corresponding increase in contributions. The last increase in the contribution rate from
7.4 per cent to 8.4 per cent was done in 1979. Since then the benefits had been enhanced
23 times due to political reasons, but there had been no commensurate increase in the
contribution rates.

This deficiency is largely accounted for by the basic mismatch between the benefit rate
and the contribution rate. In the case of the SSS, even for the high-income contributor,
the ratio between the present value of the stream of benefits divided by the present value

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of the stream of contributions, or the benefit ratio works out to 1.60. For the beneficiaries
of the minimum pension, the benefit ratio is estimated at 7.93.

Table-5 below indicates that by international comparisons, the SSS contribution rate is
low while its administrative cost is high and the return on investments is poor. At present
the SSS contribution rate at 8.4 per cent (comprising 3.3 percent contribution by the
employee and 5.1 percent by the employer) is much smaller compared to that of GSIS
and similar funded and aged social security programs in other countries. It compares
unfavorably with the GSIS with a contribution rate of 21 per cent. The SSS contribution
rate is also one of the lowest among the similar pension systems for other countries such
as Malaysia with a contribution rate of 23 per cent, Singapore 32 per cent, China 30 per
cent, Vietnam 20 per cent, Turkey 20 per cent and Egypt at 30 per cent.

Table-5: Features of the Mandatory Pension Schemes in Selected Countries

Country Retirement Length of Combined Average Real rate of Administra

age Service required contribution retirement return on tion cost
(Years) for pension Rate Rate investments
(years) (%)
China 60/ 55 5-15 30 60-90 Negative High
Indonesia 55 - 5.7 10 Poor High
Korea 60 20 9 60 Poor -
Malaysia 55/ 50 - 23 20-25 3.44% Low
Philippines 60 10 8.4 89 Poor High
Singapore 62 - 32 20-30 2% Low
Thailand 55 15 5 15 Poor Medium
Source: Holzmann, Robert, Ian W. Mac Artjir and Yvonne Sin “Pension Systems in East
Asia and the Pacific: Challenges and Opportunities”, Social Protection Unit, The World
Bank, June 2000.

The SSS funds are also being utilized to subsidize consumer loans, housing loans and
development loans, which constitute about 50 per cent of total investments. At the end of
October 2001, housing loans comprised 26 per cent of total investments, member loans
15 per cent, development loans 8 per cent, government sector loans 17 per cent, equities
in private sector 29 per cent, and real estate 4 per cent. Moreover, because of political
considerations, the SSS is not allowed to diversify its investments by investing in foreign
assets. The result is that the SSS has become actuarially unsound.

Demographic transition in Philippines has also exacerbated the SSS’s financial plight.
Due to an increase in expectation of life, more people are living longer and the pension
benefits have to be paid for a longer period.

Government Service Insurance Corporation (GSIS)

As the name suggests, Government officials are the members of the GSIS while private
employees are the members of SSS. The most current audited balance sheet (2000) of the
GSIS shows a total reserve fund of P166 billion comprising Social Insurance Fund pf

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P154 billion, Optional Life Insurance Fund P6.8 billion, General Insurance Fund P4.8
billion, and Employees Compensation Insurance Fund P0.5 billion. However, this does
not accurately represent the unfunded liabilities of the institution. The PRIC Secretariat
estimated that the implicit public debt of GSIS at the end of 1999 stood at P538 billion
compared with a pension reserve of P136.4 billion resulting in its unfunded liabilities
amounting to P401.6 billion.

According to a study made by the World Bank (2000) the implicit total public pension
debt for the Philippine is estimated to be 107 per cent of GDP. It may, however, be noted
here that the Philippines is not the only country having problem with contingent liabilities
relating to pension and provident funds. Governments all over the world face similar
problems, many of which are yet to explicitly recognize that the problem exists. Table-6
below highlights the severity of the problem with implicit pension debt in some countries,
which indicates that the situation in Philippines is not as bad as in some emerging
markets.

Table-6: Implicit Pension Debt in 26 emerging market economies (percent of GDP)

Country % Country % Country %

Brazil 390 Uruguay 214 Costa Rica 121
Slovenia 298 Hungary 203 Philippines 107
Macedonia 291 Croatia 201 Argentina 85
Poland 261 Estonia 189 Ecuador 63
Ukraine 257 Kyrgyz Rep 185 Senegal 51
Romania 256 Moldova 159 Mauritius 47
Malta 234 Lithuania 155 Korea 33
Portugal 233 Turkey 146 Morocco 32
Slovakia 210 Nicaragua 131
Source: Holzmann, Robert, Ian W. Mac Artjir and Yvonne Sin “Pension Systems in East
Asia and the Pacific: Challenges and Opportunities”, Social Protection Unit, The World
Bank, June 2000.

Although the financial position of GSIS is better than that of the SSS, it is estimated that
the current benefits of GSIS at the existing rates would exceed the current contributions
in 1924, and there would be serious liquidity problem in 2041 and the reserves would be
exhausted in 2068.

The better health of GSIS is due to a better match between benefits and contribution with
the benefit ratio ranging between 1.05 for the highest income bracket and 1.40 for the
lowest income member. The contribution rate at 21 percent is almost two and half times
of that of SSS. Although there is little scope for enhancing the contribution rate, which is
reasonable at 21 per cent, there is scope for improving the compliance rate and to
rationalize the benefits among the members in different income brackets. There is also
scope for enhancing the qualifying period for getting pension and to increase the
retirement age commensurate with the increase in expectation of life.

15
It may not be politically feasible to amend the Act for removal of automatic government
guarantee in the case of financial problem faced by GSIS or SSS. However, both the
systems should move from defined benefits system to defined contribution system.

There is also need for strengthening the Asset Liability Management (ALM) system in
both these organizations to minimize the risks given defined contributions.

The present thrust of the GSIS on the “Back to Basics Policy” is in the right direction.
Under the policy, the GSIS concentrated on essential activities where it is efficient such
as administration of benefits, limiting direct lending operations to salary and housing
loans to its members, and phased out peripheral programs, which can be more efficiently
handled by the private sector. The SSS can learn from these experiences of GSIS.

There is also a need to separate life and non-life components of insurance. While
government can provide some subsidies for life insurance for targeted groups of people
due to social reasons, there should be no subsidies for non-life insurance, which can be
fully funded and better managed by the private sector.

The Home Development Mutual Fund (HDMF)

HDMF. or Pag-IBIG is a mandatory savings program where accumulated contributions

from employees and employers are used primarily for housing finance. Forty-four
percent (P42.5 billion) of Pag-IBIG's assets at the end of 1999 are in the form of
mortgage loans to members. Members are allowed to withdraw their account balances
after 20 years of contributions (or upon retirement, death or disability) with an option to
withdraw partially after 10 years. For a large number of the early contributors, Pag-
IBIG's commitments are expected to fall due starting in 2001 up to 2005. Reserves,
amounting to P25 billion, are sufficient to meet P16 billion in gross benefit claims in
2000.

While Pag-IBIG appears in better shape financially than the pension institutions, the
quality of its portfolio is a point of concern. It is reported that the institution's non-
performing mortgage loans comprise 30% of its mortgage portfolio, which under the
worst case scenario (no recoveries) translates into a potential loss of P12 billion based on
mortgages outstanding at the end of 1999 (net of loan loss provisions). Actual losses,
however, would most likely be lower given recoveries on acquired assets and a 22%
government guarantee on a portion of the portfolio.

(e) Financial Performance of banks

Philippines banks had very difficult time in recent years. Despite internal and external
shocks, the banking system continued to hold its ground in 2000 with growing deposits,
manageable asset quality, and desirable capital adequacy ratio. Deposits of commercial
banks grew by 7.5 per cent in 2000. While savings deposits accounted for 60.7 per cent of
total deposits, time and demand deposits comprised 28.4 per cent and 10.9 per cent
respectively.

16
BSP is the regulator for all banks – which are categorized as expanded commercial banks,
non-expanded commercial banks, government banks and foreign banks. It is mandatory
for all banks to disclose the off balance sheet (i.e. contingent) liabilities in their balance
sheet. However, BSP itself does not disclose its contingent liabilities in national interest.

There are strict prudential norms for making provisions for loss assets and sub-standard
assets. Commission on Audit is responsible for auditing all GOCCs including government
banks and BSP.

Philippines banks, particularly the government banks, at present are beset with the
problems of high levels of non-performing assets and low rate of return, although they
have reasonable capital adequacy ratios. Moreover, both the capital and the non-
performing assets are unevenly distributed among the banks.

The asset quality of the banking system exhibited steady worsening since 1997. The non-
performing loan (NPL) ratio of the banking system increased to 17.3 per cent at the end
of 2001 compared to only 2.8 per cent at the end of 1996 (Table-7). The NPL ratio for the
non-expanded commercial banks (NEKBs) was the highest at 22.8 per cent, and that for
foreign banks was the lowest at 4.8 per cent, while the NPL ratio for government banks
stood at 17.8 per cent at the end of 2001. Restructured loans of commercial banks
increased substantially in 2000-2001 and accounted for 6 per cent of total loans.

Table-7 Gross NPL ratios (Non performing loans as percentage of total loans)

Year Total Expanded Non-Expanded Government Foreign

Commercial Commercial Commercial banks banks
Banks (KBs) Banks (EKBs) banks (NEKBs)
1996 2.8 2.4 3.7 4.4 3.3
1997 4.7 4.2 7.2 6.1 4.4
1998 10.4 10.4 13.7 10.1 7.8
1999 12.3 13.0 16.4 12.6 3.5
2000 15.1 16.8 17.6 15.0 3.8
2001 17.3 19.4 22.8 17.8 4.8

However, the banking system remained adequately capitalized. The average capital
adequacy ratio (CAR) of the banking system stood at 16.4 per cent at the end of 2000,
lower than 17.5 per cent achieved in 1999. Notwithstanding the decline, the ratio
remained well above the BSP statutory floor rate of 10 per cent and the Bank for
International Settlements (BIS) standard of 8 per cent. Meanwhile, bank provisions for
possible loan defaults improved to 6.5 per cent of total loans at end-December 2000 from
5.8 per cent in 1999. On the other hand, the proportion of banks’ reserves for probable
losses to total NPLs declined to 43.5 per cent at the end of December 2000 from 45.2 per
cent at the end of 1999.

17
The ratio of real estate loans to total loans (inclusive of inter bank loans) of commercial
banks dropped marginally to 11.3 per cent at the end of 2000 from 11.6 per cent at the
end of 1999. The current ratio continued to remain well below the BSP’s norm of 20 per
cent ceiling on bank lending to the real estate sector.

Bank’s profits continued to fall with the average return on equity (ROE) declining from
3.3 per cent in 1999 to 2.6 per cent in 2000. Return on assets (ROA) also declined from
0.5 per cent in 1999 to 0.4 per cent in 2000. The rural banks posted the highest ROE at 7
per cent followed by the commercial banks at 2.9 per cent. The ROE of the thrift banks
deteriorated to (-) 1.7 per cent in 2000 from the positive ROE of 7.4 per cent in 1999.

With outstanding guarantees at PhP40.4 billion the government commercial banks

account for almost two-thirds (63.6 per cent) of total outstanding guarantees of PhP63.5
billion for the total banking sector.

As in the case of most emerging markets, the government of Philippines is also exposed
to significant explicit and implicit risks from the financial sector. Explicit risk arises from
the deposit insurance system under which deposits up to PhP100, 000 (about US$2000)
are fully insured. Under the assumptions that the existing deposits would not be split in
anticipation of a bank failure, the maximum exposure faced by the system is about
PhP352 billion (amounting to 10 per cent of GDP). In contrast, the deposit insurance fund
has reserves on only PhP20 billion so the failure of any of the country’s large banks
would probably exhaust the reserve.

There is also an implicit risk from the possibility of a “too big to fail” bank facing a bank
run or imminent failure. While it is difficult to estimate the probability for the occurrence
of such an event, there are troubled banks in the Philippines. In a study on the basis of
1999 data, Standard and Poor’s has estimated that in the event of a “worst case scenario”
the gross non-performing assets of the Philippines banking system would be in the range
of 15 to 30 per cent of all banking system assets. This would lead to a fiscal cost to the
government amounting to 7 to 15 per cent of GDP in the event of a systematic crisis. This
is roughly the magnitude of the Mexico’s crisis in 1994-95 and much larger than
estimates of the fiscal cost of the Philippine banking crisis in the 1980s.

