7 Servicing Public Debt: Management Aspects
- A. Premchand
- Published Date:
- March 1993
Many a citizen will never be able to understand
fully the problem of the public debt, for it is too
complicated for the average layman.
SEYMOUR E. HARRIS, The National Debt and the
Reflecting the growth in the size and variety of government expenditures, interest payments and the repayment of the principal of borrowed funds have also increased substantially.1 The impact of such rising interest payments, while obviously adverse on the government budget because discretionary action on revenues or other expenditures is required if overall budgetary objectives are to be achieved, covers a wide area of decision making; since they are past commitments they reduce the flexibility of future actions. They also have an impact on future borrowing operations as they could be more costly than in the past. New incentives may have to be offered to ensure sustained purchases of public debt issues. These aspects are not covered in this chapter, however. The purpose here is more modest and the intent is to describe the approaches for formulating budget estimates for the debt outstanding and for raising any new debt, and to discuss the adequacy of internal accounting and control procedures in the management of debt. The primary consideration behind such a discussion is that any sizable difference between budgetary estimates and outcome would contribute to an expanded deficit with attendant consequences, if revenues remain the same. An inherent property of durable structures is that they flex and do not break. Since public debt is an activity that has been in existence for thousands of years, the unprecedented magnitudes of the 1980s should in principle be a continuation of that activity, but with the necessary flexibility. How the machinery coped with this complex situation and the strengths and limitations indicated by the experience are discussed below.
Public Debt Budgeting
Public debt budgeting—formulating budget estimates to pay debt service charges and repay principal—has traditionally received scant attention in the literature. Recently, however, as external debt and its related problems have grown, the need for maintaining an integrated system for recording and servicing loans has come to be recognized as urgent. Although this is an effort in the right direction, public debt budgeting itself remains, despite its overwhelming relevance for national fiscal management, an obscure area.
The conventional approach to public debt up to the Second World War was to set apart some of the proceeds of the projects financed by borrowing toward repayment of the principal. This approach was based on the dictum that the creation of debt should generally be accompanied by the means to extinguish it. Projects funded by debt were divided into self-financing (those with the potential to pay interest) and self-liquidating (those with the potential to pay interest and principal), depending on their revenue-earning capacity. Moreover, to facilitate repayments, amortization based on the principle of PAYG (pay-as-you-go) was frequently adopted, and sinking funds that were originally set up to retire war debts were resumed to maintain the proceeds earmarked for repayment. The intent behind the establishment of separate funds to repay debt was to ensure that they were not diverted for general government use. The maintenance of such funds was expected also to enhance governments’ creditworthiness and borrowing capacity. With the gradual growth in governments’ indebtedness, it was realized that government borrowing was not going to be financed by the revenue feedback from the projects in which loan proceeds were originally invested, but from new borrowing. Accordingly, several countries (notably the United Kingdom and other Commonwealth countries) gradually gave up sinking funds. Another factor contributed to their disuse: they often had rigid structures (specified in statutes) governing their investment conduct, forcing governments to borrow from outside while maintaining cash balances in the sinking funds. Many governments still have sinking funds in principle, but annual contributions are no longer related to the amortization schedules of loans. Instead, a token contribution is provided in the budget estimates, while actual repayments and interest payments are provided separately. The nonabolition of sinking funds was largely due to the difficulty of enacting the requisite laws, which led to this token provision.
The practices relating to the budgetary provision of funds for public debt are primarily influenced by legislation and institutional arrangements. Although some of the features vary among countries, the following general characteristics prevail.
First, some countries (notably the United States) have statutory limits on national debt. In the United States, this limit has changed several times and now includes all debt issued by the Treasury, agency debt in the form of participation certificates, and other debt issued by federal agencies. Although some debt is not included within the specified limits, it is quite small. The statutory debt limit was, until 1979, raised by normal legislative procedures. Now it is enacted as part of the annual congressional budget process. Somewhat less stringent limits are observed in other countries. For example, in Denmark, while no debt ceilings are in force, the extent of annual external borrowing has to be approved by Parliament. In Thailand, there is a statutory limit on foreign borrowing up to 10 percent of annual budget appropriations. In Canada, there is an annual ceiling on borrowing approved by the legislature.
