Why is Debt Management

Important?
FAD Professional Development Seminar
December 10, 2008

Brian Olden
Topics
{What is government debt management?

{Why is it important?

{Some possible impacts on debt management

operations of current crisis

{Principles of Modern Debt Management

What is Government Debt Management?

zDebt management is the process of establishing and

implementing a strategy for prudently managing the
government’s debt in order to meet the government’s
financing needs its cost and risk objectives and any other
goals the government may have set…1/
zDebt management and debt sustainability are separate
but inextricably linked.
{ Although poor debt management can contribute, broader fiscal
policy is the main determinant of debt sustainability.
{ Debt management strategies must be considered as part of a
wider fiscal policy strategy if it is to be effective in achieving its
objectives.
1/ Sound Practices in Government Debt Management-World Bank - Wheeler 2004
Why is debt management important?.......

Poorly structured debt in terms of maturity,

currency, or interest rate composition and
large unfunded contingent liabilities have
been important factors in inducing or
propagating economic crises in many
countries throughout history.1

1/ 2001 IMF/World Bank Debt Management Guidelines

Fiscal Policy and Debt Management Operations

z Debt frequently the largest portfolio on the government’s balance

sheet.

z High levels of debt, which continue to rise, have an exacerbating

effect of the government’s fiscal position
{ Debt servicing takes an increasing share of government revenues
{ Other expenditure categories suffer to meet debt service requirement
{ Prolonged fiscal deficits lead to increasing levels of interest rates
z Domestically through crowding out of private sector capital and externally
through higher spreads on government debt.

z Size of portfolio combined with associated portfolio risks highlight

need to manage debt portfolio prudently and professionally.
{ Complex nature of many government’s debt portfolios add substantially
to the level of fiscal risk
{ This includes contingent liabilities such as government guarantees
Fiscal Policy and Debt Management Operations

z Prudent debt management will not solve fiscal vulnerabilities or

atone for imprudent macroeconomic policies.
{ In fact, sound macroeconomic polices are necessary for high quality
debt management.
{ In a crisis environment or when borrowing is increasing at an
unsustainable level putting sound debt management policies in place is
extremely difficult.
{ Little appetite for sound debt management practices when focus is on
raising cash by any means.

z Current crises may see a number of well-intentioned medium-

term debt strategies being shelved as debt managers struggle to
meet the borrowing requirement
{ i.e. objectives of increasing portfolio duration or reducing currency risk may
be shelved if short-term or external debt is all that is available.
{ Fiscal vulnerability may be compounded by increased rollover and currency
risk inherent in the debt portfolio.
{ Debt managers must try to balance crisis management with longer-term
portfolio considerations-easier said than done.
Fiscal Policy and Debt Management Operations

z Transparency in debt management operations can

however, help identify fiscal vulnerabilities.
{ Analysis of key debt indicators can highlight where potential
problems are emerging.
{ Inability to execute a medium-term debt strategy can be an
indicator of risk to the fiscal position

z Differentiation between perceived professionalism of

debt management offices (DMOs) may assume greater
importance in a market where public sector borrowing
needs increasing rapidly.
{ In the past poor debt management practices have been cited by
credit rating agencies as a contributory factor in credit
downgrades
Some debt related indicators of Fiscal Vulnerability

z High and increasing ratio of public debt/GDP

{“Safe” level of Debt/GDP may be higher for developed countries than for those
with a high incidence of default

Debt-intolerant countries tend to have weak fiscal structures and weak

financial systems. Default often exacerbates these problems, making
these same countries more prone to future default. 1

z High short-term debt

{In many cases a symptom rather than a cause of impending crisis

{Traditional debt service ratios only include interest costs and amortization of
long-term debt- Assumption that S-T debt will be rolled over

{Dangerous assumption particularly in a period of constrained liquidity.

Therefore indicators of high short-term debt/total debt may indicate significant
fiscal vulnerability

1/ Debt Intolerance- Reinhart, Rogoff and Savastano: NBER WP- 2003

Some debt related indicators of Fiscal Vulnerability

z High proportion of external debt

{ Widening spreads on external debt in comparison to similarly rated
borrowers frequently a significant indicator
{ Ratio of external debt/exports–high ratio can indicate vulnerability as
larger proportion of foreign income required to service external debt
portfolio
{ Ratio of S-T external Debt to International Reserves
z Reserve adequacy risk important in assessing vulnerability to rollover risk

z Many countries in the 1990/s and 2000’s strived to reduce

proportion of external debt in their portfolios by developing their
domestic markets
{ Flight of capital from emerging markets may reverse this trend pretty
quickly
{ Only block is lack of access to gummed up international bond markets
{ Greater need for IFI financing becoming increasingly evident.
 Mean Foreign Debt/General Government Debt -by Credit Rating Category
1997-2008F
90

