United Kingdom
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Page 234
The government's current debt management policy was first outlined in the Report of the Debt Management Review in 1995. 1 The debt management policy objective is: "to minimize over the long term the cost of meeting the government's financing needs, taking into account risk, whilst ensuring that debt management is consistent with the objectives of monetary policy."
This policy objective is achieved by
- pursuing an issuance policy that is open, predictable, and transparent;
- issuing conventional gilts that achieve a benchmark premium;
- adjusting the maturity and nature of the government debt portfolio by means of the maturity and composition of debt issuance and other market operations, including switch auctions, conversion offers, and buybacks;
- developing a liquid and efficient gilts market; and
- offering cost-effective retail savings instruments through national savings.
Before the 1995 review, the formal objective for debt management was to
- support and complement monetary policy;
- subject to this, avoid distorting financial markets; and
- subject to this, fund at least cost and risk.
However, it was felt these objectives were not an appropriate description of the way that debt management policy functioned in practice. In particular:
- Funding at least cost subject to risk is the primary objective of debt management policy.
- An efficient and liquid gilts market lowers yields and, hence, reduces funding costs, thus helping to achieve the primary objective.
- Debt management is not the major tool of monetary policy, nor is monetary policy the main objective of debt management. Page 235
- The objective did not mention the important specific roles of the gilts market and national savings.
The current objective focuses on the long term. This avoids the government seeking short-term gain by, say, reducing the debt interest bill over the published forecast period. The long-term nature of many of the instruments used in the debt market plus the importance of maintaining an issuer's reputation mean that it is preferable to focus on long-term aims rather than seek short-run gains.
By taking account of risk, the government does not follow a purely cost-minimizing strategy. Rather, the government seeks to ensure that it is robust against a variety of economic results. The main way of doing this is by considering the effect of issuance on the ensuing government debt portfolio. Broadly speaking, the government will not be able to predict which particular gilt will prove to be cheaper than any other, because they will seldom be any better informed than the market on the future path of key macroeconomic variables. Indeed, the market will price any relevant information into the gilt yield curve. Therefore, it would seem futile for the government to attempt to beat the market systematically by trying to anticipate the future path of the economy that differs from that embodied in market expectations. It is therefore preferable for the government to select a portfolio that would protect it from as wide a range of economic shocks as possible.
In terms of operational delivery of the new debt management objective, the 1995 review heralded a move away from a highly discretionary debt management policy. The review rejected the thesis that discretion benefited the government in that it could sell appropriate debt at advantageous prices. It was felt that under such arrangements, the government would pay an unnecessary premium, because it would be systematically attempting to beat the market and there would be no certainty over or transparency in the path of issuance policy. Therefore, the review advocated a change to a policy that would promote a more efficient, liquid, and transparent market. It recommended a move toward a policy of annual published remits that would set out in advance issuance in terms of type and maturity of gilt, a preannounced auction calendar, and a movement toward more gilt sales by auction and less by tap.
On May 6, 1997, the chancellor of the exchequer announced that he was granting operational control of interest rate policy to the Bank of England. Among the other changes announced were that operational responsibility for debt and cash management should pass to Her Majesty's Treasury. Following a consultation exercise in July 1997, treasury ministers announced the creation of a new executive agency, the United Kingdom Debt Management Office (DMO), which would be charged with carrying out the government's operations in the debt and cash markets. The DMO became officially operational as of April 1, 1998, and took over responsibility for debt management from the Bank of England from that date. Full responsibility for cash management was assumed on April 3, 2000.
Before April 1998, the Bank of England acted as the government's agent in the debt and cash markets. The transfer to Her Majesty's Treasury helped mitigate any perception that the government's debt and cash operations might benefit from inside knowledge over the future path of interest rates and avoided a potential conflict of interest, or perception of conflict, between the objectives of the government's debt and monetary policy operations. This separation of responsibilities allows the setting of clear and separate objectives for monetary policy, debt management, and cash management, with benefits in terms of reduced market uncertainty and, hence, lower financing rates. The Bank of England's monetary policy committee is able to raise any issues about the implications of debt management for monetary policy with the treasury's representative at monetary policy committee meetings.
As with all executive agencies, the DMO's relationship with the treasury is outlined in a framework document.2 The basic structure for debt management is that treasury ministers advised by officials in the debt and reserves management team will set the policy framework within which the DMO will make operational decisions within the terms of the annual remit is set for them by treasury ministers. The Page 236 DMO's business objectives include a requirement for the DMO to advise the treasury about the appropriate policy framework, but strategic decisions rest with the respective ministers. The Bank of England acts as the DMO's agent for gilt settlement and retains responsibility for gilts registration.
The government's overall policy on debt management is set out in "The Code for Fiscal Stability," which has statutory effect by virtue of Section 155 of the Finance Act, 1998. Paragraph 12 of the code states that:
the primary objective of debt management policy shall be to minimize-over the long term-the costs of meeting the Government's financing needs whilst:
- taking account of risk; and
- ensuring that policy does not conflict with monetary policy.
All central government borrowing is done through the treasury (including the DMO) or national savings, although the Bank of England acts as agent for foreign currency borrowing for the official reserves. National savings is responsible for providing personal savings products to members of the public (mainly small investors).
The treasury has wide discretion as to how to raise money by borrowing, and it does so through two statutory funds, the National Loans Fund and the debt management account. Its main power to borrow for the National Loans Fund is conferred by Section 12 of the National Loans Act, 1968, which was subsequently amended in 1998 to establish the debt management account. This provides that the treasury can raise any money that it considers expedient to raise for the purpose of promoting sound monetary conditions in the United Kingdom, and this money may be raised in such manner and on such terms and conditions as the treasury thinks fit. Section 12(3) of the same act makes it clear that the treasury's power to raise money extends to raising money either within or outside the United Kingdom, and in other currencies. There are no set limits on the extent to which the treasury may borrow from outside the United Kingdom. The treasury's power to borrow for the debt management account is conferred by Paragraph 4 of Schedule 5A of the National Loans Act, 1968, and this paragraph, like Section 12 of the act, gives the treasury a wide discretion as to how to raise money. Paragraph 4(3) is similar in terms to Section 12(3) of the act, and it provides that the treasury's power to raise money under Paragraph 4 extends to raising money either within or outside the United Kingdom, and in other currencies. Again, there is nothing in Schedule 5 of the act to limit the amount of money the treasury may borrow from outside the United Kingdom.
In practice, treasury borrowing takes a wide range of forms and ranges from the issuing of long- term securities (gilts) to the issuing of short-term treasury bills (12 months maximum) under the Treasury Bills Act, 1877.
The chancellor of the exchequer, under...
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