INSTITUTIONAL FRAMEWORK FOR PUBLIC SECTOR BORROWING
by Mr. Nihal Kappagoda
(Article Reference: Document No.17, September 2002)

The Importance of Public Debt Management

Public debt management has become a priority for many developing and transition economy countries, which is a change from the early 1980s. When the debt crisis emerged in 1982, governments that undertook debt management focused their attention on controlling and recording medium- and long-term external public debt. Less attention was paid to controlling and monitoring private non guaranteed debt including short-term debt. Different institutions within governments dealt with domestic and external loans. External and domestic debt obligations were consolidated only when debt service payments of the government had to be estimated for the preparation of the budget and the payments accounted for audit purposes. The management of domestic debt was handled separately and not considered to be a priority at that time.

This approach changed in the 1990s - particularly during the latter half of the decade - as a result of factors that altered the international financial environment. The volume and terms of private sector debt had been subject to regulation under a regime of exchange controls. The borrowings were registered and recorded after the loans were contracted following approval. This changed with the liberalization of capital accounts in many developing countries when the control and approval of private sector debt was dispensed with. In some countries a system of registration was used for monitoring purposes. In many cases, even this was dispensed with in the belief that the external borrowings of private sector firms were their responsibility.

The Asian Crisis of 1997 showed that this approach was untenable. Governments should have known the full extent of the obligations of the public and private sectors - in particular those of large borrowers - for effective public debt management. They took responsibility for some private sector borrowings as defaults would have had an impact on the country's credit rating and consequently on the volume and terms of future external borrowings. Accordingly governments need to estimate total external private non guaranteed debt. A combination of sample surveys, voluntary reporting by borrowers and reporting by commercial banks through which loan transactions are handled is necessary to obtain these estimates. Further, governments should wherever possible eliminate policies that encourage excessive risk taking by the private sector.

The level of contingent liabilities also became a concern for governments after the crisis. These are liabilities that could arise due to predefined events or circumstances such as defaults on guarantees. Further, obligations of the public sector as a whole became those of the government and included borrowings guaranteed by it, both explicitly or implicitly. Borrowings by the private sector that were the result of government policies which encouraged them added a further dimension to the level of contingent liabilities. Payments that could arise due to unfunded pension liabilities, health care and other benefits of the public sector, insurance and reinsurance programs of the government, indemnities, comfort letters and other forms of assurances that are not legally binding could be a potential burden in times of crisis. These liabilities need to be identified, recorded and quantified and the magnitudes monitored for sound macroeconomic management.

With the removal of capital controls, the public and private sectors have the choice of raising financial resources from either the domestic or international capital markets provided that the domestic markets were adequately developed and had a range of borrowing instruments. These changes eliminated the distinction between domestic and external sovereign liabilities to a large extent and made the management of the total domestic and external debt of the public sector a priority.

Objectives for Public Debt Management

In many emerging market countries the objectives for public debt management are not clearly defined[7]. The same is true of the governance structure and legal basis for public sector borrowings making it difficult for those responsible for debt management to function. The Organization for Economic Cooperation and Development identified four overall objectives for public debt management among its members in a survey[8] of debt management structures conducted in 2000. These are to:

• ensure the financing needs of the government;
  
• minimize borrowing costs;
  
• keep risks at an acceptable level; and
  
• support the development of domestic markets.

While these objectives are appropriate for any country accessing international capital markets that has a well-developed domestic capital market, many developing countries will initially give priority to obtaining the financing needs of the public sector at a low cost. In the initial stages of development countries have little choice in the sources and currencies of funding as the borrowing is mostly from official sources. As access to international capital markets increases, the objectives should also take account of the government's risk preferences and tolerances. The push to strengthen and deepen domestic capital markets and develop secondary markets will take place with the liberalization of the capital account of the balance of payments and when borrowers wish to exercise a choice between the domestic and international capital markets. The main objective of public debt management should be to ensure that the financing needs of the public sector are met at the lowest possible cost while bearing an acceptable level of risk in the medium to long-term. This should be included in the mandate of the office given responsibility for public debt management.

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[7] Developing Government Bond Markets, A Handbook, International Monetary Fund and World Bank, 2001.
[8] Public Debt Management: A New Priority, Nihal Kappagoda in Bulletin on Asia-Pacific Perspectives 2001/02, ESCAP, United Nations, 2001.

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