International Monetary Fund Fiscal Affairs Department

1. Local Government Cash Management – International Experience and OptionsInternational Seminar on Local Government Treasury Cash Management - December 10-11, 2009 International Monetary Fund Fiscal Affairs Department Holger van Eden Deputy Division Chief Public Financial Management Division II Fiscal Affairs Department E-mail: hvaneden@imf.org Sanya, Hainan Province, People’s Republic of China

2. Overview • What is Government Cash Management? • The Treasury Single Account: a key component • How have countries developed Cash Management? • How can central and local governments coordinate development of cash management? • What model does international experience suggest for China? • Factors to consider • Questions and Discussion

3. 1. What is Government Cash Management Formal Definition: Government 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” [1] Informal Definition: cash management is the neglected “little brother” of debt management >>> often seen as less urgent, significant costs to implement well, benefits broader than just lower cost [1]Government Cash Management, Good –and bad – practice, Mike Williams, 2004

4. Why is Cash Management important? Without it: • Budget execution can be disrupted by lack of funds • Excess liquidity - idle balances – can accumulate at non-treasury units and spent inappropriately • Payments can be delayed, revenues held up, benefitting mainly the banking sector • Cash shortages can exist while overall government has a cash surplus, requiring unnecessary borrowing >>>inefficient use of cash resources • Cost of cash accumulation can be substantial>>> it is financed implicitly by government debt, and/or the remuneration is very low (opportunity costs) • Short-term borrowing and investment of cash can be very risky (interest rate risk, roll-over risk, investment risk, credit risk, non-availability risk)

5. Two objectives of cash management • Ensure availability of cash resources at all times for efficient and unconstrained) implementation of the annual budget • Use available cash with the least cost and risks >>> Developing countries usually initially focus on the first objective; first task of government is to provide public goods and services to citizens

6. Main elements of Modern Government Cash Management • A Treasury Single Account (TSA) for pooling liquidity, held preferably at the central bank • A government direct payments system, centralized through a Treasury-managed TSA, or decentralized payment by ministries and agencies through zero-balanced bank accounts connected to the TSA • Immediate transfer of all government revenues to TSA, including of so-called “own-revenues” of line ministries and agencies • Policies for better matching expenditure and revenue flows, including timing of higher-level government grants • A cash flow forecasting system • Targeting of a remunerated TSA balance (usually slightly positive) • Use of appropriate short-term financial instruments, both at the liability and at the asset side

7. Why is Cash Management difficult? (1) • A comprehensive payment and related accounting system needs to be developed (either fully centralized in MOF, or decentralized with zero-balancing of commercial accounts overnight to TSA) • Setting up a comprehensive TSA can be politically difficult and technically a lot of work; is seen to infringe on line ministry, agency, or local government independence >>> message: control over cash is not the same as control over the budget • Commercial banks need the capacity to provide electronic payments services, and perform sweeping with central bank • Cash forecasting is inherently difficult (economic uncertainties, lots of information needs, an IFMIS is required)

8. Why is Cash Management difficult? (2) • Financial markets need certain level of development to offer required financial instruments • Central bank may resist remuneration of cash balances and/or government using commercial banks or financial markets • Capacity (systems and staffing) constraints in government • Coordination needs (with debt management, Central Bank, other parts of government) • Central bank and commercial banks may resist structural decrease of cash holdings

9. 2. TSA central element of government cash management Definition: “ a unified, hierarchical structure of government bank accounts that provides a consolidated framework for government cash management” Three essential elements: 1. Allows full fungibilty of government cash resources (at a the level of government the TSA deals with); 2. No bank accounts outside supervision and (ultimate) control of Treasury; 3. Comprehensive consolidation of cash resources (both budgetary and extra-budgetary)

10. Characteristics of TSA • TSA balance almost always held at central bank (no credit risk, usually cost-effective, CB acts as bank clearing house) • Payment transactions often channeled through banking system, not central bank (depends on development of banking system) • Bank accounts of ministries are usually transformed into ledger accounts, that is accounting identities; cash balance is transformed into drawing rights on TSA, up to budget allocation • TSA arrangements generally ensure that revenue and disbursement floats are minimized >>> direct payments, electronic transfers, sweeping

11. Objectives of a TSA • Aggregate control over government cash resources >>> pre-condition for active cash management >>> does not detract from budget authority of ministries and agencies • Maximizes use of cash resources; minimizes idle balances • Minimizes borrowing costs • Minimizes transaction costs, i.e. the float, and allows central negotiation of banking services • Provides control and monitoring of payments and revenues of government agencies • Facilitates reconciliation between banking and accounting data >>> provides essential information for cash forecasting

