MEDIUM EDIUM TERM ERM DEBT EBT STRATEGY TRATEGY Maria A. Oliva Senior Economist International Monetary Fund Note: A portion of this content appears as text within the course itself. This training material is the property of the International Monetary Fund and is intended for use in IMF Institute for Capacity Development courses. Any reuse requires the permission of the IMF. The views expressed in this material are those of the course staff and do not necessarily represent those of the IMF or IMF policy.
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MEDIUM TERM DEBT TRATEGY Managggyement Strategy Period 1 Period 2 Period 3 Period 4 Period 5 Overall Fiscal Overall Fiscal Overall Fiscal Overall Fiscal Overall Fiscal Budget Balance
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MMEDIUMEDIUM TTERMERM DDEBTEBT SSTRATEGYTRATEGY
Maria A. OlivaSenior EconomistInternational Monetary Fundy
Note: A portion of this content appears as text within the course itself.
This training material is the property of the International Monetary Fund and is intended for use in IMF Institute for Capacity Development courses. Any reuse requires the permission of the IMF. The views expressed in this material are those of the course staff and do not necessarily represent those of the IMF or IMF policy.
Public debt managementPublic debt management
“Public debt management is the process of Public debt management is the process of establishing and implementing a strategy for managing debt to achieve the
t’ fi i i k t government’s financing, risk, cost objectives and other goals, such as developing the domestic debt market”developing the domestic debt market
Guidelines for Public Debt Management: IMF/World Bank, 2001
Tunisia 45.5 49.7West Bank & Gaza 21.7 20Yemen 48.1 50.1
Source: World Economic Outlook, http://www.imf.org/external/index.htm
Medium-term Debt Sustainability Framework (MTDS):
• Framework to design the characteristics of the sovereign debt portfolio taking into account a sovereign debt portfolio taking into account a medium-term/long-term objective.
• Framework to examine costs and risks d bl bassociated to possible borrowing strategies to
cover a financing need.
Why an Explicit Debt Management Why an Explicit Debt Management Strategy Framework??Because we need to understand
… cost-risk tradeoffs of our sovereign debt portfolio
h th iti f d bt tf li h l … how the composition of our debt portfolio can help minimize amplify the magnitude of external and domestic shocks
… how the macro affects borrowing
ff d d b… how monetary policy affects domestic debt issuance
… new risks and complexities affecting the debt portfoliop g p
The Framework: A 8 step approach
The Framework: A 8 step approachA 8-step approachA 8-step approach
Step1: Identify Objectives & Scope p fy j p
Step 2: Identify Costs & Risks of the Existing Debt
The main goal and intermediate goals Steps to reach the goal Steps to reach the goal.
SSCOPECOPE Choosing the “appropriate” definition of “government” matters.
f d b f l lTTHEHE CCURRENTURRENTDDEBTEBT PPORTFOLIOORTFOLIO
The characteristics of the current debt portfolio is legacy that conditions future decisions.
Medium MTDS:
Framework to design the characteristics of the sovereign debt portfolio taking into account a sovereign debt portfolio taking into account a medium-term/long-term objective.
Period 1 Period 2 Period 3 Period 4 Period 5Period 1 Period 2 Period 3 Period 4 Period 5
What type of Instruments?Fixed/Variable? Maturity? Maturity? Currency? Official or Market?
OOBJECTIVESBJECTIVESOOBJECTIVESBJECTIVES
OBJECTIVE: GO FROM A TO E
CB “Go with h idCB the tides
and wind”
D
AA
EStart: Einitial portfolio
Final Note: plans are made subject to constraints Final destination: desired portfolio
p j(navigation skills, weather conditions and forecast, ship size, etc.)
TTHEHE SSTRATEGYTRATEGYPlan that provides direction and benchmarks for debt management
Government’s medium term goals
TTHEHE FFORMALORMAL
g
Standard goals: 1 tt i i i i k/ t OOBJECTIVEBJECTIVE 1.- attaining a given risk/cost level 2 - domestic debt market
24
2. domestic debt market development
SUBJECT TO: SUBJECT TO:
CCONSTRAINTSONSTRAINTSTTHEHE REALITYREALITY &
MT Macro-economic outlook
Stock of debt
Market development Market development
Market access
25
Legal and institutional framework
SSCOPECOPESSCOPECOPE
Liabilities: Financial claims to financial sector Non-fin Liabilities: Financial claims to financial sector, Non-fin private sector and to the rest of the world
MMARKETABLEARKETABLE DEBTDEBTOO
But …..