80

70

60

50

40

30

20

Foreign Debt/GDP Ratios

10

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007F 2008F

Year
Mean (Aaa to A3) 40.3 Mean (B1 to C) 75.4 Mean (Ba1 to Ba3) 64 Mean (Baa1 to Baa3) 55.4
 Share of foreign curre ncy de bt in total, percent
100

90
Bulgaria
80
Russia Chile
70
Colombia Turkey
60

50 Philippines

40
Mexico

Percent of GDP
30 Brazil Hungary

20 China

10
S. Africa India
0
2000 2001 2002 2003 2004 2005 2006
Source: M oodys
Some other signs of Fiscal Vulnerability

z High level of contingent liabilities both implicit

and explicit.
{This is particularly pertinent in a situation where many
countries are explicitly and implicitly guaranteeing their
banking sectors

z High debt-to-revenue ratio – shows less room to

generate fiscal space
{Increasing ratios will also have a spiraling affect as
higher debt service costs necessitate higher primary
surpluses to enable reduction in budget deficit positions
 Ireland- Interest Cost as a %of Tax Revenue
25

20

15

10

Percent of Tax Revenue

0

994 995 996 997 998 999 000 001 002 003 004 005 006 007 08F 09F
1 1 1 1 1 1 2 2 2 2 2 2 2 2 20 20
Year

Source: NTMA and Department of Fiance 2009 budget estimates

The role of debt management in overall fiscal
sustainability

z Debt Managers not responsible for formulating fiscal

policy or more specifically the borrowing requirement
z However, most Debt Managers are responsible for
implementing the policy within agreed guidelines
{ Identifying the financing sources
{ Deciding on the appropriate portfolio currency and maturity
structure and the structure of the borrowing program is typically
the responsibility of the debt manager
z This is important as the maturity and currency structure of
government debt can (and frequently does) raise concerns about
government liquidity.
z Over-reliance on particular currencies can increase budget costs
associated with debt portfolio
The role of debt management in overall fiscal
sustainability
z Timely and accurate recording, reporting and analysis of debt
portfolio important elements in identifying possible risks to the fiscal
position.
{ Most debt management offices also responsible for recording and
reporting on guarantees
{ Misreporting or lack of timeliness or coverage may understate the extent
of government obligations

z Integration of debt management operations with cash management

also important in ensuring that government financial resources are
managed as efficiently as possible
{ Need to ensure sufficient resources are available to meet governments
daily operational needs.
{ Need to coordinate with Central Bank to ensure coordination of
monetary and fiscal policy through accuracy of forecasting of
government cashflows and debt related operations
z More recently advising the government on management of financial
assets has become a key role of more sophisticated DMO’s
Impact of the current financial crisis on debt
management
z Borrowing levels increasing sharply as governments’ pressurized on
three levels:
{ increasing fiscal deficits resulting from reduced revenue receipts
{ the need to finance various fiscal stimulus packages
{ Financing bailouts of financial institutions and other sectors
{ Trend towards reduction in debt levels likely to be severely tested in
FY09 and probably beyond

z Financing responsibility of debt managers

{ Advanced countries need to borrow more but real problems lie in
emerging markets with less than fully developed financial markets
{ Domestic debt markets under strain due to flight of foreign capital and
lack of domestic liquidity
{ International markets closed to all but the most highly rated issuers.
z Spreads on existing issues have also widened considerably both for highly
rated and emerging market issuers
z Competition between issuers likely to increase-debt managers will need to
earn their crust
Impact of the current financial crisis on debt
management –cont’d

z Reassessment of medium-term debt strategies essential to take account of

the new financial realities.

z Strategic priorities in recent years have focused on re-positioning portfolios

to optimize debt portfolio from a cost and risk perspective
{ New realities will dictate more immediate focus on funding access
{ Debt managers with widest range of instruments available to them will be in best
position to meet challenges.
z Domestic bond and bill markets
z Medium-term Note Programs
z International capital markets
{ Investor relations and communication strategies will play an important role even
for highly rated borrowers as competition for funds increases.
{ Likely to see increased demand for external debt issuance when markets begin
to recover as domestic markets unable to absorb scale of new issuance –either
that or IFI help as we are seeing.