12. Who to include in TSA? • Ministries, agencies, all budget units • Extra-budgetary funds such as social insurance funds , health funds, road funds, etc. • Donor funds, debt financing • Local government ??? In some cases.... Not: public enterprises, civil service pension funds that invest, other investment vehicles If not included: set up own TSA to enable cash management

13. Two types of TSA • Centralized: all payments executed by Treasury through TSA held at central bank • Decentralized: most payments executed through ministries and agencies through commercial bank accounts (and possibly, central bank bank accounts) which are swept overnight in main TSA account >>> centralized model includes centralized accounting, >>> decentralized model requires adequate commercial banking infrastructure, and linkage of central and ministry accounting systems >>> various decentralized models

14. TSA rarely one account ! • Main TSA account at central bank operated by Treasury • TSA sub-accounts or ledger accounts for all ministries and agencies (cash is usually not actually held in these accounts) • Zero-balanced transaction accounts at commercial banks held by ministries/agencies • Imprest accounts for petty cash, held by ministries/agencies • Transit accounts held for bookkeeping purposes, either at CB or commercial banks • To monitor revenue flows • To facilitate revenue sharing among levels of government >>> should be swept in main account daily

15. TSA and automated systems • TSA can be established with manual payment and accounting system, but an integrated financial management information system enhances efficiency greatly • A treasury ledger system is essential in keeping track of cash flows over the TSA • Automated systems allow daily reporting of expenditure and revenues transacted over the TSA • In both centralized and decentralized payments systems Treasury control is largely automated. Spending limits are set per agency and line item, per time period (month, quarter, or year) • Modern treasuries perform only limited transaction audits

16. 3. Phases in Cash Management Development (1) Not necessarily exactly in this order: • Ad hoc cash rationing and/ or resort to central bank financing • Orderly cash rationing through budget and cash allotments • Cash pooling through initial TSA development, limited sweeping • More efficient payment mechanisms and revenue collection (direct payment mechanism) • Basic cash monitoring and cash flow pattern analysis • Cash matching through adjustment of timing revenue intake, transfers and expenditure flows – measures that are not detrimental to budget execution • Remuneration of TSA balance

17. Phases in Cash Management Development (2) • Smoothing of major fluctuations in TSA balance; use of treasury bills and (collateralized) term deposits for rough tuning • Completion of TSA, comprehensive sweeping arrangements • Development of more sophisticated forecasting casting capacity, based on pattern analysis, IFMIS and notification system • Deepening of T-bill and term deposit market, development of repo market • Fine-tuning: targeting of TSA balance, at slightly positive level • Coordination with debt management • Improvements to departmental, and lower level of government cash management >>> incentives • Improved information exchange and coordination with central bank; • No government impact on money markets/monetary policy

18. Characteristics of Underdeveloped Cash management • Recurring cash shortages; cash determines budget execution, does not facilitate it • Multitude of departmental and MOF bank accounts, quite a few unused • Uncertainty over timing MOF transfers, both to the same and lower levels of government • Use of advances, instead of direct payments • Delays in payments and in receipt of revenues • Retention of own revenues at line ministries and agencies • Use of central bank for short-term financing and investment needs, at non-market rates • Impact of government cash flows on monetary conditions

19. 4. Cash Management and lower levels of government • International experience is quite divers • Lower levels of government have developed cash management usually after central government • Local government is constrained by more limited market access, and by more limited capacity, and by regulation • Some countries have chosen full integration with central government, some full autonomy for local government • Intermediate models are also possible, and most prevalent • In almost all countries local government borrowing and short-term borrowing is regulated

20. Full integration with central government • Used in France, and in many smaller transition and developing countries • Requires integration, or at least linkage of payment and accounting systems between levels of government • Implies integration of local government bank accounts in TSA, both at CB and commercial banks • Requires separation of authorization and control functions from payment mechanisms (centralized or decentralized) – France exception • Often makes use of decentralized treasury offices • Use of commercial banks for payments essential, unless very large central bank network

21. Benefits of full integration Benefits: • Minimizes cash needs of general government • Provides control and transparency of government cash flows; • avoids misuse of funds • simplifies overall fiscal policy control • provides insight for higher levels of government on lower level budget execution • Addresses low systems and staff capacity concerns at lower levels of government • Utilizes capital market access at center • Coordination with central bank easier