OOTHERSTHERSLLOANSOANS
What is the relevant coverage ? Is it feasible?
Central Government, General Government, Public Government, Public Enterprises?
Should contingencies be included? If so, which ones? How should these be valued?
Debt OutstandingDomestic and External DebtDomestic and External Debt
The sovereign debt portfolio at time t is
1
NewDebtIssued t LegacyDebtt‐1 maturity t i*Debt t‐1 g y yPrimaryBalancet ContingentLiabilities t Valuationt
Analyzing the current portfolio implies using some matrix
800,000Baseline
600,000Domestic debt
400,000
External debt
0
200,000
0
2013
2016
2019
2022
2025
2028
2031
2034
2037
2040
2043
2046
2049
Financing of Debt:Financing of Debt:d bl ff lWhat Instruments? Fixed/Variable? Maturity? Currency? Official/
Market?
Cost characteristics
Risk characteristics:
Market riskMarket risk
Refinancing risk
External debt Domestic debt Total debtRisk Indicators External debt Domestic debt Total debtRisk IndicatorsAmount (in millions of USD)Nominal debt as % GDPNPV as % of GDPCost of debt Weighted Av. IR (%)
ATM (years)
NPV as % of GDP
Debt maturing in 1yr (% of total)ATR (years)Debt refixing in 1yr (% of total)
Refinancing risk
Fixed rate debt (% of total)FX debt (% of total debt)ST FX debt (% of reserves)FX risk
Interest rate risk
ST FX debt (% of reserves)FX risk
Debt Portfolio Debt Portfolio and
Cost Measures
Defining Cost:Defining Cost:
D bt t bj ti ll f th • Debt management objectives usually focus on the economic cost
– Measures that focus exclusively on prevailing accounting/budgetary practices may also be inadequate
• Cost can be measured in different ways– Accrual, due-for-payment, cash, p y ,– Nominal versus real value– Discounted cash-flows (Present Value) versus cash-flow measures
• Different cost measures provide different information on cost - do not rely on one cost measurecost do ot rely o o e cost easure
• Debt / GDP and NPV of Debt / GDP also capture extent of debt burden – also “costs” (solvency)
• Annual interest payments + the potential impact of changes in exchange rates and other changes to the changes in exchange rates and other changes to the principal (e.g. inflation indexed debt)
D bt P tf li Debt Portfolio and
Risk Measures
Types of riskyp
Exchange RiskExchange RiskInterest Rate Risk
Term premium
Interest Rate Risk
Term premiumMarket Risk Term premiumInflationReal interest rate
Term premiumInflationReal interest rate
Refi a ci g RiskRefi a ci g RiskRefinancing RiskRefinancing Risk
– Volatility of underlying factors (risk factors = interest and exchange rate volatility)
– Trends
Our main focus here is on downside risk
Interest rate riskInterest rate risk
Vulnerability of funding costs to higher interest rates when variable rates are reset and/or fixed rate debt needs to be refinanced
Typical measures of exposure– Fixed-Floating ratio
– Floating rate debt as a percentage of total debt
– Debt exposed to interest rate re-fixing within a specific time period • Maturing fixed rate debt to be rolled over• Maturing fixed rate debt to be rolled over• Variable rate debt (include interest rate swaps)
– Average Time to Re-fixing (ATR)
ATR = time weighted average until all principal payments in the debt portfolio become subject to a new interest rate
E h i kExchange rate risk The exposure of the portfolio to changes in the
exchange rate exchange rate
Typical measure of exposure
– Share of foreign currency debt in total debt• Can be split by specific currency (dollar risk Euro risk • Can be split by specific currency (dollar risk, Euro risk
etc.) – Currency composition
f f b– Degree of foreign currency liabilities mismatch relative to foreign currency reserves
R fi i i kRefinancing riskIt captures the exposure to not being able to refinance debt
Typical measures of exposure
– Redemption profile of the outstanding debt stock
– Share of debt falling due within a particular periodShare of debt falling due within a particular period
– Ratio of debt falling due to tax revenue
– Average Time to Maturity
ATM = time weighted average to maturity of the all the ATM time weighted average to maturity of the all the principal repayments in the debt portfolio
What Can Mitigate Refinancing Risk?
