04 November 2011

IFAC: Sovereign debt crisis demands financial management reform by governments

The situation in Greece is only the tip of the iceberg. Sub-standard accounting, auditing, and financial management led eventually to financial reporting fraud by the Greek Government, and ultimately triggered a market reaction that revealed much more widespread financial fragility in the European public sector, evidenced by the need for bailouts and increased debt servicing costs. In Germany, the government recently disclosed an accounting error equivalent to 2.6 per cent of GDP. To put the size of that error in context, the cost of Japan’s earthquake and tsunami in early 2011 was equivalent to approximately 5 per cent of GDP. That this error was not obvious to Germany’s Ministry of Finance is indicative of the general state of government financial management. A similar, though smaller, error reported in the Irish Government’s financial statements this week corroborates this negative assessment of the state of public sector financial management.

Fiscal mismanagement in the public sector is not isolated to Europe; it is a global problem. At the core, it stems from political shortsightedness and the inadequate systems that governments use to manage public finances, in particular the use of cash-based accounts in a highly complex financial world.

As early as 2007, IFAC stated that it “is concerned that the standards and regulations governing sovereign issuers are not of sufficient quality to protect investors and ensure the stability of capital markets”. In 2011, the consequences of poor financial management in the public sector are all too apparent. Consistent with its recent submission to the G20, IFAC calls for urgent research and action to address this critical, but neglected, component of the international financial system.

IFAC recommends that work should be conducted or commissioned by the FSB, to consider the nature of institutional changes that are needed in public sector financial management to facilitate greater transparency and accountability, and to protect the public and investors in government bonds. IFAC believes the FSB should examine reformed fiscal arrangements which include:

• audited financial statements within six months of year end;
• budgeting, appropriations, and reporting on the accrual basis;
• full transparency in fiscal positions ahead of general elections, ensuring that voting is fully informed;
• independent, audited projections of fiscal position to accompany budgets; and
• limitations on deficit spending, or at least full transparency around the reasons for deficit spending and explanations of how, over an economic cycle, fiscal balance will be restored.

Press release

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