Analyzing Cost and Risk: The MTDS Analytical Tool

Analyzing Cost and Risk: The MTDS Analytical Tool

Lars JessenBanking and Debt Management

Second Asian Regional Public Debt Management Forum Thailand, March 16-18, 2011

Agenda

Risk models for analyzing cost and risk on government debt portfolios

The Medium-Term Debt Management Strategy (MTDS)

The MTDS Analytical Tool Some thoughts about risk modeling

Risk Models in Debt Management

Models are widely used by debt managers to provide input to decision-making, and to better understand the cost and risk trade-offs

Provides supplement to qualitative analysis Starting point is a clear definition of cost and risk

– This may seem trivial, but is at the core of risk modeling

A model should only contain elements that are needed to answer specific questions– Additional details = additional complexity

3

The MTDS Toolkit

Supports a structured approach to developing a medium-term debt management strategy– Requires a clear description of the framework within

which the strategy is developed, including objectives for debt management, macro-economic issues, etc.

Available on the web-sites of the Bank and the Fund (search for “MTDS”)– Guidance Note

– Analytical Tool and User Guide

MTDS is a framework to fully assess relevant costs and risks associated with a government’s desired composition of debt

5

The Process to Develop a Debt Management Strategy

1. Objectives and scope of the MTDS

2. Current strategy and cost and risk of existing debt

3. Potential sources of finance

4. Medium-term macro and market environment

5. Vulnerabilities, risks, and structural factors

6. Analysis of alternative debt management strategies

7. Review with fiscal, monetary and market authorities

8. Propose and approve MTDS

Why a Cost-Risk Analysis Tool?

Supports qualitative analysis, i.e., complements the analysis described in the Guidance Note

Allows– Detailed cost-risk analysis of individual strategies

– Detailed analysis of individual instruments

– Detailed comparisons of strategies

– Sensitivity of portfolios to changes in macro assumptions

What Does the MTDS Analytical Tool Do?

Projects cash flows as function of– Market scenarios, i.e., future interest rates and

exchange rates

– Debt management strategies, i.e., which borrowing instruments

– Macro assumptions, i.e., primary balances

Computes summary statistics based on complete cash flows at the end of each year

Multi-currency, multi-instrument

Closely linked with DSA and MTEF

The Basic Structure of the Analytical Tool (1)

INPUT

•Existing debt cash flows

•Macro variables – Primary

balance

•Structure of new debt

– Borrowing strategy

•Financial variables– Interest rates– Exchange

rates

ENGINE

Cash-flow Simulation

OUTPUT

CostRisk

Excel-based

Developed on the basis of scenario-analysis models used by debt management offices– Structurally, it is similar to deterministic and stochastic

scenario models used in practice

Four separate spreadsheets– SDModel0XL.xls – the engine

– Strategy_Test.xls – specifies strategies to be tested

– ScenarioXLTest.xls – stress scenarios

– ScenarioAnalysis.xls – comparison of strategies

The Basic Structure of the Analytical Tool (2)

Measurement of Cost

Nominal interest cost

Real interest cost

Nominal interest cost to GDP

Nominal interest cost to government revenues

Average interest rate

Interest cost adjusted for gains/losses on indexed debt

Etc.

Measurement of Risk

Baseline Scenario

Risk Scenario 1

Time

Cost

Risk1,X

Cost1,X Costbaselin

e

Time

Example of Output

Interest/GDP, end 2013 Debt/GDP, end 2013

How Can a Model Support the Development of a Strategy?

Gives deeper insight to the debt-process Forces discipline

– Clear cost and risk definition

– Clarification of macro framework

– Clarification of constraints, including regarding the domestic market

– Clear time horizon

Ensures integrity when comparing alternative strategies

Allows identifying strategic targets– For example, a target range for Average Time to

Maturity or Average Time to Refixing

Common Challenges in Cost-Risk Modeling

Simple concepts, but need lots of details– Model building and application is a gradual process

Lack of integrated and high quality database– The cash-flows of the existing debt is the starting point

Projection of market variables– How to model future market rates if no or limited history?

Macroeconomic projections Non-standard instruments Availability of resources for model development

and lack of technical expertise

Some Final Thoughts …

Scenario analysis is extremely useful when developing a Medium-Term Debt Management Strategy– Keep in mind that models are useful - but always wrong!

Can a sound debt management strategy be developed without scenario analysis?– Yes, but a model allows digging deeper

Model building is an iterative process– It is better to start with modest objectives and add to it than to try

to build the ultimate model

Is the MTDS analytical tool a black box?– Not custom-built, rather, can accommodate many types of debt

– Requires training

– World Bank and IMF are piloting a simpler model that would be substantially more user-friendly

©2007 The International Bank for Reconstruction and Development / The World Bank1818 H Street NW Washington DC 20433Telephone: 202-473-1000Internet: www.worldbank.org

E-mail: [email protected]

All rights reserved

This volume is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent.

The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries.

Rights and Permissions

The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly.For permission to photocopy or reprint any part of this work, please send a request to Diane Cashman at [email protected] and [email protected].

16