(f) External Sector Related Contingent Liabilities

Explicit contingent liabilities in the external sector include the following:

• Government guarantees for non-sovereign borrowing from non-resident,

• Exchange rate and trade related guarantees (e.g. exchange rate guarantees, forward
arrangements, letters of credit for external borrowing),
• Indemnities and guarantees relating to external-sector for BOT projects in
infrastructure or recently privatised enterprises.

Implicit liabilities in the external sector include the following:

18
• External guarantees provided by nationalised banks, developmental financial
institutions, EXIM banks etc.
• Default of an institutional government and public or private entity on external non-
guaranteed debt and other external liabilities.
• Clearing the liabilities of privatised entities with significant foreign participation
• Take-over of strategically important foreign companies
• Bank failure (beyond state institutions) where deposits of non-residents are also
affected
• Investment failure of a state-run investment fund with participation by foreigners
• Default of the central bank on its obligations to foreign exchange contracts
• Environmental damage affecting offshore areas, where foreign claims are involved

Information on all these liabilities are not readily available. However, as indicated earlier,
the bulk (97 per cent) of the national government guarantees consist of guarantees on
foreign debts of GOCCs, and the National Power Corporation, which enjoys automatic
government guarantee on its bonds, has the largest share (42%) of outstanding foreign
loans of GOCCs. Government financial institutions, including the BSP, also have large
outstanding foreign loans.

Forward cover for foreign exchange risks

Government financial institutions (GFIs), such as the Land Bank (LBP) and the
Development Bank of the Philippines (DBP), are allowed to incur foreign loans from
multilateral funding agencies and re-lend funds to private sector entities for industrial,
agricultural and other development projects. While the concerned GFI generally takes on
the credit risk, it also seeks national government guarantee to cover the foreign exchange
risk. The national government provides the service, in the absence of hedging facilities in
the private market, to take advantage of concessional loans from the multilateral funding
agencies. In exchange, it charges guarantee fees based on the difference in peso T-bill
and the interest rate on the foreign loan. These fees are generally adequate to cover
exchange rate risk over time, since the expectations on peso depreciation are factored in
the T-bill rates. Unfortunately, the BTr does not monitor these loans with foreign
exchange cover separately.

External Debt

As per the World Bank’s classification, Philippines is categorised as a“Moderately

indebted country” with the present value of debt to GNP ratio at 66 per cent and the
present value of debt to gross exports (both goods and services) ratio at 111 per cent
(Table 9-B). Philippines ranks 12th among the top 15 debtor countries and other debt
indicators are quite favourable. Its debt service ratio is 14 per cent, concessional debt
constitute 26 per cent of total debt (second highest after India among the top 15 debtor
countries) and short term constitutes 11 per cent of total external debt (Table-9-A).

19
 Table-9-A: International Comparison of Top Fifteen Debtor Countries in 1999

Country and Rank Total Share of External Ratio of Ratio of Ratio of

in terms of stock of external concessio debt to short- short- debt
external debt debt nal debt GNP ratio term debt term debt services to
(US$ bn) in total (percent) to total to foreign exports of
debt (%) debt (%) exchange goods and
services
1. Brazil 244.7 0.7 33.5 12.1 84.8 110.9
2. Russian Federation 173.9 0.2 46.3 9.1 186.2 13.5
3. Mexico 167.0 0.8 35.5 14.4 75.7 25.1
4. China 154.2 19.2 15.9 11.5 11.2 9.0
5. Indonesia 150.1 20.8 113.3 13.3 75.7 30.3
6. Argentina 147.9 1.4 53.7 21.3 120.0 75.8
7. Korea, Republic 129.8 0.6 32.3 26.8 47.0 24.6
8. Turkey 101.8 5.5 54.3 23.1 100.6 26.2
9. Thailand 96.3 10.1 79.9 24.3 68.7 22.0
10. India 94.4 47.3 21.3 4.3 12.4 15.0
11. Poland 54.3 13.4 35.6 11.0 24.2 20.4
12. Philippines 52.0 25.7 64.8 11.0 43.4 14.3
13. Malaysia 45.9 5.4 62.5 16.4 24.7 4.8
14. Chile 37.8 1.1 55.9 14.6 38.1 25.4
15. Venezuela 35.9 0.2 35.6 6.3 18.5 23.2

Source: Global Development Finance, 2001, Country Tables, the World Bank.

Table-9-B: International Comparison of Top Fifteen Debtor Countries in 1999

Country and Rank Present value PV to GNP ratio PV to exports of Indebtedness

in terms of present (PV) of Total goods and classification
value of external debt external debt (per cent) services
(US$ billion) (per cent)
1. Brazil 242.7 32 380 Severe
2. Mexico 172.0 40 119 Less
3. Argentina 154.4 54 429 Severe
4. Indonesia 149.7 103 246 Severe
5. China 134.5 14 61 Less
6. Russian federation 130.9 37 141 Moderate
7. Korea, Republic 124.3 31 73 Less
8. Turkey 97.5 49 168 Moderate
9. Thailand 94.3 75 128 Moderate
10. India 70.5 16 114 Less
11. Philippines 51.9 66 111 Moderate
12. Poland 51.2 34 118 Less
13. Malaysia 47.1 59 50 Moderate
14. Venezuela, RB 37.8 40 155 Moderate
15. Chile 35.9 51 172 Moderate

Source: Global Development Finance, 2001, Analysis and Summary Tables, The World Bank.
Note: For Severely Indebted countries, either PV/XGS > 220 or PV/GNP > 80
For Moderately Indebted countries, either 132 < PV/XGS < 220 or 48 < PV/GNP < 80
And For Less Indebted countries, Both PV/XGS < 132 and PV/GNP < 48.

20
Total external debt of the Philippines declined marginally from US$52 billion at the end
of 1999 to US$51.1 billion at the end of 2000. Public sector accounted for 66 per cent of
total debt stock at the end of 2000 and around 66 per cent of the public debt consisted of
liabilities of the National government.

By creditor type, bilateral and multilateral creditors combined accounted for the bulk (48
per cent) of the country’s sources of external financing. Foreign holders of bonds and
notes represented 25.8 per cent of total external debt while banks and other financial
institutions provided 21.5 per cent of total credits.

In terms of the currency composition, liabilities were largely denominated in US dollar

(55 per cent) followed by Japanese Yen (27 per cent) and the multi-currency loans (10 per
cent) from the World Bank and the Asian Development Bank.

All the debt indicators are favourable as indicated below:

• The ratio of debt services to exports of goods and services improved from 14.3
per cent in 1999 to 12.3 per cent in 2000.
• The maturity profile of the country’s external debt remained concentrated in
medium- and long term (MLT) loans constituting 88.6 per cent of total debt at the
end of 2000.
• The average maturity of MLT loans stood at 16.6 years in 2000, although it
declined marginally from 16.9 years in 1999.

All these indicators indicate that although the current situation is manageable,
government has substantial exposure to external sector risks and needs to have
appropriate policies to deal with exchange rate fluctuations. It is desirable that the
government fixes benchmarks for the interest rate, maturity and currency mix of the
future external loans. It may also like to put a limit on external debt and the national
government guarantees to be provided on external debt.

21
 6. Management of Contingent Liabilities- cross Country Experiences

The issue of managing contingent liabilities in an emerging economy like Philippines is

to be seen in the broader context of economic development. The approach is to view
contingent liabilities as a potential tool for furthering the developmental process. The
critical aspect is the more effective management of contingent liabilities so that the
associated risks are minimised and the costs are not unlimited. Further, since the origin
of problem was the need to manage country risks on private investment flows, such
liabilities need to be seen in the overall risk management framework in the emerging
economy. Such a framework should cover the management of both the existing liabilities
and the future issue of such liabilities, and both the explicit and implicit contingent
liabilities. The broader framework should also include the direct liabilities of the
government as in the case of many developed countries like Australia, Canada, New
Zealand, UK and USA.

Provision of government guarantees per see is not bad. But, problems of contingent
liabilities arise when the risks inherent in such contingent liabilities are not properly
assessed and quantified, and adequate provision is not made in the event of default by the
borrower. As a result, when guarantees are invoked, it leads to heavy budgetary burden
on the issuing Governments. Contingent liability, therefore, became a bad word.

The conventional budgeting system on the basis of cash accounting followed by most
Governments also contributed to the growth of contingent liabilities. In such a budgeting
framework, guarantees appeared as an off balance-sheet item or a memorandum item in
the Budget. Since they did not appear as part of the overall balance sheet and resource
utilisation statements, they were often viewed as a free resource, which encouraged
Governments to issue guarantees liberally for attracting private sector investment,

Even in cases where the risks were understood, very often the Governments did not
bother because the implications of such contingent risks was to be felt in the long run
only and there was no immediate budgetary implications.

The problem of moral hazard also surfaced. With Governments willing to extend all
support to foreign investment, investors sometimes insisted on blanket guarantees. Once
they could get commitment for assured returns as in the case of many BOT projects on
power, the investors sometimes did not make serious appraisal of the projects and their
risk/return profile. As a result, unviable and uneconomic projects were also taken up for
investment, which led to situations where Governments often ended up paying the
minimum assured returns to the investors from its own budgetary resources.

However, there is no fundamental difference between the risks associated with direct
loans taken by the Government and those associated with Government guarantees. If
there is a shortfall of demand or income of a project funded by direct loans, the
Government has less revenues than expected, and it must use general taxes to pay back
lenders. With a guarantee, the Government also must use taxes to pay out the contingent

22
liability if the primary borrowers default. If the Government takes the preservation of the
facility, in both cases it is responsible for making debt service payments. In some cases,
guarantees can be better than direct loans because guarantees can be made more explicit
and can cover only sub sets of risks, while the rest of the risks can be assigned to the
private operators and insurance companies. But Government should make proper
appraisal and use discretion while granting guarantees.

Explicit contingent liabilities may represent a significant balance sheet risk for a
government and are a potential source of future tax rate variability. However, unlike most
government financial obligations, contingent liabilities have a degree of uncertainty. They
are exercised only if certain events occur or do not occur and the size of the actual fiscal
outgo depends on the structure of the undertaking.
Sound public policy requires that a government needs to carefully manage and control the
risks of their contingent liabilities. The most important aspect of this is to establish clear
criteria as to when contingent liabilities will be used and to use them sparingly. In a well-
managed program, the government debt office may be called on to assist in evaluating the
government’s cost and risks under the contingent liabilities, and to recommend policies
for managing these risks.
For a government seeking to manage risks for contingent liabilities the first step should
be to determine its degree of risk aversion in the area of contingent liabilities and the
extent of the balance sheet risk it wishes to be accountable for. It also needs to decide
whether it wishes to manage its own balance sheet solely, or whether to be accountable
for risks generated in other parts of the public sector or in the private sector.

Experience in the industrialised countries suggests that more complete disclosure, better
risk sharing arrangements, improved governance structures for state-owned entities and
sound economic policies can lead to very substantial reductions in the government’s
exposure to contingent liabilities.

Annexure-B presents a brief survey on the experiences of ten countries viz. India,
Australia, Canada, Columbia, Czech Republic, Hungary, New Zealand, Philippines the
United Kingdom and United States with regard to the management of contingent
liabilities. The choice of countries was based on the advanced nature of the consideration
of the problem of contingent liabilities and the ready availability of such information.
Individual country practices differ in dealing with contingent liabilities, but all countries
share a common set of principles to capture maximum contingent liabilities affecting
government budget.

In all the countries surveyed, the consideration of contingent liabilities was an integral
part of improving transparency in government operations in general and fiscal
transparency in particular. Indeed it is tied to a process of bringing “open government” so
that citizens and outsiders (foreign investors, commercial banks, credit rating
organisations, multilateral financial institutes etc.) can more accurately assess the
government’s financial position.

23
All countries adopted the Government fiscal framework in line with the IMF’s Guidelines
on Fiscal Transparency. In addition, these countries also publish information of the
International Investment Position and report information on the new foreign exchange
reserves template introduced by the IMF under the SDDS.

Cross-country experiences with respect to various aspects of management of contingent

liabilities are summarised below.

(a) Transparency in recording and reporting

(i) Authority for Approval and Issue of government guarantees:

In all the countries either the Department of Finance or the Ministry of Finance or the
Treasury is in charge of approval and issue of government guarantees except in the
United Kingdom where the respective Ministries/ Departments are empowered to
approve such guarantees.

