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«Government Cash Management: Its Interaction with Other Financial Policies Mike Williams Fiscal Affairs Department INTerNATIoNAl MoNeTAry FUND ...»

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Technical noTes and Manuals

Government Cash Management:

Its Interaction with Other Financial Policies

Mike Williams

Fiscal Affairs Department



Fiscal Affairs Department

Government Cash Management

Its Interaction with Other Financial Policies

Prepared by Mike Williams

Authorized for distribution by Carlo Cottarelli

July 2010

DISCLAIMER: This Technical Guidance Note should not be reported as representing the views of the IMF. The views expressed in this Note are those of the authors and do not necessarily represent those of the IMF or IMF policy.

JEL Classification Numbers: H62, H63, H68 Keywords: government cash management, cash management, debt management, financial policies Author’s E-Mail Address: mike.williams@mj-w.net TECHNICAL NoTEs ANd MANUALs

Government Cash Management:

Its Interaction with Other Financial Policies Mike Williams

This note1 addresses the following main issues:

• What good practice in government cash management means; and how it interacts with other policies.

• Why close coordination or integration between debt and cash management is important.

• How in practice cash managers can develop more active policies; the potential benefits of that to financial market development; and its implications for monetary policy.

• What this means for institutional structures: for debt and cash managers, and for their interaction with the central bank.

This note offers guidance on policy, institutional and practical issues for governments looking to develop a more sophisticated cash management function, specifically to move towards more active cash management.2 This involves financial market intervention by the government cash manager, with the aim of smoothing the projected short-term profile of the government’s net cash balances. The note is particularly relevant to emerging market coun- tries where there are already functioning, if not necessarily well-developed, domestic money and bond markets. It is less immediately relevant for low-income countries that are highly dependent on donor financing and concessional loans or credits, and who lack even a limited domestic financial market.3 After a brief overview of good cash management practices, the note focuses on the interac- tion between cash and debt management, which takes the discussion into the interaction of cash management with monetary policy and financial market development. After discussing Note: Mike Williams is a former Chief Executive of the UK Debt Management Office and is on the Fiscal Affairs Department roster of experts.

1This note has benefitted from comments from Ian Lienert, Israel Fainboim, Brian Olden, John Gardner, Tej Prakash, and Allison Holland (all IMF), Antonio Velandia (World Bank), and Ian Storkey (consultant).

2This note is intended as an accompaniment to Lienert (2009).

3Although cash programming and forecasting may be just as critical for these countries.

–  –  –

In this paper, references to the ministry of finance (MoF) should be taken to include the treasury functions, notwithstanding that some countries have a separate treasury department or agency. A debt management unit (DMU) may also be part of the MoF or separately constituted (e.g., as a debt management office, DMO). The DMU or DMO may perform cash management functions, although these will often be shared with the MoF.

Cash Management and Other Financial Policies Cash Management: An Overview There is a general understanding of what constitutes good practice in government cash management, as summarized in Box 1.

Box 1: Key Characteristics of Good Practice in Government Cash Management Centralization of government cash balances and establishment of a Treasury Single Account (TSA) Modern systems: an adequate transaction processing and accounting framework (processing government transactions with few handling steps, reliance on electronic transactions); modern banking, payment, and settlement systems Ability to make accurate projections of short-term cash inflows and outflows

Strong institutional interaction, covering in particular:

•   nformation  sharing  between  the  cash  managers,  revenue-collecting  agencies  and  I spending ministries (and any relevant ministry branch offices) •    trong coordination of debt and cash management S •    ormal  agreements  between the MoF  and the central bank  on information  flows and  F respective responsibilities Use of short-term instruments (treasury bills, repo and reverse repo, term deposits, etc.) to help manage balances and timing mismatches The Treasury Single Account System A TSA is a prerequisite for modern cash management. It involves the consolidation of all government cash balances into a single account, usually and preferably at the central bank. This 4Both the IMF and World Bank have stressed that poor cash management may be costly and damaging to other policies. “Results of the World Bank/IMF joint public debt management and market development technical assistance program] indicate that weak government cash management is a major impediment to public debt management and debt market development,” see introduction to Mu (2006).

| 2 Technical Notes and Manuals 10/13 2010 consolidation allows the MoF to minimize the volume of idle balances in the banking system, with consequent cost savings. These derive from the interest saved from using cash surpluses in one area of government activity to cover cash shortages in another. If cash is not consolidated, the extra cash requirement has to be financed by borrowing.

There is no best way in which the TSA interacts with the government invoice processing or payment arrangements. All expenditure transactions of the government may be approved centrally in the MoF Alternatively, line agencies may be responsible for government payments.

and they may have separate accounts in the banking system to facilitate that. The central bank (or possibly the MoF directly) may be responsible for processing receipts and payments though the local payments and interbank clearance systems, or the task may be contracted out to the banking sector. Some countries operate a hybrid system under which major receipts and payments flow directly across the TSA, but smaller transactions rely on the commercial banking system. In all these arrangements it is important that any balances left with the banking system are swept overnight back into the TSA. It is then for the government cash managers to decide to what extent any net balance should be lent back to the banking system.

The TSA usually includes multiple subaccounts, for example to maintain the distinct accounting identity or ledger of line ministries, agencies and tax departments.5 If necessary, a cash disbursement ceiling for each spending entity can be enforced against these ledgers. For cash management purposes, positive and negative balances in these accounts are netted into the main TSA operational account—the top account in a pyramid structure.6 This distinction between ledger accounts and actual bank accounts is important. The legal authority to spend of a government spending unit is not represented by actual cash. At any one time the aggregate permissions to spend may greatly exceed the cash held in the top account.

