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because they reduce local investments for multiple years. 5. S hocks do not have purely external sources or origin. Instead, they respond to political incentives, can be mitigated through increased transparency, and their impact depends on states’ fiscal capacity. 6. F iscal rules and markets currently do not impose sufficient discipline on states’ finances to mitigate contingent liability shocks.
Improved Transparency and Fiscal Rules, the Disciplining Role of Markets, and Better Intergovernmental Frameworks Are Needed to Achieve Better Subnational Fiscal Outcomes in South Asia This chapter has reviewed the exposures to subnational fiscal risk across South Asia and has provided new evidence on the adverse effects of contingent liability shocks on fiscal and economic outcomes in India. It shows that contingent liability shocks occur relatively frequently, trigger fiscal adjustments, and are influenced by policy makers’ incentives as shaped by the prospects of election, transparency, fiscal rules, existing fiscal space, and the softness of budget constraints. It also shows that contingent liability shocks significantly affect local economic development: triggered contingent liabilities reduce investment in Indian states for up to four years after the shock and thus dampen local economic activity. India’s experience is illustrative for the rest of the region, especially for countries such as Pakistan, where provincial borrowing has been expanding, and for Maldives and Nepal, which have started to decentralize fiscal policy. Our analysis suggests some pathways to mitigate contingent liability shocks and the associated negative spillovers. For the pathways to be effective, policy makers must understand that the realizations of contingent liabilities are rarely exogenous events. The accrual of contingent liabilities is a policy decision that is shaped by the incentives of
The accrual of contingent liabilities is a policy decision that is shaped by the incentives of local policy makers and their abilities to manage subnational fiscal risks. local policy makers and their abilities to manage subnational fiscal risks. Broadly, our analysis has focused on four factors that influence fiscal risks. The first is transparency, which, in an electoral system, is crucial to hold policy makers accountable. The second is a legal framework, including fiscal rules—either self-imposed or imposed by the central government—that limits the ability of subnational decision makers to accrue excessive liabilities. The third is market pricing, which ensures that the debt financing cost incurred by SNGs is commensurate with the subnational fiscal risk. The fourth is fiscal capacity and its reflection in the intergovernmental framework. Based on these considerations, the discussion that follows proposes policy recommendations for governments in South Asia to achieve greater fiscal discipline.
Policy Recommendations Transparency The effect of transparency measures on the management of subnational fiscal risks may be slower but more significant and persistently positive than the other factors. Gradually, the Indian states adopted measures to improve transparency and public information on subnational debt and contingent liabilities. The positive effect of these measures took time to materialize, but when they did, the effects appeared significant and lasting. There is no reason why India’s positive experience with fiscal transparency at the subnational level could not be replicated more widely in South Asia and beyond. To increase fiscal transparency across South Asia, central and subnational governments could undertake three measures. A first step would be the adoption of accounting standards that highlight contingent liability risks when they accrue, not when they materialize,