(ii) Centralised Unit for monitoring of government guarantees:

In most of the countries either the Department of Finance or the Ministry of Finance or
the Treasury is in charge of monitoring of guarantees. However, in the countries such as
the United Kingdom, Columbia, Hungary and New Zealand where a full-fledged Public
Debt Office (PDO) exists, the PDO monitors guarantees as a part of overall risk
management for the government in ALM framework.

(iii) Automatic guarantee:

In general the USA and New Zealand avoid automatic guarantee and makes proper
evaluation of risks before providing any kind of guarantee. However, other countries
provide automatic guarantees, particularly fiduciary guarantees for insurance or certain
items for social reasons. Government of India provides automatic guarantee to Small
Savings Scheme, Public Provident Funds and Life Insurance, Australia to certain
liabilities of government controlled financial institutions, Canada to Crown Corporations
on insurance, Hungary to reinsurance of priority lending, Philippines to some of the
GOCCs under their respective charters and UK to items of national security.

(iv) Contingent liabilities not monitored:

Generally implicit contingent liabilities relating to Pension, Provident and Insurance are
not monitored regularly due to lack of proper methodology and adequate information.

(v) Ready up-to-date data on contingent liabilities:

Up-to-date data are readily available at regular intervals in Australia, Canada, Hungary,
New Zealand, U.K. and U.S.A. But no such data, except for government guarantees, are
made available for India, Columbia, Czechoslovakia and Philippines.

24
 (vi) Reporting to general public:

All information relating to monitored contingent liabilities are disseminated for general
use. However, some countries may not reveal certain information in national interest or
for their adverse effects on the financial markets. For example, in the case of the United
Kingdom, the law allows non-reporting of certain contingent liabilities, which are
important for reasons of national security or commercial confidentiality.

(b) Accountability, Auditing and Legal and Institutional System

(i) Legal requirements for reporting contingent liabilities:

All the countries, as indicated below, either have in place or in the process of enacting
particular legislation for monitoring and reporting of contingent liabilities.

India: Proposed Fiscal Responsibility and Budget Management Act under article 292
Australia: Charter of Budget Honesty Act (BHA) 1998
Canada: Financial Administration Act
Columbia: Law 448 enacted on 21-07-98
Czech Republic: Law of Budgetary Rules
Hungary: Public Finance Act 1992
New Zealand: Fiscal responsibility Act, Public Finance Act, Local Government Act,
Philippines: Republic Act 4860 (for only guarantees given to foreign loans)
UK: Code of Fiscal stability
USA: Federal Credit Reforms Act 1990

25
 (ii) Contingent liabilities regulated by law:

The scope of contingent liabilities, which are monitored, vary across the countries
depending on their magnitudes and importance. Items, which are monitored regularly in
different countries, are indicated below:

India: All Guarantees, Public Provident Fund, Small Savings Scheme, Life Insurance
Australia, Canada, New Zealand: Guarantees, indemnities, uncalled capital
Columbia- Contingent Liabilities of state entities
Czech Rep- Guarantees, hidden debt
Hungary- Guarantees, reinsurance
Philippines- Guarantees to GOCCs
UK, USA- All material contingent liabilities

(iii) Limits on contingent liabilities:

For effective management of risk, it is desirable to have limits on contingent liabilities;

otherwise it may put pressures on fiscal sustainability. Respective laws in Canada and
New Zealand indicate ceilings on contingent liabilities as percentage of GDP. In Hungary
also there is limit on contingent liabilities as percentage of revenue. In the USA there is
automatic limit through appropriation of subsidies relating to contingent liabilities in their
annual budget. Other countries viz. India, Australia, Columbia, Czech Republic,
Philippines, UK donot have any statutory limits on contingent liabilities. However, India
is in the process of enacting the Fiscal Responsibility and Budget Management Act,
which sets an annual limit of 0.5 per cent of GDP on the issue of new contingent
liabilities.

(iv) Audit by Independent Auditors:

In all the countries, there are independent audit organizations, which audit not only the
annual balance sheet but also the contingent liabilities. The details of the Audit Offices in
different countries are indicated below:
India: Comptroller General of Accounts
Australia: National audit Office
Canada, Columbia, Czech Rep: Yes
Hungary- State Audit Office
New Zealand: Yes, applies Generally Accepted Auditing Principles (GAAP)
Philippines- Yes by Commission on Audit
UK: National Audit Office
USA: Yes, applies Federal Financial Accounting Standards

26
 (c) Policy Framework and Practices

(i) Medium term policy framework:

While presenting Budget, governments of Australia, Canada, Hungary, New Zealand,

Philippines, U.K. and U.S.A. provide a medium term fiscal strategy and fiscal outlook
and projections. But the governments of India, Columbia, and Czech Rep donot provide
such policy framework and outlook. However, India’s proposed Fiscal Responsibility and
Budget Management Act provides such requirements in the Annual Budget every year.

(ii) Designated contingent liability redemption fund

India, Australia, Canada, Columbia, Hungary, New Zealand and U.S.A. have designated
Contingency Redemption Fund, which can be used in the case of recall of guarantees. But
the governments of Czech Rep, Philippines and U.K. donot have any such funds.

(d) Risk Management Capacities

(i) Accounting practices

It is generally accepted that the accrual accounting is the best suitable accounting
methodology for measuring risk relating to contingent liabilities. In
Australia, Canada, Hungary, New Zealand, and U.S.A., budgeting is done on the basis of
accrual accounting. But the countries of India, Columbia, Czech Rep, Philippines, and
U.K. still use mainly cash accounting, although accrual accounting may be used for
certain items like committed loan repayments and interest payments.

(ii) Statement on fiscal risk included in the budget

Governments of Australia, Canada, Hungary, New Zealand, U.K., and U.S.A. include a
statement on fiscal risk in their budget, while so such statements are given in the budgets
of India, Columbia, Czech Rep, and Philippines.

(iii) A full fledged and independent public debt office

In Australia, Canada, Columbia, Hungary, New Zealand, U.K., and U.S.A., a full-fledged
Public Debt Office (PDO) exists. The PDO is in charge of managing overall risk of both
loans and guarantees in the framework of Asset Liability Management (ALM). But, no
such integrated PDO exists in India, Czech Republic, and Philippines.

27
 7. Tasks for Philippines Government

An efficient fiscal management system requires that the government treat any non-cash
program involving a contingent fiscal risk like any budgetary or debt item. Most
importantly, the system has to make the potential fiscal cost of off-budget programs
visible ex-ante. Accrual-based budgeting and accounting systems help fiscal discipline
but are neither sufficient nor necessary in their entirety. Disclosure of full fiscal
information is most critical. Disclosure of face values of contingent liabilities as in the
case of the USA enables the markets to analyse and measure the complete fiscal risks and
thus indirectly assist the government in its risk assessment. Formulation of efficient rules
and regulations on the use of government guarantees, pension funds and insurance
programs, and on the operations of the government owned and controlled corporations
(GOCCs) and subnational governments are also equally important.

To minimize future outflows on contingent government liabilities, the Philippine government

needs to further elaborate its tools, procedures and capacities in analyzing and dealing with
risks on program-by-program basis. As evidenced by the comparative country experiences
discussed above, the existing rules for guarantees, government-guaranteed agencies and other
off-budget obligations in Philippines are not effective in limiting the total face value of
contingent government liabilities. The system is weak to minimize the likelihood of
contingent government liabilities being called and the size of public outlays required when
they are called. Specifically, before the government adopts a program of contingent support, it
needs to have a systematic and comprehensive analysis on the attributes of the underlying
risks, factors influencing the size of these risks, and the incentive mechanisms of the parties
under the program. The Government should avoid providing blanket guarantees too many
GOCCs. All these activities require the establishment of a full-fledged risk analysis office
equipped with up to date methodology and expertise.

On the basis of effective risk analysis, the government can design the appropriate
programs that would still deliver the desired outcomes but minimise the government’s
risk exposure. The objective would be particularly to expose the government only to
those risks that are beyond control of the parties under the program and that would spread
the potential cost of the program between the government and the beneficiaries. Under a
state guarantee, for instance, the government would identify and cover in the guarantee
contract only selected risks, which may be shared by it, while other risks may be left to
be assumed by other stakeholders or beneficiaries. With respect to the autonomous public
sector agencies, the government should strengthen the financial and managerial
accountability of their staffs by remunerating sound risk analysis and early warning
signals rather than short-term profits of these agencies.

28
The following specific tasks are required to be completed in the near term:

1. Setting up a Centralised Middle Office in the DOF

First, to create a full fledged institutional structure in the DoF to manage contingent
liabilities. For this purpose, it is necessary to set up a Middle Office for management of
Contingent Liabilities in the DOF with sanction of sufficient budget and recruitment of
technical experts. The main reason for locating it in the Department of Finance is that
there are strong links between budgeting and sovereign liability management functions.
At the same time, it would help to mitigate conflicts in objectives between fiscal
management and monetary policy, through active co-ordination between the middle
office and the BSP.

The middle office is usually an entity, which serves as the risk manager, formulates and
advises on the sovereign liability management strategy and develops benchmarks for
assessing the risk-cost trade-off of the contingent liabilities. The role of the “middle
office” is to identify, quantify and monitor contingent liabilities, make analysis of risk,
provide advice and management information system (MIS) inputs for formulation of
appropriate policies in the overall framework of the public debt and contingent liability
management, keeping into perspective the long-term financial requirements for economic
development and maintaining fiscal sustainability.

The Middle Office will advise the government on the following tasks:

 Identification, measurement, monitoring and management of CLs

 To complete the inventory of all existing explicit and implicit CLs
 Review charter of all GOCCs regarding exposures of CLs
 Quantification of exposures and real contingent liabilities for the NG
 To produce status reports on CLs and present to Congress and for general
dissemination of information
 Evaluation and recommendations for the issue of future CLs

 Designing appropriate guarantee instruments for BOTs

 Reviewing, restructuring of the existing ones for BOTs
 Formulation or review of policies, guidelines and regulations for contingent
liabilities
 Determination of risk based guarantee fees,
 Evaluation and monitoring of risks for all CLs


 To organise training, seminars and workshops on capacity building etc.

Role of the Middle Office

29
The scope of the middle office at the initial stage should include both explicit and implicit
contingent liabilities and could gradually be expanded to include management of both
internal and external debt. The Middle Office should immediately deal with fixation of
ceiling on contingent liabilities, their allocation between domestic and external sectors
and among competing sectors (such as agriculture and allied sectors, industry, transport,
communications, power, banking and other financial services, real estate etc.). It should
also develop benchmarks for currency composition of external loans, maturity, interest
rates, composition of loans under floating and fixed interest rates etc. for which
guarantees may be considered.

The middle office can also review the contractual obligations for BOT projects, estimate
monetary obligations of the national government, suggest inputs for feasible unbundling
of risks and for possible renegotiating of contracts, specify early warning systems for
defaults, provide advice to improve the legal, institutional and regulatory framework
affecting BOT/ PSP projects.

The middle office should also act as the apex monitoring unit for all contingent liabilities.
Thus, data on contingent liabilities should be regularly transferred by different agencies
to the middle office. The middle office should ensure that it develops a completely
computerised data recording system, which is amenable to modern risk management
analysis and can be easily retrieved and cross-classified by various characteristics such as
sector, currency, interest rate, and maturity.

The middle office would be responsible for bringing out an annual status report on
contingent liabilities, which should enhance the transparency and accountability of the
liability position of the government. The report should clearly define and disclose the
main objectives of contingent liability management, the strategic benchmarks of the
liability portfolio and performance of portfolio management by the relevant agencies as
measured by the cost of the actual liability portfolio relative to the benchmark portfolio.

Strategic Benchmarks and Risk Management

Based on the risk-management framework and cost-risk trade-off, the Middle Office
would be expected to determine strategic benchmarks for the contingent liability
portfolio. The strategic benchmarks could be the proportion of domestic and foreign
currency debt; the currency composition, average duration, mix of floating-fixed interest
rate debt and maturity structure of foreign currency debt portfolio; and maturity structure
and duration for the domestic debt portfolio, for which government guarantees can be
provided.

Strategic benchmarks, designed by the Middle Office, should have the approval of the
Secretary of Finance. For this purpose, the Contingent Liability Advisory Committee
should advice the Finance Secretary periodically on the appropriateness of the framework
and the strategic benchmarks.

30
Once, the strategic benchmarks are approved, the Middle Office should regularly
disseminate the relevant benchmarks to the concerned agencies involved for contracting
or issuing government guarantees. This would enable them to determine their liability
management strategy so as to be consistent with the strategic benchmarks.

