## Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries (wpiea2024167-print-pdf)

## Source details

**Canonical URL:** [Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries (wpiea2024167-print-pdf)](https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024167-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2024/english/wpiea2024167-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2024/english/wpiea2024167-print-pdf.pdf.json)

---

### Scope and structure
- Document organization:
  - Executive Summary (page 5)
  - I. Introduction (page 6)
  - II. Definition and Characteristics of EMDE Foreign-Currency Public Debt (page 7)
  - III. Management of Foreign Currency Risk in Sovereign Debt Portfolios (page 12)
  - IV. Survey Results on DMO Risk Management Practices (page 13)
  - V. Epilogue (page 18)
  - Annex I–V and Figures/Box listings (pages 20–28)
- Annex highlights:
  - Annex I. A Stylized Action Plan for Developing Capacity in Public Debt Management (page 20)
  - Annex II. Formulating a Debt Management Strategy (page 21)
  - Annex III. Content of a Debt Management Strategy Document (page 22)
  - Annex IV. Risk Management Framework for Using Derivatives in Sovereign Debt Portfolios (page 23)
  - Annex V. Characteristics of EMDE Sovereign Foreign Currency Debt (end-2022) (page 26)

### Foreign currency risk and fiscal implications
- Key dynamics:
  - Foreign currency risk stems from foreign currency-denominated debt and unhedged debt servicing costs.
  - Exchange rates are typically among the most volatile financial variables; movements can significantly increase the value of outstanding debt and debt-servicing costs (in local currency).
  - Volatile debt-servicing costs increase budget outcome volatility, undermine resilience, erode financial stability, and can raise overall debt levels.
- DMO response priorities:
  - actively assess foreign currency risk in sovereign debt portfolios;
  - devise strategies for appropriate hedging of existing sovereign debt exposures;
  - devise borrowing plans that rely less on foreign-currency denominated instruments;
  - support measures to develop the local-currency government bond market (LCBM).

### Capacity development gaps and survey findings (survey of 30 countries; LIC survey May 2022)
- Survey coverage and respondent composition:
  - Coverage: 30 countries—14 in sub-Saharan Africa, 8 in Latin America, 3 in Europe and Central Asia, and 3 in Asia and Pacific.
  - About 80 percent of respondents were low-income countries (LICs).
  - 20 percent of respondents represent emerging markets (EMs).
  - LIC debt management survey (May 2022) sent to 69 LICs with a response rate of forty percent.
- Institutional and operational constraints identified:
  - unstable macroeconomic conditions;
  - shallow and concentrated investor bases;
  - weak financial infrastructures;
  - often lacking legal authority to contract financial derivatives.
- Demand for capacity development:
  - most respondents indicated a wish to develop capacity to quantify risk and improve local-currency debt markets.
- Quantitative survey findings (percentages preserved exactly):
  - Debt management law grants standard provision to issue debt securities: 86 percent.
  - Law allows DMO to conduct liability management operations (LMOs): 69 percent.
  - Law allows DMO to contract financial derivatives: 55 percent.
  - DMOs prepare a debt management strategy: 93 percent.
  - DMOs prepare an analysis of risk profile: 79 percent.
  - DMOs prepare a currency risk management strategy: 45 percent.
  - DMOs with explicit targets for foreign currency risk exposure: 58 percent.
  - DMOs assessing impact of interest rate fluctuations on local currency value of interest payments: 43 percent.
  - DMOs conducting stress tests for a period of 1-3 years: 42 percent.
  - DMOs conducting stress tests for a period of 3-5 years: 33 percent.
  - About half of responding DMOs had experience changing composition of domestic and external primary issuances: 53.3% Yes / 46.7% No.
  - External or domestic debt buyback or debt exchanges: Yes ~20 percent (exact rows: Domestic debt exchanges Yes 23.3% / No 76.7%; External debt exchanges Yes 20.7% / No 79.3%; Domestic debt buybacks Yes 23.3% / No 76.7%; External debt buybacks Yes 17.9% / No 82.1%).
  - Use of derivatives reported in figure rows (selected exact values):
    - Contract futures or options? Yes 13.3% / No 86.7%
    - Contract an interest-rate swap or forward? Yes 6.7% / No 93.3%
    - Contract a currency swap or forward? Yes 100.0% / No 0.0% (figure row; textual context notes very limited actual use)
  - Risk identification awareness (exact values from figure rows):
    - Domestic interest rates? Yes 39.3% / No 60.7%
    - Local currency value of the public debt stock? Yes 50% / No 50%
    - Local currency value of interest and amortization payments? Yes 51.7% / No 48.3%
  - Additional figure values presented: 55.2%, 69%, 86%, 44.8%, 31%, 14%; 39.3%, 50%, 51.7%, 60.7%, 50%, 48.3%; 23.3%, 20.7%, 23.3%, 17.9%, 53.3%, 46.7%; 13.3%, 6.7%, 100.0%, 86.7%, 93.3%; and 6.9%, 10.3%, 3.4%, 6.9%, 13.8%, 27.6%, 31.0%, 13.8%, 79.3%, 62.1%, 65.5%, 79.3%.

### Core elements of an FX risk strategy and operational prerequisites
- Strategy components and systems:
  - Adoption of a debt management strategy with well-defined targets for foreign currency risk.
  - Integrated debt management system to monitor exposures and identify mismatches in maturities, currencies, and interest rate risks.
  - Consistency with the Medium-term Fiscal Framework.
  - Definition of a hedging strategy and a risk management framework for derivatives.
- Preconditions before engaging in derivatives:
  - determine internal vs external advisory resources;
  - ensure adequate personnel and institutional capacity for hedging;
  - assess ability to control counterparty, legal, liquidity and operational risks;
  - if external advisors used, apply transparent selection criteria and terms of reference.
- Two hedging approaches via derivatives:
  - (a) the portfolio approach (macro hedge);
  - (b) a hedge on a debt obligation-by-debt obligation basis (micro hedge).

