Aim High to Achieve High Essay

Cash Management Framework and its Integration with Debt Management Professional Development Seminar on Debt Management December 10, 2008 Sailendra Pattanayak and Brian Olden, FAD Overview Definitions of Cash Management Outline of a modern cash management framework Cash rationing vs. cash management Benefits of an efficient cash management system Prerequisites for effective cash management Banking and payment arrangements Cash forecasting Institutional framework Managing cash balances-the basic requirements Issues surrounding integration of cash and debt management Discussion on appropriate institutional framework

Some definitions of cash management The strategy and associated processes for managing cost-effectively the government’s short-term cash flows and cash balances, both within government, and between government and other sectors. (Williams 2004) Having the right money in the right place at the right time to meet the government’s obligations in the most cost-effective way. (Storkey 2001) Cash management framework Banks y Pa m s nt e Spending units s ue en ev R Treasury system Debt management Central bank Monetary policy Cash manager Financial markets dev. Short-term Investments Short-term Borrowings

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Main building blocks for cash management Control over receipts and expenditures. Forecasting cash requirements. Managing government cash balances – surpluses/deficits. Cash rationing (misnomer cash budgeting) Last resort liquidity management Limits ability to commit until sufficient funds are available (delays implementation) No forward cash planning Disruptive to programs, vendors High corruption potential Need transparent ex ante rules Public procedure Likely to undermine budget priorities Benefits of efficient cash management Ensure obligations can be met as they fall due Minimize idle balances and associated costs

Conduct cost-effective borrowing operations Contributes to development of short-term money markets Reduce liquidity impact from budget deficits/surpluses Separation of cash management from monetary policy Enhanced transparency of government flows Common issues in transition and developing countries/LICs Budget execution focused on compliance with annual budget law rather than efficiency of resources. Fragmented treasury system with many separate bank accounts-both in commercial banks and CB. Cash rationing is the main expenditure control system-creates uncertainty of resource availability for BI’s.

Spending units not concerned with borrowing costs. Daily cash needs met by the central bank-less of an issue with EU applicant countries due to prohibition on CB borrowing. Liquidity managed for monetary policy purposes. Prerequisites for cash management Awareness within the government of the opportunity cost of money Consolidation of government cash balances in a TSA Fund and accounting controls through treasury ledger system Developed expenditure and commitment controls Well developed cash planning and forecasting function Efficient payment system to sustain cash balances at optimum level Such as centralized payments processing

Prerequisites for cash management – contd. Realistic budget Adequate accounting framework Tailor-made cash forecasting modules can be part of IFMIS, whose accounting module can provide daily data on inflows and outflows. Access to financial markets and use of modern instruments for cash management Cash management separated from, but linked to, monetary policy Integration of cash and debt management Single Treasury Account All revenues and expenditures go through TSA The consolidation of government cash resources through a TSA should be comprehensive Budget institutions (BI’s) do not have separate bank accounts.

BI’s transactions managed through the treasury ledger system Where transactional accounts are necessary, balances are swept up into TSA periodically (preferably daily) All monies seen as fungible to prevent inefficient use of public cash resources. The cash balance in the TSA is maintained at a level sufficient to meet daily operational requirements of the government Advantages of a TSA Provides complete, real time, information about government funds Helps preparation of accurate and reliable cash flow forecasts Facilitates effective reconciliation between the government accounting systems and cash low statements Serves to ensure transparency and reduce need for extra budgetary funds Improves operational and appropriation control during budget execution Reduces the uncertainty about the cash reserves for liquidity management purposes, and the volatility of the cash flows Facilitates efficient payment mechanisms Requirements for an efficient TSA Political support is essential (such as for closure of agency a/cs) Legal and regulatory requirements E. g. authority to open bank accounts should vest with the MoF/Treasury Technological requirements

Adequate transaction clearing and inter-bank settlement systems Development of an RTGS at the CB for high value transactions Major commercial banks and treasury connected to the RTGS Framework agreements between the Treasury, TSA Bank (CB) and Banks providing retail banking services Revisiting the chart of accounts for coverage of non-bank expenditure transactions Capacity development of TSA users Reasons For TSA To Reside At Central Bank Safe haven for government cash deposit. Aids the efficient management of liquidity in the economy. Cost effective banking arrangements.

