Chapter

II Fiscal Implications of the Crisis: Direct Costs

Author(s):
International Monetary Fund
Published Date:
September 2009
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Government support to the financial sector can take various forms, with different implications for gross and net debt. Operations undertaken directly by the government typically entail an upfront rise in gross government debt, though not necessarily a change in net worth and the deficit, given the related acquisition of assets. Over time, the fiscal impact will critically depend on the realization value of the acquired assets (i.e., recoveries from their sale). Other operations—those undertaken by the central bank or guarantees—have less immediate implications for the fiscal accounts, but may also have important costs over the medium term. For all, a transparent treatment in the fiscal accounts is necessary (see Box 2.1 and Appendix I).

Headline Support to Financial Sectors3

Advanced Countries

Many advanced countries have provided, or announced the intent to provide, significant support to their financial sectors. Support measures have varied markedly in extent and nature (see Table 2.1 and Appendix II). Estimates in Table 2.1 are based on official announcements of amounts allocated for financial sector support (or the maximum amount of banks’ liabilities to be guaranteed), although they may not be used in full.4 However, data on central bank operations reflect actual changes in the balance sheets since June 2007.

Table 2.1.Headline Support for Financial and Other Sectors and Upfront Financing Need

(As of June 2009; in percent of 2008 GDP; average using PPP GDP weights)1

Capital InjectionPurchase of Assets and Lending by Treasury2Guarantees3Liquidity Provision and Other Support by Central BankUpfront Government Financing4
(A)(B)(C)(D)(E)
Advanced North America
Canada0.010.913.51.510.9
United States5.21.310.98.46.75
Advanced Europe
Austria5.30.030.18.9
Belgium4.80.026.44.8
France1.41.316.41.66
Germany3.80.418.03.7
Greece2.13.36.25.4
Ireland5.90.0198.15.9
Italy0.70.00.00.77
Netherlands3.410.333.613.6
Norway2.015.80.014.715.88
Portugal2.40.012.02.49
Spain0.04.618.34.6
Sweden2.14.847.513.65.210
Switzerland1.10.00.025.51.1
United Kingdom3.913.849.714.420.011
European Central Bank (ECB)6.4
Advanced Asia and Pacific
Australia0.00.78.80.7
Japan2.421.27.32.90.812
Korea2.35.514.54.50.813
Emerging economies
Argentina0.00.90.04.20.914
Brazil0.00.80.012.50.015
China0.00.00.021.30.0
India0.40.00.09.20.4
Indonesia160.00.00.11.30.1
Hungary1.12.41.115.73.517
Poland0.00.03.25.50.0
Russia1.21.20.514.32.3
Saudi Arabia0.01.2N/A33.11.218
Turkey0.00.30.03.10.019
Average
G-202.23.58.89.23.6
Advanced economies3.45.414.06.85.6
In billions of U.S. dollars1,1491,9464,6462,4841,858
Emerging economies0.20.30.113.60.4
In billions of U.S. dollars223871,60547
Sources: IMF staff estimates; and IMF, World Economic Outlook, April 2009. See Appendix II for details.

Amounts in columns A, B, C, and E indicate announced or pledged amounts, and not actual uptake. Column D shows the actual changes in central bank’s balance sheet from June 2007 to April 2009. While the expansion of central bank balance sheet is mostly related to measures aimed at enhancing market liquidity as well as financial sector support, it may occasionally have other causes. Also, it may not fully capture some other types of support, including those arising from changes in regulatory policies. For the euro area countries, see the ECB line. Averages for column D include the euro area as a whole.

Column B does not include Treasury funds provided in support of central bank operations. These amount to 0.5 percent of GDP in the United States, and 12.8 percent in the United Kingdom.

Excludes deposit insurance provided by deposit insurance agencies.

This includes support measures that require upfront government outlays. It does not include recoveries from the sale of assets acquired through interventions.

Estimated upfront financing need for 2009–10 is $960 billion (6.7 percent of GDP), consisting of the allocated amounts under the Troubled Asset Relief Program (TARP; $510 billion);Treasury purchases of government-sponsored enterprise preferred stocks ($400 billion); and Treasury support for Commercial Paper Funding Facility ($50 billion).

Support to the country’s strategic companies is recorded under (B); of which €20 billion will be financed by a state-owned bank, Caisse des Dépôts et Consignations, not requiring upfront Treasury financing.

