A government’s contingent liabilities are liabilities that may be incurred depending on the outcome of a future event.
Regardless of their developmental status or soundness of budget, every government faces the threat of indebtedness due to both explicit and implicit liabilities. Among explicit liabilities are any obligations for which the government is legally bound to pay if the beneficiary entity fails to pay its lender. Government guarantees and on-lending practices are among the most common of explicit liabilities. For example, by guaranteeing debt payments of other entities, such as municipalities or SOEs, the government can help reduce funding costs and hence leverage private sector investment for the provisioning of important goods, such as electricity, transport, and other infrastructure.
Trade and exchange rate risks, deposit insurance, private pension funds, crop insurance, flood insurance, and war-risk insurance can be all explicit liabilities that can eventually become a direct liability on the government balance sheet. There are also implicit liabilities that the government is not legally obligated to cover, but which would cause major societal disruption if unpaid for, such as natural disaster relief or potential bailouts and defaults.
What are the risks associated with Contingent Liabilities?
Contingent liabilities create risks to government balance sheets that may be hidden and not properly captured.
As contingent liabilities often materialize in times of economic distress, they may exacerbate or even trigger fiscal crisis which have been shown to disproportionately affect the poorest segments of society. Managing risks from CLs is therefore important in supporting the achievement of the World Bank Group’s twin goals.
How can the risks be managed?
Risks from CLs should be managed in a framework where the analysis and measurement of risks forms a basis for developing a risk management strategy and designing effective risk mitigation tools.
But developing a sound risk analysis and measurement framework requires significant investments in resources, capacity building, and time. Governments should view this process as iterative and long-term.