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 4

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

overnight. (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

offset 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

options, 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

of 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 of

– 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 overnight

• 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

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-5000

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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

0

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?

0

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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

offsets 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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