The public debt is how much a country owes to lenders outside of itself. These can include individuals, businesses, and even other governments. The term “public debt” is often used interchangeably with the term sovereign debt. Public debt usually only refers to the national debt. Some countries also include the debt owed by states, provinces, and municipalities. Regardless of what it’s called, public debt is the accumulation of annual budget deficits. It’s the result of years of government spending more than it earned. Public debt impacts external debt, but they are not the same. If interest rates go up on the public debt, they will also rise for all private debt. That’s one reason most businesses pressure governments to keep public debt within a reasonable range.
In the short run, public debt is a good way for countries to get extra funds to invest in their economic growth. Public debt is a safe way for people in other countries to invest in another country’s growth by buying government bonds. This is much safer than foreign direct investment. That’s when people from other countries purchase at least a 10% interest in the country’s companies, businesses, or real estate. It’s also less risky than investing in the country’s public companies via its stock market. Public debt is attractive to risk-averse investors since it is backed by the government itself. When used correctly, public debt can improve the standard of living in a country. It allows the government to build new roads and bridges, improve education and job training, and provide pensions. This encourages people to spend more now instead of saving for retirement. This spending further boosts economic growth.
Governments tend to take on too much debt because the benefits make them popular with voters. Increasing the debt allows government leaders to increase spending without raising taxes. Investors usually measure the level of risk by comparing debt to a country’s total economic output, which is measured by GDP. The debt-to-GDP ratio indicates how likely the country is to pay off its debt. Investors usually don’t become concerned until the debt-to-GDP ratio reaches a critical level. The World Bank has said the tipping point is 77% or more. When debt approaches a critical level, investors usually start demanding a higher interest rate. They want more return for the greater risk. If the country keeps spending, then its bonds may receive a lower credit rating. This indicates how likely it is that the country will default on its debt.
In the long run, public debt that’s too large causes investors to drive up interest rates in return for the increased risk of default. That makes the components of economic expansion, such as housing, business growth, and auto loans, more expensive. To avoid this burden, governments need to carefully find that sweet spot of public debt. It must be large enough to drive economic growth but small enough to keep interest rates low.
A. Public Debt Management (PDM)
Public Debt Management is commonly defined as ‘the process of establishing and executing a strategy for managing the government’s debt to raise the required amount of funding at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk. It should also meet any other PDM goals the government may have set, such as developing and maintaining an efficient market for government securities.
According to this definition, the goals or objectives of government debt management (DeM) should be to:
Meet the borrowing requirements of the government;
Borrow at the lowest possible cost over the medium to long run;
Keep a prudent degree of risk in the debt portfolio; and
Meet any other goals the government may have set, such as developing and maintaining an efficient market for government debt securities.
The main tool to achieve these goals is to prepare and execute a DeM strategy.
Looking at the cost–risk objectives, trade-offs must be made. For emerging market countries, it is commonly cheaper to borrow in low-coupon foreign currencies than in domestic currency. On the other hand, borrowing in foreign currencies normally increases risk in the portfolio (Increased foreign currency exposure). While borrowing in the short end of the yield curve is cheaper in most cases than longer-term borrowing, the risk will increase because the short-term interest is more volatile and the loans need to be refinanced more often (Increased interest rate exposure and refinancing risk). Against this background, the essential ingredient in strategy development is to analyze different borrowing scenarios and the trade-offs that must be made. The risk tolerance of the government will finally decide these trade-offs and be reflected in the strategy document.
Thus, the main role of the debt manager is to achieve the desired composition of the government debt portfolio, which captures the government’s preferences regarding the cost/ risk trade-offs. The DeM tools are the medium-term debt management strategy (MTDS) based on cost–risk trade-offs of the debt service flow in the actual and forecasted debt portfolio under different scenarios, annual borrowing plans based on the determined strategy, and borrowing and other DeM operations to meet the strategic goals. The DeM strategy operationalizes the DeM objectives and has a strong focus on managing the risk exposure embedded in the debt portfolio—specifically, potential variations in the cost of debt servicing and its direct impact on the budget.
