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IMFSurvey Magazine: Policy

IMF Develops New Risk Measures Tools for Public Debt

Traders in Sao Paulo, Brazil: emerging market economies are less diversified and thus more vulnerable to financial shocks (photo: Mauricio Lima/AFP)

EMERGING MARKET PUBLIC DEBT MANAGEMENT

IMF Develops New Risk Measures Tools for Public Debt

By Carlos Medeiros, Michael Papaioannou, and Marcos Souto
IMF Monetary and Capital Markets Department

January 14, 2008

  • IMF developing tools to measure risks of emerging market bonded public debt
  • Risk Measures method helps determine sustainable public debt strategy
  • These templates are available to both country authorities and IMF economists

Responding to the need to better assess the risks involved in managing bonded public debt, the IMF has recently developed practical tools for use by both country authorities and IMF economists to measure such risks.

The new Risk Measures framework can be used to analyze the soundness of a country's public debt management, while providing a method to determine a sustainable public debt strategy and a consistency check for macroeconomic policies.

Establishing a sound debt strategy, in the context of strong monetary and fiscal policies, can help immunize a country against sudden, adverse market changes and financial turmoil.

How to manage effectively

Public debt managers need to consider a number of factors to manage public debt effectively, including

    • the degree of market, credit, and liquidity risks;

    • the level, maturity, and composition of debt;

    • the availability of information on the debt portfolio;

    • potential costs associated with the debt management strategy; and

    • the coordination of debt management with fiscal and monetary goals.

By considering these factors, public debt managers can become more aware of the impact of changes in financial and economic circumstances on their debt obligations and be in a better position to develop policy responses quickly to address such changes. It can also help them minimize the difficulties in the management of public debt.

Measuring the risks of public debt is therefore a critical first step in managing the debt. A key benefit from this step is the reduction of vulnerabilities, including to international financial shocks. Smaller and emerging market countries are more vulnerable because their economies are less diversified, have a smaller base of domestic financial savings and less developed financial systems, and are more susceptible to financial contagion.

New assessment tools

To help assess risks in public debt management, the IMF's Monetary and Capital Markets Department, with the assistance of the Technology and General Services Department, has developed a two Excel-based Risk Measures templates. Risk Measures provides an operational framework for evaluating risks of bonded public debt and for managing these risks through debt management operations.

The framework also offers the possibility to develop a clear understanding of the relative position of a country's public debt riskiness with respect to other countries at a similar level of development. Accordingly, it provides an indication of a country's credit rating, access to international capital markets, and prospects for the placement of its debt with international investors.

Potential costs

The templates allow the calculation of a number of measures, both conventional and new. Among these are indicators that capture interest rate and exchange rate risks (duration, convexity and value at risk or VARs), credit risk (contingent claims approach), and liquidity risk arising from a possible lack of sufficient tradability in government debt market instruments.

They also estimate a measure for potential costs associated with a particular debt management strategy (cost-at-risk). These measures are estimated for both individual debt instruments and sets (or portfolios) of debts instruments. Such measures offer guidance in assessing debt vulnerabilities, evaluating debt management operations, and developing a debt management strategy that minimizes the cost of servicing debt obligations.

Future work

Going forward, the work on risk measures will be extended in several directions. The templates will be enhanced to include

    • loans—of particular interest for assessing the debt vulnerabilities of low income countries;

    • techniques to identify optimal debt management strategies to lower exposure to interest rate and exchange rate risks;

    • other methodologies to assist with the management of the bonded debt, for a particular risk appetite, such as the use of efficient frontiers; and

    • techniques to assess the impact of different hypothetical, but possible, scenarios.

For information on how to obtain a copy of the Risk Measures templates, please contact Marcos Souto (202-623-8283, msouto@imf.org) or Michael Papaioannou (202-623-7799, mpapaioannou@imf.org)


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