### Measurement of foreign currency exposure (debt-manager perspective)
- Share of foreign currency debt:
  - d_t_fx = D_t_FX / D_t = D_t_FX / (D_t_DX + D_t_FX) = (∑_{j=1}^{m} e_{t,j} D_{t,j}^{FX}) / (D_t^{DX} + ∑_{j=1}^{m} e_{t,j} D_{t,j}^{FX}),
  - where d_t_fx is share of foreign currency debt; D_t_FX is foreign currency debt; D_t is total debt; D_t_DX is domestic currency debt; t, j, m, and n are time intervals; and e_{t,j} is exchange rates.
- Mismatch relative to reserves:
  - d_t_fxr = D_t_fx / R_t = (FX_t) / (R_t) = (∑_{j=1}^{m} e_{t,j} FX_{t,j}) / (∑_{h=1}^{n} e_{t,h} R_{t,h}),
  - where d_t_fxr = D_t_fx / R_t is the ratio of foreign currency debt to foreign currency reserves and R_t is foreign currency reserves.
- Note on composition: composition of foreign currency reserves may differ from foreign currency debt when e_{t,j} ≠ e_{t,h} for any h and j.

### Strategy selection, stress testing and evaluation
- Strategy evaluation:
  - Assess issuance choices: foreign-currency vs domestic-currency; fixed-rate vs floating-rate; short-term vs long-term.
  - Evaluate implied debt service costs and impacts on risk indicators.
  - Use stress (scenario) tests to determine impacts of exchange rate and interest rate shocks and severe macroeconomic events.
  - Rank strategies supported by probabilities of realization of risk-factor changes.
- Policy objectives in EMDEs:
  - build a local-currency yield curve;
  - extend maturities and create benchmark issuances to build secondary-market liquidity;
  - diversify investor base and develop new financial products (inflation-linked bonds, zero coupon bonds);
  - coordinate with monetary authorities to build sufficient foreign exchange reserves.

### Derivatives: operational, legal, and market considerations (Annex IV)
- Role and trade-offs:
  - Derivatives can reduce exchange or interest rate risks but introduce counterparty, liquidity, and operational risks.
  - A positive swap spread is not sufficient justification unless it is “sufficiently positive” to compensate for additional swap transaction risks.
- Counterparty policy core elements:
  - minimal credit scoring or external rating for counterparties;
  - demonstrated market share of counterparties;
  - assignment of credit lines to each counterparty;
  - weights for individual transaction types;
  - accurate legal documentation;
  - rotation among counterparties for diversification.
- Collateral and CSA considerations:
  - Collateralization reduces counterparty risk via market-value settlements.
  - CSA to an ISDA specifies initial margins, margin-call frequency and thresholds, and type of collateral.
  - CSAs are typically two-way; stronger-credit parties may negotiate better terms.
- Market infrastructure:
  - Central clearing reduces counterparty and systemic risk.
  - Exchange-traded derivatives increase transparency and liquidity; OTC remains more customizable.
- Liquidity and operational risks:
  - Collateral calls increase liquidity/operational burden; fewer margin calls reduce operational burden but raise counterparty risk.
  - Independent calculation and bilateral confirmation of cash flows are essential.
- Accounting and valuation:
  - Derivatives are often mark-to-market and recorded on-balance sheet; underlying bonds commonly recorded at nominal value, creating reporting challenges.
  - Accrual accounting standards do not capture market valuations; harmonized and national accounting standards vary.
- Special considerations for lower-rated sovereigns:
  - Banks may require guarantees or collateral for cross-currency hedging; premia and collateral costs must be included in hedge cost estimates.
- Multilateral and private hedging options:
  - Multilateral Development Banks (MDBs) offer cross-currency swaps with effectively one-sided counterparty risk, no credit charge in the swap, and no collateral calls.
  - Private providers (e.g., TCX and others) offer currency-hedging solutions for eligible countries.

### Boxed practical guidance and capacity-development action plan
- Box 1: Aspects of debt composition and management
  - Long tenors and amortizing structures mitigate external exchange rate risk; domestic instruments often have short maturities increasing rollover/refixing risk.
  - Many countries have strategies that are unpublished, lack senior approval, and are not underpinned by robust cost-risk analysis.
  - Weaknesses include legal framework, debt recording, coordination with monetary policy, cash flow forecasting, and audit/oversight deficiencies.
- Annex I: Medium-term focus (three priority areas)
  - Consolidate debt management functions toward an organized Debt Management Office.
  - Develop and maintain staff and institutional capacity.
  - Develop a comprehensive strategy based on cost-risk analysis and market development.
- Annex I: Short-term actions
  - Allocate office space and equipment.
  - Establish robust debt recording and risk management systems.
  - Strengthen back-office and middle-office functions by hiring additional staff.
  - Formalize the debt management strategy regarding refinancing, currency risk, and interest rate risk.
- Annex II–III: Strategy formulation checklist
  - Define portfolio scope; develop market/macro scenarios including severe but plausible shocks; project primary deficit/surplus and net borrowing requirement; define alternative strategies; perform cost-risk analysis; express strategy in strategic benchmarks; secure government/parliament approval; review annually.

### Key policy recommendations (summary)
- Measure and monitor foreign currency exposure using portfolio and reserve-based indicators (formulas provided).
- Incorporate stress testing (short-term and medium-term horizons) and probability-weighted scenario analysis into strategy selection.
- Prioritize capacity development in risk quantification and stress testing, local currency market development, and legal/regulatory frameworks before expanding use of derivatives.
- Strengthen governance, resources, information systems, and policy coordination (GRIP): robust legal framework, adequate human/physical resources, comprehensive data access/recording, and policy coordination with fiscal and monetary authorities.
- Consider MDB and private hedging providers where domestic capacity or market access is limited, accounting for costs of collateral, guarantees, and accounting implications.

*Source: IMF Working Paper — Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries (wpiea2024167-print-pdf).*

### Executive Summary ......................................................................................................