Advisory Committee for the Middle Office:

Operations of the Middle Office could be supervised by a Contingent Liability Advisory

Committee comprising of senior executives from the DOF, DBM, NEDA, BSP, COA,
SSS, GSIS and some other government departments and GOCCs. This would ensure that
advisory role of the Middle Office would be respected by different entities involved for
management of contingent liabilities.

The middle office should be staffed with officials with the necessary expertise from the
DOF, and on a deputation basis from the other organisations mentioned above.
Investment in infrastructure and human resource development should be an area of
priority for the government to promote professional approach towards contingent liability
and overall debt management.

2. To prepare standardised Manual and Guidelines

In order to have uniformity in measurement and reporting necessary information, the

DOF in consultation with other departments and BSP and COA should prepare
standardized manuals on the following items for all GOCCs, and particularly for the
Non-Banking Financial Corporations (NBFCs):

(a) Manual for measurement of all contingent liabilities- explicit and implicit
(b) Manual on prudential norms for income recognition, asset classification and
provisioning for advances and investment portfolio.
(c) Guidelines for risk management and Asset and Liability Management (ALM)
framework.
(f)

3. Disclosure and Accountability

As an
initial step towards risk management, it is necessary to promote disclosure and
accountability with regard to at least explicit contingent liabilities. In its Code of Good
Practices on Fiscal Transparency, the IMF also recommends that countries should
disclose in their Budget documentation the main central government contingent
liabilities, provide a brief indication of their nature and extent and indicate the potential
beneficiaries. The Code suggests that best practice in the area would involve providing
an estimate of the expected cost of each contingent liability wherever possible and the
basis for estimating expected cost.

31
Best management practice for contingent liabilities is to make adequate provision for
expected losses and to hold additional assets against the risk of unexpected losses. In
cases where it not possible to derive reliable cost estimates, the available information on
the cost and risk of contingent liabilities should be summarised in the notes to the Budget
tables or the government’s financial accounts.

Before a full-fledged accrual accounting system is in place, it may be desirable to present

a separate budget for contingent liabilities (as was done in the USA before 1990).

GOCCs also should estimate and disclose their contingent liabilities. Once the concepts,
definitions, methodology and data problems have been resolved and key organisational
challenges have been addressed, all the GOCCs must be directed to disclose their
contingent liabilities in their Annual Reports and to have appropriate policies for
contingent liability management
1. .

4. Reporting to DOF

All government departments and GOCCs may be required to submit half yearly reports
to the Middle Office in DOF on their contingent liabilities and risk mitigation measures.

5. Good Corporate Governance

Risks associated with contingent liabilities can be reduced by promoting sound

governance arrangements for managing sub-national entities and state-owned enterprises,
and making them accountable for managing their own risks. It is necessary to strengthen
the corporate governance and risk management capability in all GOCCs and local bodies.

6. Capacity Building

As the co-ordinating organisation and nodal office, DOF may formulate time bound
program for capacity building within government and GOCCs for management of CLs. It
is also necessary to improve infrastructure and hardware and software capacities for
information systems, central databases networks and interface with all organisations
dealing with CLs.

7. Limit on Guarantees

DOF may issue an Executive Order for removing all automatic guarantees on some
GOCCs and to put a limit on guarantees. Future requests for guarantees may be examined
on the basis of normal appraisal procedures for providing either loans or grants.

8. Sector Specific Policies

32
(a) Pension Funds and Social Security: SSS and GSIS are the major sources of explicit
and implicit contingent liabilities of the government, and reduction of risk arising from
unfunded or underfunded pension liabilities is needs to be given urgent attention.
Contribution rates for SSS are much lower than the benefits and need to be increased to
reduce the current gap between contributions and benefits. Management of the
investment portfolio of the reserve funds for both SSS and GSIS needs to be fully
professionalised and insulated from political interference.

To provide a truly equitable, universal and meaningful social security protection, the SSS
must align its benefits and hence its contributions to that of similar programs both locally
and internationally. There is an urgent need to enhance the SSS contribution rate to at
least 12 per cent in the current year and to double the present rate of 8.4 per cent, if not to
the level of GSIS rate, in a phased manner in three years. It is estimated that the gradual
increase in the SSS contribution rate from 8.4 per cent to 20 per cent will increase the
actuarial life of the social security fund by at least 20 years.

While increases in social security contributions are always politically sensitive, the task
faced by the Philippine policy makers may not be difficult on considering the fact that the
GSIS members are already contributing 21 per cent. Therefore, actions to bring benefits
and contribution in line with each other are urgently required for fiscal sustainability of
the social security system.

Although there is little scope for enhancing the contribution rate of GSIS, which is
reasonable at 21 per cent, there is scope for improving the compliance rate and to
rationalize the benefits among the members in different income brackets. There is also
scope for enhancing the qualifying period for getting pension and to increase the
retirement age commensurate with the increase in expectation of life.

It may not be politically feasible to amend the Act for removal of automatic government
guarantee in the case of financial problem faced by GSIS or SSS. However, both the
systems should move from defined benefits system to defined contribution system.

There is also need for strengthening the Asset Liability Management (ALM) system in
both these organizations to minimize the risks given defined contributions.

The present thrust of the GSIS on the “Back to Basics Policy” is in the right direction.
Under the policy, the GSIS concentrated on essential activities where it is efficient such
as administration of benefits, limiting direct lending operations to salary and housing
loans to its members, and phased out peripheral programs, which can be more efficiently
handled by the private sector. The SSS can learn from these experiences of GSIS.

There is also a need to separate life and non-life components of insurance. While
government can provide some subsidies for life insurance for targeted groups of people
due to social reasons, there should be no subsidies for non-life insurance, which can be
fully funded and better managed by the private sector.

33
(b) The banking sector urgently needs strengthening. Cross-country evidence suggests
that timely rehabilitation is one of the key factors in determining the success of bank
rehabilitation efforts. The current level of asset performance, the system could face
severe difficulty if another major external shock such as that of 1997 occurred or if the
economy’s growth rate slowed significantly. The government is currently attempting to
encourage private sector driven measures to restructure banks. But the effectiveness of
privately led asset management companies is subject to question. In the meantime, the
government should also continue its efforts to improve capital standards and supervision.

It is also equally important to improve the supervision and regulation of the banking and
insurance system and capital markets, including the use of such instruments as mandatory
risk limits and minimum capital adequacy norms. Stronger accounting and disclosure
requirements for private corporations are important mechanisms for limiting the
likelihood that a systemic crisis might occur, and will limit the government's exposure if
it does.

The Philippine banks have been entertaining sales of their non-performing loans to the
U.S. opportunity funds for the past several months. Several banks are presently in
negotiations with U.S. investment banks and opportunity funds. But these negotiations
have not resulted in significant transactions, as most of the banks do not have the capital
adequacy to sustain large write-offs in their NPLs without adversely affecting their
capital base.

The government has currently circulated a very comprehensive draft of proposed

regulatory changes to reduce the "friction costs" of investing in NPLs and makes it easier
for foreign investors to establish Special Purpose Asset Vehicles to acquire and manage
the NPL resolution process. In addition to proposed tax relief and a reduction or
moratorium on real estate transfer taxes, the legislation will make it easier for foreign
investors to own Philippine real estate assets.

These measures are in the right directions and need to strengthened and brought to their
logical ends on time bound schedule.

(c) GOCCS: Auditing and accounting of the GOCCs need to be strengthened. It may
also be desirable to institute performance contacts and sign Memorandum of
Understanding (MOUs) with major GOCCs and GFIs (as being done in India) indicating
their medium term corporate objectives and planning and annual targets on both physical
and financial achievements.

In the medium and long term the following tasks may be completed:

1. Cash and Accrual Basis of Accounting

One important task for the medium term is to move towards the full accrual system of
accounting as required under the Revised Government Statistics (GFS 2000) the IMF. The
Government accounts in the Philippines, as in the case of many countries, are currently

34
maintained on mainly cash basis, and not on complete accrual basis. It is generally
recognised that cash-based systems are not suitable for measuring, recording and
monitoring contingent liabilities, which can be captured by only accrual accounting.

The accrual accounting model is widely used in business financial reporting where it
provides a measure of profitability of the business. In government, it can be used to
assess inter-generational or inter-temporal equity, which implies that one generation or
one period should not be made to pay for the benefits extended to and enjoyed by another
generation or period. A simple measure of inter-generational equity is what is called Net
Asset/Equity, which is defined as the balance of assets and liabilities. If Net Asset/Equity
is negative, it implies that the future generations will have to bear the burden of
additional taxation if the Government has to honour its commitments.

There is an increasing awareness on this issue and many governments are switching over
to accrual based accounting. The Philippine government has already decided to proceed
towards accrual accounting for bringing more transparency in reporting. The decision
needs to be implemented on priority basis.

In order to achieve accrual accounting, it is important to change the accounting system in

both the government, GOCCs and private entities as there are close inter-linkages among
them and the systems need to be comparable and standardized. It is understood that
Philippines adopts the Generally Accepted Accounting Practices (GAAP), which is
suitable for adopting the accrual system. For uniformity and comparability of the annual
balance sheets, the Commission on Audit in consultation with the government needs to
prescribe a set of accounting rules for the various types of contingent liabilities. Given
the lack of common accounting standards for government non-bank financial institutions,
a necessary step would be to have some sort of accounting manual for these institutions.
The manual would prescribe acceptable practices for income recognition or interest
accrual, and set standards on provisioning and treatment of past due accounts.

2. Improvement in Audit

It is necessary to strengthen both the internal and external audit teams to deal with
accrual system of accounting and to measure and report properly the explicit and implicit
contingent liabilities. A full audit of the non-bank financial institutions may be called for.
Equally important, a broader role for resident auditors in reviewing the financial
statement of GOCCs would ensure that not only are transactions properly booked in the
balance sheet but also profit and loss statements are reflective of the true financial
positions of the corporations.
It should be made mandatory for all GOCCs, particularly for SSS, GSIS, RSBS, HGC
and Pag-ibig, to disclose contingent liabilities in their annual reports and balance sheets.

It is also necessary to introduce performance auditing and corporate governance auditing

for all GOCCs. Indian Banks and financial institutions have already adopted corporate
governance auditing as a part of their annual statutory auditing as required by the
regulatory authority i.e. the Reserve Bank of India (RBI).

35
In India there is also a system of signing a Memorandum of Understanding (MOU)
between a public sector undertaking (PSU) and the concerned administrative ministry of
the department on the annual targets on various aspects of physical and financial
performance. The achievement of the PSU in terms of the targets under MOU is audited
as per performance auditing by the statutory auditors and the specific grades are awarded
to the PSUs. The similar system of signing MOUs with GOCCs and their performance
auditing may be introduced by the government of Philippines for better monitoring the
overall performance of the GOCCs.

3. US System of Provisioning

In the long run, budgeting for contingent liabilities would ideally follow the U.S. example
where both direct and contingent liabilities are integrated in the budget based on their
subsidy costs, i.e., for loans, the present value of amounts not repaid and the difference
between the interest rate charged from borrowers and government’s cost of funds; for
guarantees, the present value of the difference between cash payments for defaults and
cash received from fees and recoveries. The main advantage of adopting this approach is
that government becomes indifferent as to choosing between cash subsidy, a loan or a
guarantee on loans. The US system of budgeting and management of contingent liabilities
are discussed in details in Annexure-3.

4. Setting up of a contingency fund or contingent liability redemption fund

The system of charging a uniform flat rate of guarantee fee is not good for effective
management of contingent liabilities. The guarantee fee charged needs to be based on the
cost of borrowing, plus the cost of provisioning and the cost of building-up reserves for
unanticipated losses. Guarantee fees collected should not be taken as general revenues;
rather be kept in a separate contingency fund or contingent liability redemption fund.
Where sophisticated risk adjusted pricing is possible, the revenue from the guarantee fee
as risk premium will enable adequate reserves to be built up over time. The government
still may have to allocate some initial capital from general revenues into the Reserve
Fund in the event that the contingent liability is called prior to the build up of sufficient
reserves through fee income. The amount of capital allocated would reflect the
governments risk preferences.

5. Setting up of a full fledged Public Debt Office

In the long run, the Philippines government may move towards setting up a full-fledged
Public Debt Office under the overall charge of DOF. Major functions of public debt
managers as regards management of contingent liabilities of the government may include
valuing contingent exposures, discussing with the sovereign credit rating agencies the
extent of the government's exposure and its policy response, restructuring contingent
claims and analysing their possible effects on the governments future financing needs.

