UNCTAD Virtual Institute for Trade and Development
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Sovereign Asset and Liability Management: An E-Learning Training Course
I. Institutional Setting
II.Asset and Liability Management Office
III.Debt Management Office
IV. Potential Conflicts of Interest Between the Central Government and Central Bank

Potential Conflicts of Interest Between the Central Government and Central Bank

Just as there are arguments for and against consolidation of the government wide balance sheets, there is a lack of consensus whether the operations of the government, namely the DMO, and CB should be fully integrated.  Review of the literature indicates there is greater support for coordination and cooperation in comparison to full integration.  Each approach has its own benefits and drawbacks and the approach taken will likely be determined by country specific attributes: composition of the economy, strength of political and financial institutions, and resources available to the DMO and CB.  The main argument for full integration of the DMO and CB is that this approach will reduce government wide risk as the sovereign assets and liabilities will be assessed in a broader manner. The primary rationale against full integration is the reduction or elimination of the CB’s autonomy and deviation from the CB’s implementation of monetary policy to maintain financial and monetary stability.

“To help manage the government’s balance sheet risk and reduce the economy’s vulnerability to economic and financial shocks, government debt managers, fiscal policy advisers, and central bankers need a shared understanding of the objectives of debt management policy and of traditional macroeconomic policy instruments” (Wheeler, 2004).  “Given the interdependencies between debt management, fiscal policy, and monetary policy, it is essential that they understand how the policy instruments operate, how they can reinforce one another, and how policy tensions can arise” (IMF, 2003). “One of the main reasons for decentralizing debt management was that at least in the short run, the pursuit of the three policy objectives involved trade-offs, and the assignment of separate policy objectives would enhance the credibility and effectiveness of policy implementation” (Togo, 2007).  The case can be made that each of these should operate independently as the institutions that govern debt management, fiscal, and monetary policy can most effectively manage their own risk.  However, in the absence of any kind of policy coordination, sovereigns may inadvertently increase risk in the short run and pursue policies that are incongruent with long term policy objectives.

“CB operations affect general government finances, in part because some share of the CB profits accrue to the government.  In an extreme case, it is conceivable that CB losses might require capital injections by the government…While liquidity-enhancing measures proved to a be a major policy tool in coping with the 2008 financial crisis, they came at the expense of risks accumulating on CB balance sheets and thus, indirectly on the general government balance sheet” (Rawdanowicz et al., 2011).   “Coordination between the CB and government is warranted in the case of a commodity-based country with large fiscal surpluses that are being held at the CV, particularly if the government owns a dominant share of the CB liabilities.  In this case the government balance sheet is  directly affected by the risk  management practices of the CB” (Das et al., 2012).

This raises the issue of CL from not just the financial sector but from the CB itself.  The general government must be able to reliably estimate the potential for losses by the CB that would require the central government to intervene.  Conflicts will arise if the CB is reluctant to share information with the central government regarding potential losses.  The CB may be hesitant to disclose this information in an attempt to shield poor decisions or underperformance of particular assets.  This can create a tension between the central government’s need to balance its overall balance sheet, especially CL, and the CB’s desire to maintain its operations independently.  In many instances, however, a fully integrated balance sheet approach will not be implemented and a less formal approach will be taken.  “In Chile the Banco Central (CB) manages its assets and liabilities independently of the the Ministerio de Hacienda (Ministry of Finance) that takes as given the decisions of the Banco Central, for example, regarding foreign reserves and their composition by instrument and currency of denomination. This institutional framework is common to other countries which adopt an ALM approach, such as Brazil and South Africa” (Chile, 2014 forthcoming).

Conflict between the DMO and CB may result from the different mandates each institution has been given.  Most authors argue that coordination and communication is necessary while also maintaining the autonomy between debt management and monetary policy.  Another problem that may arise from integration of the DMO and CB is the perception by potential debt purchasers and credit agencies that there is a lack of institutional control and safeguards between the two institutions.  This could result in lower sovereign credit ratings and higher borrowing costs. Historically, some nations have faced inflated borrowing costs only because they were perceived as being “similar” to other countries when in fact the actual financial, economic, and institutional attributes were very different.

The primary task to coordinate between the CB and the general government will be the relative amounts and composition of foreign exchange reserves and the foreign debt portfolio in order to hedge risk.  “A degree of coordination between the management of reserves and debt can in principle reduce risk exposures.  This can apply to levels of reserves/debt, to currency composition, and to maturity.  As to levels, it may be wasteful for the public sector simultaneously to issue large amounts of foreign debt and hold large amounts of foreign reserves is likely to be well below the cost of the debt.  However, to some extent such borrowing can be justified as a form of insurance (or purchase of liquidity) to ensure reserves are adequate to meet unexpected demand…However, there are often formidable practical difficulties in organizing such coordination and it often does not occur.  When it does, it is more likely the result from meetings between the debt managers (often part of the finance ministry) and the CB rather than because one agency is responsible for both” (Hawkins and Turner, 1999).

The IMF Guidelines for Public Debt Management (2003) indicates the tension that may arise between cash management and the CB if there isn’t any coordination.  Sound cash management by its nature combines elements of debt management and monetary operations… Notwithstanding the desire for a clear separation of debt management and monetary policy objectives and accountabilities, the search for liquidity creates a challenge for cash managers that might be more easily dealt with if cash and debt management functions are integrated in the same institution or work in close collaboration.”