# **1. Introduction**

Contingent liabilities are obligations that emerge only upon the materialization of an uncertain event. The uncertainty surrounding the timing and the magnitude of the event are both factors outside the control of the government and have the potential to create unexpected pressures on government finances.<sup>2</sup> To avoid unnecessary adjustments in an unplanned and/or untimely manner during the fiscal year, governments need to identify, measure, and manage risks from contingent liabilities. In many countries, the energy sector is one of the key sources of risk exposure of the government. The energy sector generates significant investment needs and is expensive to finance. Therefore, governments sometimes choose to provide guarantees to entities responsible for undertaking investments for the generation, transmission, and distribution of energy to help them become profitable or sustainable. Also, energy utilities are often owned by the government. All of this is true in South Africa where the energy sector is dominated by Eskom, a state‐owned and vertically‐integrated electric utility. Additionally, there are independent power producers (IPPs) that are increasingly becoming important actors in generating electricity from renewable sources. Eskom has entered into power purchase agreements (PPAs) with these IPPs.

The objective of this note is to illustrate credit risk assessment practices explored in South Africa and provide guidance to risk managers in other countries. The work presented in this note draws on the activities of a project carried out by the World Bank Treasury<sup>3</sup> in collaboration with the National Treasury of South Africa (NTSA) for assessing and managing the contingent liabilities of the Government of South Africa stemming from Eskom’s guaranteed debt portfolio. The main counterpart of the project is the Credit Risk Directorate of the Asset and Liability Management (ALM) division in NTSA. The project is part of the Government Debt and Risk Management program which aims to provide assistance to middle‐income countries to improve macroeconomic and fiscal management by reducing vulnerability to financial and other shocks.<sup>4</sup> This note draws on a framework for risk assessment and management presented in a World Bank policy research working paper on contingent liabilities risk management (Bachmair, 2016). The four steps outlined in the paper are highlighted and extended, with an emphasis on sections related to credit risk analysis and quantification. This note may be considered an extension of the working paper and provides a more focused country case for South Africa.

While the focus of the paper is on explicit guarantees, i.e. contractual obligations signed by the sovereign, the methodology could easily be extended to implicit guarantees, since the underlying credit

> 2 For South Africa, Bachmair and Bogoev (2018) assessed contingent liabilities and their impact on debt dynamics. The realization of contingent liabilities may increase government debt by 0.6 to 0.8 percent annually over the next years.

> 3 The project was supported under the Government Debt and Risk Management (GDRM) program: http://treasury.worldbank.org/bdm/htm/GDRMProgram.html

> 4 The Government Debt and Risk Management program is financed by the Swiss State Secretariat for Economic Affairs and covers projects in 15 other countries. More information on the program can be found at: http://treasury.worldbank.org/bdm/htm/GDRMProgram.html.

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