Public Debt: General Policies and Best Practices
Public Debt: General Policies and Best Practices
Lisbon, Portugal June 2007
*
Content
Foreword on the version including the peers’ suggestions
1. Introduction
2. General Policies
· First principle: sound regulatory framework
· Second principle: best management practices
· Third principle: focus on the expected goals
· Fourth principle: priorities in face of scarceness of time and resources
· Fifth principle: debt structure on sustainability criteria
· Sixth principle: intergenerational equilibrium
· Seventh principle: transparency in all operations
· Eighth principle: thorough process auditing
3. Best management practices on public debt
Best management practices
· Conceptualization
· Criteria on best practices
· Executive management
· Operational management
· Accountable entity
Transparency and accountability
Auditing
4. Final considerations
Foreword on the version including the peers’ suggestions
During the 2004 meeting in Moscow, the document An Exercise of Reference Terms to Carry Out Performance Audit of Public Debt was presented. Once the comments from the PDC were incorporated, the final version of the document was endorsed in the 2005 meeting held in Sofia, Bulgaria on June 2-3. Currently, the document is being translated into the five official INTOSAI languages so as to be distributed at the XIX INCOSAI.
Since the scope of the aforementioned document was the proper auditing process, it was decided, during the Sofia meeting, to prepare a document on general policies and best public debt management practices, in order to provide the auditor a complete context on these issues. As agreed, the document would have informative purposes, without any other aim, and its main goal would be to offer a conceptual framework on public debt management issues.
The first draft of the document was presented in June 2006 in Buenos Aires, Argentina, and was titled Public Debt: General Policies and Best Practices. It was considered that this exercise might prove to be useful to broaden the auditor´s knowledge and vision when it comes to evaluate and present pertinent and feasible recommendations on the implementation of public debt public policies. This does not intend whatsoever to meddle with policy decisions which are not encompassed by SAIs mandates.
Understanding the public debt policies operators logic may provide the auditor with additional elements to correctly assess the auditing findings. We are aware that an auditor should not debate on the motive to borrow, however, understanding those motives might prove to be useful for the assessment of the public debt policies outcomes.
I want to thank the valuable input from our peers of the United Kingdom, Sweden, Canada, Russian Federation, Ukraine, Bulgaria, the Republic of Yemen and Lithuania.
I completely agree with my colleagues from UK, Sweden and Canada; you cannot use this document to perform an audit but you can use it to understand the conceptual framework of the debt phenomenon. We think that every auditor must understand the design of public policies, even though his proper function is limited to audit the implementation of such policies. We should not surpass our work’s scope and much less when we have to act upon our findings. However, being professional entails us to know the conceptual framework of public policies design.
It is nonetheless our intention to duplicate the World Bank or the International Monetary Fund’s efforts, but to use them as well as the substantive parts of other similar endeavors, to ease the understanding of what are considered the best practices, and to build up, taking into account these ideas, the general principles that have prevailed within the governments, when deciding contracting debt.
The UK and Sweden’s remarks allowed us to be categorical on defining the boundaries of the auditors’ exercise: auditing policies implementation and their outcomes. Policies decision-making goes beyond SAIs’ mandate. Canada’s considerations were extremely useful and therefore they were fully included in the document in order to precise and focus several concepts and to clarify translation inaccuracies. It was also decided to eliminate all information referring to economic policy in order to avoid any confusion among our auditors. Additionally, the comments from the SAI of the Russian Federation and Lithuania regarding the indicators and the need for accounting standardization were included.
The text submitted by the SAI of Ukraine on internal auditing was included as part of the section on the functions to be considered for a Debt Management Office. Likewise, Ukraine proposes to carry out new research work on debt management, conduct code, general accepted public debt governmental accounting standards, and contingent debt, as well as the Debt Management Office’s main stakeholder.
As suggested by the SAI of Lithuania, it was clarified that, every time the term “debt” is mentioned, we refer to the concept “public debt”; the term “Parliament” was also added along with the term “Congress”, for both concepts to be used according to each country’s political system. We also clarified, in section related to auditing, that we refer to the standards issued by INTOSAI, and we restructured, as part of the management auditing, the section on human resources and information systems auditing, according to the World Bank’s criteria. Likewise, we would very much thank the SAI of Lithuania, if they send us the list of literature with reference on this theme, for that information to be included in this paper.
I want to thank SAIs of Bulgaria and the Republic of Yemen for their support and acknowledge on our work, as mentioned in their communications.
In brief, the present document should be perceived as a complement of the former on performance audit. Its scope is rather modest and constitutes a summary on the topics commonly known by the experts as “generally accepted”. Its objective is to provide the auditor with a framework wherein policy decisions on public debt are taken; as well as to understand debt managers’ point of view. The main issue, auditing is encompassed in the former document.
In conclusion, the original text has been improved with the aforementioned considerations.
1. Introduction
A State faces two restrictions on indebtedness decisions. The first is of financial nature. The indebtedness level is limited by the State’s capacity of generating future cash flows to fulfill the debt terms. The second restriction has to do with optimal indebtedness policy to be followed by the State: Which is the optimal indebtedness level for the present and future citizenship? These two restrictions are not independent from each other, given that the optimal indebtedness level depends also on future available resources to comply with the debt terms
These two restrictions encompass the so-called “general policies”. On one hand, the optimal indebtedness policy is related to the financing nature, as well as the positive and negative externalities generated. On the other hand, financial restrains originate fiscal solvency principles and their correlation to macroeconomic and monetary policies.
