DEBT MANAGEMENT:OBJECTIVES, COORDINATION AND ACCOUNTABILITY

Debt Management Objectives and Coordination

Objectives

The main objective of public debt management is to ensure that the government's financing needs and its payment obligations are met at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk. Prudent risk management to avoid dangerous debt structures and strategies (including monetary financing of the government's debt) is crucial, given the severe macroeconomic consequences of sovereign debt default, and the magnitude of the ensuing output losses. These costs include business and banking insolvencies as well as the diminished long-term credibility and capability of the government to mobilize domestic and foreign savings.

Governments should try to minimize expected debt servicing costs and the cost of holding liquid assets, subject to an acceptable level of risk, over a medium- to long-term horizon. Minimizing cost, while ignoring risk, should not be an objective. Transactions that appear to lower debt servicing costs often embody significant risks for the government and can limit its capacity to repay lenders. Developed countries, which typically have deep and liquid markets for their government's securities, often focus primarily on market risk, and, together with stress tests, may use sophisticated portfolio models for measuring this risk. In contrast, emerging market countries, which have only limited (if any) access to foreign capital markets and which also have relatively undeveloped domestic debt markets, should give higher priority to rollover risk. Where appropriate, debt management policies to promote the development of the domestic debt market should also be included as a prominent government objective. This objective is particularly relevant for countries where market constraints are such that short-term debt, floating rate debt, and foreign currency debt may, in the short-run at least, be the only viable alternatives to monetary financing.

Scope

Debt management should encompass the main financial obligations over which the central government exercises control. These obligations typically include both marketable debt and non-market debt, such as concessional financing obtained from bilateral and multilateral official sources. In a number of countries, the scope of debt management operations has broadened in recent years. Nevertheless, the public sector debt, which is included or excluded from the central government's mandate over debt management, will vary from country to country, depending on the nature of the political and institutional frameworks.

Domestic and foreign currency borrowings are now typically coordinated. Moreover, debt management often encompasses the oversight of liquid financial assets and potential exposures due to off-balance sheet claims on the central government, including contingent liabilities such as state guarantees. In establishing and implementing a strategy for managing the central government's debt in order to achieve its cost and risk objectives and any other sovereign debt management goals, the central government should monitor and review the potential exposures that may arise from guaranteeing the debts of sub-central governments and state-owned enterprises, and, whenever possible, be aware of the overall financial position of public- and private-sector borrowers. And, the borrowing calendars of the central and sub-central government borrowers may need to be coordinated to ensure that auctions of new issues are appropriately spaced.

Coordination with monetary and fiscal policies

Debt managers, fiscal policy advisors, and central bankers should share an understanding of the objectives of debt management, fiscal, and monetary policies given the interdependencies between their different policy instruments. Debt managers should convey to fiscal authorities their views on the costs and risks associated with government financing requirements and debt levels. Policymakers should understand the ways in which the different policy instruments operate, their potential to reinforce one another, and how policy tensions can arise. Prudent debt management, fiscal and monetary policies can reinforce one another in helping to lower the risk premia in the structure of long-term interest rates. Monetary authorities should inform the fiscal authorities of the effects of government debt levels on the achievement of their monetary objectives. Borrowing limits and sound risk management practices can help to protect the government's balance sheet from debt servicing shocks. In some cases, conflicts between debt management and monetary policies can arise owing to the different purposes---debt management focuses on the cost/risk trade-off, while monetary policy is normally directed towards achieving price stability. For example, some central banks may prefer that the government issue inflation-indexed debt or borrow in foreign currency to bolster the credibility of monetary policy. Debt managers may believe that the market for such inflation-indexed debt has not been fully developed and that foreign currency debt introduces greater risk onto the government's balance sheet. Conflicts can also arise between debt managers and fiscal authorities, for example, on the cash flows inherent in a given debt structure (e.g., issuing zero-coupon debt to transfer the debt burden to future generations). For this reason, it is important that coordination take place in the context of a clear macroeconomic framework.

Where the level of financial development allows, there should be a separation of debt management and monetary policy objectives and accountabilities. Clarity in the roles and objectives for debt management and monetary policy minimizes potential conflicts. In countries with well-developed financial markets, borrowing programs are based on the economic and fiscal projections contained in the government budget, and monetary policy is carried out independently from debt management. This helps ensure that debt management decisions are not perceived to be influenced by inside information on interest rate decisions, and avoids perceptions of conflicts of interest in market operations. A goal of cost minimization over time for the government's debt, subject to a prudent level of risk, should not be viewed as a mandate to reduce interest rates, or to influence domestic monetary conditions. Neither should the cost/risk objective be seen as a justification for the extension of low-cost central bank credit to the government, nor should monetary policy decisions be driven by debt management considerations.

Debt management, fiscal, and monetary authorities should share information on the government's current and future liquidity needs. Since monetary operations are often conducted using government debt instruments and markets, the choice of monetary instruments and operating procedures can have an impact on the functioning of government debt markets, and potentially on the financial condition of dealers in these markets. By the same token, the efficient conduct of monetary policy requires a solid understanding of the government's short- and longer-term financial flows. As a result, debt management and fiscal and monetary officials often meet to discuss a wide range of policy issues. At the operational level, debt management, fiscal, and monetary authorities generally share information on the government's current and future liquidity needs. They often coordinate their market operations so as to ensure that they are not both operating in the same market segment at the same time. Nevertheless, achieving separation between debt management and monetary policy might be more difficult in countries with less-developed financial markets, since debt management operations may have correspondingly larger effects on the level of interest rates and the functioning of the local capital market. Consideration needs to be given to the sequencing of reforms to achieve this separation.