z Spreads on government bonds likely to remain wider than before due to

increased competition for funds, deterioration in credit quality and ongoing
trend to reprice risk upwards
{ Debt service costs likely to increase
 Potential 2009FundingRequirementsforEuroAreacountriesUS$bn

Current level of Potential

Deficit 2009Funding agreedcapital Funding
Country Redemptions Financing reqmt injections Debt Guarantees Reqm't1/ %of GDP
Austria 11.43 6.35 19.05 19.05 107.95 50.8 12%
Belgium 24.13 5.08 27.94 22.098 63.5 39.37 7%
Finland 8.89 -7.62 6.35 5.08 406.4 21.59 8%
France 142.24 78.74 177.8 50.8 508 284.48 10%
Germany 175.26 19.05 200.66 101.6 0 353.06 9%
Italy 207.01 63.5 254 0 0 254 11%
Ireland 6.35 11.43 21.59 0 0 21.59 8%
Netherlands 40.64 -2.54 38.1 46.736 254 111.76 12%
Portugal 7.62 7.62 13.97 5.08 25.4 21.59 8%
Spain 38.1 30.48 63.5 63.5 127 120.65 7%
Greece 33.02 11.43 50.8 6.35 19.05 58.42 16%
Slovenia 1.27 0 2.54 0 10.16 5.08 9%
Total 695.96 223.52 876.3 320.294 1521.46 1342.39
1/ Includesassumptionof20%call onguaranteeddebt
Source:BNPParibas Projections November 2008
End2008GDPfigurestakenfromWEO
EUR/USDexchange rate=1.27
 Potential 2009FundingRequirements forEuroAreacountries %of GDP

Current level of Potential Increasenet

Deficit 2009Funding agreedcapital Funding of
Country Redemptions Financing reqmt injections Debt Guarantees Reqm't1/ redemptions
Austria 3% 1% 4% 4% 25% 12% 9%
Belgium 5% 1% 5% 4% 12% 7% 3%
Finland 3% -3% 2% 2% 141% 8% 4%
France 5% 3% 6% 2% 17% 10% 5%
Germany 5% 0% 5% 3% 0% 9% 5%
Italy 9% 3% 11% 0% 0% 11% 2%
Ireland 2% 4% 8% 0% 0% 8% 5%
Netherlands 4% 0% 4% 5% 28% 12% 8%
Portugal 3% 3% 5% 2% 10% 8% 5%
Spain 2% 2% 4% 4% 8% 7% 5%
Greece 9% 3% 14% 2% 5% 16% 7%
Slovenia 2% 0% 4% 0% 18% 9% 7%
Average 4% 1% 6% 2% 22% 10% 5%
1/ Includesassumptionof 20%call onguaranteeddebt
Source:BNPParibas Projections November 2008
End2008GDPfigures takenfromWEO
EUR/USDexchange rate=1.27
 Possible Impact of crises on Euro area government funding
requirement funding
10%

8%

6%

4%

2%

% of GDP
0%

-2%

-4%

-6%
4 5 6 7 8
200 200 200 200 200 09
ntial 20
Year Pote

Austria Belgium Finland France Germany Italy Ireland

Netherlands Portugal Spain Greece Slovenia
So what can debt managers do to help
alleviate the impact
z A professional approach to public debt management helps reassure
investors
{ Investors and credit rating agencies need assurance that government
debt is being managed professionally.
{ Timely and accurate communication a key component of any debt
management strategy

z Attracting and retaining the right skills to manage debt professionally

is a key element
{ Ability to interact on an equal footing in financial markets requires
specialized financial skills typically only found in private financial
institutions
{ Needs to be combined with an awareness of public policy needs.
{ Major challenge in trying to attract and retain skills to ensure sustainable
debt management capacity in government
z may not be so challenging in today’s environment
So what can debt managers do to help
alleviate the impact
z Adjust strategies to take account of the new realities
z Keep policy makers informed as to the situation in
financial markets. Debt managers together with Central
Bank officials frequently the closest to the financial
markets
{ Can offer valuable insight to government when quick decisions
need to be made
{ Most of the Debt offices started with debt as the primary focus
{ Integration of cash and debt management was, in most cases,
eventually regarded as an essential element in efficient financial
asset and liability management and came under umbrella of the
debt manager.
{ As expertise and level of specialization increased other functions
transferred to debt manager as its role as financial manager to
the government increased.
z E.g Ireland’s NTMA, Sweden’s National Debt Office
Now that we’ve established that sound
debt management practices are important
what do we mean by it
Six Principles of Sound Practice in DM

