New Zealand
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Page 153
The New Zealand Debt Management Office (NZDMO) was established in 1988 with the aim of improving the management of risk associated with the government's debt portfolio. It is responsible for managing the government's debt, overall net cash flows, and some of its interest-bearing assets within an appropriate risk management framework.1
This chapter outlines the evolution of public debt management in New Zealand, the portfolio and risk management framework in which the NZDMO operates, and the development of the market for government securities.
The objective of the NZDMO is to maximize the long- term economic return on the government's financial assets and debt in the context of the government's fiscal strategy, particularly its aversion to risk. That objective requires the NZDMO to balance the likely risks incurred in minimizing cost.
In terms of managing the government's debt portfolio, the NZDMO adopts a risk-averse approach for a number of reasons. For instance:
- Evidence suggests that individuals tend to be risk averse in their decision making and expect the government to reflect that preference in managing its interests.
- Losses incurred in the government's portfolio impose costs that taxpayers are unable to avoid.
- The government does not have a competitive advantage over other market participants in attempting to derive excess returns from its portfolio management, except for its privilege as an institution exempt from taxation and regulation, which the NZDMO does not consider ethical to exploit.
The debt management objective has changed through time, with earlier versions placing an emphasis on risk reduction. That position reflected the significantly higher net debt levels in the late 1980s and early 1990s and the fact that nearly half of the debt was denominated in foreign currencies. Since then, net Page 154 debt has been reduced by 65 percent, and foreign- currency exposure has been eliminated.
The NZDMO's major responsibilities involve
- developing and maintaining a portfolio management framework that promotes the government's debt management objectives;
- financing the government's gross borrowing requirement, managing foreign currency assets required to meet net foreign currency interest and principal payments, and settling and accounting for all debt transactions;
- managing the six principal types of risk-market, credit, liquidity, funding, operational, and concentration-in a manner consistent with the government's fiscal strategy and the NZDMO's internal policies;
- determining a portfolio structure in terms of currency, maturity, and credit exposures consistent with the government's risk aversion and having regard for costs;
- implementing a sound framework for measuring performance on a risk-adjusted basis;
- maximizing the value added to the portfolio, on a risk-adjusted basis, subject to limits set in respect of market, credit, and liquidity exposure;
- disbursing cash to government departments and facilitating departmental cash management;
- undertaking lending to government organizations and state-owned enterprises and facilitating and executing derivatives transactions in accordance with government policy;
- providing capital markets advice for other areas of the New Zealand Treasury, other government departments, and government organizations;
- providing debt-servicing estimates and accounting reports for fiscal forecasting and reporting purposes; and
- maintaining and enhancing, where appropriate, relationships with investors who hold, or are potential holders of, New Zealand government securities, financial intermediaries, and the international credit-rating agencies.
The NZDMO was established because a large volume of government debt created considerable risks for the taxpayer, and those risks needed to be managed in a comprehensive manner.
Beginning in the 1970s, large fiscal deficits became the norm in New Zealand, and ineffective monetary policy led to one of the highest rates of inflation in the Organization for Economic Cooperation and Development (OECD). By the early 1980s, a price and wage freeze had been introduced, and monetary policy was exercised primarily through direct controls and regulation. At the same time, to limit the rate of monetary growth, financial institutions were subject to lending-growth guidelines, which in practice were largely ineffective. Increasingly restrictive measures were introduced by tightening reserve-ratio requirements for banks and raising the government-securities ratios for finance companies and building societies. An attempt was made in 1983 to absorb excess liquidity through auctions of government securities. The effectiveness of the auction program to neutralize the fiscal injection through higher voluntary holdings of government securities was severely constrained by a requirement that upward pressure was not be exerted on interest rates. In that environment, most of the government's borrowing was in foreign currencies, which also served to finance the country's persistent balance of payments deficits.
Following the election of a new government in 1984, dramatic changes occurred in economic management through a series of macroeconomic and microeconomic reforms that enabled the price system to emerge as the dominant signal for investment, production, and consumption decisions. Major changes included
- the removal of controls on prices, interest rates, and wages;
- a free float of the New Zealand dollar and the removal of capital controls;
- a reduction in marginal tax rates and a broadening of the tax base;
- the elimination of subsidies and price supports;
- the removal of reserve-asset requirements for financial institutions; Page 155
- extensive deregulation; and
- substantial reforms of the public sector.
Transparency around fiscal policy improved, and deficits were reduced. As was typical of most OECD countries at the time, New Zealand had no separate objective regarding debt management. There was a growing view, however, that a more professional approach to portfolio and risk management was required to manage the stock of public sector debt, particularly the large foreign currency component. Against that backdrop, the NZDMO was formed in 1988 to manage the public debt denominated in both foreign currency and New Zealand dollars under the authority of the minister of finance.
The NZDMO was established as a self-contained unit within the New Zealand Treasury, rather than as a separate entity, because at the time it was thought that important linkages would otherwise be lost. In addition to debt-servicing forecasts for the budget and other fiscal releases, the NZDMO provides a range of capital markets advice to other sections of the treasury. Location within the treasury also allows close monitoring of the NZDMO's development and its effectiveness in managing the government's asset and liability portfolios.
Later restructuring of the treasury, prompted by a heightened emphasis on the government's aggregate balance sheet, led to the NZDMO being folded more closely into the treasury's branch structure. Since 1997, the NZDMO has formed part of the asset and liability management branch. Activities of the branch that are not the responsibility of the NZDMO include managing the government's contingent liabilities and advising on the financial management of departments, state-owned enterprises, and other institutions in which the government has an ownership or balance-sheet interest.
The secretary of the treasury is directly responsible to the minister of finance for the actions of the NZDMO. The head of the NZDMO is the treasurer, who reports to the asset and liability management branch manager, who is a deputy secretary.
In addition to normal accountability arrangements, the NZDMO's operations are also overseen by an advisory board, which provides the secretary of the treasury with quality assurance on the NZDMO's activities, risk management framework, and business plan. Members of the advisory board are selected on the basis of their experience in supervising portfolio management, payments, and banking activities; finance and risk management theory; and operational risk and reporting requirements. The advisory board currently includes a senior partner with a major accounting firm, the director of a corporate treasury and risk management advisory firm, and a finance academic.
By design, the structure of the NZDMO resembles that of a private sector financial-markets institution, with separate front, middle, and back offices. That structure leads to clearly defined responsibilities and accountabilities, procedural controls, and the segregation of duties, which is consistent with best practice. The portfolio management group is responsible for portfolio analysis, developing and negotiating transactions, managing the government's liquidity and cash disbursement system, and relationship management with international investors and rating agencies. The risk policy and technology group is responsible for...
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