### Executive Summary

### Scope and Structure of the Document
- The document is organized into sections and annexes covering the definition, measurement, management, and capacity development related to foreign-currency public debt in EMDEs.
- Main sections and their starting pages:
  - Executive Summary ............................................................................................................................................ 5
  - I. Introduction .................................................................................................................................................. 6
  - II. Definition and Characteristics of EMDE Foreign-Currency Public Debt ................................................... 7
  - III. Management of Foreign Currency Risk in Sovereign Debt Portfolios .................................................... 12
  - IV. Survey Results on DMO Risk Management Practices ............................................................................. 13
  - V. Epilogue ......................................................................................................................................................... 18
- Annexes and supporting items:
  - Annex I. A Stylized Action Plan for Developing Capacity in Public Debt Management ............................. 20
  - Annex II. Formulating a Debt Management Strategy ..................................................................................... 21
  - Annex III. Content of a Debt Management Strategy Document .................................................................... 22
  - Annex IV. Risk Management Framework for Using Derivatives in Sovereign Debt Portfolios .................. 23
  - Annex V. Characteristics of EMDE Sovereign Foreign Currency Debt (end-2022) ..................................... 26
  - References ......................................................................................................................................................... 28
  - Box 1. Aspects of Debt Composition and Debt Management Practices Across Select Developing Economies ........ 11
  - Figures:
    - Figure 1. General Government Foreign Currency Debt Indicators of EM and LIC Countries, end-2021 ....................... 10
    - Figure 2. Survey Results: Sovereign DMO’s Risk Management Practices .................................................................... 16

### Definitions and Measurement
- Section II focuses on:
  - Definition and Characteristics of EMDE Foreign-Currency Public Debt.
  - Determination of a Measure of Foreign Currency Risk.
  - Public Debt Foreign Currency Risk in EMDEs.

### Debt Management Policy and Operational Framework
- Section III addresses:
  - Building the Debt Management Policy Framework and Defining the Responsibilities of the Debt Manager (starting page 12).
  - Strengthening the capacity to analyze the costs and risks of the debt portfolio under different scenarios.
  - Consistency with the Medium-term Fiscal Framework.
  - Defining the Hedging Strategy.

### Survey Findings and Current Practices
- Section IV provides survey-based material on DMO risk management practices, including:
  - Current Risk Management Practices.
  - Foreign Currency Risk.
  - Interest Rate Risk.
  - Liability Management Operations.
  - Use of Derivatives.
  - Development of the Local Currency Government Bond Market.
  - Debt Management Strategy.
  - DMO Professional Profile and Resources.
  - Capacity Development Prioritization.
- Figure 2 illustrates "Survey Results: Sovereign DMO’s Risk Management Practices" (page 16).

### Capacity Development and Implementation Tools
- Annex I presents "A Stylized Action Plan for Developing Capacity in Public Debt Management" (page 20).
- Annex II and Annex III deal with formulation and content of a Debt Management Strategy (pages 21–22), with specific subtopics:
  - Objectives and Scope.
  - Existing Debt Portfolio.
  - The Environment for Debt Management Going Forward.
  - The Debt Management Strategy.
- Annex IV provides a "Risk Management Framework for Using Derivatives in Sovereign Debt Portfolios" (page 23).

### Data and Illustrative Evidence
- Annex V contains "Characteristics of EMDE Sovereign Foreign Currency Debt (end-2022)" (page 26).
- Figure 1 shows "General Government Foreign Currency Debt Indicators of EM and LIC Countries, end-2021" (page 10).

### Glossary and Acronyms
- The document includes a glossary listing acronyms used throughout the paper, including but not limited to:
  - AE Advanced Economies
  - AFR Africa
  - APD Asia and Pacific
  - ATM Average Time to Maturity
  - CaR Cost-at-Risk
  - CSA Credit Support Annex
  - DFIs Development Finance Institutions
  - DMO Debt Management Office
  - EM Emerging Markets
  - EMDE Emerging Markets and Developing Economies
  - ESA European System of Accounts
  - EUR Euro
  - FX Foreign Exchange
  - JPY Japanese Yen
  - IBRD International Bank for Reconstruction and Development
  - IDA International Development Association
  - ISDA International Swaps and Derivative Association
  - IT Information Technology
  - LIC Low-Income Countries
  - LMIC Low- and Middle-Income Countries
  - MDB Multilateral Development Bank
  - MoF Ministry of Finance
  - MSME Micro, Small, and Medium Enterprises
  - OTC Over-the-Counter
  - TCX Currency Exchange Fund
  - USD US Dollar

*Source: IMF Working Paper — Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries (table of contents and glossary).*

### Executive Summary

### Executive Summary

### Foreign currency risk and public debt management
- Foreign currency risk derives from foreign currency-denominated debt and unhedged debt servicing costs.
- Exchange rates are typically among the most volatile financial variables; their movements can significantly increase the value of outstanding debt and debt-servicing costs (in local currency).
- Volatile debt-servicing costs increase the volatility of the budget outcome, adding to economic uncertainty and undermining an economy’s resilience to encountered risks; this can erode financial stability and lead to further shocks in debt service costs and higher overall debt levels.
- To mitigate adverse consequences, public debt management offices (DMOs) need to:
  - actively assess foreign currency risk in sovereign debt portfolios;
  - devise strategies that envision appropriate hedging of existing sovereign debt exposures;
  - devise borrowing plans that rely less on foreign-currency denominated instruments;
  - support comprehensive measures to develop the local-currency government bond market (LCBM).

### Capacity Development (CD) gaps and survey findings
- CD experience shows significant gaps in risk management capacities of DMOs in emerging markets (EM) and developing economies, including low-income countries (LICs) — collectively referred to as EMDEs.
- Survey results:
  - Approximately 80 percent of respondents were low-income countries.
  - 20 percent of respondents represent emerging markets.
  - Only 45 percent of those surveyed indicated that they prepare a foreign currency risk management strategy.
- Common constraints identified:
  - unstable macroeconomic conditions;
  - shallow and concentrated investor bases;
  - weak financial infrastructures;
  - often lacking legal authority to contract financial derivatives.
- Demand for capacity development:
  - most respondents indicated a wish to develop capacity to quantify risk and improve local-currency debt markets to broaden financing options.

### Strategies, instruments, and operational considerations
- Selection of a hedging program and available instruments depends on an EMDE’s particular economic and financial conditions.
- The paper provides an overview of main strategic and operational issues related to public debt hedging practices, including the use of swaps and other derivatives.
- Key institutional and capacity development challenges discussed:
  - management of foreign exchange risk in sovereign debt portfolios;
  - overall implementation of a foreign exchange risk-management strategy;
  - the need for good governance and control over derivative transactions.

### Core elements of a foreign currency risk strategy
- Adoption of a debt management strategy with well-defined targets for foreign currency risk is critical.
- Such a strategy should be based on a debt management system that allows authorities to monitor sovereign risk exposures in an integrated manner.
- In principle, this system would allow mismatches in assets and liabilities’ maturities and in foreign currency and interest rate risks to be identified, measured and managed systematically and efficiently.