{ Debt management Objectives and Coordination

{ Transparency and Accountability

{ Institutional Framework

{ Debt Management Strategy

{ Risk Management Framework

{ Development and maintenance of an efficient market for

government securities
Common Debt Management Objectives

z The main objective of public debt management is to ensure that the

government’s financing needs and its payment obligations are met
at the lowest possible cost over the medium to long run, consistent
with a prudent degree of risk.1/

z Other objectives could include:

{ developing the domestic government debt market
{ Need to ensure that debt management objectives consistent with fiscal
and monetary policy objectives

1/ 2001 IMF/World Bank Debt Management Guidelines

Transparency and accountability

z Debt management effectiveness is strengthened

if goals and policy instruments are known by the
financial markets

z Transparency enhances good governance

through greater accountability of public
institutions involved with debt management – -
Ministry of Finance - central bank, sub-national
governments etc.
Transparency and accountability

z Need for clear, publicly disclosed allocation of

roles and responsibilities for:
{Debt management policy
{Development of risk management framework
{Debt management operations
{Primary market issuance
{Secondary market regulation and control
{Depositary facilities
{Clearing, registration, & settlement arrangements
Institutional Framework
Legal Framework
z Need to establish the appropriate setting for debt
management related legislation- separate public debt
law versus inclusion in wider public financial
management legislation

z Some essential prerequisites to be enacted in legislation

(to be discussed in more detail in subsequent
presentations)
{ Establishment of authority to borrow and manage debt portfolio
{ Defining Institutional arrangements and structures
{ Delegation of authority
{ Reporting and audit requirements
Institutional Framework
Governance Arrangements
z Efficient debt management requires governance
arrangements, that oversee development and
maintenance of internal processes, resources and staff
capacity to enable:

z Development of a medium-term debt management

strategy with yearly updates, based on a sound analysis
of cost and risk, taking account of macroeconomic and
market constraints, and

z The ability to execute that strategy efficiently, while

managing operational risk in a prudent manner.
Institutional Framework
Governance Arrangements

z Specifically governance arrangements need to

take into account:
{The flows of management and operational information
from the debt management function, both internally and
externally (to Parliament and via the website etc).

{Performance assessment of the function.

{Arrangements for audit and formal reporting to

Parliament or the wider public.
Institutional Framework
Governance Arrangements
z Policy setting structure
{ Many DMO’s have established an Advisory Committee to
oversee governance of debt management function
- particularly where separate DMO’s exist
- Can include external advisors from the private sector
{ Alternative is a debt policy committee
- More likely in a situation where DMO is within MOF or Treasury
- Members made up of relevant stakeholders

z Governance structure needs to take into account inter-

institutional coordination
{ Role and input of Central Bank
{ Role of other government institutions or departments –i.e
Ministry of Planning, Fiscal Policy Unit, Presidents office etc.
Institutional Framework
Governance Arrangements

z Clear allocation of roles and responsibilities for

debt management
{Should be vested in a single unit or debt management
office
{Require the establishment and maintenance of
comprehensive and accurate debt data.

z Appropriate institutional setting for the Debt

Office. Internationally 3 models typically found
{Separate Debt Management Office (SDMO)
{Unit within the MOF /Treasury
{Located in the Central Bank
Structure of Decision Making Process for
Debt Management
Institutional Framework
Internal Organizational arrangements
z Organizational structure must ensure clear accountability
and transparency of responsibilities.
{ Should be based on the principles of separation of
responsibilities

z Institutional arrangements have to be adapted to country

circumstances. Must take into account:
{ Lack of capacity and technical expertise
{ Absence of developed domestic debt markets
{ Financial sector vulnerability to exogenous and endogenous
shocks
{ Lack of control over contingent liabilities
Medium-Term Debt Management
Strategy-What should it reflect?
What should the MTDS reflect?
z Identify the objectives for public debt management and scope of the
MTDS.
z •Identify the current debt management strategy and analyze cost
and risk of the existing debt.
z •Identify and analyze potential funding sources, including cost and
risk characteristics.
z •Identify baseline projections and risks in key policy areas—fiscal,
monetary, external and market.

z•Review key longer-term structural factors.

z •Identify the cost-risk tradeoffs, and rank alternative strategies.
z •Review implications of candidate strategies with fiscal and
monetary policy authorities, and for market conditions.
z •Submit and secure agreement on the MTDS.
 Developing a Strategy

Cost/Risk
Analysis

Constraints Information on
cost and risk

Debt Management
Consistency/ Strategy Development Demand
constraints, e.g.
constraints
sustainability