Second, in many countries annual provisions for interest and payment of principal, although included in the budget, are not subject to a vote. For example, in the United Kingdom and other Commonwealth countries, outlays on interest and related debt charges are included in the budget and treated as charged expenditure (consolidated fund standing services) and are not subject to the annual supply procedure of a parliamentary vote. In France, public debt payments are included in the estimates for treasury operations. Although included in the budget law, these appropriations are considered crédits évaluatifs; amounts provided in the budget are considered indicative, and any payments required to be made over and above the budgeted amounts can be paid by the Treasury without any additional authorization by the legislature. In the United States, interest on the public debt is automatically provided under a permanent appropriation enacted in 1847. Neither repayments nor the proceeds of borrowing are included in the budget as they are not considered expenditures or receipts. During the year and at year-end, the Office of Management and Budget furnishes reports to the Congress on the trends in budget implementation and the variations caused by changes in policy factors, in the macroeconomic assumptions on which the budget was formulated, in the technical assumptions of the estimates, and in the public debt charges. In some Latin American countries (for example, Argentina), debt charges are explicitly provided for and included in the annual appropriation procedures. There are other minor variations in these approaches; basically, however, public debt charges provided in the budget are flexible enough for the government to exceed the amounts provided, if so warranted, to fulfill contractual obligations.
Third, public debt is managed in some countries through separate (autonomous) organizations and special accounts. Variations of this practice can be illustrated from the experiences of Côte d’Ivoire, Senegal, Sweden, and the United Kingdom. In Côte d’Ivoire, public debt is managed by the Caisse Autonome d’Amortissement (CAA—Autonomous Amortization Fund), which operates under the supervision of the Ministry of Finance. CAA receipts comprise earmarked tax receipts, transfers from the Treasury and from funds such as coffee and cocoa, and interest on on-lent funds. In Senegal, there is a special account, also called Caisse Autonome d’Amortissement, which is not autonomous. Sweden has a separate National Debt Office (Riksqaldkontoret), which is responsible for all state borrowing in both domestic and foreign markets. It is also a member of an advisory group (in addition to the Central Bank and the Ministry of Economic Affairs), which provides policy guidance on the flotation of new loans. In the United Kingdom, all moneys raised through the creation of debt are payable into the National Loans Fund (NLF). The NLF is essentially a channel through which all government borrowing and domestic lending transactions pass. These include, in addition to the debt offered to the public, the proceeds of national savings, treasury bills, and ways and means advances from the Bank of England and others. Debt repayments and interest payments that are appropriated through the budget are conducted through the NLF.
Fourth, in several countries, the day-to-day management of public debt is carried out by the central banks. In performing these tasks, the central bank functions as a fiscal agent responsible for the issue of securities and the collection of related moneys as well as for debt payments. In some countries, particularly in Latin America, some central banks maintain quasi-fiscal accounts and directly assume the additional burden between budgeted funds and the amounts needed for debt services. These transactions are reflected in the balance sheets of the central banks and may not always be reimbursed through budgetary transfers; they may instead be adjusted in the profits transferred to the government. In some cases, central banks may even incur losses.
Budget Estimate Formulation
The formulation of budget estimates for public debt charges is traditionally made on an accrual basis even in cash-based budgetary and accounting systems. Such estimates take into account the cumulative debt at the beginning of the fiscal year. In addition, estimates are made of the new debt that will be raised during the year. In formulating these estimates, due attention is paid to the level of the deficit expected and the amounts of foreign and domestic debt that will be raised for both the financing of the government budget deficit and for meeting the requirements of on-lent funds. In estimating external debt charges, countries with relatively stable exchange rates base their budget estimates on the year-end level of exchange and interest rates. In countries envisaging changes in these rates, the average expected rates for the next fiscal year are taken into account. The expected rates are internal calculations, however, and generally these calculations are not explicitly stated in the explanatory notes on budgetary estimates. Also, any publicity about these calculations could have an adverse impact on the markets.
