Government Cash Management

The Danish central government holds liquid funds in order to handle current payment flows. The funds are held in the central government's account at Danmarks Nationalbank, and the central government’s large receipts and disbursements are settled via this account. The account accrues interest on market terms. The overall management of the liquid funds is handled by Government Debt Management via the issuance and buy-back policy of maintaining a specific balance on the account at year-end, as well as ensuring that the balance is always positive.

In the management of costs and risk, the central government's account is an integral part of the government debt portfolio. This means that the overall duration of the government debt, as well as the issuance policy and buy-back policy, are subject to coordinated management with the balance of the central government's account.

11.1 CASH MANAGEMENT IN DENMARK

As a consequence of timing differences between central-government receipts and disbursements, the central government has a cash requirement. In Denmark these liquid funds are held on the central government's account at Danmarks Nationalbank, and large payments are settled via this account. The central government's retail payments are outsourced to the banking sector, so that ingoing and outgoing retail payments are handled by a bank, and only a net amount is transferred between Danmarks Nationalbank and the intermediary bank. The balance of the central government's account accrues interest at the discount rate. The management of the central government's account and its payment flows constitutes the cash management by the central government. Rather than management of revenue and expenditure accounts, this is in fact liquidity management.

The overall framework for the cash management by the central government is given by the EU Treaty's prohibition of monetary financing, combined with the central-government funding rules. This entails that the central government's account with Danmarks Nationalbank cannot show a deficit and that the central government on an annual basis normally does not influence the overall domestic liquidity, and thereby the total (net) deposits of the banks and mortgage-credit institutes with Danmarks Nationalbank. Over the course of the year, payment fluctuations will entail temporary shifts in domestic liquidity. In Denmark , these liquidity impacts are managed via Danmarks Nationalbank's monetary-policy instruments^[1].

The central government's account is managed within this framework as an integral part of the overall government debt portfolio, where the balance of the account is included in the duration target for the overall debt.

Box 11.1 illustrates the framework and the overall relations between cash management, government debt management and the monetary-policy instruments.

Central-government payments
The Danish Ministry of Finance prepares forecasts of the overall amounts of central-government payments in Budget Reviews and Finance Acts. On this basis, as well as information on the timing of the payments, Danmarks Nationalbank forecasts the course of central-government payments over the year, cf. Box 11.2 . The forecasts are a significant input to the central government's cash management and to the use of Danmarks Nationalbank's monetary-policy instruments.

Payments to the central government's account originate from direct and indirect taxes, the EU and other central-government receipts. In 2005, these payments totalled DKK 526 billion, of which the largest share stems from ingoing VAT and income tax payments.

Payments from the central government's account are disbursements to local government and abroad (development aid, EU, etc.), salaries and pensions, government benefits and subsidies, and interest and redemption payments on the central-government debt. In 2005, these disbursements totalled approximately DKK 480 billion.

Funding rules and the EU Treaty
Domestic and foreign borrowing are subject to funding rules. The domestic funding rule stipulates that in principle domestic borrowing denominated in kroner covers the central government’s gross domestic financing requirement, i.e. the central government's current deficit and redemptions on the domestic debt. Viewed in isolation, a gross domestic financing requirement implies that the central government increases liquidity in the domestic money market. An equivalent level of domestic borrowing offsets the liquidity impact and ensures that over the course of the year the central government by and large does not influence domestic liquidity.

The foreign funding rule implies that the foreign borrowing requirement, which is equivalent to the redemptions on the foreign debt, is financed by foreign borrowing (in foreign currency). The foreign debt is raised primarily in order to maintain the foreign-exchange reserve. Foreign borrowing thus does not influence domestic liquidity, but is included directly in the foreign-exchange reserve, cf. Table 11.1.1.

The domestic and foreign funding rules set the framework for the issuance strategy for the year. There is a degree of flexibility within this framework, e.g. in the event of unforeseen receipts or disbursements at the end of the year, or in order to avoid inexpedient purchase or sale of government securities due to narrow focus on the calendar year.