It does not include the temporary swap of government securities for assets held by Italian banks undertaken by the Bank of Italy.

Excluding asset accumulation in sovereign Wealth Fund, the balance sheet expansion during the period was only 4.5 percent of GDP.

A maximum amount of €20 billion (12 percent of GDP) is allocated to both the guarantee scheme and the reinforcement of core capital, with the latter not exceeding €4 billion.

Some capital injection (SKr 50 billion) will be undertaken by the Stabilization Fund.

Estimated upfront financing need is £289 billion (20 percent of GDP), consisting of Bank Recapitalization Fund (£56 billion), Special Liquidity Scheme (£185 billion), and financing for the nationalization of Northern Rock and Bradford & Bingley (£48 billion).

Budget provides ¥ 3,900 billion (0.8 percent of GDP) to support capital injection by a special corporation and lending and purchase of commercial paper by policy-based financing institutions.

In 2009, W 8 trillion will be provided from the budget to support small and medium-sized enterprises (SMEs).

IMF staff estimates.

Liquidity support and loan purchases are provided through public banks and deposit insurance fund, and entail no upfront government financing.

Small interventions have been recently implemented through the deposit insurance agency that are not yet quantified.

The expansion of the central bank balance sheet reflects mostly the increase in net foreign assets as a result of IMF and European Union disbursements in the context of the Stand-By Arrangement. During this period, the increase in central bank domestic assets was limited to 2.3 percent of GDP

A significant part of the central bank balance sheet expansion was due to a large accumulation of foreign assets during 2008.

Column B shows loans by the SME Industry Development Organization, not requiring direct Treasury financing.

Sources: IMF staff estimates; and IMF, World Economic Outlook, April 2009. See Appendix II for details.

Amounts in columns A, B, C, and E indicate announced or pledged amounts, and not actual uptake. Column D shows the actual changes in central bank’s balance sheet from June 2007 to April 2009. While the expansion of central bank balance sheet is mostly related to measures aimed at enhancing market liquidity as well as financial sector support, it may occasionally have other causes. Also, it may not fully capture some other types of support, including those arising from changes in regulatory policies. For the euro area countries, see the ECB line. Averages for column D include the euro area as a whole.

Column B does not include Treasury funds provided in support of central bank operations. These amount to 0.5 percent of GDP in the United States, and 12.8 percent in the United Kingdom.

Excludes deposit insurance provided by deposit insurance agencies.

This includes support measures that require upfront government outlays. It does not include recoveries from the sale of assets acquired through interventions.

Estimated upfront financing need for 2009–10 is $960 billion (6.7 percent of GDP), consisting of the allocated amounts under the Troubled Asset Relief Program (TARP; $510 billion);Treasury purchases of government-sponsored enterprise preferred stocks ($400 billion); and Treasury support for Commercial Paper Funding Facility ($50 billion).

Support to the country’s strategic companies is recorded under (B); of which €20 billion will be financed by a state-owned bank, Caisse des Dépôts et Consignations, not requiring upfront Treasury financing.

It does not include the temporary swap of government securities for assets held by Italian banks undertaken by the Bank of Italy.

Excluding asset accumulation in sovereign Wealth Fund, the balance sheet expansion during the period was only 4.5 percent of GDP.

A maximum amount of €20 billion (12 percent of GDP) is allocated to both the guarantee scheme and the reinforcement of core capital, with the latter not exceeding €4 billion.

Some capital injection (SKr 50 billion) will be undertaken by the Stabilization Fund.

Estimated upfront financing need is £289 billion (20 percent of GDP), consisting of Bank Recapitalization Fund (£56 billion), Special Liquidity Scheme (£185 billion), and financing for the nationalization of Northern Rock and Bradford & Bingley (£48 billion).

Budget provides ¥ 3,900 billion (0.8 percent of GDP) to support capital injection by a special corporation and lending and purchase of commercial paper by policy-based financing institutions.

In 2009, W 8 trillion will be provided from the budget to support small and medium-sized enterprises (SMEs).

IMF staff estimates.

Liquidity support and loan purchases are provided through public banks and deposit insurance fund, and entail no upfront government financing.

Small interventions have been recently implemented through the deposit insurance agency that are not yet quantified.