### Rationale and context for active FX risk management
- Poorly structured debt portfolios (maturity, currency, interest rate composition) and large contingent liabilities have been important factors in inducing or propagating sovereign debt crises.
- Issuance of large volumes of short-term, floating-rate or foreign currency-denominated debt can put government budgets at risk during periods of slow growth or unstable financial market conditions and impact creditworthiness.
- Debt managers measure and manage currency exposure to:
  - assess potential volatility in debt servicing costs due to exchange rate fluctuations;
  - appropriately budget contingent liability funds for debt servicing and contribute to tax smoothing;
  - engage in liability management operations, including derivative transactions, to mitigate foreign exchange-related risks and possibly reduce debt servicing costs.

### Risk assessment and strategy selection practices
- Debt managers assess various issuance strategies (foreign-currency vs domestic-currency debt, fixed-rate vs floating-rate, short-term vs long-term maturities) to finance deficits and/or undertake liability management operations, provided debt risk indicators remain within prespecified limits.
- Strategies are evaluated on implied debt service costs and impact on risk indicators.
- Stress (scenario) tests determine impacts of changes in risk factors (e.g., exchange rates, interest rates) and underlying macroeconomic conditions, including extreme events.
- Ranking of strategies should be supported by probabilities of occurrence of changes in risk factors.

### Constraints in EMDEs and policy objectives for DMOs
- Developing economies generally have lower capacity in foreign-currency risk management and face limited access to capital markets.
- Common DMO objectives to expand financing choices and limit foreign currency risk:
  - build a local-currency yield curve for proper pricing of risk;
  - extend maturities;
  - create benchmark issuances and build liquidity in the secondary market;
  - diversify the investor base (attract foreign investors or a new class of investors; develop new financial products such as inflation-linked bonds, zero coupon bonds; develop currency-risk markets);
  - support financial sector development and promote financial stability.
- DMOs also work with monetary authorities to build sufficient foreign exchange reserves to weather potential financing difficulties during a crisis.
- Institutional and professional capacity enhancement requires sustained long-term effort.

### Measurement of foreign currency exposure (debt-manager perspective)
- From a debt manager’s perspective, foreign currency risk factor = volatility of the exchange rate and extent of exchange rate exposure of the sovereign debt portfolio.
- The share of foreign currency debt in the debt portfolio is denoted:
  - d_t_fx = D_t_FX / D_t = D_t_FX / (D_t_DX + D_t_FX) = (∑_{j=1}^{m} e_{t,j} D_{t,j}^{FX}) / (D_t^{DX} + ∑_{j=1}^{m} e_{t,j} D_{t,j}^{FX}),
  - where d_t_fx is share of foreign currency debt; D_t_FX is foreign currency debt; D_t is total debt; D_t_DX is domestic currency debt; t, j, m, and n are time intervals; and e_{t,j} is exchange rates.
- A mismatch analysis of foreign currency liabilities relative to foreign currency reserves is another indicator:
  - d_t_fxr = D_t_fx / R_t = (FX_t) / (R_t) = (∑_{j=1}^{m} e_{t,j} FX_{t,j}) / (∑_{h=1}^{n} e_{t,h} R_{t,h}),
  - where d_t_fxr = D_t_fx / R_t is the ratio of foreign currency debt to foreign currency reserves and R_t is foreign currency reserves.
- Note: composition of foreign currency reserves may differ from foreign currency debt when e_{t,j} ≠ e_{t,h} for any h and j.

### Considerations before using derivatives and hedging approaches
- Sovereigns with substantial foreign currency debt often consider hedging part or all such positions; measuring exchange rate exposure is complex due to co-movements between exchange rates and interest rates and high correlations among bond markets.
- Exchange rate risk measurement can combine sensitivity of the debt portfolio to exchange rate changes and probability of realization of a given exchange rate change (multivariable approaches such as simulation exercises recommended).
- Before using derivatives, authorities should:
  - determine whether to use internal resources (knowledgeable and well-trained DMO staff) or external advisors;
  - ensure adequate personnel and institutional capacity to undertake hedging activities if relying on internal resources;
  - carefully assess ability to establish a hedging program and control risks from derivatives, including counterparty, legal, liquidity and operational risks.
- If external advisors are used, transparent criteria and terms of reference for selection should be in place.
- Two main approaches to establish a hedging program via derivatives:
  - (a) the portfolio approach (macro hedge);
  - (b) a hedge on a debt obligation-by-debt obligation basis (micro hedge).

### Macro-fiscal perspective and cross-country patterns
- A broadly-used proxy for public debt foreign currency risk is the share of outstanding sovereign debt issued or guaranteed in foreign currency to total public debt or GDP.
- The paper references general government foreign currency debt indicators of EM and LIC countries at end-2021 (Figure 1).
- Observations noted:
  - LICs’ share of foreign currency debt is larger than that of EM countries.
  - By region, Sub-Saharan African and Middle East and North African regions have larger shares of foreign currency debt in their debt portfolios.
- Cross-country comparisons show portfolio structures are not uniform and developing country debt portfolios are dominated by official sector external debt, reflecting a relatively higher level of foreign exchange rate risk.
- Mitigating factors:
  - long tenors and amortizing structures of multilateral and bilateral loans mitigate foreign exchange risk and help contain refinancing and re-fixing risks.
  - For LICs with concessional debt, lower interest costs than in EM countries help mitigate macro-fiscal risks.

### Organization of the paper (structure overview)
- Section II: definition and types of currency risk from the debt manager’s and macro-fiscal perspectives.
- Section III: management of foreign currency risk, including prerequisites for the use of derivatives.
- Section IV: survey results of DMO risk management practices.
- Section V: conclusions on contributions of the paper and further advancements in foreign exchange derivatives practices for foreign currency risk management.

