Posted by Yasemin Hurcan, Fatos Koc, and Emre Balibek[1]
The COVID-19 pandemic is posing many challenges for the economy and PFM systems. Governments face the dilemma of finding additional resources to meet increased spending both on health and fiscal stimulus packages. At the same time, revenue collection is decreasing or delayed as the recession kicks in. In the immediate future, liquidity management will be critical to enable governments to meet their extended obligations.
Cash and debt management offices around the world are now facing a number of challenges including: (i) unexpected increases in borrowing needs; (ii) significant market volatility; (iii) increasing operational risks due to safety and health risks in workplaces; and (iv) increasing volatility in government cash flows and balances. These challenges highlight the importance of accessing liquidity as quickly as possible to manage unanticipated cash flows. Tools or safety nets that governments can use to manage cash flow and provide liquidity include increased issuance of short-term treasury bills (T-bills) in financial markets, contingency credit/repo lines from commercial banks, and overdraft facilities from central banks.
Given the limitations for raising short-term financing under market stress conditions, as observed during the Global Financial Crisis, several governments have built “cash buffers” that can help them mitigate short-term liquidity needs. Many OECD countries, including the United States, Canada, Portugal, Hungary, and Greece, have adopted cash buffer policies that include maintaining a targeted level of liquid financial assets available for use at all times (Cruz and Koc, 2018). The main objective of keeping cash buffers is to support governments cash and debt management by providing a cash cushion against liquidity and refunding risks arising from unanticipated volatility in cash flows, errors in cash forecasting and temporary loss of access to funding. Drawdown of these cash buffers helps governments meet additional funding needs until long-term financing can be secured. Many governments may need to adjust the size and timing of their borrowing programs, the instruments offered and the issuance techniques. These revisions require a certain timeframe for decision making, approval processes, and market communication. A sufficiently large cash buffer can help the government meet its financing needs within this timeframe.
Governments may also want to revise their cash buffer polices as a risk management tool to address COVID-19 challenges. This will require an understanding of how the crisis will impact the cash flow and cash balance positions of governments. New expenditure measures will have to be translated into cash flow forecasts, while revenue forecasts will need to be adjusted for the expected fall in economic activity. Debt managers will have to review the market situation. Depending on these revised cash flow forecasts, cash managers will have to analyze how much can be drawn from the cash buffer, and over what period. The spending and cash plans of governments may need to be revised to make room for healthcare and other high priority spending items.
Once initial liquidity needs are met, the target cash buffer level should be reviewed. Countries without a cash buffer may choose to assess whether a cash buffer policy is needed, whether it can be funded and, if so, calculate the right size of the buffer.
There is no one-size-fits-all arithmetical technique to determine the right size. The “optimal” level often reflects a government’s overall risk management objectives in managing cash and debt. The size of a buffer therefore be determined by country-specific factors. These factors include the volatility of daily cash flows, the reliability of cash forecasts, the scope for managing unanticipated fluctuations, and the availability of other safety nets. The optimal level varies considerably depending on a country’s financial maturity, economic flexibility, and access to financial markets. Simple rules of thumb, based on total gross or net cash outflows, or the proportion of debt service over a specified period can also be used.[1]
In some countries, legal constraints (e.g. a debt rule or an annual borrowing limit) may restrict the amounts of financing that can be raised for building a cash buffer. In such cases, once a decision is taken to change the cash buffer policy, the legal framework may also need to be amended.
Public disclosure of a cash buffer policy can have a positive signaling effect on market participants and the general public. This has been observed in many countries including Denmark, Greece, Portugal and Italy. However, policy makers need to be mindful of the volatility of cash flows through government bank accounts due to seasonal and other factors. For this reason, some countries using cash buffers have decided to disclose general information about their policies, without providing details of the actual and target level of these buffers.
[1] Hurcan, Koc, Balibek (forthcoming) discuss some practical methods of analyzing the required level of cash buffers.
This article is part of a series related to the Coronavirus Crisis. All of our articles covering the topic can be found on our PFM Blog Coronavirus Articles page.
[1] Yasemin Hurcan and Emre Balibek are Senior Economists in the IMF’s Fiscal Affairs Department. Fatos Koc is a Senior Policy Analyst with the OECD (see OECD page on Public Debt Management).
[2] Hurcan, Koc, Balibek (forthcoming) discusses some practical methods of analyzing the required level of cash buffers.
Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.