36
In the long run, the middle office for the contingent liability management may be
converted into a middle office for the overall public dent management. The need for a
middle office, however, cannot be viewed in isolation. It should be analysed in the
context of total structure of liability management comprising the Head Office (i.e. the
office responsible for final approval of guarantees), Front Office (responsible for
appraisal of guarantee requests and making negotiations with the lenders), Middle Office
(responsible for measurement, monitoring, policy formulation and risk management) and
Back Office (responsible for auditing, accounting, data consolidation, and functions of the
dealing office). The institutional character assumes significance in view of the need for
an active risk management framework, professional approach and expertise required for
management of debt and contingent liabilities.

The role of a public debt manager in managing contingent liabilities of the government
owned and controlled corporations (GOCCs) depends on the degree to which
management of GOCCs is decentralized, the quality of the corporate governance in these
corporations and their technical capability for risk management. For example, in a well
board managed and completely decentralized public sector structure, the GOCCs may be
responsible for designing their own guarantees and underwriting instruments, for
implementing the necessary provisioning and reserving and for managing any subsequent
restructuring in their assets and liabilities. Within this framework the government may
wish to have a central agency such as the Department of Finance, the Treasury or the
Public Debt Office to be responsible for evaluating risk-covering instruments in order to
standardize budgetary procedures and to control their fiscal impact.

International Experience

International experiences and practices of management of contingent liabilities by leading

public debt offices bear many valuable lessons for countries in the process of
strengthening their debt management capacity. Many countries - mainly advanced and
some emerging market economies - have set up integrated public debt offices and are
successfully managing their sovereign debts. In most countries where debt offices have
been set up, there is clear evidence of moving towards fiscal consolidation. There has
also been a significant change since late 1980s in the institutional structure, the role and
style of functions of public debt management towards risk management. This has been
enabled by institutionalisation of the debt office with an in-house risk management
culture, as a specialised institution, staffed with professionals and market specialists. The
role of such debt offices, in many instances, gradually transformed into treasury
operations on the lines of those performed by investment banks, corporates and foreign
exchange management by central banks. Within the debt office, middle office emerges as
the risk manager, which formulates and advises on the debt management strategy and
also develops benchmarks for assessing the risk-cost trade off of the portfolio. Annex 3
summarises the key sound practices in sovereign debt management.

The primary requirement for a debt office is to bring the size of public debt at sustainable
levels. Without sustainability of debt, risk management would not have much impact
towards insulating the debt portfolio from systemic risks. The main risks that needs to be

37
managed for the sovereign debt portfolio are foreign currency risk, interest rate risk,
credit risk, liquidity risk, refinancing risk, operational risk and payments and settlement
risk. Many debt offices have addressed management of market risks like currency and
interest rate risk by establishing a risk management framework for the sovereign debt in
an asset-liability management framework.

A prudential risk management framework is essential for reducing uncertainty among

sovereign debt managers as to the government’s tolerance for risk, its willingness to trade
off cost and risk objectives. Once the risks are identified, risks and costs for alternative
debt strategies are measured in a scenario-based model under a base case scenario and
different market rate scenarios; or in a simulation-based model under value-at-risk, cost-
at-risk or budget-at-risk approach. The government then chooses the strategy that best
represents the government’s preferences for managing the risk/cost trade-off and
generally tend to choose it along an efficient frontier, which entails minimum risk. The
debt managers may also use various derivatives such as buyback operations, currency and
interest swaps and other hedging activities.

The institutional structure for public debt management, world wide, could be broadly
characterised into two categories – setting up of a centralised public debt office and
scattered debt management responsibilities. The former category of a centralised debt
office, which has been the showcase for countries currently strengthening their debt
management capacity, is mainly found in advanced countries and a few emerging market
economies. For these countries, there has been a preference to locate the debt office as a
separate entity under the Ministry of Finance or within the mainstream Ministry. There
are also some instances of locating the debt office outside the Ministry as an autonomous
agency, but with a Memorandum of Understanding (MOU) signed between the Ministry
of Finance and the Public Debt Office. This institutional mechanism is usually,
safeguarded, by public debt legislation or legal statutes.

The second category of institutional structure reflects dispersed debt management

responsibility, either within the Ministry of Finance (for most emerging market
economies) or scattered between the Ministry of Finance (responsible for external public
debt management) and the central bank (responsible for the internal public debt
management). A World Bank survey of about 50 developing economies showed that in
around 11 per cent of these countries, central bank manages domestic debt. Some of the
emerging market economies, with dispersed debt management responsibilities between
the Ministry of Finance and the central bank (Hungary, Colombia, South Africa) have
already separated debt management responsibility from their central banks. Moreover,
some emerging market economies with debt management responsibility within the
Ministry of Finance (China, India, Thailand, South Korea, Brazil, and Mexico) have
started to set up a middle office under the Ministry of Finance as a first step towards
strengthening their debt management capacity.

Although, independent set-up for the Public Debt Office and the Ministry of Finance are
regarded as somewhat separate watertight compartments for locating the debt office, in
reality, however, there is a very thin dividing line between the two. The Ministry of

38
Finance always exercises some measure of control over the operations of the debt office,
irrespective of its location. This is unavoidable because it is the liability of the
Government that is to be managed by the debt office. Therefore, even among the most
independent set-ups like National Treasury Management Agency of Ireland and the
Swedish National Debt Office which are entrusted with day-to-day management
responsibilities, the Ministry of Finance determines the policy, sets the operational
guidelines and the benchmarks under which the debt office is required to operate.

Governance issues promoting sound and professional approach towards debt

management, required debt offices to clearly define and disclose its objectives for debt
management, establishing an organisational structure that ensures clear accountability
and transparency of responsibilities with appropriate internal controls, and establishment
of a legal framework wherever possible. For enabling sound risk management practices,
most debt offices established prudent risk management strategy and policy, strengthened
middle office analytical capability, and defined a framework for risk management
ensuring consistency with other macroeconomic policies and objectives. Debt offices also
accorded priority to recruitment of trained staff, and selection and implementation of
effective management information systems.

6. Capability Building for Contingent Liability Management

Continual upgrading the professionalism for management of public debt and contingent
liabilities is essential for maintaining debt sustainability over time. Once the public debt
management responsibility is centralised and a computerised debt recording system
functions efficiently, the main challenge is to develop a risk management office (or
middle office). Building a sound risk management capability within a sovereign debt
management operation can take several years given the experiences of Belgium,
Colombia, Ireland, New Zealand and Sweden. However, there is no uniform model for
this and it needs to be country-specific.

Given that risk management skills are a scarce resource and training staff in this area is
very expensive, a strategy needs to be developed to hire new staff with these skills and to
have an intensive training program for existing staff. Appropriate policies also need to be
formulated to retain these staff given their obvious marketability. The manager or the
head of the middle office should also have strong technical and public policy skills.

A decision on whether to introduce specialist risk management software should be

deferred until risk management skills and a sound technical knowledge have been
built up within the office. Rushing into these decisions may lead to the
establishment of a risk management framework without a full understanding of
the alternative strategies or an understanding of how the designated software
actually works. There is also the question of compatibility of this software with
the management information systems.

7. Privatisation of some of the GOCCs

39
Government may examine the feasibility of privatising some of the weak GOCCs.
Privatisation does not imply outright sale of the public enterprises but a combination of
various measures to reduce the control of government in the equity holding, management
and policy formulation relating to the public enterprises.

8. Innovative Systems for BOT projects

It is important to design contingent liabilities in such a way that they have risk sharing
mechanisms embodied in them, and ensuring that all the risks are not under control of the
beneficiary given that this creates moral hazard risks for the government. Sound risk
sharing arrangements would include providing termination dates for the contingent
claims, pricing the contingent liability on a risk adjusted basis and charging the
beneficiaries accordingly. It also requires beneficiaries to post collateral securities and to
strip down blanket risk guarantees into different risk dimensions so that risk can be more
evenly distributed between the government and the potential beneficiaries. All new
commitments should be scrutinised thoroughly and, whenever possible, must embody
risk sharing arrangements and sunset or termination clause.

Given the substantial support that public-private infrastructure partnerships are likely to
receive from the government, government may work toward establishing capabilities to
audit the award of these projects. The goal would be to assure the public that the
government had achieved value for its money. In the United Kingdom, the National Audit
Office supplements its own skills with those of professional advisors, including lawyers,
investment bankers, and accountants. Skills within government units in India could be
augmented through a similar system.

Government risk sharing should only be considered as a last resort. To prevent excessive
government exposure, decisions should be transparent and based on explicit cost-benefit
analysis for the project to be guaranteed, including an assessment of the likely cost to
taxpayers and the impact of alternative forms of government support.

Guarantees of "policy risks" should support a credible reform program but not be
regarded as a substitute for it. In the medium-term policy reforms for enabling private
participation in infrastructure projects should obviate the need for a guarantee. All the
stakeholders viz. Private operators, beneficiaries, banks and government should share a
part of the risk. In structuring guarantees the government must ensure that the normal
"performance incentives" for private investors are not undermined, essentially by not
covering "normal business risk," including exchange rate and interest rate movements,
and some other market risks which can be covered by the insurance companies and
capital markets.

If the amount of guarantees rises significantly in private infrastructure projects, it may be

desirable to establish a "guarantee corporation", which would help develop standardised
guarantee products, facilitate learning across projects, reduce the need for government
and local bodies to issue guarantees, allow the employment of competent staff to do so
and limit taxpayer exposure in a transparent way.

40
 9. Reforms in Pension Funds.

As discussed earlier, in the medium term, the government should move towards defined
contribution schemes or fully funded programs for SSS and GSIS to make them
financially viable and more sustainable over time.

10 Continue with sound macroeconomic policies

Sound macro economic system supported by strict fiscal and monetary discipline is the
best defense against any economic and financial crisis leading to contingent liabilities.
The odds for the occurrence of a financial crisis and so the risk of implicit contingent
liabilities can be reduced by sound macro-economic policies, complemented by
appropriate legal, regulatory and institutional set-up for effective prudential regulation,
monitoring, surveillance and supervision of the financial system and improved corporate
governance. However, these entail structural reforms with an unavoidably long-time
scale.

41
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Treasury Board of Canada Secretariat. TB Circular 1984-63: Policy on the contingent

liabilities of the government of Canada and consequential policies with regard to the
reporting of the financial position of, and insurance schemes operated, by Crown
Corporation.

Towe, C.M. (1991),'The Budgetary Control and Fiscal Impact of Government Contingent
Liabilities', IMF Staff Papers Vol. 38 (1)

U.K. Finance Act, 1998.

U.K. H M Treasury, “Fiscal Policy: Public Finances and The Cycle”, 1997.

43
United States General Accounting Office. Budgeting for Federal Insurance Programs.
GAO/AIMD-97-16, September 1997.

World Bank, “Dealing with Public Risk in Private Infrastructure.” Edited by T Irwin, M
Klein, G.E. Perry and M Thobani, Washington DC.

44
 Annexure-A: National Government Guarantees to GOCCs

Name of GOCC Government Guarantees Nature of Statutory limit

guarantee on guarantee
1. Cultural Center Absolute guarantee to both principal and Automatic
of the Philippines interest Solidary

2. Employees' Guarantees the benefits prescribed under this Automatic

Compensation Title Subsidiary
Commission
3. Government Guarantees the fulfillment of the obligations of Automatic
Service the GSIS to its members as and when they fall Subsidiary
Insurance due
System
4. Home Guarantees the payment of employees' and Automatic
Development employers' contributions and dividends to the
Mutual Funds members when they are due

5. Home Guaranties the payment by the Corporation Automatic 20 times the

Guarantee both of the principal sums and interest of the Subsidiary capital and
Corporation bonds, debentures, collateral, notes, or other surplus of the
such obligations of the Corporation, Corporation

6. Human Guarantees both the principal and interest by Automatic

Settlement the Government of the Republic of the Subsidiary
Development Philippines
Corporation
7. Laguna Lake Guarantees both the principal and the interest Automatic
Development of the bonds, debentures, collaterals, notes and Subsidiary
Authority such other obligations
8. Land Bank of Loans from both local and foreign sources Automatic Up to an
the Philippines And bonds and other obligations Subsidiary aggregate
subject to limits amount not
Special Guaranty Fund. In the event that the exceeding, at any
Bank shall be unable to pay the bonds, Automatic one time, five
debentures, and11 other obligations issued by Subsidiary times its
it, a fixed amount thereof shall be paid from a unimpaired
special guaranty fund to be set up by the capital and
Government surplus

9. Light Rail Funds borrowed from any source, private or Automatic P300 million
Transit public, foreign or domestic Subsidiary
Authority

10. Local Water Both the principal and interest Automatic Pesos 1,000
Utilities Subsidiary million for
Administration domestic loans
and US$500
million for
foreign loans

45
 Annexure-A. National Government Guarantees to GOCCs: Continued

Name of GOCC Government Guarantees Nature of Statutory limit

guarantee on guarantee
11. Mactan-Cebu Loans or other indebtedness of the Authority Subject to
International contract
Airport
Authority
12. Manila Loans or other indebtedness of the Authority Subject to Total
International contract indebtedness
Airport shall not exceed
Authority the net worth of
the Authority

13. Manila Both principal and the interest of the bonds Automatic The total
Waterworks and issued by said System by virtue of this Act, and Solidary principal
Sewerage shall pay such principal and interest in case of indebtedness of
System the System fails to do so. the System
exclusive of
interest, shall not
exceed One
Billion Pesos at
any given time
14. National The payment of all loans, credits and other Automatic
Development indebtedness contracted by the Company Solidary
Company
Loans, credits convertible to foreign currencies, Subject to
or other forms of indebtedness, from foreign contract,
governments or any international financial Solidary
institution or fund source, including foreign
private lenders.