*Source: IMF Working Paper — Executive Summary (wpiea2024167-print-pdf).*

### Box 1. Aspects of Debt Composition and Debt Management Practices Across Select Developing

### Box 1. Aspects of Debt Composition and Debt Management Practices Across Select Developing Economies

### Key objectives and general findings on debt composition and management
- Goal: identify mix of debt instruments (maturities, currencies, and interest rate structures) consistent with authorities’ medium-term debt management objectives.
- Long tenors and amortizing structure help mitigate exchange rate risk in external debt portfolios.
- Domestic debt portfolios often have relatively short maturity of available debt instruments, resulting in higher refinancing and re-fixing risks.
- Low cost of concessional and some semi-concessional borrowing helps offset generally higher cost of commercial and market-based borrowing.
- Weak performance in debt management strategies across a sample of developing countries has generally been related to strategy quality and governance:
  - Many countries have some form of strategy, but it is often unpublished, does not have the approval of senior policy makers, and is not supported by an institutional decision-making process ensuring regular production, implementation, and updating.
  - Most strategies are not underpinned by robust cost-risk analysis of the debt portfolio.
- Deficiencies identified include legal framework, debt recording, coordination with monetary policy, and challenging deficiencies in key analytical functions:
  - Need to identify robust debt management strategies.
  - Need to assess cost effective and beneficial terms for external borrowing.
  - Need to improve cash flow forecasting and cash management.
- Weaknesses in policies/procedures related to external borrowing are of particular concern; less than one-third of countries in the sample met ad hoc minimum requirements on assessing external borrowing policies and procedures.
  - Indicators show: (i) little consideration given to the most beneficial/cost-effective borrowing terms and conditions; (ii) general absence of documented procedures for borrowing in foreign markets.
- Operational and institutional weaknesses aggravate analytical deficiencies:
  - Deficiencies in operational controls, business continuity planning, and staff responsibilities increase overall risk as borrowing instruments diversify.
  - Absence of effective and independent auditing of debt management policies, functions, and performance undermines accountability.

*For details, see “Helping Developing Countries Address Public Debt Management Challenges—An IMF-World Bank Capacity Building Partnership.”*

### Preconditions and steps to manage foreign exchange risk in sovereign debt portfolios
- Preconditions to operationalize risk management framework:
  - Build the debt management policy framework and define the debt manager’s responsibilities.
  - Strengthen capacity to analyze costs and risks associated with the debt portfolio given its diverse characteristics.
  - Ensure consistency with the medium-term macro-fiscal framework.
  - Define the hedging strategy and risk management framework.
  - Prepare a robust risk management framework for derivatives.
  - Regular stress tests are recommended to evaluate portfolio resilience to economic and financial shocks.
- Typical functions and responsibilities of the public debt management entity may include:
  - Preparation of medium-term debt management strategies, including local-currency bond market development.
  - Preparation of annual borrowing plans based on the determined strategy.
  - Handling of all borrowings, credit arrangements, and other debt management activities to achieve the strategy goals.
  - Debt data recording and other debt administration activities.
  - Preparation of reports and statistical bulletins on government debt and debt management.
  - Assistance in the annual budget preparations.
- Note on central bank role: the central bank can continue administering T-bill and bond auctions as an agent and advisor, but the MoF must be clarified as the final decision maker on auction calendar, amounts, tenors, and price; a Memorandum of Understanding should reflect this order.

### Analytical capacity, strategy formulation, and stress testing
- Domestic and external debts differ by currency denomination, interest rates, investor base, and repayment profiles; these differences expose public debt to varied future risks and liabilities.
- A well-articulated formal debt management strategy should be based on articulated and measurable debt management objectives and include rigorous cost-risk analysis and projection of portfolio evolution over time (Annex 1 referenced).
- If projected gross financing needs remain high over the medium term, interest rate and rollover risks could be raised and financing constraints possible due to small domestic financial sectors.
- The debt management strategy should clearly spell out sources of financing (external or domestic) (Annexes 2 and 3 referenced).
- Regular stress tests should be conducted on the debt portfolio to assess resilience to economic and financial shocks.

### Consistency with macro framework and hedging/derivatives frameworks
- Debt management strategy should be integral to the overall macroeconomic framework and coordinated with fiscal and monetary policies.
- To ensure debt sustainability, prudent fiscal policy together with debt management and local currency bond market development strategies need close coordination.
- Hedging strategy considerations:
  - Conduct further analysis of market constraints to assess hedging costs and estimate an optimal hedging ratio.
  - Decide whether to hedge part or all sovereign foreign exchange exposure and which financial entities (domestic vs external) will undertake hedging activities; set appropriate criteria and terms of reference.
- Risk management framework for derivatives should include:
  - (i) a strong legal basis;
  - (ii) adequate information systems to properly report transactions and connect to relevant payment systems;
  - (iii) robust cash management processes to handle posting/collection of collaterals;
  - (iv) detailed counterparty risk frameworks (e.g., for selection of banks with whom ISDAs will be signed).
- Annex IV referenced for operational issues relating to derivatives; LICs may face particular challenges given deficient debt recording/accounting systems for tracking derivative positions and market-valuing collateral.

### Survey results on DMO risk management practices (survey of 30 countries; December 2021; LIC survey May 2022)
- Survey coverage: debt management authorities (and monetary authorities for certain money market aspects) of 30 countries—14 in sub-Saharan Africa, 8 in Latin America, 3 in Europe and Central Asia, and 3 in Asia and Pacific region.
  - About 80 percent of respondents are LICs, while 20 percent represent EMs.
- LIC debt management survey (May 2022) sent to 69 LICs with a response rate of forty percent.
- Main limitations revealed:
  - Lack of adequate institutional infrastructure for FX risk management.
  - Limited experience in use of derivatives and limited foreign currency risk management techniques.
  - Lack of DMO legal authorities to contract financial derivatives in some cases.
  - Unstable macroeconomic conditions, shallow and concentrated investor bases, and weak financial infrastructures.
  - Most countries consider developing capacity in risk quantification and developing local currency debt markets as very important.
  - Other notable challenges: integration of cash and debt management, implementation of annual borrowing plans, deepening investor base, and local debt market development.
- Operational environment constraints:
  - Insufficient resources and inadequate information flows undermine effective debt management, including staffing and physical/IT equipment, and institutional arrangements for data recording and monitoring.
  - Resource constraints more evident among fragile and conflict-affected states and small and developing states.

