At a time state governments are facing increasing fiscal pressures due to mounting pandemic related expenditure demands amid falling revenue collections, the International Monetary Fund (IMF) has advocated states such as Tamil Nadu should build contingency reserves to meet unforeseen expenditure demands.

‘A contingency reserve or planning margin could be established for new initiatives to provide flexibility. A Tamil Nadu Contingency Fund of Rs 1.5 billion, or less than 0.1% of total expenditure, already exists in the budget. Although this fund may handle some limited unforeseen expenditure, it is not appropriate for substantial policy priorities that emerge during the fiscal year,’ IMF said in a report on ‘Modernising budget formulation and managing fiscal risks’ of Tamil Nadu. The report was published Friday.

The IMF said an adequate contingency reserve would amount to 2 per cent or 3 per cent of total expenditure. “Its rules of engagement should be carefully designed so that allocating the contingency reserves does not turn into an alternative budget preparation exercise,” it said in the report.

A contingency reserve is a mechanism to address uncertainties, linked with fiscal risks, during execution of the prepared budget for the year. IMF said it can take several forms. In many countries, it is an unallocated appropriation in the annual budget law. In other countries, it is a fund with an appropriate amount of financing authorized under the legal framework and replenished at the beginning of each fiscal year, depending on the drawdown during the previous year.

The benefit of such an appropriation is that urgent but unforeseen needs can be met without seeking additional appropriations or having to cut spending elsewhere, which may lead to the accumulation of arrears. While the UK and Turkey have contingency reserves of less than 1% of their total expenditure, Canada (close to 2%), Russia (3%), and Philippines (8%) have much higher reserves.

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