In recent years, with widening fiscal deficits and growing external and domestic debts, two improvements have been made in budgeting public debt. These improvements are not uniform or universal, however, and practices continue to vary from one country to another. The first occurred when, in recognition of the linkages between debt, fiscal policy, and balance of payments, several countries began to prepare different scenarios to analyze the implications of external debt. As an integral part of this exercise, the borrowing scenarios for both current and future years are examined and their implications for such factors as government expenditure, the ratio of debt/GDP, and exports are analyzed. Although the analysis of domestic debt is less sophisticated than that of external debt, it is also examined as part of scenarios dealing with the financing of development plans.
The second improvement relates to the introduction of margins in formulating budget estimates for public debt charges. Given the uncertainty in the movement of exchange and interest rates, the estimates provide an extra margin so that additional requirements can be met without resorting to supplementary budgets. This practice was particularly discernible in Latin American countries with high inflation. Such margins may prove, and have indeed already proved, inadequate when fluctuations in the rates are higher than estimated. On the contrary, in the United Kingdom and the United States, which have the practice of providing for “reserves” and “allowances” to meet additional requirements stemming from unforeseen situations and higher rates of inflation, public debt charges are not included in these estimates, perhaps because public debt payments can be made without any explicit legislation in both countries. Different budgetary outcomes have, in turn, necessitated resort to other practices.
Estimates and Outcomes
The budgetary outcomes can and often do differ from estimates, primarily owing to changes in the exchange rate, interest rate, indexed borrowing, additional borrowing undertaken to finance an expanded deficit, assumption of debt by the government previously privately held, and acceptance of payment responsibility for defaults on guaranteed debt. These changes may occur simultaneously or separately. The budgetary impact in the form of a higher budget deficit can be substantial in all cases. The budgetary approaches to meet these contingencies differ among countries; broadly, however, five approaches are prevalent. First, separate and autonomous funds and margins in the estimates provide a cushion against any excessive adverse impact on the budget balance. The funds are frequently so organized that when funds are re-lent to other public organizations and enterprises, they are lent with shorter amortization periods. The funds are generally liquid (on the assumption that public organizations are regular in their payments to the treasury), and are in a position to finance the additional burdens arising from major changes in the principal economic indicators. A similar purpose is served by the provision of a margin for contingencies in the estimates. Here, again, the margin should be adequate in theory to accommodate moderate changes.
The second approach shows an essential trust in the working of the invisible hand or the working of self-balancing ingredients of the budget. Thus, in principle, increases in the interest or exchange rates may not necessarily lead to higher aggregate expenditures, as major shortfalls could occur in some categories of expenditure. They could also be balanced through debt rescheduling in the form of capitalization of interest or deferral of payment.
The third approach allows central banks to cover the difference between estimates and actual payments needed. In most countries, central banks meet these requirements initially from their own resources and are later extended to governments in the form of overdrafts or ways and means advances. It is expected, however, that they will either be reimbursed by the government or the transactions will be formalized through the issue of relevant debt instruments. In some Latin American countries (such as Argentina and Ecuador), these differences are financed by the central banks and are adjusted through either reduced transfers to governments or registering losses. Even this approach may not prove a viable alternative, and, in some cases, supplementary appropriations may have to be approved to finance the additional requirements (Brazil). The main feature of this approach is an effective shift of financing responsibility from the government budget to the central bank. Although in a larger sense this transaction will become evident in the context of integrated accounts of the budget and the fiscal transactions of the central bank, in the immediate short term the government budget may not show it.
The fourth approach consists in resort to the build-up of arrears. As the impact of the changes may be heavy, governments may choose, and have in fact frequently chosen, to defer payments for both technical (legal) and the more substantive reason of a severe squeeze on financial resources.
Finally, in some countries the additional requirements are financed routinely as these payments are not subject to budgetary appropriations. This built-in flexibility, which was primarily intended to maintain governments’ credit ratings, also brings with it a benign neglect of the public debt transactions.
