9 Leading Issues in Debt Management

This article throws light upon the nine leading issues in debt management. Some of the issues are: 1. Optimal Maturity Structure 2. Low Interest Obligation 3. Preference Pattern of Investors 4. The Issue of Debt Monetization 5. Maintenance of Interest Rate 6. Public Debt as an Instrument of Economic Stability 7. Debt Management and Need for an Appropriate Policy Mix and Others.

Issue # 1. Optimal Maturity Structure:

Choice of maturities constitutes the major issue in debt manage­ment. The earlier view is that public debt should be well funded, i.e., being in long term maturities. If a large proportion of the total debt consists of short term debt and among this, if a higher proportion is held by the banks, it may generate a high degree of liquidity.

This in turn may contribute to an inflationary pressure at a time when the economy warrants anti-inflationary policy. As a result increased li­quidity of debt, make it difficult to control inflationary situation.

Debt management principle assumes that maturity issues can always be refunded. An important technique adopted in modern days to keep public debt in conformity with the preference pattern of lenders i.e., to comprise between liquidity and interest earnings is popularly called “swapping operation”.

It is the simultaneous purchase and sales of government securities of wide ranging maturities by the central bank of a country. As a result the total volume of public debt remains un­changed.

As particular issues mature, they will be refunded into other issues, which are called swapping of debt. Usually, the interest offered on short term debt is lower than on long term debt. Suppose the total debt of government consist of larger proportion of short term debt.

Then the repayment obligation at a particular point of time will be large. This constitutes a disadvantage from debt operation. How­ever, the interest obligations from short term debts will be compara­tively low. This is an added advantage.

Hence, while framing the maturity structure of public debt, this advantage and disadvantage should be properly weighted and analyzed. Another situation can emerge when the total debt consist of larger proportion of long term debt, than short term debt. In this case the repayment obligation at a point of time will be lesser, but the burden of interest payment will be very high.

Hence, while selecting the most appropriate maturity structure, these conflicting possibilities must be taken into account. The management of public debt must strike a judicious balance be­tween these issues.

Issue # 2. Low Interest Obligation:

It is a reality that larger the volume of public debt, greater is the volume of tax to be raised to meet the interest payment and repay­ment obligation. In this case the government has to impose addi­tional taxes or the rate of existing taxes should be raised to mobilize the required revenue to meet interest payment and repayment of principle.

Hence the government should always strive to keep the interest cost of servicing public debt at the minimum possible ex­tent. Heavy taxation for revenue mobilization involves much stress and frictions in the economy.

Hence, the safe limit of public debt is determined by the degree of strains and frictions which the economy can sustain. So in public debt management, issues like interest rates, tax mobilization for interest payment and debt redemption should be planned in such way that the economy is subjected to minimum possible strains and frictions.

Issue # 3. Preference Pattern of Investors:

Debts with varying maturity structure and interest rates can be floated to raise a given volume of public debt. The investors in public debt always prefer to hold government bonds of different maturities with different interest rate structure.

Hence it is usually advocated that public debt should be managed in such a way, as to satisfy the need of the investors with regard to their preference for variety of govern­ment bonds with different maturity, structure and interest rates.

The investors prefer diversified bond structures, to strike a balance be­tween their interest income and liquidity objectives. However, there is a conflict between interest income and liquidity objectives. Short debts have a high degree of liquidity, but low interest income earning capacity.

On the other hand long term debt possesses high interest income, but low liquidity. Whereas individual investors are in need of both liquidity and high interest income. How to overcome these con­flicting objectives is an issue in debt management.

Therefore, in the management of public debt, debt structure should be planned in such a way as to secure the interest obligation of the government at the minimum possible level and to realize the preference pattern of investors based on liquidity and interest income.

Issue # 4. The Issue of Debt Monetization:

Government bonds are freely bought and sold in the money market like any other negotiable credit instrument. So the monetisation of public debt create a problem in modern debt management system.

The investors are free to monetize their bonds. As a result there is every possibility that the repayment obligations of government at any point of time may be high. This may even disrupt the expendi­ture programme of the government.

Hence some economists argue that the principle of debt management should be capable of impos­ing restrictions on the monitisation of public debt. Government should fix interest rate for long term and short term debts in such a way that the interest earnings to bond holders increase as the maturity period of bond is lengthened.