This is not a problem so long as cash is available when payments actually need to be made.

The focus here is on domestic currency accounts. A MoF may also hold foreign currency accounts at the central bank to meet its external obligations. In general this is not efficient. It is preferable for the MoF to obtain foreign currency as required, usually from the central bank (which decides whether to purchase from the market or draw on its reserves). Alternatively it may be possible for the MoF to hold foreign currency subaccounts within the TSA, which are managed as accounts fungible with domestic currency accounts.

In some countries, government balances are held outside the central bank, in a government-owned commercial bank. This model potentially weakens the MoF’s policy leverage 5Fainboim and Pattanayak (2010) list the types of bank account that may be seen as part of the TSA system. This paper explains the essential features and benefits of a TSA, elaborates alternative models and approaches for its design, and discusses the preconditions and sequencing for successful implementation of a TSA.

6In some countries, the MoF may hold a number of bank accounts at the central bank and be able to transfer cash between them. This has some of the characteristics of a TSA. However, if the transfer relies on a daily policy decision, it is likely to be much less efficient and reliable—and more subject to operational risk—than an automatic and complete netting.

–  –  –

Cash Flow Forecasting Forecasts of future cash flows are essential for more active cash management. The separation between the permission to spend and making actual cash payments means that flows through the TSA must be the focus of the forecast. Ideally, forecasts of daily cash flows across the TSA should be available for at least three months ahead. This must be coupled with an ability to monitor actual changes in the aggregate balance of the TSA top account, certainly the following morning if not closer to real time.

Good forecasting is a challenge in all countries. Forecasting systems use a variety of techniques (see Lienert, 2009), which tend to draw on both bottom-up information—the detailed information available to line ministries and tax departments—and top-down analysis—how total spending and revenue varies over time. It is important to emphasize the use made of the relevant spending or revenue departments’ knowledge. They are usually closer to the transactions than the MoF and should be monitoring expected and actual cash flows, whether income or expenditure. This requires good information networks, both personal and systemsbased. Who is best placed to pull the forecasts together is discussed further below.

Policy Interaction The TSA is the focal point of cash management policy. How cash managers interact with other functions has important implications for a range of wider financial policies. These interactions are illustrated in Figure 1.

The TSA fluctuates with cash inflows and outflows generated by taxes and expenditures and debt and other capital transactions. The first policy choice is how budget execution and payment processes interact with expenditure flows (i.e., the arrangements for expenditure approval and how that relates to the timing of expenditures). The second relates to how far the level of cash balances is a policy target. Effective targeting requires cash flow forecasts, and efficient budget execution facilitates forecast preparation. Depending on how accurately the cash balance target is met, there will be benefits to monetary policy; and how the MoF chooses to manage the target through operations in the money markets also has implications

–  –  –

Source: Williams (2009).

for both monetary policy and financial market development. These in turn bring potential benefits to debt management.

The Importance of Cash and Debt Management Coordination The importance of close coordination between these two functions is widely emphasised. It is helpful to consider the reasons.

Financing the government’s gross borrowing requirement requires choices between instruments: internal or external, short- or long-term, fixed-rate or floating-rate, retail or wholesale, and so on. Good practice dictates that these choices are made in the context of a mediumterm debt management strategy (MTDS), which sets out how the government intends the composition of the debt portfolio to develop over time, consistently with its trade-off between cost and risk.7 These strategic choices will have direct implications for the mix of shorterterm and longer-term instruments, that is, between treasury bills (T-Bills) and treasury bonds (T-Bonds).8 Decisions as to which instrument to issue, and when, should be made by the debt manager. These choices will depend on market appetite, market volatility, and interest rate prospects. In some circumstances the choice may be constrained by the overriding need to meet the fiscal deficit financing requirement, that is, the need to issue debt whatever the strategy requires. Selling T-Bills sometimes may be the only option, despite the high rollover requirement of short-term borrowing. On other occasions there may be pressures to act opportunistically to take advantage of favourable conditions and issue bonds to overfund 7See World Bank and IMF (2009).

8T-Billsare discounted instruments with maturity of one year or less: T-Bonds here includes all securities with an original maturity or more than one year.

–  –  –

Thus debt managers have to juggle the full range of instruments in making decisions about issuance. They have to trade off from day to day, week to week, and month to month, the demands of the strategy and the demands of the market.

Issuance choices, of bills and bonds, are made taking into account demand, supply, and price information.

• In relation to demand, intermediaries and/or end-investors may need a steady flow of T-Bonds to meet their obligations or shorter-term instruments for liquidity management. Their needs will change across the year with their own cash flows and market developments.

• From the supply perspective, government financing choices are made in the context of the profile of financing flows. Most countries have marked quarterly, monthly, and intra-monthly seasonal patterns of cash flows. The driver of seasonality is typically tax receipts.9 Two examples are shown in Figure 2. The pattern may be exacerbated by the in-year timing of debt redemptions. If there is an underdeveloped money market, this pattern has to be reflected in the pattern of bond issuance, which also has to be geared to bond redemptions. For prudential reasons, some countries frontload debt issuance to build a cash buffer. This is not always possible and it can be costly when the interest earned on surplus cash is much less than the cost of additional borrowing.

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