XXV. Fiscal Activities of Public Institutions

Ke-young Chu, and Richard Hemming
Published Date:
September 1991
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Which monetary activities of central banks have an expenditure dimension?

Do other public institutions undertake similar activities?

How are these activities reflected in fiscal accounts?

Conventional accounting methodologies may seriously misrepresent the size and composition of public expenditure. While the consolidation of expenditure by local and central governments is routinely undertaken, the consolidation of expenditure by nonfinancial and financial public institutions (including public enterprises) with that of the general government is not common practice, because such expenditure is assumed to be akin to private sector expenditure. For purposes of public sector consolidation, only the cash balances of public institutions are consolidated into the general government accounts. This is appropriate for gauging the financial policy implications of government operations, but—because many public institutions do not operate along solely commercial lines—may understate the full scope of general government activities. In many cases, such institutions are charged with important public policy objectives which require them to undertake quasi-fiscal expenditures.

As the same time, public institutions, like the government, may also undertake certain activities which, though not involving an immediate cash outlay, expose the government to potential future spending. Such noncash policies, generally in the form of explicit (contingent) or implicit (conjectural) insurance or loan guarantees, which can have important economic effects, are not adequately captured under conventional expenditure or deficit measures.

Quasi-Fiscal Expenditures

Central banks

Central bank activities have various quasi-fiscal aspects. Revenue generation by central banks is commonplace. For example, the administration of a multiple exchange rate system under which the central bank has a monopoly over the purchase and sale of foreign exchange (the exchange rate being more depreciated for the latter than the former) is tantamount to an export-import tax scheme, the revenues from which will be captured in the profit/loss account of the central bank. The collection of seignorage revenue and the inflation tax, whose proceeds eventually benefit the government, is another example.

A central bank may also undertake a wide range of quasi-fiscal expenditures. The following are the most important:

Credit subsidies

Provision of subsidized credit to priority sectors such as agriculture or export, either directly or indirectly (through rediscounting of commercial banks’ bills at a subsidized rate), is a major implicit expenditure which in many cases seriously weakens the income position and balance sheet of central banks.

Support of financial institutions

It is common for central banks to assist financial institutions in difficulty by injecting capital or lending at subsidized rates (for instance, to development banks), assuming their liabilities, or taking over some of their nonperforming assets on nonmarket terms. The subsidy element would be reflected in the income position of the central bank.

Foreign exchange subsidies

Foreign exchange subsidies on particular types of transactions such as essential imports or debt service payments are often provided. In the case of forward cover (exchange rate guarantees) granted on subsidized terms to enterprises for import bills or external debt service payments falling due in the future, the impact consists of revenue forgone in the current period (lower than actuarial insurance premia) and higher expenditure in the future, when the exchange rate loss cannot be covered by the insurance funds set aside earlier.

Foreign exchange swap arrangements

Central banks often acquire foreign exchange reserves from domestic commercial banks with a commitment to sell them back later at a predetermined and agreed exchange rate. Of course, the more the commercial banks perceive the exchange rate to be overvalued in comparison with market signals, the more they will be inclined to participate in such a transaction. When the foreign exchange acquired is sold to an importer at an obviously overvalued exchange rate, an implicit subsidy is involved. If the exchange rate depreciates before the swap arrangement is fully undone, the central bank then buys foreign exchange at a more depreciated exchange rate. The transfer of that foreign exchange back to the commercial banks at the earlier exchange rate leads to a swap loss which is matched by an income transfer to the commercial banks.

Foreign exchange revaluation

When the central bank revalues its positive (or negative) holdings of net foreign assets, an unrealized revaluation gain (or loss) ensues. Because this revaluation has no impact on private sector purchasing power, the usual practice is to block it separately in a revaluation account. Clearly, though, such unrealized revaluation gains or losses have significant implications. Consider, for instance, the case of a country that has had severe balance of payments difficulties which led to a negative net foreign assets position. A devaluation would involve offsetting adjustments in net foreign assets (becoming more negative) and the revaluation account (becoming more positive) on the asset side of the central bank balance sheet. This asset is obviously nonperforming, while interest accrues in domestic currency terms on larger negative net foreign assets. Recognition of the burden occasioned on the income position of the central bank by large revaluation losses, whether realized or not, is one reason why arrangements are often made to transfer unrealized revaluation losses from the central bank to the government. Such transfers would not directly affect the government deficit. However, to the extent that they involve increasing central bank net claims on the government, interest payments of the government would increase.

