The Challenges of Efficient Government Cash Management Gemloc Peer - - PowerPoint PPT Presentation

The Challenges of Efficient Government Cash Management

Gemloc Peer Group Discussion March 2013 Mike Williams mike.williams@mj-w.net

Cash management – what it is and the characteristics of good practice The development process…

• The Treasury Single Account
• Cash flow Forecasting
• Rough Tuning
• Fine Tuning

…and the challenges faced by countries at different phases of this process

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Today’s Discussion

To Recall the Objectives of Cash Management….

Economising on cash within government

• Saving costs
• Reducing risk

Managing efficiently the government’s aggregate short-term cash flow

• Both cash deficits and cash surpluses

In such a way as also to benefit

• Debt management
• Monetary policy
• Financial markets (market liquidity and infrastructure)

Ensuring cash is available to meet commitments Overriding objective – other objectives must be subject to it But other objectives are important

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Approaches to Cash Management

Traditional (Passive) Approach

• Essentially passive
• Monitoring cash balances,

maintaining cash buffer to handle both volatility and unanticipated outflows

• If necessary restraining /

slowing expenditures or delaying bill payments - cash “rationing” not cash management Modern (Active) Approach

• Managing cash more actively
• Trying to smooth weekly or daily

cash flow by more active borrowing and lending in money market

• Allows lower average cash buffer

– with benefits to other policies

• Gives tools to protect

expenditure plans from cash flow volatility

Cash management is: “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.” Most OECD and many middle income countries

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The Policy Challenges are Inter-related…

Cash Balance (TSA)

Tax etc inflows Expenditure etc outflows

• 1. Budget

Execution

• 2. Targeting

Balances

Debt redemptions, less capital receipts Debt issuance

• 6. Debt Management

Policy (and Gov Balance Sheet)

• 4. Cash Flow

Management in Money Market

• 3. Monetary

Policy

• 5. Market

Development Cash Flow Forecasting

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• 1. Efficient internal payment processing
• A minimum of intermediate handling steps
• Increased reliance on electronic transactions
• 2. Account aggregation and minimisation of idle

balances

• Minimising the level of idle balances held by other government

bodies

• A MoF account at the central bank (i.e. the TSA)
• All government cash balances are held in the central bank
• vernight. (Variety of techniques including ZBAs)
• 3. Internal systems to forecast receipts and payments,

and hence the MoF’s account at the central bank

• Forecasts of future changes in the TSA to devise the strategies that

would have the effect of smoothing those changes.

Characteristics of Good International Practice - 1

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Characteristics of good international practice - 2

• 4. Agreements between the MoF and central bank covering:
• The flow of forecast information from the MoF
• Information from the central bank on actual changes in the TSA balance
• How MoF’s operations interact with the bank’s monetary policy operations
• Remuneration, of the balance, preferably at a market-related interest rate.
• 5. Integration of (or at least co-ordination between) government

debt and cash management functions

• Allows debt decisions to be taken in the context of government’s cash flows
• Ensures management of government cash flows supports debt

management

• 6. The use of short-term borrowing instruments to help manage

the timing mismatch between inflows and outflows

• Most countries use Treasury bills; some also use repo and reverse repo
• 7. Efficient infrastructure for payment and settlement, with

securities typically being held in dematerialised form

Characteristics of Good International Practice - 2

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Cash Management is a Project

Most of the actions are for the Treasury function to take forward, with support as necessary from others in MoF But effective cash management also needs:

• A supportive central bank (CB)
• Competent finance functions in spending units (SUs) and the tax

administration to supply good cash flow forecasts – and see that as part of their responsibilities

• A flexible banking system and a developed money market.

Development of cash management is therefore best thought of as a project

• Dependencies, bottlenecks and a need to prioritise
• Needs also to link with money market development

4 streams of work

• Within MoF; with SUs and Tax admin; with CB; and with market

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Typical Phases of Development

Phase 1: Treasury Single Account

• integration of government accounts
• sweeping of overnight balances into single MoF account at central bank

Phase 2: Forecasting capability

• the development of a capability within MoF to monitor and forecast flows in

and out of government – i.e. changes in MoF balances at central bank

Phase 3: Rough tuning

• the issue of Treasury bills (or other instruments) – in a pattern designed to
• ffset the liquidity impact of net daily cash flows, i.e. to smooth the change

in MoF’s balance at the central bank

• separate management of structural surpluses

Phase 4: Fine tuning

• more active policies, drawing on a wider range of instruments or institutional
• ptions, to smooth more fully MoF’s balance at central bank

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The Treasury Single Account

Aggregate all Government cash balances in TSA at CB

• Facilitates monitoring and control, also fiscal and financial

planning.