Budgeting for public debt reveals a number of problem areas that are almost all process oriented. Because debt and related interest charges have grown considerably, and because the unexpected changes in rates may affect the pursuit of specific fiscal targets such as expenditure as a ratio of GDP, it is important that efforts are made to identify the specific problems and solutions. Both the problems and their severity would obviously differ among countries. A comprehensive list of all the problems in all the systems is not intended here, but the following problems merit more detailed consideration.
The budgetary and accounting systems of governments (both industrial and developing) do not promote a financial consciousness, in particular of the costs of interest charges, among those who are primarily responsible for the growth of public debt—the spending departments, including those responsible for development projects financed through borrowing. Since the systems do not permit explicit identification and presentation of the costs of borrowing money, spending agencies do not have to recognize the cost aspects of interest payment and thus no effort is made to minimize those costs.2 This practice can be attributed to the separation of financial responsibility from policy and administrative responsibility, as well as to excessive fragmentation of government tasks. Stronger financial planning (either as part of rolling expenditure budgets or as an independent exercise) and cash management are required.
In countries that have annual legal limits on the government’s borrowing authority, experience suggests that an element of uncertainty is thereby introduced into the budget process. It also appears to have adversely affected the government’s capacity to plan and carry out an orderly debt program. Postponement of borrowing may force governments to resort to new issues of debt when the market is less inclined, forcing the sale at rates of return above the prevailing market rate. These issues, in turn, add to the costs of borrowing, which is far from the original intent. These problems are needlessly compounded when the borrowing limits have to be amended in contingencies such as changes in exchange and interest rates. Several alternatives exist for avoiding this situation: (1) legislatures may have to aim at controlling the underlying fiscal factors contributing to increased debt rather than nominal limits of debt; (2) the borrowing authority could be based on a built-in margin or a formula-based increase, thus providing an element of flexibility; and (3) payments over and above the approved budget estimates could be approved as supplementary budgets as with other expenditures.
Experience also shows, however, that a permanent appropriation or related enabling authority to make the necessary payments may have induced some neglect of these problems. While maintenance of the credit rating of governments is clearly important, it is equally essential that governments undertake comprehensive financial planning to compile an inventory of debt and to provide for debt charges. Such planning should include, as noted in Chapter 6, the anticipation of possible defaults in guaranteed debt. Although it could be argued that such anticipation could be self-fulfilling, nonanticipation could also have an enduring adverse impact. Without financial planning it is likely that government cash management will be severely affected and will send wrong signals to the market. In public debt management, signals have as much impact as does substance and therefore they need to be addressed.
Debt Management: Internal Accounting and Controls
Debt management irrespective of where it is administratively located (ministry of finance, central bank, or autonomous agency or fund) should have at least three features. First, it should operate on a double-entry basis that permits the credit and debit sides of the transactions to be recorded in equal amounts. Second, it should be on an accrual basis so that transactions are recorded as and when they occur rather than when cash changes hands. Supplementing this, there should be a cash-based principal subsystem and a cash-based interest subsystem. The two types of accounts need to be reconciled at regular intervals. Third, the system should be designed to incorporate audit trails to ensure the adequacy of documents supporting the accounting entries. Supplementing this, and if the systems are on a computerized basis, there should be a security apparatus to prevent tampering with records. Although these features may appear self-evident, the difficulty in maintaining the systems in practice has contributed to many wrong signals on the status of government finances as well as on the pursuit of appropriate policies. Frequently, the data are incomplete, are not reconciled regularly, and take too long to compile. The strengths of the systems turn out to be the weaknesses in the process. Instead of lightening the tasks of the managers, the lack of attention and the inadequate systems could obscure them.
For example, in 1991, interest payments in the U.S. budget amounted to $286 billion. In addition to being the largest single category of federal expenditures, it was equivalent at that level to about 17 times the amount spent on education, and 15 times that spent on natural resources and the environment. See United States, General Accounting Office (1992).
Chi1e has tried to improve the situation by showing debt as part of the receipts of each agency. The budget is organized, following commercial practice, into incomes and expenditures. The incomes of the agencies include the amounts of loans whose proceeds are allocated to that agency.