Public debt general policies[1] consist of debt management principles and strategies aimed at managing the government’s financial liabilities while maintaining an efficient market for governmental securities (Canada proposed this writing. The footnote addresses the suggestion presented by the SAI of Lithuania).
Best practices are the activities undertaken according to general policy guidelines and the debt management legal framework, so as to attain the lesser possible cost and the highest yield.
2. General policies
The term “general policies” refers to the set of principles considered necessary for a good decision making. In this regard, the principles would act as the general framework wherein an analysis methodology is established. They are the generally accepted references by specialists on a specific field. They differ from the best practices because the latter constitute proved criteria and specific practices, aiming at strengthening and developing actions. Best practices improve the management by means of the rational use of resources; general policies guide decision-making in a broader scenario. General policies are made operative by means of best practices. (This paragraph takes into account the proposal presented by the SAI of Canada).
Governments use debt in order to address economic recessions, to face financing needs stemming from exceptional events such as financial shocks or natural disasters, to extend the use of the country’s resources throughout time, or to finance new material and human capital investments. However, an excessive indebtedness might cause long-term negative consequences and a burden for forthcoming generations, as well as discourage private investment and increase the country’s inclination to suffer financial crisis or inflationary trends.
General policies might be encompassed within eight principles: 1) a sound regulatory framework, 2) best management practices, 3) focus on the expected goals, 4) priorities in face of scarceness of time and resources, 5) debt structure on sustainability criteria, 6) intergenerational equilibrium, 7) transparency in all operations, and 8) thorough process auditing. (According to the suggestion presented by the Accounting Chamber of Ukraine, taking into consideration their practical application and importance it was rational to set out another sequence, beginning with the legislative base, moving to the strategy of public debt management and then according to priority).
· First principle: sound regulatory framework
It can be said that an important step to implement a sensible practice of debt is to count on a group of regulations containing general policies in its broadest sense as well as sufficient regulation of management, accountability and public debt auditing.
This legal framework must clearly establish competence for contracting debt; issuing new instruments, investment resources, offering guaranties and, in general, conducting any type of transactions related to this matter.
The legal framework must contain:
o Specific goal definition as well as debt destination.
o Authorized entities to approve and contract loans.
o Cases and conditions in which government offers its guaranties.
o Government branch responsible for the definition of national policies and strategies regarding debt.
o Commitments regarding reports publication on debt status and, in general, on information disclosure.
o Faculties and responsibilities of the audit institution.
· Second principle: best management practices
This principle establishes that best practices must ensure the fulfillment of acquired commitments, reduce vulnerability before financial hindrances, offer quality information for decision making and ensure the accomplishment of the loans’ goals.
An efficient debt management contributes to increasing the issuer’s credibility and allows developing a long-term sustainable strategies on management and allocation of debt. It also helps improving the country’s credit rating, as well as easing the efficient access to the internal and external markets. Furthermore, it contributes to lessen the political pressure on debt issuing.
In some countries, the main components of a sound debt management are based on clear liability management goals, an adequate coordination between this and fiscal and monetary policies, a sensible risk management framework, and a broad operative capacity permitting an efficient financing and sound practices on risk management.
Best practices are processes, operations and systems identified by leader institutions and organisms, acknowledged for attaining advances in their performance of a specific area, and constituting a model for peer institutions. They are characterized by using the most advance techniques, highly qualified personnel and performance standards.
· Third principle: focus on the expected goals
According to the SAIs role and mandate, the decisions made by the central government regarding the credits aims and orientation cannot be questioned by auditors, their scope is limited to policy implementation and outcomes. Nevertheless, it is considered that understanding these decisions, as well as their context, might help the auditor performing his auditing duties. (With this paragraph, we take into account the comments presented by the SAIs of the United Kingdom, Sweden and Canada, which indicate that auditors shall not question the Executive Branch’s decisions).
This principle compels the policy maker to justify, in responsible manner, the reason and the purpose of the credit.
Why does a country get indebted? A government finds itself in need of getting credits in order to finance those operations not covered by the fiscal and non-fiscal incomes and that must be met with no delay. According to the classification of the World Bank, the credit utilization has three goals:
i. Investment loans for the financing of goods, activities and services devoted to social and economic projects dealing with a broad range of sectors.
ii. Development loans for the implementation of public policies
iii. Loans for structural, financial and social reforms, and for improving public sector resource management.
(In order to avoid misunderstandings, the information related to economic policy was eliminated. This way the comments from the SAIs of the United Kingdom, Sweden and Canada were addressed).
· Fourth principle: priorities in face of scarceness of time and resources
This fourth principle establishes the governments’ obligation to count on a legal and normative framework with clear priorities as to contract debt, in accordance with public and social needs. (This paragraph writing was modified as suggested by the SAI of Canada).
International organizations, specially the World Bank, often offer soft credits for certain goals that by themselves are not subject to be challenged, but not necessarily trigger progress. For example, construction credits for homeless people are not morally questionable but, from the point of view of public finances, they might not be convenient. An employment program might have two effects: that homeless people have an income, thus enabling them to construct their own housing with their own resources.
One might absurdly argue that a country with many social support credits would not solve its problems and increase to unsustainable levels, its budgetary deficit. Therefore, this principle sustains the necessity of establishing financing priorities.
In order to understand this principle, it is convenient to reflect on how we can classify the debt for helping us establish priorities. Debt may be classified, according to its objective, as follows:
I. Ballast, passive and active debt.
And, in accordance with its payment flows in:
II. Self-supporting and non-self- supporting debt.
Ballast debt is the liability that happens when government expenditure not only not increases community productive capacity, but also causes distortions in the public account and injures the economy as a whole.