The activities of public corporations can pose significant fiscal risks to governments. These risks can arise not only from explicit and implicit contingent liabilities (such as guaranteed and non-guaranteed debt) but also from the impairment of assets (for example, in the form of on-lent loans).
Governments should assess and quantify such risks in order to reduce them. Doing so can improve fiscal policy—by enabling governments to compare the merits of alternative policy measures and their impact on fiscal sustainability while also improving the monitoring of policy implementation.
Guaranteed, on-lent, and non-guaranteed debt of public corporations expose governments to credit risk. Credit risk, in this context, refers to the risk that systemically important public corporations fail to meet their financial obligations in accordance with agreed terms, obligating the government to step in to service their debt. To assess such risk, one methodology is to develop credit ratings—risk rankings that are usually expressed as letters, numbers, or a combination of both.
The World Bank has developed a technical assistance (TA) package to assist governments in improving the management of explicit and implicit contingent liabilities from public corporations. It includes an evaluation of the credit risk that accrues to the central government when public corporation fails to meet its financial obligations to lenders. This evaluation is facilitated by the Credit Rating Tool to Assess and Quantify Credit Risk from Public Corporations. The tool involves scoring risk factors and aggregating the scores into a credit rating.
This note provides detailed guidance on the use of the credit-rating tool and expands on the key concepts underlying the adopted methodology. The guidance sections describe the required inputs, assumptions, analyses, and outputs. The theoretical section defines the credit-rating approach, shares international examples in its application, compares it with alternative methodologies, and discusses the rating process.
Users can apply the analytical tool to various situations—and use it to inform policy decisions with respect to individual transactions, as well as to portfolio-based analysis. Key applications for a sovereign risk manager may include the following:
- Supporting decisions related to new guaranteed or non-guaranteed debt, such as their issuance or the setting of risk-based guarantee fees or limits.
- Informing a government’s financial oversight of individual public corporations (including the quantification of explicit and implicit contingent liabilities).