Posted by Mike Williams
Good government cash management matters. It matters not only from the fiscal and budgetary perspective of cost effectiveness and efficiency, but also because of the benefits it can bring to other financial policies—in particular to debt management, to monetary policy, and to the development of the local financial markets. This interaction between cash management and other financial policies is the focus of a new IMF Fiscal Affairs Department (FAD) .
There is a growing understanding of what constitutes good practice in government cash management. Guidance is available from FAD on the core components: the development of the Treasury Single Account (TSA) and cash flow forecasting and management. Although this TNM touches on those issues, I have written it primarily for governments and their advisers looking to develop a more sophisticated cash management function, and specifically to move towards more active cash management.
The TNM grew out of work prepared for a conference in Lima early in 2010; but it draws heavily on my own experience working as a consultant in several countries, large and small, in Asia, Africa, the Caribbean, and Europe as well as Latin America, and also my time as CEO of the UK Debt Management Office. Many European debt management units are realising the advantages of integrating—or very closely coordinating—debt and cash management decisions, and that thread runs through the TNM. There are good policy reasons for coordination: issuance decisions have to juggle the full range of instruments, across bonds and bills, trading off from day to day, week to week, and month to month, the demands of the strategy and the demands of the market, and taking account of price, demand, and supply factors. As the sophistication of market interventions develops, the need for day-to-day coordination expands; and a single government interface with the market becomes especially important.
Treasury bills are the usual instrument of choice in moving towards more active cash management and “rough tuning” (i.e., short-term borrowing and investing designed to offset the impact on the banking sector of the major seasonal flows of cash in and out of government accounts). In more developed markets repo is the instrument used for “fine tuning” (smoothing more fully all short-term fluctuations in the TSA balance at the central bank) and for borrowing and lending outside the normal Treasury bill issuance schedule.
How in practice cash managers develop these more active policies can potentially bring major benefits to financial market development; a developed money market is important both as an objective in itself and through its links to other financial markets. Cash management also interacts with monetary policy operations; it should facilitate them—if the government balances its own cash flows it will remove the main autonomous influence on domestic monetary conditions, taking weight off the central bank’s own interventions. There can, however, be strains between cash management and monetary policy when the central bank does not have sufficient means (i.e., collateral) to mop up excess domestic liquidity. In the TNM, I have discussed some of the ways of handling this problem, and avoiding as well the risks to market development of co-existing Treasury bills and central bank bills.
In any event there are important areas of operational coordination between cash managers and the central bank, particularly in relation to information flows. Best practice is that the bank should pay market-related interest rates on the TSA balance and any other government’s deposits.
These policy interactions need to be reflected in institutional structures for debt and cash management, and for their interaction with the central bank. The priorities of the traditional cash management unit, which is usually part of the treasury department of the ministry of finance (MoF), have historically been seen as narrow: ensuring that the government is able to meet its financial obligations at all times, that the budget is executed smoothly, and that cash outlays are kept in line with cash availability. But the broader definition of modern cash management, and the scope for wider policy and financial benefits, brings into focus the benefits from closer institutional integration of debt and cash management functions.
An integrated debt and cash management unit has the same front, middle, and back office structure as a conventional debt management unit. The front office workload is potentially greater, particularly as the number of daily market transactions increases with more active cash management. This in turn requires effective systems to process transactions and to access market data. The main continuing requirement is to refine short-term cash flow forecasting capability. Although there is no single model, there is often a difference between the compilation of “above the line” (i.e., revenue and expenditure) forecasts, which may fall to those monitoring budget execution, and projections of “below the line” transactions (debt and other financing operations) where the cash and debt managers may be better placed. In the TNM I have also touched on database requirements: most countries develop databases for cash flow forecasts that are separate from the main financial management information system of the government. This reflects their different purposes. Cash flow data are needed to support immediate operational decisions, and do not have to be of “accounting” quality or precision, but the databases have to be flexible and under the control of the cash managers.
The other institutional dimension discussed is the relationship between the MoF and the central bank. Despite the scope for mutual benefit, the potential for tension between the MoF and the central bank makes it important to put arrangements in place that address the legitimate concerns over possible interactions. These concerns can be handled on three levels: the overall relationship needs to be clarified at a policy level; the more operational interactions would normally be covered by a memorandum of understanding; and the services supplied by the central bank should be covered by some form of “service level agreement” to clarify expectations on both sides.
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