• Allows Treasury to minimise the volume of idle balances in the

banking system with consequent cost savings

TSA can work with variety of payments systems

• Payments approvals centralised in MoF/ Treasury or dispersed

to spending agencies

• Processing of payments centralised within MoF/ Treasury/

Central Bank or dispersed to the banking sector

Any balances left with the banking system should be swept overnight back into the TSA – next slide

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TSA Mechanisms

Subsidiary accounts can be notional (ledger accounts)

• Still able to track, account for, and report on specific flows
• Can maintain distinct accounting identity of spending units or extra-

budgetary funds (EBFs); allow separate legal entities to retain self- generated funds; (or ring-fence donor funds)

All cash should be in TSA overnight

• Mechanism depends on whether centralised or dispersed payment

authority

• Zero Balance Accounts (ZBAs)

– Sweeping cash – Disbursement or credit limit – can be enforced against ledger accounts – “Just in time” transfers

Also depends on

• Technological development of banking sector and government,

including information systems and reliable communications network

• Internal accounting arrangements (and incentives) to minimise level
• f idle balances and reduce timing uncertainties

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TSA Challenges

Too many accounts under control of spending units

• Often many thousands
• Reluctance to repatriate balances to TSA

Extra budgetary funds – also donor funds

• Policy resistance – who controls the cash
• If not in TSA, Treasury should still be able to borrow from EBFs

Prefunding (seed funds)

• Should be avoided (unless subject to sweeping)

Collection funds or collection lags

• Abolish in favour of transaction fees

Technology challenges

• Poorly integrated domestic banks
• Lack of an integrated financial management information system

(IFMIS) as facilitator

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Cash Flow Forecasting: the Aim

Objective is to anticipate cash needs of government Forecasts needed of total net cash flow (hence also cash balance)

• Receipts and payments (above the line); and
• Financing transactions (below the line) - debt redemptions,

new borrowing, also eg asset sales

• May need to identify foreign currency and donor project flows

separately (depends on structure of TSA)

Forecast information is needed for some period ahead

• Timing of future peaks and troughs must be identified to make

decisions about the maturity of required borrowing or lending

Ideally

• Daily (if necessary weekly) some 3 months ahead
• Rolled forward regularly (weekly)

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Key Features of Forecasting Framework

What matters is cash flow

• Separation of permission to spend from actual spending
• Tax in TSA not in banking system

Monitor actual changes in close to real time

• Analyse divergences – and forecast errors

Information flow from those in spending units and tax departments closest to cash flows

• Add information on large payments

Concentrate on major inflows and outflows

• Focus on largest spending units [80/20 rule]

Emphasis on history and experience

• Not econometrics

Separate forecasting from budget execution

• Need unbiased estimates – what is going to happen, not what

“should” happen

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Forecasting: the Challenges

Volatility and uncertainty of cash flow

• Lack of past data; unreliability of historical patterns

Poor information flows from agencies

• No incentive to cooperate - develop carrots and sticks – may need

legislation

• Avoid information going up hierarchy, across and down; develop

personal contacts with opposite numbers in major SUs and tax admin

Too much focus on short term

• Cash tomorrow is important – but must have a longer term perspective

to plan ahead – otherwise forced into rationing

Too bound up with budget execution

• Budget-constrained profiles are not forecasts
• Emphasis on targets detracts from unbiased forecasting
• Involvement of budget department risks game playing by SUs

Forecast database should usually be separate from IFMIS

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The Instruments for Managing Cash

Borrowing

Treasury bill usually main instrument in moving to more active cash management

• TBill has different roles as instrument
• f

– debt management – cash management – monetary policy

• Emphasis on shorter-term (e.g. 1

month) bills for cash management

Some EU countries issue commercial paper (CP) Repo usually used for fine tuning – but requires liquid market