Table 11.1.1 illustrates the principal elements of the central government's debt portfolio and Danmarks Nationalbank's balance sheet. When foreign loans are raised by the central government, the central government's account and the foreign-exchange reserve increase by the same amount on Danmarks Nationalbank's balance sheet. In the case of domestic borrowing by the central government, the increase in the account is offset by a reduction of the net deposits of the banks and mortgage-credit institutes on Danmarks Nationalbank's balance sheet. Via the funding rules it is, however, ensured that normally there is no long-term impact on the net balance with Danmarks Nationalbank.

Article 101 of the EU Treaty prohibits lending by Danmarks Nationalbank to the central government. Thus, the central government's account cannot show a deficit.

Handling the central government’s liquidity impact
Most receipts and disbursements via the central government's account at Danmarks Nationalbank affect the liquidity of the banks and mortgage-credit institutes, cf. Chart 11.1.1. The liquidity impact is managed via Danmarks Nationalbank's monetary-policy instruments.

The forecasts of central-government payments are important to the planning of the central government's issuance and buy-back policy and to Danmarks Nationalbank's management of the short-term liquidity impact, cf. Box 11.2 . Danmarks Nationalbank applies the forecast to planning market operations in cases where the banks and mortgage-credit institutes overall need to obtain or place liquidity.

Government cash management
On the basis of the funding rules, a target is set for the balance of the account at the end of the year, and an adequate buffer is ensured to absorb any uncertainty regarding forecasts, shifts in payments, etc. As a precautionary measure, the objective is therefore a minimum balance of DKK 10 billion on any given day. Within this framework, the buy-back and issuance policy is used to smooth the balance of the account over the year, where this is considered to be advantageous, cf. Chart 11.1.2.

Government debt management
The central government's account is a sub-portfolio of the overall government debt. In this way, cash management is an integral part of the management of the government debt.

In the cost and risk management of the government debt, the central government's account is subject to coordinated management with the government debt via a duration band for the overall government debt. The central government's account is included in the duration calculation with a duration of 0 years. In terms of costs, it is less important whether e.g. an increase in the balance of the central government’s account remains on the account or is used to buy back government securities, provided that the duration remains unchanged. This is because the reduction of the interest payments on buying back government securities, rather than receiving interest at the discount rate, will essentially be set off by the profit on the higher swap volume that is required. In general, the interest costs on the overall debt will by and large be unaffected by movements in the distribution of the debt on assets and liabilities, provided that the duration is kept constant.

Government Debt Management's issuance and buy-back strategy is determined in accordance with the funding rules, which makes central-government cash management an integral part of the strategy. Moreover, the issuance and buy-back policy is used to manage the central government's account in the event that a negative balance on the central government's account is forecast if no further measures are taken, cf. Box 11.3.

11.2 CASH MANAGEMENT IN AN INTERNATIONAL PERSPECTIVE

In most other countries, cash management is also an integral part of government debt management. The key difference in various countries' approaches to cash management lies in the access to a remunerated account at the central bank.

In a number of countries, the central government does not have access to a remunerated account at the central bank. This means that the central government's deposit with the central bank is minimised and the rest of the central government's liquid funds are placed directly in the money market. As a consequence, the country’s ministry of finance or government debt management office becomes an active player in the money market and assumes a certain credit risk. The investment strategy is designed to achieve the highest possible return, with due consideration of the market and credit risk. Many euro-area member states place the central government’s liquid funds directly in the money market. Within the euro area, each member state is typically a small player in a large market, and thereby a price taker.

In the Danish cash management model, with access to a remunerated account at Danmarks Nationalbank, the central government has delegated its active money-market role to Danmarks Nationalbank. In Denmark the central government would in all probability not be a price taker if it pursued an active investment strategy in the Danish money market. This would mean that both the central government and the central bank would be able to influence the short-term market rates. In view of the fixed-exchange-rate policy, and in accordance with international best practice, monetary policy should not be conducted via government finances. Clear separation of the central government and Danmarks Nationalbank at the very short end of the money market is therefore important.