22. Challenges of full integration Challenges: • Extremely complex to develop and manage required payment and accounting system if country is large >>> example: requires in France 50k staff (on country of 50 million) • Consolidation of bank accounts may infringe on fiscal autonomy, unless central government acts only as payment facilitator • Remuneration and interest payment issues for cash surpluses and shortages, respectively, need to be sorted out • Cash forecasting becomes even more complex • Provides little incentive for lower levels of government to use cash efficiently

23. Full autonomy • In many federal governments around the world: US, Germany, Brazil, Latin America, even smaller European countries, local government not included in central TSA • Full autonomy, however often limited by some regulation and oversight • Local governments need to : • develop own TSA, and payment and accounting systems • develop own cash forecasting cash forecasting capacity • own capital market access >>> in summary: local governments need to develop cash management capacities mirroring those of central government

24. Benefits and challenges of full autonomy Benefits • Enables gradual development of cash management through the layers of government • No need for full systems integration/linkage • Does not infringe on local autonomy Challenges • More difficult for lower levels of government to set up TSAs, and payment and accounting systems due to weaker financial management capacity • Does not provide information and control for central government over lower levels • Money market access of lower levels of government may be very limited >>>will lead to higher cash balances for general government

25. Intermediate models for decentralized cash management Various dimensions: • Central government facilitates TSA and IFMIS development >>> sets norms, provides support • Central government provides/intermediates short-term borrowing and lending >>> Eurozone members, quite a few developing countries • Partial integration: some layers of general government are integrated, but perhaps not central government and 2nd-tier • Central government sets regulatory framework: limits short-term borrowing, defines norms for short-term investment, requires reporting >>> a number of intermediate models possible

26. Benefits and challenges of Intermediate models Benefits • Local government can reap synergies from central government systems experience • Less complex, more gradual development path • Control and oversight is improved • Local government can utilize central government market access Challenges • There are differences in capacity and needs between local governments at same level and different levels >>> makes it complex for central government to support development and provide regulation • Oversight and control remains problematic

27. 6. An intermediate model for China? (1) Assumed starting position: • TSAs already set up at provincial and larger city levels (levels 2 and 3), but coverage not complete • Financial management capacity declines at lower levels of government, uneven distribution • Payment and accounting systems in development, but not standardized over layers of government; • In-year reporting of expenditures and revenues between layers of government limited • Local government cash holdings very large, but distribution uneven • No direct access to capital market for local government

28. An intermediate model for China? (2) Possible model, for discussion: • TSA, payment and accounting systems to be standardized at respective levels of government >>> regulation • Higher levels of government to retain independent TSAs; lowest levels of government to be integrated in provincial or larger city level • Central government to facilitate inter-provincial cash exchanges and capital market access for rough-tuning • On voluntary basis only • Remuneration/interest payments at market rates • At risk of provincial governments • Center sets ranges for minimum and maximum cash balances • Approach can be cascaded downward • Gradual development in coordination with PBC • Relaxation of capital market access in medium-term for provinces, larger cities >>> regulated autonomy in future

29. An intermediate model for China? (3) Limitations: • Solution would not work for fine-tuning • Cash down- and up-flows could not be avoided due to lack of oversight on lower level budget execution • Further development of TSAs at local government levels is first priority, including sweeping capacity • May be to restrictive for advanced provinces and larger cities

30. Benefits of intermediate option for China Benefits: • Builds on present developments and provides reasonable autonomy for stronger levels for local government; • Less complex, requires much less central coordination and management than full integration • Can be gradually cascaded downward • Keeps full control on formal borrowing and investments of local government

31. Disadvantages of intermediate option for China Disadvantages: • Will not reduce cash balances as much as centralized option • Will not provide center as much oversight and control as centralized option • More advanced provinces, cities may want to opt out, and gain market access earlier • Still requires substantial capacity building effort by central and provincial MOF/finance departments, including new regulation

32. 8. Factors to consider in model choice • Development level of existing TSAs and payment and accounting systems at various levels of government • Scope for integration/linkage of automated systems between levels of government • Capacities of systems and staff at various levels • Available technologies of central bank and banking sector, and geographical coverage of branch network • Capital market development/access of smaller players • Level of fiscal transparency and accountability at lower levels of government

33. Questions & Discussion 1. What are the most urgent reforms/improvements necessary for local government cash management? 2. Would an intermediate model (independent TSA for provinces, capital market access via center, standards and norms through regulation and support) be appropriate for China? 3. Is there need for a Local Government Finance Law?

34. Thank You - 谢谢!