This may reduce the intensity of investors to monetize the debt dearly because he may be losing interest in­come. Another method is to frame government securities as non- marketable credit instruments. In this case, interest obligation will be high.

The combination of the two possibilities discussed above can be adopted as a third device. That is the government should impose non-marketability restrictions up to a certain period, coupled with the provision of larger interest rates for longer maturity periods.

Issue # 5. Maintenance of Interest Rate:

The available investment funds in any economy are distributed be­tween the private sector and public sector. Larger floating and invest­ment in public debt reduce the availability of funds for the private sector. This will invariably raise the rate of interest in the market.

In such a situation, the investors in government bonds will suffer a loss of income. This will prompt them to abstain from investments in government securities. This is an issue to be addressed in debt management.

Hence government should assure the investors that they will not lose interest income by holding government securities, instead of investing the fund in the private sector. The success of this objective depends upon the effective use of monetary policy with fiscal policy.

The central bank through open market operation can ensure stability in the value of government bonds, during times of wide interest fluctuations.

Issue # 6. Public Debt as an Instrument of Economic Stability:

Public debt is an important instrument used to bring about stability in the economy by controlling inflation and deflation. To achieve the objective of economic stability, extreme flexibility is needed in debt policy.

In a situation of underemployment, refunding debt issues must be placed so as to have minimal contractive effect upon private de­mand for goods and services. This means that funds should not be withdrawn from those with high propensity to spend. It means that funds going into debt instruments should not be mobilized from indi­viduals, but should be newly created in the banking system.

Oppo­site is the case when the problem is one of over spending. During this period the average maturity of existing public debt should be lengthened. This is done by the central bank through open market operation of selling the long term securities and purchasing with the sale proceeds, the short term securities.

In this situation the objec­tive should be that of restricting monetary demand, transferring funds from potential spenders and certainly not creating new funds in the system.

Issue # 7. Debt Management and Need for an Appropriate Policy Mix:

A well framed debt management system should possess an appro­priate mix of monetary and fiscal policy to achieve the objectives of economic growth with stability. For the successful management of debt of rations, the public authority must ensure stability of interest rate structure in the money market.

The public authorities should ensure stability in interest rate structure, to facilitate proper aug­mentation of required money by floating public debt. This task is done by the central bank of a country through the maintenance of interest rate structure in the desired level.

Through open market op­eration, in government securities, the central bank ensures stability in the value of government securities. This removes the fear of inves­tors about an upward or downward movement of security price or interest rate structure. For achieving this, monetary policy should be prudently designed and used appropriately.

Coupled with this the fiscal operation of the government should be properly planned to reduce the debt burden to the minimum extend. The complementa­ry of fiscal policy arises in regard to the relation of public debt with financing of budget deficit or with disposal of budget surplus.

The budget deficit or budget surplus is adopted in accordance with the situation of unemployment or inflation. Hence the public authorities must decide as to how to finance the deficit or to dispose of the surplus. In short a proper policy mix is needed for a scientific man­agement of public debt.

Issue # 8. Debt Ceiling:

Another constraint on debt management relates to the size of the debt. For instance in America congress annually authorizes a set limit which the treasury cannot exceed. At the same time congres­sional action or inaction with regard to revenue legislation and appropriations often fall for increase in government borrowing beyond the debt ceiling.

This requires the secretary of the treasury periodically to appear before congress and to request for an increase in the ceiling. The debt ceiling policy Musgrave observes is a roundabout device to secure control over expenditure levels.

Issue # 9. Inflation Proof Bond:

Another proposal advanced over the year is for the issuance of a “stable purchasing power bond”. The redemption value of such a bond vary with the cost of living index, thus protecting the small investors against the loss of purchasing power, during inflation as well as depriving him of a gain if prices should fall.

The coupon rate on such a bond will be correspondingly lower since it would carry no inflation premium. Its availability would be of great value to the small investors who find it difficult to protect themselves against inflation.

It entails no risk to the treasury since the tax automatically rises and falls with the price level. Musgrave observes that the use of such debt instruments world increase the effectiveness of debt manage­ment as a tool of stabilization policy. However in-spite of these ad­vantages, it is difficult to administer such a debt instrument.