No better alternative for economies in transition Although not confined to developing or transition economies Different Models for TSA Operations There are a number of models: Use commercial bank branch networks to channel funds to/from regional treasury offices to the TSA at CB Use regional branches of the CB where a reliable commercial branch network is not available Regional treasury offices act as banks (only recommended where the commercial banking sector is regarded as too unstable) Use commercial banks branch network to clear funds directly between TSA and taxpayers/suppliers

TSA Structure – Option 1 State Treasury Head Office Settlement Reconc . Central Bank Limited Treasury communication and information systems State Treasury Regional office Payment order Central Bank Regional branch Settlement State Treasury Local office Budget unit Payment order TSA Structure – Option 2 State Treasury Head Office Settlement Reconc. Central Bank State Treasury Regional office (2a) Advanced Treasury communication and information systems State Treasury Local office Budget unit Payment order TSA Structure – Option 3

Reconc. Central Bank Settlement State Treasury Head Office Commercial Bank Head Office Very Reliable and Advanced Commercial Bank Sector Commercial Bank Regional Branch Payment Order Budget Unit Management of Cash Balances of TSA Define separate pools of funds within TSA system, for instance: Liquidity Deposit Investment Differentiation based on liquidity needs, level of uncertainty, costs of alternative sources, etc. Select instruments that match expected cash needs Integrated management of assets and liabilities.

Transparent and efficient pricing of assets, liabilities and services! Key elements of a Cash Management Framework Annual plan, 3-month rolling projections, monthly operational plan, and frequent forecasts A good cash forecasting system should provide for daily forecasts that are updated frequently A team led by official with authority to collect information from various departments Plan prepared by competent staff and based on a realistic budget, following clear funds release procedures and budget execution rules Key Relationships

Debt and cash manager Managing daily cash flows Borrowing to meet short/medium term needs Investing surplus assets Encouraging strong secondary market in government securities Central Bank Government’s banker Manages monetary policy Ministry of Finance Overseeing tax and spending Forecasting fiscal position and daily cash flows Sets debt and cash management policy Cash Management Unit – Functions Coordinate submission of monthly cash flow projections by budget institutions (spending units and revenue agencies) Prepare (consolidated) cash flow projections on a rolling basis Monitor cash inflow/ outflow outturns and dentify seasonal/monthly patterns Monitor major receipts and payments and the daily cash position, including government bank balances Prepare and analyse revenue / expenditure reports and update cash projections as appropriate Make proposals to Exchequer / Liquidity Committee for adjusting cash flows as the need arises Keep the central bank fully informed of projected cash flows Core elements of cash planning Comprehensive information network Regular, reliable estimates of future cash flows Determine and implement strategy for matching cash flows with fiscal operations plan, e. g. elay commitments speed up revenue mobilization borrow from the market (short or long-term) invest surplus balances optimally (short or long-term) Review and update financial plans refine forecasting techniques/set performance targets Cash Forecast and Balances 1 2 3 4 5 6 7 8 9 10 11 12 Revenues Central Forecasts Spending Agency Financial Plans/Allotments Balance Arrears Overcommmitment Random revenue shocks Annual predictable pattern Seasonal revenue fluctuation, spending patterns Structural revenue fluctuation, spending patterns Corrective Measures: Smoothing cash flows Cash Balance Structural: 1.