Information on Initiatives
cost and risk
Macroeconomic Debt Market
Framework Development
IMF’s role in assisting countries to
develop MTDS
z IMF led by MCM and supported by FAD and WB have
developed a toolkit to assist countries develop an MTDS.
Consists of:
{ Guidance Note: a step-by-step “how-to”guide on the process of
developing and implementing an MTDS
{ Scenario Analysis Model (spreadsheet-based analytical tool) to
help compare alternative strategies under different scenarios for
future market rates, accompanied by a User’s Guide
{ A template for strategy documentation
z Follow-up from 2007 board Paper on Strengthening debt
management practices
Risk Management Framework
z Modern risk management techniques are important tools for achieving strategic debt
management objectives and targets.

z Risk management function now a central feature of all modern debt management
offices.

z The increased requirement for transparency of government operations also includes

a requirement to monitor and report on the risks inherent in the debt portfolio

z Risk framework should manage trade-offs between cost and risk of the government
debt portfolio.
{ Some existing risk frameworks may need to be re-thought in light of current environment.
{ Some commentators now blaming introduction of tools such as VAR and CAR for lulling
portfolio managers (both asset and liability) into a false sense of security.
{ However even in relatively unsophisticated debt offices simple yet prudent risk
management techniques can be useful

z Should also take account of other fiscal risks such as contingent liabilities and
government guarantees in particular.
 Impact of risk profiles on MTDS decision making process
•Type •Factors to consider •Possible Implications for strategy
•Interest rate risk Impact of significant changes in domestic and international •May need to adjust level of fixed/floating
interest rates on the debt service cost and market value of the interest rates
portfolio
•Currency risk •Currency exposure •Seek to diversify currency mix to match
trade patterns or historical patterns against
domestic currency
•Rollover risk •Rollover risk What is the current average term to maturity •Seek to extend maturities in the domestic
for the total debt portfolio market. Maintain bias toward longer-term
debt in external borrowing.
•Fiscal risk •Realism of the budget-will the borrowing target be met? Are zMay wish to reduce volatility to the
there fiscal risks to the budgetary position-contingent budget of debt service fluctuations by
liabilities. Does a Medium-Term Fiscal Framework exist that biasing towards longer-dated fixed-rate.
can be used as the basis for forward macro-assumptions for zConsider building a precautionary buffer.
MTDS purposes. zTest robustness of preferred strategy to
sharp increase in recognized contingent
liabilities.
zMedium-Term objectives may need to be
revised frequently in light of volatility of
fiscal projections.
•External •The scale of the current account deficit, the reliance on FDI, •May need to consider external borrowing if
vulnerabilities •What are the alternatives if external markets become CA deficit cannot be financed by other
unavailable sources such as FDI in the short-term
•Assessing likely scenarios if external
capital markets become unavailable
Development of a Government Securities
Market
z What defines success in terms of developing a domestic market?

z For the issuer:

{ Ability to raise required government financing –the debt managers
primary objective
{ Active primary market for government securities in which financial
intermediaries actively participate
{ Development of an active and liquid secondary market
{ Broad investor base

z For economy in general

{ Liquid government debt market along the yield curve spectrum to allow
pricing of other issuers placements.
{ Regulatory environment in place
{ Market infrastructure in place
{ Few restrictions on domestic or foreign investors
Development of a Government Securities
Market
To achieve all or some of these objectives

z Need to develop policies to encourage development of an efficient

government securities market
{ primary market
{ secondary market.
{ Retail market?
{ Promotion of systems to support transparency and reporting

z Work with other institutions-Central Bank Stock Exchange, securities

regulator etc. – to ensure the infrastructure is in place to encourage
domestic and foreign investors to invest.
{ Capacity to sell short-development of repo’s and stock lending
{ Settlement and payment systems

z Need to ensure legal framework is consistent

{ Public Debt Law
{ Central Bank Law
{ Securities Law
Coordination with Fiscal Policies
z What is the impact of fiscal and monetary policy on debt
management strategy and operations?

z How to ensure that there is coordination with macro strategic

objectives?

z Use of the debt sustainability analysis as an input into debt strategy

z Identification of fiscal vulnerabilities using debt information

z How does debt management integrate with budget execution and

cash management systems
Coordination with Monetary Policies
z Monetary policy and debt management should be seen to be
separate but coordination essential for liquidity management
purposes

z Need for information exchange

{ Cash forecasts
{ Conflict of debt issuance instruments –particularly at the short-end of
the yield curve

z CBs role as government banker and fiscal agent

z Central banks role and incentives for developing government

securities market
{ Role in monetary operations
{ Role in developing money markets
{ Government yield curve as an input into monetary policy