15. National The payment by the NEA of both the principal Automatic U.S. $500M
Electrification and the interest of the bonds or other evidences Solidary
Administration of indebtedness, and shall pay such principal
and interest in case the NEA fails to do so;

Loans, credits convertible to foreign currencies,

or other forms of indebtedness, from foreign Subject to US$800 million
governments or any international financial contract,
institution or fund source, including foreign Solidary
private lenders.

16. National Food Both the principal and the interests of the bonds Automatic
Authority and other evidences of indebtedness and shall Subsidiary
pay such principal and interests in case the
Authority fails to do so

Foreign indebtedness Automatic US$500 million

46
 Annexure-A National Government Guarantees to GOCCs: Continued

Name of GOCC Government Guarantees Nature of Statutory limit

guarantee on guarantee
17. National Home Both principal and interest by the government Automatic
Mortgage and of the Republic of the Philippines Solidary
Finance
Corporation
18. National Both the principal and the interest of the bonds, Automatic The total amount
Housing debentures, collateral, notes or other Subsidiary of the bonds or
Authority obligations securities issued
shall not exceed
ten times its paid
up capital and
surplus.
19. National Payment of the loans, credits and indebtedness Subject to Total
Irrigation up to the amount herein authorized contract, indebtedness
Administration Solidary with foreign
countries not to
exceed
US$500M.
20. National Power Both the principal and the interest of the bonds Automatic Five hundred
Corporation issued by said Corporation Subsidiary million pesos

Foreign Loans Subject to

contract,
Solidary

21. Philippine Loans, credits, indebtedness and bonds Subject to US$1 billion
Aerospace issued contract,
Development Solidary
Corporation
22. Philippine Government Guarantee. The Government of Implicit
Health the Philippines guarantees the financial
Insurance viability of the Program
Corporation
23. Philippine bonds or other securities and loans Subject to
National Oil contract,
Company Solidary

24. Philippine Foreign Loans. Subject to

National contract,
Railways Solidary

25. Philippine Ports Loans or other indebtedness of the Authority Subject to Total outstanding
Authority contract indebtedness
shall not exceed
the networth of
the Authority.

47
 Annexure-A National Government Guarantees to GOCCs: Completed

Name of GOCC Government Guarantees Nature of Statutory limit

guarantee on guarantee
26. Philippine Domestic or foreign loans, credits and other Subject to Shall not exceed
Postal Authority indebtedness, and to issue bonds, notes, contract fifty per cent
debentures, securities and other instruments of (50%) of its net
indebtedness worth.

27. Philippine Principal and interest of domestic and foreign Subject to Total principal
Tourism loans contract domestic debt
Authority not to exceed 200
million pesos
while total
foreign debt not
to exceed
US$200 million
28. Public Estates Bonds, credits, loans, transactions, Subject to
Authority undertakings or obligations of any kind which contract
may be incurred by the Authority

29. Quedan and Sovereign Guarantee. The Republic of the Automatic

Rural Credit Philippines shall answer for the payment of Subsidiary
Guarantee guarantee obligations duly incurred by the
Corporation Corporation

30. Social Security The Government of the Republic of the Implicit,

System Philippines accepts general responsibility of the Subsidiary
solvency of the SSS.

31. Southern Both the principal and interests on bonds, Automatic The bonds issued
Philippines debentures, collaterals, notes or such other Subsidiary shall not exceed
Development obligations incurred by the Authority pesos
Administration 500 million

Foreign Loans. Subject to Exclusive of

contract, interest, shall not
Solidiary exceed
US$200 million

32. Investment Trade and The payment of obligations incurred Automatic Shall not exceed
Development by the Corporation under the provisions of this Subsidiary fifteen (15) times
Corporation Decree is fully guaranteed by the Government its subscribed
(TIDCOR) of the Republic of the Philippines capital stock
surplus

48
 Annexure-B

International Experiences in Management of Contingent Liabilities

This annexure surveys the experiences of ten countries – India, Australia, Canada,
Columbia, Czech Republic, Hungary, New Zealand, Philippines the United Kingdom and
United States with regard to the management of contingent liabilities. The choice of
countries was based on the advanced nature of the consideration of the problem of
contingent liabilities and the ready availability of such information. The situation in
other countries such as Bulgaria and Thailand was also examined, but it was not possible,
without further investigation, to clearly spell out the legal and accounting regime in place
and how such liabilities are recorded and managed. Individual country practices differ in
their dealing with contingent liabilities, but all countries share a common set of principles
to capture maximum contingent liabilities as they affect the government budget.

In all the countries surveyed, the consideration of contingent liabilities was an integral
part of improving transparency in government operations in general and fiscal
transparency in particular. Indeed it is tied to a process of bringing “open government” so
that citizens and outsiders (foreign investors, commercial banks, credit rating
organisations, multilateral financial institutes etc.) can more accurately assess the
government’s financial position.

In this survey it was not possible to ascertain the technical details and methodology for
the measurement of contingent liabilities and associated risks. But countries such as New
Zealand Treasury, the General Directorate of Public Credit in Columbia and the public
debt offices in Canada, UK and USA monitor explicit contingent liabilities of the
government as part of overall asset-liability management. In any case, the risks
associated with contingent liabilities have to be considered as part of reducing balance
sheet risk for the government.

All frameworks tended to look at the issue as part of the Government fiscal framework, in
line with the IMF’s Guidelines on Fiscal Transparency. In addition, these countries also
publish information of the International Investment Position and report information on
the new foreign exchange reserves template introduced by the IMF under the SDDS.

(a) Definition of Contingent Liabilities

While all frameworks generally define contingent liabilities as costs borne by the
Government if a particular event occurs, the precise scope and the detailed items reported
vary across countries. Nevertheless, in most frameworks there is provision to publish
information in the form of quantifiable and non-quantifiable contingent liabilities. Some
examples of quantifiable contingent liabilities are loan guarantees, non-loan guarantees,
indemnities, warranties, promissory notes, callable share capital in international
organisation and liabilities arising out of legal proceedings and disputes (though usually
within maximum limits).

49
Non-quantifiable liabilities include guaranteed benefits payable by national pension,
provident and insurance schemes, environmental contingencies, exchange rate risks and
in some cases (e.g. UK) liabilities relating to privatisation. There is also an implicit
reason for the non-disclosure or partial disclosure of contingent liabilities for tactical
reasons such as “moral hazard” (arising out of say, bank failures) or litigation claims
against the Government (e.g. litigation involving health matters).

(b) Legal Regime and Institutional Set Up

Most Governments have in place Acts pertaining to powers to borrow, invest and enter
into other financial obligations on behalf of its citizens, and the responsibilities to report
major contingent liabilities to the parliament through budget documents and other
financial reports. The legal framework usually sets out the maximum amount of new
borrowing and guarantees that the Congress, Parliament or the Minister of Finance can
approve over a specified period, usually the fiscal year. The authority to borrow and to
issue guarantees is delegated to the Minister of Finance or the principal public debt
manager under the Ministry of Finance or Treasury, and requires the Finance Minister to
be accountable for these decisions to the Parliament.

In all regimes, the need to report on contingent liabilities is also underpinned by fiscal
legislation, the main Act and Regulations. The most comprehensive is the Federal
Reform Act of USA, whose important objective is to neutralise budgetary incentives,
making policy makers indifferent to whether they choose grants, direct loans or
guarantees. The conditions for the recognition, measurement and disclosure of
contingent liabilities are clearly spelt out.

The legislative arrangements of the countries surveyed indicate that the regimes delegate
powers to the Minister of Finance on the design and issue of guarantee instruments and
other implementation aspects.

Some countries, such as Colombia and Sweden, are passing this responsibility onto the
government debt manager. In the case of Sweden, the Swedish National Debt Office is
the only government agency that can issue government guarantees. The Office has
developed a model for pricing guarantees in which clients are charged a risk based
premium and all revenues and losses are met from a fund, which is separate from the
Budget. In Colombia, the General Directorate of Public Credit is currently developing a
methodology for valuing contingent liabilities based on Monte Carlo simulations. It will
use this model to evaluate the risks associated with a wide range of government
guarantees, and to establish clear budgetary procedures for disclosure and provisioning.

(c) Accounting

Among the ten countries surveyed, in five countries i.e. India, Czech Republic,
Columbia, Philippines and the united Kingdom, conventional budget is prepared on the
basis of cash accounting i.e. transactions and events are recognised when cash is received
or paid. The financial results are measured in terms of inflows and outflows of cash and

50
changes in the cash balance. The focus of such reporting is on budgetary compliance and
maintaining liquidity solvency- two aspects of Government’s finances that are of prime
concern to the Parliament and to the executives for current decision making. However,
cash accounting has a number of serious drawbacks, such as the following:

♦ It fails to take account of future commitments, guarantees, or other contingent

liabilities. A liability is not recognised until the cash is paid to settle the debt. The
most significant omission being the pension liability of the Government, which is
handled on pay as you go basis.
♦ It fails to accurately represent the amount of resource usage. For instance, a large
capital acquisition will distort expenditure upward in the first year but the usage of
that asset will not be recognised in following years.
♦ Recognition of cash payments alone sometimes results in an unnoticed deterioration
in fixed assets.
♦ Perhaps the most significant deficiency in the system is the absence of a system of
cost allocation. The focus of cash costs alone results in understatement of costs
incurred by the Government departments in delivering goods and services.

In the other countries surveyed i.e. Australia, Canada, Columbia, Hungary, New
Zealand, and the United States of America, there is a clear preference for using the
accrual accounting framework, although the degree of implementation of this method
varies from country to country. Accrual accounts also show cash transactions but also
record contingent liabilities when they are created. By measuring changes in assets and
liability structure, it also provides invaluable information on the financial position of the
Government.

The Accrual and Consolidation Model requires that:

♦ A financial flow is to be reported at the time when an economic value is created,

transformed, exchanged, transferred or extinguished, whether or not cash is
exchanged at the time.
♦ All economic cost, cash or non-cash, be covered and matched with the revenue
(measured in terms of economic benefits) of the period,
♦ Both short term and long term items be included in the financial statements and
♦ All sub-entities are aggregated for the entity.

It is generally accepted that cash-based accounting systems are not well suited to record
contingent liabilities, which are often treated as off-balance sheet items. The preferred
method is certainly the accrual-based accounting systems, which can capture contingent
liabilities as they are created. Within such systems, contingent liabilities are recorded at
face value and expected present value of contracts. The Governments of Canada and the
United States have formulated standards for accounting contingent liabilities.

None of the frameworks actually sets out the valuation methods for estimating the
contingent liabilities. Rather, greatest reliance is on the exposure method. This is to list
the maximum exposure or the maximum potential amount than can be lost from

51
contingent liabilities. Thus a guarantee covering the full amount of a loan outstanding
would be recorded at the full nominal value of the underlying loan. Such lists are given
by the UK, New Zealand and Australian regimes. The obvious limitation of the method
is that there is no information on the likelihood of the contingency occurring. Further
research is necessary to ascertain the valuation methodologies that underpin the
calculation of the contingent liabilities.

(d) Recording, Monitoring and Management

In most of the regimes surveyed, the reporting of the contingent liabilities is set out as
indicated in the following sections. Further work is required to ascertain at the country-
level how each contingent liability is identified, measured, recorded, monitored and
managed.