### Current risk management practices (survey quantitative findings)
- Legal authorities and strategy preparation:
  - Debt management law grants standard provision to issue debt securities: 86 percent.
  - Law allows DMO to conduct liability management operations (LMOs): 69 percent.
  - Law allows DMO to contract financial derivatives: 55 percent.
  - DMOs prepare a debt management strategy: 93 percent.
  - DMOs prepare an analysis of risk profile: 79 percent.
  - DMOs prepare a currency risk management strategy: 45 percent.
- Foreign currency risk management:
  - DMOs with explicit targets for foreign currency risk exposure: 58 percent.
  - DMOs conduct stress tests over short term (less than one year) or medium term (3-5 year) based on exchange rate forecasts: majority (exact percent not provided beyond “majority”).
  - Majority assess local currency value of amortization and interest payments and public debt stock when assessing exchange rate fluctuation impacts.
  - Less than half prepare a Currency Risk Management Strategy.
- Interest rate risk:
  - DMOs assessing impact of interest rate fluctuations on local currency value of interest payments: 43 percent.
  - DMOs conducting stress tests for a period of 1-3 years: 42 percent.
  - DMOs conducting stress tests for a period of 3-5 years: 33 percent.
- Liability management operations:
  - About half of responding DMOs had experience changing composition of domestic and external primary issuances.
  - About 20 percent of respondents undertook external or domestic debt buyback or debt exchanges.
  - Such exercises were infrequent (1–3 times over three years) and two-thirds of them hired legal and financial advisors for debt buyback operations.
- Use of derivatives:
  - Very limited experience: only a couple had contracted currency or interest-rate swaps and only one had contracted futures or options.
  - Limited number of countries have an ISDA Agreement, a collateral agreement, or a policy related to use of financial derivatives for risk hedging.
- Local currency government bond market development:
  - About one-third of respondents indicated they have a strategy to assess and improve their local currency government bond market.
  - Training needs identified:
    - Enabling macroeconomic conditions: creating sound conditions for steady reduction in interest rates and inflation.
    - Money market: increasing trading of short-term instruments and developing repo markets.
    - Primary market: developing deep and liquid markets, developing predictable and stable sources of financing, extending maturities and building benchmark yield curves, increasing participation of long-term investors, and developing a primary dealer system.
    - Secondary market: increasing liquidity and transactions.
    - Investor base: further diversifying investor base from insurance companies, pension funds, and retail investors; attracting more foreign investors in local currency securities; easing access to international capital markets.
    - Financial market infrastructure: establishing modern trading platforms and improving coordination among central bank, regulators, and supervisors.
    - Legal framework: establishing a legal framework that encompasses debt operations, public finance management, and debt policy.
- Debt management strategy and implementation challenges:
  - Integration of cash and debt management highlighted as key challenge by more than 70 percent of respondents.
  - Formulation and implementation of annual borrowing plans and communicating the debt management strategy also cited as challenges.
- DMO professional profile and resources:
  - About one-third of respondents reported DMOs have senior staff dedicated to risk management or legal issues (1 to 3 staff).
  - Capacities generally seen as limited.
  - Lack of resources and inadequate information flows highlighted as impediments to effective debt management, including staffing, physical/IT equipment, and institutional arrangements for data recording and monitoring.
  - Resource constraints more evident among fragile and conflict-affected states and small and developing states.

### Survey figure data highlights (selected percentages reproduced exactly)
- Legal and operational permissions (Yes/No):
  - Contract financial derivatives? Yes 55.2% / No 44.8%
  - Conduct LMO including debt buybacks and debt exchanges? Yes 69% / No 31%
  - Issue debt securities? Yes 86% / No 14%
- Risk identification (Yes/No) on awareness of portfolio elements:
  - Domestic interest rates? Yes 39.3% / No 60.7%
  - Local currency value of the public debt stock? Yes 50% / No 50%
  - Local currency value of interest and amortization payments? Yes 51.7% / No 48.3%
- Liability management operations (Yes/No):
  - Domestic debt exchanges: Yes 23.3% / No 76.7%
  - External debt exchanges: Yes 20.7% / No 79.3%
  - Domestic debt buybacks: Yes 23.3% / No 76.7%
  - External debt buybacks: Yes 17.9% / No 82.1%
  - Change the mix of domestic/external primary issuance: Yes 53.3% / No 46.7%
- Use of derivatives (Yes/No):
  - Contract futures or options? Yes 13.3% / No 86.7%
  - Contract an interest-rate swap or forward? Yes 6.7% / No 93.3%
  - Contract a currency swap or forward? Yes 100.0% / No 0.0% (note: figure presents this row; interpretive context in source text indicates very limited use)
- Importance of capacity development areas (Not important / Somewhat important / Very important):
  - Local currency markets development: (chart indicates strong importance)
  - Use of derivative instruments: (chart indicates lower usage)
  - Legal documentation and regulatory framework: (chart indicates importance)
  - Risk quantification and sensitivity analysis: (chart indicates Very important)
- Additional figure percentages (use/importance axes):
  - 55.2%, 69%, 86%, 44.8%, 31%, 14% (legal/LMO/issue securities rows)
  - 39.3%, 50%, 51.7%, 60.7%, 50%, 48.3% (risk identification rows)
  - 23.3%, 20.7%, 23.3%, 17.9%, 53.3%, 46.7% (LMO operation rows)
  - 13.3%, 6.7%, 100.0%, 86.7%, 93.3% (derivatives rows)
  - 6.9%, 10.3%, 3.4%, 6.9%, 13.8%, 27.6%, 31.0%, 13.8%, 79.3%, 62.1%, 65.5%, 79.3% (additional chart values presented in figures)

### Capacity development prioritization and enabling conditions
- Capacity development objective: help LICs mitigate debt vulnerabilities by establishing and executing a debt management strategy and identifying and monitoring debt-related fiscal risks linked to debt composition (interest rate, currency, and rollover risks).
- Effective debt management supports debt sustainability, reduces economic and financial volatility, supports sustainable financial sector development, and supports growth and development.
- Ineffective debt management can generate significant fiscal costs, unduly expose countries to changing market conditions, and weaken crisis preparedness.
- Enabling conditions for effective public debt management grouped into four mutually reinforcing dimensions: governance, resources, information, and policy (box 2 referenced).