External debt rescheduling

Nonblocking at the central bank of public sector external debt payments falling due, but subject to rescheduling, may weaken the income position of the central bank. Assuming that current domestic interest rates are higher than foreign interest rates, and that an expected exchange rate depreciation does not cover this differential, the government may find it advantageous to assume the servicing of rescheduled obligations, although it may still try to shift the exchange risk to the central bank. To the extent that the central bank reduces the resulting excess liquidity in the banking system by selling (or buying fewer) domestic securities at higher domestic interest rates, this has an expenditure impact. The reverse argument applies when domestic interest rates are artificially low while the exchange rate is expected to depreciate; in this case, one may expect the government to rush to make payment of external obligations falling due, with the central bank inheriting the burden of servicing the rescheduled amounts and the exchange rate risk.

Other public institutions

While it is commonly recognized that central banks undertake numerous quasi-fiscal activities, many other financial and nonfinancial public institutions are also involved in such activities, and especially quasi-fiscal expenditure. Financial institutions, such as development banks, may also provide loans at below-market interest rates to priority sectors of the economy. Nonfinancial public institutions undertake quasi-fiscal expenditure, insofar as they do not operate strictly along commercial lines. In developing countries, such institutions may provide certain essential goods (especially food) and services at prices below cost-recovery levels, in order to meet social objectives. Nonfinancial public institutions may also create employment at levels higher than are justified on commercial terms, pay wages at above market-clearing levels, or provide certain goods and services to employees. The costs of attaining these noncommercial objectives could be met through explicit budgetary subsidies or transfers, and are therefore equivalent to expenditures.

Fiscal impact

Since quasi-fiscal activities are generally reflected in a public institution’s profits, if these are remitted to the government it can be argued that such activities are also reflected in the government surplus or deficit. Their impact on aggregate demand and the public sector sector’s claim on private saving are therefore also taken into account. However, the level and structure of revenues and expenditures of the public sector are misrepresented, and hence the role of the government in the economy is not clearly reflected in the data. When the net income position of a public institution turns out to be negative, there is no established mechanism through which its deficit is reflected in the government accounts, since no profit transfer occurs. As a result, the government surplus or deficit does not reflect the impact of its activities on aggregate demand or on savings flows in the economy. Moreover, even if profit transfers occur, numerous methodological issues arise in assessing whether the true impact of a public institution’s activities has been adequately consolidated into the public sector accounts. These issues relate to differences in accounting practices between public institutions, which are likely to calculate profit transfers on an accrual basis, and general government, which generally uses cash-based accounting systems. To the extent that the profit transfer of a public institution differs from its cash surplus in a given year, the economic impact of its activities will not be correctly gauged.

Contingent and Conjectural Liabilities

While conventional accounting methodologies can be modified in a fairly straightforward manner to account for quasi-fiscal expenditures, it is more difficult to modify these procedures to account appropriately for noncash policies. Contingent policies, such as loan guarantees, deposit insurance, and social security, commit a public agency (or the government) to a potential future cash flow. In other words, in comparison to a noncontingent liability (such as interest-bearing debt), the contractual obligation of the government for a contingent liability is dependent, in its timing and amount, on the occurrence of some discrete event. From an income statement point of view, contingent liabilities do not appear when the obligation is incurred, but rather only when the actual expenditure is made. Nonetheless, such transactions expose the government, directly or indirectly, to potential expenditures that should be reflected on the public sector’s balance sheet. In practice, however, most contingent liabilities are not treated as potential liabilities, and are de facto treated as “off-balance sheet” activities.

Whether on- or off-balance sheet, the provision of such contingent claims to the private sector can affect economic behavior—especially if the claims are valued by the private sector more highly than any fees or charges levied in exchange for their provision. Thus, the conventional practice of accounting for expenditures only when a cash outlay is incurred may seriously understate the government’s current fiscal impact. Moreover, when such liabilities are not carefully monitored (and put “on balance sheet”), it may be difficult to control public finances.