Smooth debt profile Smooth debt profile
Offi i l s s s b ff f B P ds d t Official reserves as a buffer for BoP needs and to enhance confidence
gbudgetary uncertainty and exposure to interest risk
Why a MTDS? Financial Markets Development
P blic debt ma a eme t ca effecti el s pp t the • Public debt management can effectively support the development of more robust financial markets, improving the functioning of the financial system
– Facilitating corporate debt markets• Providing a benchmark for the private sector• Providing scope for securitization of banks’ assetsg p f z f
– Facilitate repo market development• Improving liquidity of banks’ balance sheetsp g q y
– Facilitate development of derivatives markets• Allowing for more effective risk management within g g
the economy
Pricing and Monetary Policy
Baseline and Monetary Policy
• Key variables: Interest and Exchange Rates
• Interest rates:
–Short-term driven by monetary policy–Nominal rates driven by inflation expectations–Monetary policy stance may influence real interest rates given the Monetary policy stance may influence real interest rates given the impact of macroeconomic stability on risk premium
• Exchange Rates:• Exchange Rates:
–Influenced by interest rates (parity equation) f f f–Relationship with foreign reserves, including a policy of foreign
reserve accumulation
THE YIELD CURVE
Yield Curve or Term Structure Plots of yields to maturity of a series of bonds against their term to maturity
Crude representation of risk: return trade off of bond investment alternatives
with reasonably equivalent risk (liquidity, credit, call, premium/discount)
Determinants:
real interest rate
Term structure in one year
inflation premium risk premium
)1()1()1()1( )1( ,13
3,12
2,11 n
nn fffii
Term structure in one year
Term Structure Shapes
NormalYTM YTM
Symptoms of economic downturn, recession
Normal
Inverse
YTM YTMThe longer maturity
the higher the risk
Term to maturity (in years) Term to maturity (in years)
Flat
Humped
YTM YTM
Term to maturity (in years)Term to maturity (in years)
L ss liq id b dsLess liquid bonds
YTM Liquid bondsq
Term to maturity (in years)Term to maturity (in years)
EXCHANGE RATE POLICY EXCHANGE RATE POLICY
• Foreign currency denominated debt
• Exchange rate regimes:
–Fixed exchange rate regimes with an open capital account can aggravate liquidity risk in case of sudden stops or reversals (changes in market sentiment)
– Reducing FX debt and monetary policy, and exchange rate policy coordination.
• FX support, public debt management coordination and FX reserves
d l li i bTo develop an explicit Debt Management StrategyManagement Strategy…
There is a need to understand
• … cost-risk tradeoffs of the debt
• … how debt structures can dampen or amplify the magnitude of external and domestic shocks
• … how the macro affects borrowing
• how monetary control helps domestic debt issuance• … how monetary control helps domestic debt issuance
• … constraints: institutional, market, …
• … new risks and complexities
They got speculative grades … with few variations from Moody’s 4
Moodys: Government Bonds Ratings, a Historical View
B1 few variations from Moody s
3B2
Foreign currencyLocal currency
… and below investment grade from S&P2B3
4
S&P: Local and Foreign Currency Ratings, An Historical Perspective to Date
B+
0
1Caa1
2
3B
B-
Ma
y-98
Ap
r-03
Se
p-0
9Ju
n-1
0D
ec-1
0Ju
n-1
2
Ma
y-07
Se
p-1
3
De
c-12
Se
p-9
8Ju
l-99
Fe
b-1
3
No
v-12
Se
p-1
3
Ma
r-98
Jun
-03
Ma
y-10
Ma
r-11
No
v-12
BOL KHM DRC GHA HND KEN MOZ NIC SEN ZMB
1
B
CCC
0 No
v-05
Ma
y-0D
ec-1
0
Jul-0
6
De
c-04
Ma
y-0
No
v-05
Se
p-0
7A
ug
-10
Oct-0
8S
ep
-09
Jun
-12
Au
g-1
3M
ay-0
Jul-0
8Ju
l-04
Ap
r-06
Au
g-1
3D
ec-1
1
No
v-05
Ma
y-0M
ay-1
De
c-12
Ma
r-1
NR…and if rated by S&P and Moody’s… 5 7 0 4 6 5 7 0 8 9 2 3 4 6 3 1 5 9 0 2 1
BRB BFR CMR GHA HND MLI MOZ RWA SEN UGAZMB
y
Ri kMacro-economic risks and
implications for the debt strategy Risksimplications for the debt strategy
Risks
For the Governme
nt Implications
for the MTDSFinances
f D
Real Sector
Real Growth Inflation
Fiscal Sector Risks Implications
Fiscal receiptsPrimary Balance
Monetary Sector
Further global economic slowdown
Reduce inflows of aid and FDI ?Decline in oil and other commodityMonetary Sector
Commodity PricesInterest rate
commodityprices?