*Source: IMF Working Paper "Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries" (Box 1 and related sections as provided).*

### Box 2. Getting a GRIP on Public Debt Management

### Box 2. Getting a GRIP on Public Debt Management

### Main enabling conditions for an effective debt management
- Governance
  - Robust sovereign debt management starts with adequate legal and institutional arrangements and authority for debt management activities, consistent with best practice.
  - A comprehensive public debt management law, which clearly delineates responsibilities, including reporting requirements, is essential to providing the legal and institutional architecture for a debt management office to operate effectively.
- Resources
  - The debt management office needs to have adequate human and physical capital to undertake its role effectively.
  - Resources allocated to public debt management should be commensurate with the nature and complexity of the current (and expected) debt portfolio.
- Information
  - For a debt management office to fulfill its tasks effectively, it must have ongoing access to all relevant data and information.
  - This may include data collection from multiple parts of government, making it critical that the debt manager has the authority to request this information.
  - Likewise, it must have the necessary capacity to record and manage debt data effectively.
- Policy
  - Debt policy should ensure consistency with the overall macroeconomic framework through appropriate coordination mechanisms with fiscal and monetary authorities.
  - Debt management policy should be supported, and approved, by the highest levels of government and legislature.

*Source: IMF (International Monetary Fund). 2022. “Macroeconomic Developments and Prospects in Low-Income Countries—2022, International Monetary Fund, Washington, DC."*

### Implementing debt management strategies and capacity development
- Recent Fund debt management CD has focused on translating a published debt strategy into an implementable plan through the use of a new joint Fund-Bank Annual Borrowing Plan Tool (APBT).
- The ABPT also allows for the integration of cash management considerations.
- A good cash management system provides the government with several benefits, including timely payments; reduction in short-term borrowing costs; and avoidance of expenditure arrears.
- For currency risk management, countries ranked their technical assistance priorities in the following order: (1) risk quantification and stress testing, (2) local currency debt market development, (3) legal and regulatory framework, and (4) use of derivative instruments.
- Survey findings and implications:
  - The foreign exchange risk of EMDEs and LICs is significant, and foreign currency risk exposure of their sovereign debt portfolios needs to be measured and managed.
  - Strategies to manage foreign currency debt portfolio risk are typically part of the sovereign’s overall debt management strategy.
  - DMOs often face institutional, operational and analytical impediments when developing foreign currency risk management.
  - Recent survey results indicate that less than half of respondents, particularly LICs, were actively assessing and hedging their foreign currency risks.
  - DMOs should address capacity development constraints in personnel, institutional framework, data, and analysis before relying on advanced instruments.

### Use of foreign exchange derivative instruments: potential and constraints
- Potential uses
  - When appropriate DMO capacity has been built up, public debt managers in EMDEs can use foreign exchange derivative instruments to achieve an optimal debt portfolio composition (managing the foreign exchange risk) or for cheaper funding (reducing the cost of borrowing).
  - Currency swaps could be used to convert the currency denomination of new debt to a target currency for attaining lower cost foreign currency funding, while the foreign exchange risk exposure of the servicing and repayment obligations of the contracted debt remain hedged.
  - Exchange rate derivatives may be used to alter the currency composition of an existing debt portfolio to attain a desired currency exposure at the lowest possible cost.
  - Currency derivatives may be used to hedge interest rate risks when interest rate derivatives are illiquid or available only for short maturities.
- Valuation, collateral and cost considerations
  - In pricing cross currency swaps employed in public debt management, collateral—often used to reduce credit risk—complicates their valuations.
  - The placement of relatively sizeable collateral affects adversely the cost effectiveness of using such derivatives instruments, especially for low-rated sovereigns.
  - Transaction costs of currency swaps are typically lower than those of debt buybacks and debt swaps, although swap rates tend to increase with the level of indebtedness.
  - International accounting standards require that all derivative transactions be marked to market (and be recorded as on-balance sheet items), which makes assessment of risk-management effectiveness more difficult.
- Constraints for many EMDEs and developing economies
  - Many emerging markets and, in particular, developing economies may not be able to use foreign exchange derivatives because (i) they lack DMO expertise in derivatives, (ii) these instruments may be relatively unavailable in their domestic markets, or (iii) costs to access global derivatives markets are high—mainly owing to insufficiently established or poor credit ratings.
  - Alternative approaches to reach desired currency exposure include debt buybacks or debt swaps, if feasible, or contracting new debt in the target currency, acknowledging these approaches take longer than derivatives.
  - To develop competency in derivatives, DMOs need broad concerted efforts to enhance internal capabilities (personnel and institutional capacity), including specialized TA from international financial institutions and private entities.

### Annex I. A Stylized Action Plan for Developing Capacity in Public Debt Management
- Medium-term focus (three priority areas)
  - Consolidating debt management functions with the ultimate objective of establishing a Debt Management Office—organized along functional lines—within or outside the MoF;
  - Developing staff capacity and ensuring that necessary institutional capacity is maintained;
  - Developing a comprehensive strategy for debt management based on cost-risk analysis, taking into account the macroeconomic framework and ongoing efforts to develop domestic financial markets.
- Short-term actions to achieve medium-term targets
  - Allocate sufficient office space and equipment as a first step toward developing staff capacity and the build-out of the debt management office;
  - Establish a robust debt recording and risk management system for recording and analysis of public debt;
  - Strengthen the back-office functions of the DMO by hiring additional staff to bolster capacity where it is required (e.g., debt recording capacity);
  - Strengthen the middle-office function of the DMO by hiring additional staff to bolster financial analysis of the debt portfolio and the assessment of alternative borrowing strategies;
  - Formalize the debt management strategy—specifically with regard to refinancing, currency risk, and interest rate risk—as a first step toward formalizing the process of deciding among different funding options.

### Annex II. Formulating a Debt Management Strategy
- Practical steps
  - First, the debt portfolio to which the debt strategy applies is defined.
  - Second, scenarios for market and macroeconomic variables are developed. This includes the outlook for interest rates and exchange rates, as well as anticipated growth in gross domestic product, government revenues, and expenditures—under both normal and stress situations. It is important that the modeling includes some severe, but plausible, economic shocks as it is the tails, not the means, of the distributions of key macroeconomic variables that potentially cause problems.
  - Third, projections of the primary deficit or surplus, incorporating likely capital expenditure, are developed. This determines the net new borrowing requirement.
  - Fourth, the various debt management strategies to be analyzed are defined. They should be realistic but forward-looking.
  - Fifth, the performance of each alternative strategy is evaluated. This is a cost and risk analysis rather than an optimization exercise.
  - The final step combines the cost and risk analysis with other constraints and objectives to arrive at a recommendation.
- Benchmarks and governance
  - The strategy is usually expressed in terms of strategic benchmarks (composition (stock) or issuance (flow) benchmarks) that provide transparent guidance for new issuance and portfolio management activity.
  - The government, and if appropriate, the parliament, should approve the debt strategy.
  - The agreed upon strategy should then be communicated publicly, and future issuance plans should be consistent with it.
  - The debt management unit would then report regularly on progress toward achieving the strategy.
  - The strategy should be reviewed annually, with changes prompted by significant market developments, improvements in internal capacity, or changes in underlying assumptions and constraints.