Transparency and Accountability

As outlined in the Code of Good Practices on Transparency in Monetary and Financial Policies: Declaration of Principles (MFP Transparency Code), the case for transparency in debt management operations is based on two main premises: first, their effectiveness can be strengthened if the goals and instruments of policy are known to the public (financial markets) and if the authorities can make a credible commitment to meeting them; second, transparency can enhance good governance through greater accountability of central banks, finance ministries, and other public institutions involved in debt management.

Clarity of roles, responsibilities and objectives of financial agencies responsible for debt management

The allocation of responsibilities among the ministry of finance, the central bank, or a separate debt management agency, for debt management policy advice and for undertaking primary debt issues, secondary market arrangements, depository facilities, and clearing and settlement arrangements for trade in government securities, should be publicly disclosed. Transparency in the mandates and clear rules and procedures in the operations of the central bank and ministry of finance can help resolve conflicts between monetary and debt management policies and operations. Transparency and simplicity in debt management operations and in the design of debt instruments can also help issuers reduce transaction costs and meet their portfolio objectives. They may also reduce uncertainty among investors, lower their transaction costs, encourage greater investor participation, and over time help governments lower their debt servicing costs.

The objectives for debt management should be clearly defined and publicly disclosed, and the measures of cost and risk that are adopted should be explained. Some sovereign debt managers also publicly disclose their portfolio benchmarks for cost and risk, although this practice is not universal. Experience suggests that such disclosure enhances the credibility of the debt management program and helps achieve debt management goals. Complementary objectives, such as domestic financial market development, should also be publicly disclosed. Their relationship with the primary objective should be clearly explained.

Clear debt management objectives are essential in order to reduce uncertainty as to the government's willingness to trade off cost and risk. Unclear objectives often lead to poor decisions on how to manage the existing debt and what types of debt to issue, particularly during times of market instability, resulting in a potentially risky and expensive debt portfolio for the government and adding to its vulnerability to a crisis. Lack of clarity with respect to objectives also creates uncertainty within the financial community. This can increase government debt servicing costs because investors incur costs in attempting to monitor and interpret the government's objectives and policy framework, and may require higher risk premia because of this uncertainty.

Open process for formulating and reporting of debt management policies

Materially important aspects of debt management operations should be publicly disclosed. The Code of Good Practices on Fiscal Transparency---Declaration on Principles highlights the importance and need for a clear legal and administrative framework for debt management, including mechanisms for the coordination and management of budgetary and extrabudgetary activities.

Regulations and procedures for the primary distribution of government securities, including the auction format and rules for participation, bidding, and allocation should be clear to all participants. Rules covering the licensing of primary dealers (if engaged) and other officially designated intermediaries in government securities, including the criteria for their choice and their rights and obligations should also be publicly disclosed. Regulations and procedures covering secondary market operations in government securities should be publicly disclosed, including any intervention undertaken by the central bank as agent for the government's debt management operations.

Public availability of information on debt management policies

The public should be provided with information on the past, current, and projected budgetary activity, including its financing, and the consolidated financial position of the government. Disclosure of information on the flow and stock of government debt (if possible on a cash and accrual basis) is important. Liberalized capital markets react swiftly to new information and developments, and in the most efficient of these markets, participants react to information whether published or not. Market participants will attempt to infer information that is not disclosed, and there is probably no long-term advantage to the issuer from withholding materially important information on, for example, the estimated size and timing of new debt issuance. Most debt managers therefore regularly publish projected domestic borrowing programs. Some adhere to set patterns of new issuance, while retaining flexibility to fix the amounts and maturities of instruments that will be auctioned until one or two weeks prior to the auction.

The government should regularly publish information on the stock and composition of its debt and financial assets, including their currency, maturity, and interest rate structure. The financial position of the public sector should be regularly disclosed. Where contingent liabilities exist (for example, through explicit deposit insurance schemes sponsored by the government), information on their cost and risk aspects should be disclosed whenever possible in the public accounts. It is also important that the tax treatment of public securities be clearly disclosed when they are first issued. The objectives and fiscal costs of tax preferences, if any, for government securities should also be disclosed.

Transparency and sound policies can be seen as complements. The Code of Good Practices on Transparency in Monetary and Financial Policies: Declaration of Principles recognizes, however, that there may exist circumstances under which it may be appropriate to limit the extent of such transparency. For example, a government may not wish to publicize its pricing strategy prior to debt repurchase operations in order to avoid having prices move against it. However, in general, such limitations would be expected to apply on relatively few occasions with respect to debt management operations.

Accountability and assurances of integrity by agencies responsible for debt management

Debt management activities should be audited annually by external auditors. The accountability framework for debt management can be strengthened by public disclosure of audit reviews of debt management operations. Audits of government financial statements should be conducted regularly and publicly disclosed on a preannounced schedule, including information on the operating expenses and revenues. A national audit body, like the agency responsible for auditing government operations, should provide timely reports on the financial integrity of the central government accounts. In addition, there should be regular audits of debt managers' performance, and of systems and control procedures.

(by the IMF and the World Bank)