Budget retrenchment 2. Long-term debt 3. Allow commitment/spending only if revenues actually received 4. Contingent liability management 5. Comprehensiveness 6. Commitment controls Seasonal: 1. Keep allotments or commitments below revenue, build balances 2. Short-term debt 3. Limit cash payments to cash balances (arrears) 4. Accelerate receivables collection Managing Cash Balances Need to develop instruments to manage cash surpluses and deficits. Main financial instruments T-Bills Repo’s/reverse repo’s Short-term facilities with commercial banks Deposits-term and overnight With CB and with commercial banks

Access to Liquidity at short notice for unanticipated cash calls Impact on domestic financial markets will be relevant (large stocks or flows) Coordination with monetary authorities essential Obstacles to Managing Cash Balances Underdeveloped domestic financial markets-particularly money markets Lack of confidence in domestic banking system Absence of sound, efficient clearing and settlement systems Hugely improved in most transition countries over last 5 years Underdeveloped legal, judicial and regulatory infrastructures Untested standardized master repurchase agreements and other collateralization contracts

Although in place in many countries may not have been fully tested under national legal framework Integration of Cash and Debt Management Definition of Public Debt Management The process of establishing and executing a strategy for managing the government’s debt in order to raise the required amount of funding, meet its cost and risk objectives, and to meet any other debt management goals the government may have set, such as developing and maintaining an efficient and liquid market for government securities. * * Source: WB/IMF Debt Management Guidelines Issues surrounding debt and cash management

Debt management often regarded as a stand alone function. Goals and objectives of debt management formulated on the basis of the debt portfolio. Little emphasis on impact of debt management decisions on other aspects of PFM and in particular cash management. Fragmentation of responsibility for debt issuance and cash management. Institutional structure can lead to a situation where debt and cash management units competing with each other for market access. Lack of integration of debt management systems with other PFM and cash management related systems. Issues surrounding debt and cash management

Increased operational and liquidity risks if cash and debt management not integrated. Integration of cash and debt management under a separate institutional framework can create problems as well: Can lead to separation of cash management from budget execution. Can hamper co-ordination with monetary and fiscal policy. Although important to consider these issues integration benefits outweigh the potential risks. Integration focuses activities on common objectives Integrated cash and debt management should ensure common objectives in relation to efficient management of asset and liability positions

Have been situations in some countries where lack of communication between cash and debt units has led to over/under issuance in times of surplus/deficit. Risk management carried out on an financial asset and liability basis rather than focusing solely on debt portfolio. Also ensures that most cost effective instruments used to fund short- and long–term issuance objectives. Operational advantages of integration Scarce resources in government sector argue for the creation of a single financial manager for government. Typically staff with experience of financial markets not easy to attract and retain in the public sector.

Therefore advantage of maintaining a single well-trained professional staff for both cash and debt management. Important in every aspect including staff dealing with market transactions, analysis and transaction processing. Many of the operational and transaction processes are similar-necessitates only one processing center. Greater integration leads to better integration of IT systems and data on cash and debt positions. What is meant by integration of debt and cash management What is the appropriate institutional framework? Should cashflow forecasting be carried out by a DMO?

In some countries the DMO produces cash forecasts or further refines forecasts received from other institutional units such as the Treasury. In other countries it is left to the MOF to produce and communicate with Treasury. Who is responsible for determining the borrowing requirement? Although the deficit level is a policy decision the DMO is usually granted flexibility to fund this deficit as it sees fit. What is meant by integration of debt and cash management Who is responsible for financing decisions? Depends on the level of autonomy of the DMO. Delegated authority usually appropriate for fast decision making.

In countries with developed cash and debt management capacity delegated authority is a necessity to permit management to access market opportunities at short-notice without having to refer to cabinet to the minister for every decision. How to ensure linkages between cash management and budget execution Important to ensure good communication links with budget participants and revenue forecasters particularly if a separate DMO being considered. Institutional Arrangements Issues to Consider DMO’s increasingly adding cash and asset management functions –DMO not the only model.

Who should be responsible for the different elements of cash planning and management-should one institution be responsible or should it be shared across different institutions or units? Does the need to integrate cash and debt management in a separate Institutional model outweigh need for integration with other PFM functions? Institutional Arrangements Issues to Consider Institutional model is country specific. Good liaison and sharing data/information across organization boundaries is critical. Cash forecasting: MoF, BIs, revenue agency, treasury etc Active Debt and Cash Management – Monetary agency, possibly sub-national government


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