Lending

(Reverse) repo preferred instrument if market sufficiently liquid

• Secured and flexible

Many countries use bank deposits

• Lend at market rates – term or
• vernight
• Competitive process (by tender if no

transparent prices)

• But must be collateralised – reduce

credit risk

Consider (remunerated) deposits with central bank if important to underpin monetary policy stance

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Rough Tuning: Example

• 25000
• 20000
• 15000
• 10000
• 5000

5000

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105

Cumulative Daily Cash Flow

• 25000
• 20000
• 15000
• 10000
• 5000

5000 10000

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105

Cumulative Daily Cash Flow Cum Daily Cash Flow after Bill Issuance

Rough Tuning with weekly issue of Treasury Bills only Converts this profile to this profile

[Fine tuning makes it flat]

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Management of Cash Balances

Separately identify

• Management of day to day cash, including the cash buffer
• Management of a structural surplus (net of any debt repayment)

Structural surplus: distinguish between

• Cash that might be needed one day

[eg in 6 months] – usually managed by cash managers alongside the cash buffer

• Longer-term funds

– Sovereign wealth funds, funds for future generations, fiscal stabilisation funds, pension liability funds etc – Managed separately – in context of government’s whole balance sheet

Governments need access to liquidity

• Implies some cash balances
• How do you decide the minimum?

2 4 6 8 10 12 14 16

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100103106

Working Days

bn

Ring fenced balances (donor funds, stabilisation fund etc) = 2 billion Cash Buffer = 6 billion Target: keep cash flows in range of +/- 3 billion, i.e. TSA in range 8-14 billion

The Minimum Cash Balance

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What Determines the Cash Buffer?

• 1. The volatility of daily cash flows
• 2. The ability to forecast those cash flows
• The standard deviation of errors in the forecast will [should] be much less than

standard deviation of outturn – error analysis is important

• Key area for policy focus – Treasurers have less leverage over other

determinants

• 3. The scope to manage unanticipated fluctuations and the

timescale over which they can be managed

• How soon can additional TBills be issued?
• 4. Safety nets
• Emergency credit facilities or cash reserves
• End of day borrowing from commercial banks
• [Short-term borrowing from central bank]

Suggested minimum cash balance

• Maximum cumulative forecasting error over policy reaction period (plus a

precautionary balance; may also need to add an allowance for expected outflow if flows cannot be smoothed in the first instance)

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Moving to more Active Cash Management: Some challenges

Lack of money market development

• Weak demand for bills; lack of secondary market
• Undeveloped repo market (legislation may not be in place)
• How to ensure a competitive process for deposits (and manage collateral)

Tension between the MoF and the central bank

• Central bank concerned about monetary policy impact. [But active management
• ffsets government impact on banks’ liquidity – facilitates monetary policy; if CB

needs government’s deposits, it should pay market-related interest]

• Interaction with Central Bank Bills
• Requires understanding about policy approach - cover in MoU

Effective interaction with debt managers

• Issuance decision take account of seasonality of cash flow
• In time allows pre-announced bond programme independently of cash volatility
• Essential there is a single point of contact with the market – avoid 2 Front Offices

Implications for minimum cash balance

• Identify safety nets – and the policy reaction time

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The Growth of Fine Tuning

Use of “cash management bills”

• 2 weeks in USA; 1 month bills in many countries
• Bills geared to days of cash outflow (Italy, New

Zealand, Sweden)

Several developed countries active in the repo market

• 13/18 in recent survey by Italian Treasury
• Includes repo activity in debt market (to facilitate

market making)

• Very high volumes in some countries (more than £2

trillion in UK in 2011-12)

Facilitated by active central bank

• ECB’s expectations in Eurozone

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Fine Tuning: Challenges

What impact has the financial crisis had on liquidity and the repo markets? Interbank market

• Credit concerns

Repo market

• Shortening of maturities
• Bigger haircuts – although an irrational response to liquidity constraints?
• Emphasis on clearing

Shortage of good quality collateral

• Basel III
• Downgrades of government bonds – and the flight for quality
• Requirements of CCPs
• Restrictions on short selling

Implications for debt market; repo needed to unwind squeezes But fewer problems in selling Treasury bills?

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