Debt Management: Meaning, Objectives and Techniques | Economics

In this article we will discuss about:- 1. Meaning of Debt Management 2. Objectives of Debt Management 3. Techniques 4. Conclusion.

Meaning of Debt Management:

Debt management is often referred to the amount, composition and refunding of the national debt. But, in actuality, it is related to the composition (the types of securities sold) and the refunding of the debt held by the public within a country. So far as the number of new securities sold by the government is concerned, it falls within the jurisdiction of fiscal policy.

The number of securities bought and sold by the Central bank is a monetary policy decision. Thus debt management is defined as “all actions of the government, including both the treasury and central bank, which affect the composition and retirement of the public-held debt”.

Objectives of Debt Management:

The main objectives of debt management are:

1. To minimise the interest cost of servicing the debt to the taxpayer.

2. To employ it contra-cyclically as a stabilisation weapon to supplement monetary and fiscal policy.

There are potential conflicts between these two objectives because they often entail opposite policy actions. Minimising the interest cost means that during a recession, interest rates are low. The government should exchange its maturing securities with hew long-term securities carrying low interest rates so that their interest cost is less in the future.

On the other hand, when interest rates are high during a boom, the government should exchange its maturing securities with short-term securities which carry low interest rates so that it has not to pay high rates when the interest rates fall to normal levels.

The stabilisation objective requires opposite policies. During a recession, the government should sell short-term securities which should lower interest rates and increase investment spending. On the other hand, during a boom, it should sell long-term securities which would raise long-term interest rates. This would reduce investment spending.

Techniques of Debt Management:

Many techniques have been suggested by economists to achieve the objectives of debt management.

We discuss below a few practical and important techniques:

1. Lowering the Interest Cost:

The most important objective of debt management is that the interest cost of the public debt to the government should be low so that the burden of servicing the debt should be the minimum to the taxpayers. The government repays the debt by raising revenues from taxation.

The higher the cost of servicing the debt, the higher would be the level of taxation and the greater the burden on taxpayers. The government should so work out the pattern of interest rates that it conforms to the preference pattern of security holders. The lower the interest rates on government securities, the smaller will be the transference of resources from the taxpayers to bond holders.

In practice, most governments keep very low interest rates on short-term securities and gradually increase the interest rates as the maturity period of the debt lengthens. This method gives rise to wide spreads between the short-term and long-term interest rates. This induces bond holders to switch over from short- term to long-term securities thereby increasing the debt burden of the government and imposing a higher tax burden on the taxpayers.

2. Changing the Maturity Structure:

One of the techniques of debt management is to change the maturity structure of the debt as a device for economic stabilisation. This is done by “swapping operations” by the central bank. During boom period, the central bank sells more long-term government securities in the open market and purchases a corresponding amount of short-term government securities with the same amount of money.

This lengthens the average maturity structure of the existing public debt which tends to raise the interest rate. Since long-term securities are not good substitute for money, they increase the liquidity preference. As a result, the liquidity preference curve will shift to the left from LM to LM₁This raises the equilibrium interest rate from OR to OK, and reduces the equilibrium income from OY to OY₁, as shown in Fig. 4. The rise in the long-term interest rate would curb private spending by reducing availability of credit.

The value of outstanding assets of financial institutions is also reduced with the increase in interest rate. They, therefore, tend to hold more liquid short-term government securities. This is likely to cause a rise in the short- term interest rate.

If the short-term interest rate rises slightly, financial institutions will tend to hold more short-term government securities rather than cash. Thus reduction in the availability of credit and holding of more short-term securities will have a tendency to control a boom.

On the other hand, debt management requires the shortening of the average maturity structure of the outstanding public debt through the sale of short-term government securities to replace them by purchasing long-term government securities during a recession. This would tend to bring a sharp fall in the long-term interest rate accompanied with a mild fall in the short- term interest rate. Since short-term securities are a close substitute for money, the asset holders tend to substitute them for money.

This will reduce the liquidity preference and shift the LM curve to the right from LM to LM₂ with a lower equilibrium level of interest rate OR₂ and a higher income level OY₂, as shown in Fig. 4. Thus debt management requires the manipulation of the term structure of the debt to bring about economic stability.

3. Advance Refunding:

Another method of lengthening the public debt is to advance refunding of securities. The central bank offers the holders of a particular long-term government security, which still has some years to mature, to exchange their securities for a new security with a longer maturity.

The new security carries a little higher yield and the holders of the old security do not realise any capital loss or gain. This technique has the advantage over the other techniques described above in that the central bank is not required to resort to open market operations for managing the public debt.

Conclusion to Debt Management:

Debt management leads to a number of problems which should be tackled in co-ordination with monetary and fiscal policy. A large size of public debt is likely to siphon off funds from the capital market. This reduces the availability of credit in the capital market and raises the interest rate.

This is likely to increase the burden of public debt to the government and makes investors feel that they would suffer a capital loss. Moreover, any holding of public debt by the central bank correspondingly increases the cash holdings of commercial banks.

The banks, in turn, make a multiple expansion of their deposit liabilities which leads to inflationary pressures in the economy. Further, fluctuations in the demand, supply and prices of government securities during booms and recessions tend to increase the severity and longevity of booms and recessions.

For this, the central bank should be ready to purchase or sell government securities in the open market in order to bring upward or downward pressure on interest rates for economic stabilisation and to minimise the interest cost of the debt to the government.

Similarly, the government should resort to fiscal policy so as to manage the public debt effectively. A budget surplus is used as a fiscal device during boom periods. A surplus budget acts in a deflationary manner upon the money supply and bank reserves. A budget surplus means that the government revenue is more than its expenditure. It involves reduction of money in the hands of taxpayers who are levied heavy taxes.

This leads to a reduction in the deposits of the public with the commercial banks which, in turn, reduces the reserves of commercial banks. As a result, their reserves with the central bank are reduced. This leads to the reduction in the spendable money with the government. This makes the retirement of public debt held by the central bank difficult. This goes against the commonly held view that a budget surplus can be used for the retirement of public debt held by the central bank.

Despite this, coordination between monetary and fiscal policies is essential on a regular basis because of the frequent debt refunding operations of the central bank. When government securities mature, it is the central bank which is required to refund them on behalf of the government.

At the same time, the government has to follow a surplus budgetary policy to retire the public debt. But this policy is deflationary in nature and requires to be controlled by an appropriate anti-deflationary monetary policy.

If the government adopts a deficit budgetary policy for debt retirement, it would be inflationary in nature which is again required to be controlled by an appropriate anti-inflationary monetary policy. Thus for an effective debt management, there should be a close coordination between monetary, fiscal and debt management policies.