B. Main Participants in Public Debt Management
1. The State/the people/present and future citizens: At the top of the hierarchy lies the State of the nation. Debt is an inter-generational contract. Policymakers must ensure that equity is preserved between today’s and tomorrow’s generations. Borrowings by the government should not only directly benefit its present citizens, but also especially future citizens who will be responsible for debt servicing. The inter-generational character of public debt imposes significant fiduciary responsibilities on management to act with care and loyalty.
2. The Legislative (Parliament): The power to borrow and the fiscal powers to tax and spend should ideally be held in the same branch of government. It is the legislature, the direct representative of the people, that holds both powers in most countries. Legislatures are responsible for creating a sound legal framework that provides clear lines of authority and ensures transparency. The laws should grant the executive sufficient flexibility to manage debt effectively, establish clear performance benchmarks and require timely audited reports that legislators can use to prepare budgets and evaluate the debt management operations. Some external agencies look for help in monitoring PDM at a domestic level.
3. Executive branch: Executive branch may include MoF (Ministry of Finance), DMO (Debt Management Office), treasurer and controller; budget, planning, and economic ministries or departments, resource mobilization units, and program execution units. To provide greater flexibility and effectiveness in PDM, legislatures frequently delegate or assign the power to borrow to a key ministry or agency in the executive branch, such as the MoF. Generally, organizational arrangements for PDM would require the officials in debt management units within the MoF who perform important front-, middle- and back-office functions. Also, central banks would be included if they act as fiscal agents of the MoF, making payments and receiving funds in local and foreign currencies. In many countries, it may also have to include the following officials and units:
The treasurer, who is responsible for cash management;
The controller, who is responsible for public debt accounting;
The officials in the budget, planning, and economic ministries, who are responsible for integrating debt information into a budget and macroeconomic plans;
The resource mobilization units that take the lead in seeking specific funds for their investment projects; and
The multiple program execution units that are responsible for using borrowed funds.
4. Lender institutions (Domestic and external; bilateral and multilateral): DeM activities are determined by the funding sources. Most advanced countries with access to developed financial markets rely on government securities issuance as their principal funding source. Specific institutions, such as primary dealers, make commitments to participate actively in government auctions in exchange for privileged access to government debt instruments. Active secondary markets in government securities provide useful information to debt managers.
In contrast, low-income countries without access to financial markets depend mostly on long-term concessional loans obtained from several bilateral and multilateral institutions, which impose specific conditions. There is no active secondary market in concessional loans, and the inter-agency coordination activities can be challenging. Finally, there is also a group of mostly middle-income countries that can issue securities and obtain loans. The challenges of managing and auditing debt performance in each group would be different.
C. Importance of Sound Public Debt Management
Public Debt Management is important because public debt is often the largest financial liability of the government and a major contributor to the country’s external debt. Given the nature and size of public debt in most countries, it is important to lower its costs. High debt leads generally too high debt service liability. Generally, high debt service liabilities become a cause of poverty, inequality, and unemployment in highly indebted countries, because debt settlements in the face of slow economic growth do not leave enough money to finance the needed expenditures on health, education, and general welfare. In this context, the issues related to DeM become particularly important.
Every government faces policy choices concerning DeM objectives, in particular, its preferred risk tolerance, the parts of the government balance sheet that debt managers should be responsible for, the management of contingent liabilities, and the establishment of sound governance of PDM. On many of these issues, there is increasing convergence on what is considered prudent PDM practices that can also reduce vulnerability to contagion and financial shocks. These practices include
The recognition of the benefits of clear objectives for DeM
Weighing risks against cost considerations
The separation of debt and monetary management objectives and accountabilities (where appropriate, combined with consultation and information sharing between the debt manager and the central bank)
The need to carefully manage refinancing and market risks and the interest costs of debt burdens
The necessity of developing a sound institutional structure and policies for reducing operational risks, including clear delegation of responsibilities and associated accountabilities amongst government agencies involved in DeM.