Further, it is essential to evaluate vulnerabilities relating to the financial sector or the

external sector. For this, additional information have to be ascertained from sources
outside the fiscal sector, e.g. the reporting of international reserves, Central Bank Balance
Sheets and private sector potential external liabilities. In other words, the frameworks for
contingent liability disclosures only focus on potential government liability, and not on
other sources of systemic risks, which the public and private sectors have to bear in
special unforeseen circumstances.

The conclusion is that in understanding the comprehensive range of contingent liabilities

that the government faces, the fiscal frameworks governing them is only one source of
information for monitoring and management. This has to be supplemented by a range of
information and disclosure requirements for the early identification of external and
financial sector vulnerability.

It needs to be emphasised that there is no uniform system for reporting contingent

liabilities. Standards and benchmarks need to be developed taking into account the
diversity in country circumstance. While codes for data disclosures in a range of
activities are being developed by the IMF, it will be left to individual countries to
establish their own practical framework for the identification, measurement, disclosure
and management of a whole range of contingent liabilities that confront the Government.

Table-A.1 summaries the existing systems for data recording and monitoring, legal and
institutional set up, policy framework and risk management in ten countries surveyed
here. It may be observed that as judged by transparency, accountability, legal set up,
policy framework and risk management Australia, Canada, Hungary, New Zealand and
the USA provides international best practices for monitoring and management of
contingent liabilities.

52
 Table-A.1 Management of contingent liabilities - Country experiences
Items
1. Transparency- recording/ reporting
(a) Types of contingent liabilities
considered by government
(b) Who approves and issues
government guarantees?
(c) Is there centralised unit to
monitor and report contingent
liabilities?
(d) Are there ad-hoc or automatic
government guarantees?
(e) Types of contingent liabilities
recorded and monitored regularly
(f) Any contingent liability excluded
or not reported regularly?
(g) Does there exist up-to-date
database for other liabilities?
(h) Are all monitored contingent
liabilities reported to public?
2. Accountability- Legal system
(a) Are there legal requirements to
report contingent liabilities?
(b) Which of the contingent liabilities
regulated by law?
(c) Are their limits on contingent
liabilities?
(d) Is there any system of risk
management by PSUs?
(e) Is there Audit by independent
auditors?
3. Policy framework
(a) Is there policy framework for
issue of guarantees?
(b) Is there near term or medium term
fiscal framework?
(c) Is there designated contingent
fund? If so, is it adequate?
(d) Is there bail out of weak PSUs?
4. Risk Management
(a) Is budgeting done on the basis of
accrual accounting?
(b) Is a Statement on Fiscal Risk
included in the Budget?
(c) Are the concerned organisations
capable of evaluation and control
of contingent liabilities?
(d) General fiscal measures taken to
prevent fiscal risk
(e) Are the pension or provident
systems fully funded?
(f) Does there exist independent
Public Debt Office, which also
deals with contingent liabilities?
1. India
(a) Government guarantees,
debt relief, bail outs
(b) Ministry of Finance
(c) Yes, MOF/ RBI for only
guarantees
(d) Yes to small savings,
pensions and PF
(e) Only government
guarantees
(f) Liabilities for pension,
provident funds, insurance
(g) No
(h) Yes
(a) For only guarantees, govt.
plans to enact FRBM Act
(b) Government guarantees,
provident, insurance funds
(c) No, Govt. plans to have
limits under FRBM Act
(d) Yes, ALM by banks and
financial institutes
(e) Yes, by the Comptroller
General of Accounts
(a) Yes
(b) No, FRMA proposes such
framework
(c) Guarantee Redemption
Fund for $2.5 bn
(d) Yes
(a) No, govt. plans to adopt
revised IMF GFS
(b) No, FRMA proposes such
statement in the Budget
(c) Not fully
(d) Strict prudential norms for
banks and financial inst.
(e) No, adopts "pay as you
go" approach
(f) No
53
2. Australia
(a) Guarantees, indemnities
and uncalled capital
(b) Department of Finance
(c) Yes, DoF
(d) Yes for certain liabilities
under legislation
(e) Quantifiable and
unquantifiable
(f) Insurance and pension
(g) Yes
(h) Yes
(a) Yes, the Charter of Budget
Honesty Act (BHA) 1998
(b) Guarantees, indemnities
and uncalled capital
(c) No
(d) Yes, oversight by MOF
and Cabinet under GBE
(e) Yes, by Australian
National Audit Office
(a) Yes, the Charter of Budget
Honesty Act (BHA) 1998
(b) No
(c) No
(d) Yes
(a) Yes
(b) Yes
(c) Yes
(d) Sound fiscal management
under the BHA 1998
(e) No, adopts "pay as you
go" approach
(f) Yes
 Table-A.1 Management of contingent liabilities - Country experiences: Continued

Items 3. Canada 4. Columbia

1. Transparency- recording/ reporting
(a) Types of contingent liabilities (a) Contingent and potential (a) Contingent liabilities of
considered by government liabilities the Nation, entities
(b) Who approves and issues (b) Department of Finance (b) Ministry of Finance and
government guarantees? Public Credit (MoF&PC)
(c) Is there centralised unit to (c) Yes, Treasury Board (c) General Directorate of
monitor and report contingent Public Credit of the
liabilities? MoF&PC
(d) Are there ad-hoc or automatic (d) Yes to Crown corporations (d) Law 448 does not mention
government guarantees? (e) Guarantees, Aboriginal any
(e) Types of contingent liabilities and comprehensive land (e) Possible contingent
recorded and monitored regularly claims, insurance liabilities
(f) Any contingent liability excluded (f) The Canada Pension Plan (f) Law 448 requires reporting
or not reported regularly? of all possible
(g) Does there exist up-to-date (g) Yes (g) No
database for other liabilities?
(h) Are all monitored contingent (h) Yes (h) Yes
liabilities reported to public?
2. Accountability- Legal system
(a) Are there legal requirements to (a) Yes, under Financial (a) Yes, by Law 448 enacted
report contingent liabilities? Administration Act on he 21st July 1998
(b) Which of the contingent liabilities (b) Guarantees, callable share (b) Contingent liabilities of
regulated by law? capital, land claims the state entities
(c) Are their limits on contingent (c) No (c) No
liabilities?
(d) Is there any system of risk (d) Yes, except for those not (d) No
management by PSUs? dependent on govt.finance
(e) Is there Audit by independent (e) Yes (e) Yes
auditors?
3. Policy framework
(a) Is there policy framework for (a) Yes (a) Law 448 requires such
issue of guarantees? policy
(b) Is there near term or medium term (b) Yes (b) No
fiscal framework?
(c) Is there designated contingent (c) Not known (c) Yes, State Entities
fund? If so, is it adequate? Contingent Fund
(d) Is their bail out of weak PSUs? (d) Yes (d) Yes
4. Risk Management
(a) Is budgeting done on the basis of (a) Yes (a) No
accrual accounting?
(b) Is a Statement on Fiscal Risk (b) No (b) No
included in the Budget?
(c) Are the concerned organisations (c) Yes (c) No
capable of evaluation and control
of contingent liabilities?
(d) General fiscal measures taken to (d) Strict fiscal discipline (d) General fiscal policies
prevent fiscal risk
(e) Are the pension or provident (e) No, adopts "pay as you (e) No, adopts "pay as you
systems fully funded? go" approach go" approach
(f) Does there exist independent
Public Debt Office, which also (f) Yes (f) Yes

54
 deals with contingent liabilities
Table A.1. Management of contingent liabilities - Country experiences: Continued
Items
1. Transparency- recording/ reporting
(a) Types of contingent liabilities
considered by government
(b) Who approves and issues
government guarantees?
(c) Is there centralised unit to
monitor and report contingent
liabilities?
(d) Are there ad-hoc or automatic
government guarantees?
(e) Types of contingent liabilities
recorded and monitored regularly (e) So-called “hidden
(f) Any contingent liability excluded
or not reported regularly?
(g) Does there exist up-to-date
database for other liabilities?
(h) Are all monitored contingent
liabilities reported to public?
2. Accountability- Legal system
(a) Are there legal requirements to
report contingent liabilities?
(b) Which of the contingent liabilities (b) Guarantees, hidden debt
regulated by law?
(c) Are their limits on contingent
liabilities?
(d) Is there any system of risk
management by PSUs?
(e) Is there Audit by independent
auditors?
3. Policy framework
(a) Is there policy framework for
issue of guarantees?
(b) Is there near term or medium term (b) No
fiscal framework?
(c) Is there designated contingent
fund? If so, is it adequate?
(d) Is there bail out of weak PSUs?
4. Risk Management
(a) Is budgeting done on the basis of
accrual accounting?
(b) Is a Statement on Fiscal Risk
included in the Budget?
(c) Are the concerned organisations
capable of evaluation and control
of contingent liabilities?
(d) General fiscal measures taken to
prevent fiscal risk
(e) Are the pension or provident
systems fully funded?
(f) Does there exist independent
5. Czech Republic 6. Hungary
(a) Government guarantees, (a) Guarantees, reinsurance
subsidies
(b) MOF (b) MOF
(c) MOF, but there is (c) State Debt Management
reporting of partial Office
contingencies
(d) Yes (d) Yes, for reinsurance to
lending to priority sectors
(e) Guarantees and state
liabilities” reinsurance
(f) Pension and insurance (f) Pension funds
funds
(g) No, only one attempt was (g) Yes, by State Debt
done under the world Bank Management Office
(h) Yes (h) Yes
(a) Yes, Law on Budgetary (a) Yes, by the public Finance
Rules Act of 1992
(b) Guarantees, reinsurance
and priority lending
(c) No (c) Yes as percentage of state
revenue receipts
(d) No (d) Yes, strict regulatory and
enforcement mechanism
(e) Yes (e) Yes, by the State Audit
Office
(a) Is under formulation (a) yes by MOF and state
Debt Management Office
(b) Yes, three-year Fiscal
Forecast made in Budget
(c) No (c) Yes, Budget makes
provisions for CL
(d) Yes (d) Generally avoided
(a) No, attempts are being (a) Yes by both cash and
done accrual basis
(b) No
(b) Yes, Budget shows
(c) No probabilities of default
(c) Yes, ALM by concerned
agencies
(d) To consider hidden debt in (d) Strict monitoring of fiscal
the budget risks/ off-budget risks
(e) No, adopts "pay as you (e) No, adopts "pay as you
go" approach go" approach
(f) No (f) Yes, the state Debt
55
 Public Debt Office, which also Management Office
deals with contingent liabilities

Table-A.1. Management of contingent liabilities - Country experiences: Continued

Items 7. New Zealand 8.Philippines

1. Transparency- recording/ reporting
(a) Types of contingent liabilities
considered by government
(b) Who approves and issues
government guarantees?
(c) Is there centralised unit to
monitor and report contingent
liabilities?
(d) Are there ad-hoc or automatic
government guarantees?
(e) Types of contingent liabilities
recorded and monitored regularly
(f) Any contingent liability excluded
or not reported regularly?
(g) Does there exist up-to-date
database for other liabilities?
(h) Are all monitored contingent
liabilities reported to public?
2. Accountability- Legal system
(a) Are there legal requirements to
report contingent liabilities?
(b) Which of the contingent liabilities
regulated by law?
(c) Are their limits on contingent
liabilities?
(d) Is there any system of risk
management by PSUs?
(e) Is there Audit by independent
auditors?
3. Policy framework
(a) Is there policy framework for
issue of guarantees?
(b) Is there near term or medium term
fiscal framework?
(c) Is there designated contingent
fund? If so, is it adequate?
(d) Is there bail out of weak PSUs?
4. Risk Management
(a) Is budgeting done on the basis of
accrual accounting?
(b) Is a Statement on Fiscal Risk
included in the Budget?
(c) Are the concerned organisations
capable of evaluation and control
of contingent liabilities?
(d) General fiscal measures taken to
prevent fiscal risk
(e) Are the pension or provident
systems fully funded?
(a) Guarantees, indemnities,
uncalled capital, others
(b) MOF
(c) Yes, Public Debt Office
(d) Generally not
(e) Quantifiable and non-
quantifiable CL
(f) All possible CL are
considered
(g) Yes, six-monthly
statements by all
(h) Yes
(a) Yes, By PF Act, LG Act,
Fiscal Responsibility Act
(b) Quantifiable and non-
quantifiable CL
(c) Yes, under Fiscal
Responsibility Act
(d) Yes, all PSUs use accrual
accounting and report CLs
(e) Yes, GAAP used for both
public & private sectors
(a) Yes, ALM and prudent risk
management for all
(b) Yes
(c) Yes
(d) Very rare
(a) Yes, on both cash-basis
and accrual basis
(b) Yes, Fiscal Risk in ALM
Framework
(c) Yes
(d) Strict fiscal prudence and
ALM
(e) Yes
(a) Guarantees of foreign
loans of GOCCs
(b) Department of Finance
(c) Bureau of Treasury
(d) Charters of many GOCCs
allow automatic guarantee
(e) Only guarantees given to
GOCCs
(f) Other types are largely un-
monitored.
(g) No
(h) Yes
(a) Republic Act 4860
(Foreign Borrowing Act)
(b) Only guarantees given to
GOCCs
(c) $7.5 million ceiling on
govt. guarantees on
foreign loans
(d) Generally not
(e) Yes by Commisson on
Audit
(a) Yes issued by DOF
(b) Yes reported in the Budget
(c) No, present Budget only
allocated 1% of CLs.
(d) Yes
(a) No, only on cash basis
with modified accrual
(b) No
(c) Systems need
strengthening
(d) No strict hard budget
constraint
(e) Not fully funded, adopts
defined benefit system

