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Medium-term Debt Management Strategy

(MTDS): A Framework For Analyzing Cost and


Risk
Christian Mulder Cmulder@imf.org
+1.202.6236277
Asset and Liability Management Division
Monetary and Capital Markets Department

Kuala Lumpur, 3 November 2009


MTDS background

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The Motivation for MTDS
„ New borrowing opportunities ⇒ new risks
„ More choices ⇒ greater complexity
„ MTDS aims to provide coherent framework to
fully assess relevant costs and risks
„ Guide choice on composition between:
„ Concessional / quasi-concessional / commercial

„ Currency composition

„ Balance between short- and long-tenors

„ Etc.

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Context

„ MTDS can be jointly performed with debt


sustainability analysis (which is focused on
the level of debt).
„ Joint IMF/World Bank initiative
„ Tools:
„ Guidance note
„ Spreadsheet tool

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More specifically:

„ Standard DM objective: Meet government financing


need at lowest cost consistent with a prudent degree of
risk
„ MTDS focuses on the financing strategy over the medium-
term planning horizon of the government (usually 3-5 years),
consistent with macro-economic settings and related debt
objectives
„ The MTDS defines
„ desired public debt composition and
„ a plan to achieve this composition

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An integrated (8) step process…

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Debt Management Integrated in
Macroeconomic Framework and Market
Constraints
Cost/Risk
Analysis

Constraints Information on cost


and risk

Debt Management
Strategy Development
Consistency/ Demand
Constraints constraints

Market
Information on development
Macroeconomic cost and risk Financing Sources/
initiatives
Framework/Debt Market Environment
Sustainability
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8-step approach
Step 1 Step 2
Identify Identify cost &
objectives & risk of existing
scope debt

Step 4 Step 3
Identify baseline
projections & Identify potential
risks – fiscal, funding sources
monetary &
market

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8-step approach

Step 5 Step 6
Identify cost risk
Review key trade-off for
structural alternative debt
factors management
strategies

Step 8 Step 7
Review
Recommend implications for
MTDS for macroeconomic
approval policies &
market

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Analyzing cost in the MTDS

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(1): What is cost
„ Tension between nominal and real
„ Budget is formulated in nominal terms
„ Costs are real: inflation reduces the amount of goods and services that
need to be forgone to service debt

„ Real cost is essential to define but this is surprisingly hard: A first


approximation of long-term real cost of debt service is the real
interest bill (nominal bill minus inflation) plus FX debt
multiplied by the real exchange rate depreciation
„ see guidance note for complications, e.g. zero coupons

„ Risk is unexpected change in cost

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(2): What drives cost
„ Real interest and exchange rate drive long-term cost:
„ Real exchange rate (ep/p*)trend varies significantly:
„ “Asian tiger” has LT real implying cheap FX funding
„ Bangladesh suffered 10 years of about 2 percent real depreciation
„ Exchange rate overshooting: models can tell what equilibrium “real”
exchange rate is:
„ Debt of Argentina, a “closed” economy with relatively large import deficit,
tripled to 200% of GDP in one year (2002).
„ Real interest rate trend:
„ Currently low real rates. If investment demand returns this will reverse.
„ Debt market improvement, fiscal consolidation can reduce real interest rates

„ The nominal component is driven by very different models:


„ E.g. inflation targeting, money creation

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(3): Approaches to identifying
cost/risk trade offs in the MTDS
„ Review cost/risk characteristics of each instruments (step 2)

„ Numerically simulate cost of the whole portfolio over time


(step 6)
„ Horizon needs to encompass some stability otherwise not an equilibrium
estimate

„ As input to both (step 5): identify, in consultation with economic


policy-makers, structural features of the economy that may
influence the cost and thereby the desirable debt composition.

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(4): Simulation Tool

„ Any tool can work. Understanding is key. Standard


IMF/World Bank Tool may help as it is tested and
tried.
„ It creates buckets of debt to make them tractable
„ Requires macro assumptions (similar to DSA)
„ The tool has been set-up to test several strategies at a
time.
„ Allows for yield curve assumptions and to cost a buffer
„ Generates figures and ratios for the scenarios

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(5): Insurance/Costing of Roll-
over risk
„ Cost of roll-over risk and mitigation can be costed to
make it comparable:

„ Shorter maturities require buffers that cost


„ rollover risk of foreign debt (and domestic investors under
fixed exchange rate regimes who can switch into alternative
foreign investments) can be covered by building reserves
„ similarly for other domestic roll-over risks domestic buffers
can be created—overdraft arrangement with central bank or
commercial banks?
„ the net cost of these additional buffers can be included in the
relevant instrument.
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Implementing an MTDS

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Enabling Framework
„ Implementation will also highlight weaknesses in
enabling framework

„ Debt recording
„ Comprehensive? Is data sharing set up well?

„ Legal framework
„ Clear debt management objective?

„ Institutional arrangements
„ Appropriate coordination mechanisms

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Implementing the MTDS
„ Separate process from strategy formulation

„ Implementation will highlight key bottlenecks that


constrain the set of feasible strategies, e.g.:
„ Shallow local debt markets
„ Weaknesses in primary market operations
„ Potential conflict with operating framework for monetary
policy
„ Limits on availability of (concessional) external finance

„ May need special market development strategy

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Benefits

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Benefits of MTDS
„ Objective and systematic approach
„ Prompts the addressing of all key issues
„ Enables underlying assumptions to be challenged

„ Improves risk measurement and management


„ Explicitly links macro vulnerabilities to strategy
choices and portfolio evolution
„ Quantifies key debt portfolio risk exposures

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Benefits of MTDS
„ Prompts a better understanding of costs and
improves evaluation of cost-risk tradeoff

„ Facilitates policy coordination


„ Aims for consistency with the macro-economic
framework (e.g. fiscal and monetary policy settings)

„ Facilitates domestic debt market development


„ Provides medium-term supply perspective
„ Strengthens dialogue with investors, reducing uncertainty
and lowering cost

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