The expansion of the central bank balance sheet reflects mostly the increase in net foreign assets as a result of IMF and European Union disbursements in the context of the Stand-By Arrangement. During this period, the increase in central bank domestic assets was limited to 2.3 percent of GDP

A significant part of the central bank balance sheet expansion was due to a large accumulation of foreign assets during 2008.

Column B shows loans by the SME Industry Development Organization, not requiring direct Treasury financing.

  • Capital injections. Many countries have recapitalized their banks, particularly the systemically important ones. For the advanced G-20 countries, the average outlay to date is projected at 3½ percent of GDP, with considerable variation across countries (ranging from 5.2 percent in the United States to none for Australia, Canada, and Spain). Among smaller advanced economies, Austria, Belgium, Ireland, and the Netherlands have announced large programs, ranging from 3½ to 6 percent of GDP.
  • Asset purchases and direct lending by the treasury. Governments and some central banks have provided substantial direct loans and have purchased illiquid assets from financial institutions. Amounts involved range widely, with such support in Canada, Japan, Norway, and the United Kingdom accounting for over 10 percent of GDP. The advanced G-20 average is 5½ percent of GDP.
  • Guarantees for financial sector liabilities. Guarantees have been provided for bank deposits, interbank loans and, in some cases, bonds. Deposit insurance limits have been raised in almost all countries. Guarantees provided in Ireland, the Netherlands, Sweden, and the United Kingdom are particularly large, relative to GDP.
  • Central bank support. In addition to liquidity provided by expanding regular facilities, central bank support has been provided through credit lines to financial institutions, purchase of asset-backed securities and commercial paper, and asset swaps (see Appendix II).5 In only a few countries have these operations been undertaken with upfront treasury financing (Table 2.1, column D shows the actual changes in central bank balance sheets since the beginning of the crisis).

While the support operations have been large, the immediate impact on financing needs has been more limited. The immediate impact averages 5½ percent of GDP for the advanced G-20 (Table 2.1, last column). The figures are much larger when taking into account: (1) central bank liquidity provisions and (2) especially, guarantees, which do not require upfront financing.

Box 2.1.Fiscal Accounting Treatment of Support to the Financial Sector

(Guidance based on Government Finance Statistics Manual (GFSM 2001)

The following is the recommended treatment of the impact on the government balance of the main financial support operations:

Capital grants. Increase the deficit by the amount of the grant.

Equity purchases. Have no impact on the fiscal balance, if purchase is at market value, but increase government gross debt. Raise the deficit by any marked/undisputable excess of what the government pays over the value of the equity.

Asset purchases/swaps. Same as equity purchases.

Loans. Have no immediate impact on the fiscal balance if there is no inherent subsidy, but increase government debt. Reduce the balance by any amount that the government cannot expect to be repaid.

Guarantees. Have no immediate impact on the fiscal balance or debt unless there is a significant probability the guarantee will be called (in practice, when a reserve has been created). In other cases, the fiscal balance would weaken and debt increase if and when the guarantee is called.

Associated fees, interest, and dividends. Affect the deficit in the same way as other government income or expense.

Central bank operations. Are reflected in its own balance sheet and income statement, rather than those of the government. However, losses on these operations will affect the budget over time, as they affect profit transfers or necessitate recapitalization. For transparency and to facilitate policy decision making, these operations should be disclosed, possibly as complementary information in the budget.

Emerging Markets

Financial sector support has been limited so far in emerging economies, which have only recently seen a pronounced impact of deleveraging and increased risk aversion on their financial sectors. The main measures announced include:6

  • Bank recapitalization. Hungary, Poland, and Ukraine;
  • Liquidity provision. Hungary, India, Mexico, Russia, Turkey, and Ukraine. These countries have extended (or committed to extend) liquidity facilities to banks or to state-owned or managed enterprises; and
  • Guarantees. Blanket coverage has been provided in Egypt and Saudi Arabia; several other countries (Hungary, Indonesia, Mexico, Poland, and Russia) have committed to provide more limited guarantees (e.g., trade credit to exporters and interbank lending).

Based on the (limited) information available, the average immediate impact on gross debt of these operations is about ½ percent of GDP.