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(f) Does there exist independent
Public Debt Office, which also
deals with contingent liabilities
Table- A.1 Management of contingent liabilities - Country experiences: Completed
Items
1. Transparency- recording/ reporting
(a) Types of contingent liabilities
considered by government
(b) Who approves and issues
government guarantees?
(c) Is there centralised unit to
monitor and report contingent
liabilities?
(d) Are there ad-hoc or automatic
government guarantees?
(e) Types of contingent liabilities
recorded and monitored regularly
(f) Any contingent liability excluded (f) CLs related to national
or not reported regularly?
(g) Does there exist up-to-date
database for other liabilities?
(h) Are all monitored contingent
liabilities reported to public?
2. Accountability- Legal system
(a) Are there legal requirements to
report contingent liabilities?
(b) Which of the contingent
liabilities regulated by law?
(c) Are their limits on contingent
liabilities?
(d) Is there any system of risk
management by PSUs?
(e) Is there Audit by independent
auditors?
3. Policy framework
(a) Is there policy framework for
issue of guarantees?
(b) Is there near term or medium term (b) Yes, fiscal aggregates
fiscal framework?
(c) Is there designated contingent
fund? If so, is it adequate?
(d) Is there bail out of weak PSUs?
4. Risk Management
(a) Is budgeting done on the basis of (a) No
accrual accounting?
(b) Is a Statement on Fiscal Risk
included in the Budget?
(c) Are the concerned organisations
capable of evaluation and control
of contingent liabilities?
(d) General fiscal measures taken to
prevent fiscal risk
(e) Are the pension or provident
systems fully funded?
(f) Yes
9. United Kingdom
(a) Material contingent
liabilities
(b) Respective Ministries/
Departments
(c) Annual statement of CLs
of the Consolidated Fund
given in the Budget
(d) Yes, on grounds of
national security
(e) Guarantees and other
material CLs
security & public interest
(g) Information on CLs
disclosed with legal status
(h) Yes, except CLs for
national security & interest
(a) Code of Fiscal Stability
under the Finance Act
(b) All material contingent
liabilities
(c) No
(d) Yes
(e) Yes, by National Audit
Office
(a) Yes, each Ministry has to
publish legal status on CL
projected for next 2 years
(c) No
(d) Yes
(b) Publishes an Economic
and Fiscal Strategy Report
(c) Yes, each Department/
Ministry has to list and
disclose CLs & legal status (d) Present value of cash
(d) Indicates long term
economic & fiscal strategy
(e) No, adopts "pay as you
go" approach
57
(f) No
10. United States of America
(a) Guarantees, pending
litigation, claims
(b) The Treasury
(c) President Office of Budget
publishes General
financial reports
(d) No
(e) Guarantees, pending
litigation, claims
(f) Contingencies classified as
remote, and insurance
(g) Yes in Federal Financial
Reports
(h) Yes
(a) Yes, Federal credit
Reforms Act of 1990
(b) “Probable and
Reasonably Probable”
(c) Automatic limits through
appropriation
(d) Yes
(e) Yes, as per Federal
Financial Accounting
Standards
(a) Yes, on the basis of present
value measurement
(b) Yes
(c) Annual appropriations
must be made for CLs
(d) Yes
(a) Yes
(b) Yes
(c) Yes
outflows on CLs is taken
as cost in the budget
(e) No
(f) Does there exist independent (f) Yes, UK Debt (f) Yes, President’s Office of
Public Debt Office, which also Management Office Management and Budget
deals with contingent liabilities

Annexure-C

The Management of Contingent Liabilities in The United States of America

With the introduction of the Federal Credit Reform Act of 1990 (effective since the fiscal
year of 1992), the US Federal Government replaced a parallel budgeting system for
contingent liabilities with new budgetary rules for direct and guaranteed loans. These
provisions are designed to neutralise budgetary incentives, making policy makers
indifferent to whether they choose grants, direct loans or guarantees. The primary
interest is to ensure that subsidy costs of grants, direct loans and guarantees are taken into
account in budgetary discussions.

The standards for accounting for liabilities, including contingent liabilities are set out in
the Statement of Federal Financial Accounting Standards, “Accounting for Liabilities of
the Federal Government (September 1995)” published by the President Office of
Management and Budget. These standards apply to general-purpose financial reports to
US Government reporting entities.

The Act has the following specific purposes:

(a) Ensure a timely and accurate measure and presentation in the President’s budget
of the costs of direct loan and loan guarantee programmes;
(b) Place the cost of credit programmes on a budgetary basis equivalent to other
federal spending;
(c) Encourage the delivery of benefits in the form most appropriate to the needs of
beneficiaries, and
(d) Improve the allocation of resources among credit programmes and between credit
and other spending programmes.

The major provisions of the Act require that:

• For each fiscal year in which the direct loans or the guarantees are to be obligated,
committed or disbursed, the President’s budget reflect the long-term cost to the
government of the subsidies associated with the loans and guarantees. The subsidy
cost is to be estimated as the present value of the projected cash outflows discounted
at the average rate of marketable Treasury securities of similar maturity.
• Before direct loans are obligated or loan guarantees are committed, annual
appropriations generally are enacted to cover these costs. However, mandatory
programmes have permanent indefinite appropriations.
• Borrowing authority from Treasury covers the non-subsidy portion of direct loans.
• There are budgetary and financing controls for each credit programme.

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59
Contingencies

A contingency is an existing condition, situation, or set of circumstances involving

uncertainty as to possible gain or loss to an entity. The uncertainty will ultimately be
resolved when one or more future events occur or fail to occur. Resolution of the
uncertainty may confirm a gain, (i.e., acquisition of an asset or reduction of a liability) or
a loss (i.e., loss or impairment of an asset or the incurrence of a liability).

When a loss contingency (i.e., contingent liability) exists, it is classified in three

probability categories depending on the likelihood of the future event to occur:

• Probable: The future confirming event or events are more likely than not to occur.
• Reasonably possible: The chance of the future confirming event or events occurring is
more than remote but less than probable.
• Remote: The chance of the future event or events occurring is slight.

Some examples of loss contingencies are collectibility of receivables; pending or

threatened litigation; and possible claims and assessments.

Criteria for Recognition of a Contingent Liability

A contingent liability should be recognised when all of these three conditions are met.

• A past event or exchange transactions has occurred (e.g. a federal entity has breached
a contract with a non-federal entity).
• A future outflow is probable (e.g. the non-federal entity has filed a legal claim against
a federal entity for breach of contract and the federal entity believes that the claim is
more likely to be settled in favour of the claimant).
• The future outflow or sacrifice of resources is measurable.

The estimated liability may be a specific amount or a range of amounts. If no amount

within the range is a better estimate than any other amount, the minimum amount in the
range is recognised and the range and a description of the nature of the contingency
should be disclosed.

Criteria for Disclosure of a Contingent Liability

A contingent liability should be disclosed if any of the conditions for liability recognition
is not met and there is at least a reasonable possibility that a loss may have been incurred.
“Disclosure” is regarded as an integral part of the basic financial statements. Disclosure
should include the nature of the contingency and an estimate or a range of the possible
liability or a statement that such an estimate cannot be made.

In some cases, contingencies may be identified but the degree of uncertainty is so great
that no reporting is necessary in the federal financial reports. Specifically, contingencies

60
classified as remote need not be reported in general purpose federal financial reports,
though law may require such disclosures in special purpose reports.

Implementation

Conversion to the subsidy cost basis has entailed the maintenance of separate budgetary
accounts for the subsidised and unsubsidised portions of loans and guarantees.
Programme accounts receive appropriations for subsidy costs; financing accounts handle
the cash flows associated with the non-subsidised portion. Programme accounts are
included in the budget; financing accounts, however, are recorded as “means of
financing” and their cash flows are not included in budget receipts or outlays.

Future Legislation

The subsidy cost basis is currently used only for direct and guaranteed loans, not for other
contingent liabilities. However, legislation tabled in the United States Congress during
1999 shifts all US Government insurance programmes to this basis. The legislation
provides that beginning with fiscal year 2006, insurance commitments could be made
only to the extent that budget resources were appropriated to cover their “risk-assumed
cost”. This cost is defined as “the net present value of the estimated cash flows to and
from the Government resulting from an insurance commitment or modification thereof”.
As the volume of insurance commitments is many times greater than that of loan
guarantees, this legislation would have an enormous impact on the budgetary treatment of
contingent liabilities.

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 Annexure-D

Partial List of Persons Met during visit to Manila: 17 February to 2 March 2002

1. Mr. Lloyd McKay, Lead Economist, World Bank Office at Manila (WBOM).
2. Ms. Hazel Malapit, Consultant, World Bank Office at Manila.
3. Ms. Laura Pascua, Under-Secretary, Department of Budget and Management
(DBM) and the Chairperson of the counterpart team (PER Working Group)
established by the Government of Philippines;
4. Mr. Romeo de Vera, Consultant, DBM.
5. Ms. Estee Manglo, Division Chief, Planning, DBM.
6. Mr. Jo Abundo, Director, DBM.
7. Mr. Edgardo Jose L. Compos, Senior Strategy Adviser for Public Sector Reforms,
DBM and Adviser to AGILE.
8. Ms. Nieves Osorio, Undersecretary, Department of Finance (DOF), Government
of Philippines (GoPh).
9. Ms. Soledad Emilia J. Cruz, Director, Corporate Affairs Group, DOF, GoPh.
10. Ms. Dolly Celam, Corporate Affairs Group, DOF.
11. Ms Emelina Silao-Blanco, Corporate Affairs Group, DOF, GoPh
12. Mr. Richard S. Ondrik, Chief Country Officer, Philippines Country Office
(PhCO), ADB.
13. Ms. Xuelin Liu, Country Economist, PhCO, ADB
14. Mr. Romeo L. Bernardo, MD, Lazaro Bernardo Tiu & Associates Inc.
15. Ms. Marie Christine G. Tang, Senior Associate, Lazaro Bernardo Tiu &
Associates Inc.
16. Ms. Patricia K. Buckles, Mission Director, United States Agency for International
Development (USAID), Philippines.
17. Mr. Francis A. Donovan, Deputy Mission Director, USAID.
18. Mr. Joseph S. Ryan Jr., Chief, Economic Development and Governance, USAID.
19. Mr. Karoly K. Okolicsanyi, Financial Markets Development Adviser, USAID.
20. Mr. Tony Cintura, Deputy Director (Economic Research), Bangko Sentral ng
Pilipinas.
21. Mr. Guillermo Carague, Chairman, Commission on Audit.
22. Ms. Emma Espina, Assistant Commissioner, Commission on Audit.
23. Mr. Gilbert Llanto, Deputy Director General, National Economic & Development
Authority (NEDA).
24. Mr. Reynaldo P. Palmiery, Executive Vice President & COO, GSIS
25. Ms. Enrigueta P. Disuanco, Senior Vice President (Corporate Services), GSIS.
26. Ms. Maria Fe-Santos-Dayco, Vice President and Actuary, GSIS.
27. Ms. Corazon S. De La Paz, President and CEO, SSS.
28. Ms. Maribel D. Ortiz, Assistant Vice President (Research), SSS.
29. Ms. Virgina E. Gallarde, Assistant Vice President (Actuary), SSS

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