Capital flow reversalStrains in financial markets?
Step 6: Identify Cost-Risk trade-offs for alternative debt management strategiesStep 6: Identify Cost-Risk trade-offs for alternative debt management strategies
IF NeededIF Needed
Step 7: Review Implications for macroeconomic policies and marketStep 7: Review Implications for macroeconomic policies and market
Step 8: Recommend MTDS for approval
Setting up alternative strategies
New debt S1 S2 S3 S4% of gross borrowing - Over Projection Period
New debt S1 S2 S3 S4IDA FX 100% 0% 20% 50%AfDF FX 0% 0% 30% 0%Bilateral semi-conc FX 0% 0% 50% 0%Bilateral semi-conc FX 0% 0% 0% 0%Bilateral semi-conc DX 0% 0% 0% 0%Bilateral semi-conc DX 0% 100% 0% 0%Eurobond FX 0% 0% 0% 0%
Are these the right st t i s? Eurobond FX 0% 0% 0% 0%
Dom 1 an DX 0% 0% 0% 25%Dom 3 ans DX 0% 0% 0% 0%Dom 5 ans DX 0% 0% 0% 25%
strategies?
Dom 7 ans DX 0% 0% 0% 0%Commercial DX 0% 0% 0% 0%Arrears FX 0% 0% 0% 0%Arrears DX 0% 0% 0% 0%Arrears DX 0% 0% 0% 0%
Q tit ti e t ls help i f decisi ki • Quantitative tools help inform decision-making process by allowing producing a ranking of candidate strategies on a consistent basisg
• However,
The quality of outputs is only as good as th lit f th i tthe quality of the inputs
Decisions need to be made in line with Decisions need to be made in line with the pre-set objectives and take constrains into account
IIMPLEMENTATIONMPLEMENTATIONDefining financing plan in line with budgetary cash needs
Issuance plan
MMONITORINGONITORING
ssua e p a
Impact on key targetsMeet?
Developing/improving risk management system.
Meet?
“S“STRUCTURALTRUCTURAL” ” REFORMSREFORMS
Developing/improving risk management system. Market development objectivesInvestor base relation
Developing a consistent borrowing planDeveloping a consistent borrowing plan
After choosing a DMS….l iImplementation
• What is the annual financing plan that is consistent with the selected strategy?consistent with the selected strategy?
• Are there other portfolio management activities p gthat are needed to attain the portfolio targets? (e.g. derivatives?)
• How is the monitoring of implementation going to be applied? And if there are deviations how to be applied? And, if there are deviations, how are these going to be addressed?
The Financing Plan
H D th Fi i Pl f th How Does the Financing Plan for the Next Budgetary Cycle Look Like? g
D t i th ss b i ds f h t p • Determine the gross borrowing needs for each type of instrument to cover
expected budgetary needs roll over needs/amortization needs /
• Are these consistent with the debt strategy? gy
• Borrowing plan. What is the timing?
2013 Financing Needs (In domestic currency)
Gross Central Government Cash Requirements 20,000Redemptions --Total Financing Need 20,000