Net Cost over the Medium Term

The medium-term net budgetary cost of financial support operations will depend on the extent to which the assets acquired by government or the central bank will hold their value and can be divested without losses, and the potential loss from guarantees. Although there are significant uncertainties relating to each of these channels, and the current crisis is unique in its complexity and pervasiveness, past experience can provide some guidance for asset recovery rates. Moreover, estimates of default probabilities based on financial market data can be used to provide an educated guess of the potential losses from guarantees.

Recovery Rates and Net Cost

The amounts recovered from the sale of assets acquired through interventions will likely vary significantly across countries, depending on the type of intervention, the approach followed in managing and selling the assets, and various macroeconomic factors. Econometric analysis suggests that recovery ratios are positively correlated with per capita income: advanced countries had higher recovery rates (an average of 51 percent compared with 13 percent for emerging markets—see Appendix III). Recovery rates are also higher, the stronger the fiscal balance at the start of the crisis, possibly an indicator of sounder fiscal and public financial management frameworks.

Based on these estimates, the medium-term impact on gross government debt could be substantially lower than the upfront impact, but still sizable. The average net cost for the G-20 advanced economies is projected to be 2½ percent of GDP, compared to upfront cost of 5½ percent of GDP (Appendix II, Table A2.1). In general, recovery rates estimated for emerging markets are markedly lower, so the difference between the gross and net outlays would be smaller.

The timing of asset recoveries will depend on the speed of the economic and financial recovery. Past experience indicates that the bulk of asset recovery takes place only after economic and financial recovery firms up demand and stabilizes asset prices. For example, Sweden achieved a recovery rate of 94 percent after only five years following the 1991 crisis, while Japan had recovered only 1 percent of assets after five years following the 1997 crisis (by 2008, the recovery rate for Japan reached 54 percent).

Net Cost of Central Bank Liquidity Support and of Government Guarantees

Potential costs involved in central bank liquidity support are likely to be more contained than those associated with government intervention. Given the unprecedented magnitude of central bank support operations, there is little evidence to assess likely recovery rates. However, in most countries, central banks have focused on providing liquidity support (with relatively short maturities and higher-quality collateral), whereas governments have generally provided solvency support—operations with the highest risk of loss. Therefore, the recovery rate for outlays by central banks is likely to be higher than for governments. Focusing on total commitments or announcements made through new special facilities (but excluding liquidity provision through regular facilities), the potential fiscal cost is illustrated in Appendix II. In some countries, actual disbursements have been significantly lower than the total announced facilities. The computation of net cost assumes recovery rates of 90 percent against the new facilities. Under these assumptions, the net cost from central bank operations could average 1¾ percent of GDP for advanced countries (Appendix II, Table A2.2).

The expected cost of the (explicit) guarantees provided so far is not trivial, but the margin of uncertainty is large. Some indicative estimates can be obtained using standard financial derivative pricing models—in particular, by estimating the expected default frequency implied credit default swap (EICDS) spreads and applying them to the guaranteed amounts. EICDS can be regarded as indicative of the “insurance” premium for providing the guarantees, and the approach—which takes into account market volatility and hence, the probability of default of individual institutions—provides an approximate measure of the cost to government of providing this “insurance.” Based on November 2008 market data, outlays from contingent liabilities could be of the order of 1-3 percent of GDP (cumulative) for 2009-13 for the advanced G-20 countries, with a point estimate of 1¾ percent of GDP (Appendix II, Table A2.2). This range corresponds to the assumed recovery rates under an optimistic scenario (80 percent recovery rate) and a conservative scenario (40 percent recovery rate).7

Potential Total Cost of Implicit and Explicit Guarantees

In case of additional market disturbances, governments may need to provide broader support than currently implied by the explicit guarantees. For illustrative purposes, it has been assumed that governments provide an implicit guarantee on all institutions that are systemic (“too big to fail”). To derive an estimate of the potential costs for governments arising from explicit and implicit guarantees, two approaches were followed. The first one is the approach noted in the previous paragraph, applied to all systemic institutions. The second one is the “contingent claim approach,” applied to the same institutions (see Appendix IV for further details on both approaches). These approaches imply that the possible costs in case of further market disturbances could be of the order of 14–22 percent of GDP (cumulative for 2009–13) for the advanced countries, and 4–9 percent of GDP for the emerging economies in the sample (some of this financing, however, could come from the private sector).8

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