Unlike contingent liabilities, which are explicit in nature, conjectural liabilities are implicit in nature, and are not in general enforceable. Conjectural liabilities may, however, affect economic behavior substantially. Examples include provision of relief in the event of a natural disaster, or the saving of a bankrupt financial or nonfinancial private institution (such as a large bank or manufacturing firm) in instances where the potential consequences are deemed too large not to intervene. While not legally callable, the perception that such guarantees or insurance exist can fundamentally alter private sector economic behavior. For example, if it is expected that the government will provide relief in the event of a natural disaster, individuals may make inappropriate location, insurance, and savings decisions. In cases where public institutions are assumed to be backed up by the full faith and credit of the government, the private sector may extend loans to them on preferential terms. Finally, large private institutions, especially banks, may undertake more risky business activities if it is perceived that the government will ultimately be forced to rescue them from insolvency.

Country Illustrations

Social expenditure by the central bank of the Islamic Republic of Iran

Conditioned in part by the exigencies of the civil and economic dislocation resulting from the revolution and war, the Central Bank of the Islamic Republic of Iran has administered a multiple exchange rate system since the early 1980s which effectively acts as an export tax scheme coupled with a social expenditure policy. Under the system, oil is exported at an exchange rate of rials 70 per U.S. dollar, while government imports of certain essential foods, consumer, and capital goods are valued at the same rate. This rate compares to an officially sanctioned free market rate of about rials 1,400 per U.S. dollar at end-1990. In essence, the central bank uses the official exchange rate as an instrument of resource taxation and of subsidization of essential commodities—rather than as an instrument of macroeconomic management. Analysis of central government fiscal operations is also complicated by the quasi-fiscal operations of the central bank—because public sector revenues are understated by the amount of the implicit subsidies. While estimates for the full set of implicit taxes and subsidies under the current multiple exchange rate system are not available, an analysis of central bank operations reveals that the cost of implicitly subsidizing 13 essential consumer commodities (sugar, chicken, eggs, tea, cheese, butter, vegetable oil, lamb, beef, rice, wheat, detergent, and soap) amounted to rials 1, 579.3 billion in 1990/91 (or about 4.3 percent of GDP) calculated on the basis of a notional equilibrium unified exchange rate. The budgetization of these activities would not, ceteris paribus, affect the overall fiscal balance of the consolidated public sector, and would allow the central bank to use the exchange rate as an instrument of macroeconomic management.

Deposit insurance in the United States

The provision of deposit insurance to savings and loan institutions represents a major contingent liability on the part of the U.S. government. The Federal Savings and Loan Insurance Corporation (FSLIC) was created in 1934 to insure the deposits of savings and loan institutions, and was intended to create depositor confidence and to prevent runs on S & Ls. For nearly 50 years, until about 1980, such federal insurance operated successfully, with relatively few S & L failures and no runs. As a result, the liabilities were never called, and hence general budgetary support for the operations of the FSLIC was never needed.

Beginning in the 1980s, however, the situation began to change. Because S & Ls held mainly long-term fixed assets (such as mortgages), deregulation of interest rates in an inflationary environment had adverse financial implications on the profitability of the industry as a whole. High and rising interest rates increased the costs of attracting deposits, and also created capital losses on the existing portfolio of assets. Together, these were enough to wipe out the net worth of many S & Ls. Numerous S & Ls failed, requiring the FSLIC to compensate depositors. Since insurance premia charged by the FSLIC were not actuarially rated, reserves were not sufficient to cover these costs. Once it became evident that reserves would be exhausted, the contingent liabilities of the government, extended through the FSLIC, were called, and hence the costs of cleaning up the S & L crisis were placed “on-budget.” Currently it is estimated that the total (net) costs of meeting called deposit insurance obligations will reach nearly US$500 billion (at 1991 prices). While the liabilities of the government were accruing over a fairly lengthy period of time, the actual cash outlays and financing needs will be condensed into a fairly short time period.


    Robinson,David J., and Peter Stella, “Amalgamating Central Bank and Fiscal Deficits,” in Measurement of Fiscal Impact, Occasional Paper No. 59, ed. by MarioI. Blejer and Ke-young Chu (Washington: International Monetary Fund, 1988).

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    Towe, Christopher M., “The Budgetary Control and Fiscal Impact of Government Contingent Liabilities,” IMF Staff Papers, 38 (Washington, International Monetary Fund, 1991).

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