### Annex III. Content of a Debt Management Strategy Document
- Objectives and Scope
  - Describes the objectives for debt management, the scope of the debt management strategy, and the types of risks being managed.
- Existing Debt Portfolio
  - Provides the historical context for the debt portfolio, describing changes in its size (including relative to GDP) and composition through time. Changes in relevant market variables should be included, along with commentary of significant events in the evolution of the debt.
- The Environment for Debt Management Going Forward
  - Describes the environment for debt management in the future, including fiscal and debt projections; assumptions about exchange and interest rates; and constraints on portfolio choice, including those relating to market development and the implementation of monetary policy.
- The Debt Management Strategy
  - Describes the analysis undertaken to support the recommended debt management strategy, including assumptions used and limitations of the analysis.
  - Sets out the recommended strategy and its rationale, describing desired debt composition and the core arguments for such composition, including discussion of key risk factors.
  - Describes progress to be made toward the desired composition over three- and five-year planning horizons, specifying ranges for key risk indicators of the portfolio and the financing program.
  - Outlines specific measures or projects planned to manage non-quantifiable risks and/or support debt market development (e.g., plans to introduce new debt recording systems, or a primary dealer framework).
  - Outlines the periodic review process to ensure key assumptions continue to hold and the strategy remains appropriate, and the process to be followed if circumstances change significantly outside the regular review cycle.

*IMF WORKING PAPERS Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries — INTERNATIONAL MONETARY FUND*

### Annex IV. Risk Management Framework for

### Annex IV. Risk Management Framework for Using Derivatives in Sovereign Debt Portfolios

### Overview: role and trade-offs of derivatives
- Derivatives can reduce exchange or interest rate risks in sovereign debt portfolios but may introduce counterparty, liquidity, and operational risks.
- A solid risk management framework is essential; a positive swap spread (cost difference of issuing a bond in U.S. dollars and swapping into euros, compared to direct funding in euros) is not sufficient justification unless it is “sufficiently positive” to compensate for additional swap transaction risks.
- Derivatives are an imperfect substitute for direct funding instruments.

### Counterparty risk policy
- Derivatives are mostly traded “over-the-counter” (OTC) with bilateral settlement, creating mutual credit risk that evolves as market rates change and the swap acquires market value.
- Key components of a counterparty policy for debt managers:
  - minimal credit scoring or external rating for counterparties;
  - demonstrated market share of counterparties;
  - assignment of credit lines to each counterparty;
  - weights for individual transaction types;
  - accurate legal documentation;
  - rotation among counterparties to ensure competitive service, pricing, and diversification.
- Even if a sovereign has lower credit standing than a counterparty bank, credit standings may change over the life of a swap, affecting exposure.

### Collateralization, CSAs, and valuation
- Collateralization significantly reduces counterparty risk via market-value settlements at pre-agreed times during the swap life—transfers of collateral when a party is “in the money.”
- In the CSA to an ISDA contract, parties agree on:
  - initial margins;
  - frequency and thresholds for margin calls;
  - type of collateral.
- CSAs are in principle two-way, but stronger-credit parties often negotiate better terms.
- A valuation agent is assigned (typically the counterparty bank; an independent agent may be negotiated).

### Central clearing, exchange-traded derivatives, and market infrastructure
- Central clearing systems reduce counterparty and systemic risk by routing settlement and margin calls through a central counterparty.
- The new European Market Infrastructure Regulation in the European Union pushes banks (including potential counterparts for EMDEs) towards:
  - central clearing;
  - trade reporting;
  - an obligation for reconciliation of the market value at least once per year.
- Exchange-traded derivatives can reduce counterparty and operational risk through increased transparency, liquidity, and accessibility.
- OTC derivatives are more customizable and easier to develop, but the distinction with exchange-traded products is narrowing due to rapid development of electronic platforms and exchange clearing services for OTC participants.

### Liquidity and operational risks
- Collateral calls add to liquidity risk and operational risk for government treasuries.
- Few developing countries have the internal organization, back office, risk management systems, and timely liquidity management procedures to flawlessly manage collateral processes.
- Trade-off: reducing the frequency of margin calls lowers operational burden but increases counterparty risk.
- Market information needs for risk management and reporting include:
  - evaluating potential new transactions;
  - resetting rates periodically;
  - determining required collateral movements;
  - remunerating posted collateral.
- Independent calculation and bilateral confirmation of cash flows are essential.

### Accounting, valuation, and reporting challenges
- Inconsistencies can arise between accounting treatments of derivatives (often mark-to-market) and underlying bonds (often recorded at nominal value), complicating communication and evaluation of achieved risk reduction.
- Correct inclusion of derivatives in cash-based government accounts is a challenge; full adoption of market-based indicators by debt managers might require alternative presentation of sovereign liabilities to apply an economic value to the outstanding debt portfolio and account for valuation changes.
- Accrual accounting principles recommended by International Public Sector Accounting Standards and International Organization of Supreme Audit Institutions do not capture market valuations but include accrued interest under accrual accounting standards.
- ESA 95 does not permit the use of market values; harmonized and national accounting standards vary and none fully reflects market valuation of liabilities.
- Market valuation of derivatives has spillover effects for bond debt because back-to-back swaps may trigger market valuation of the underlying debt position.

### Special considerations for lower-rated sovereigns
- Lower-rated sovereigns may be required by banks to supply guarantees or pledge collateral for cross-country hedging, affecting cost-effectiveness.
- Central governments would likely require external guarantees and/or significant initial margins for doing derivatives.
- Premia and other costs of guarantees, collateral, and initial margins must be included in the overall cost of the hedge operation.

### MDBs and private currency-hedging providers
- Cross-currency swaps transacted with Multilateral Development Banks (MDBs), such as the World Bank, avoid many additional risks:
  - counterparty risk is effectively one-sided;
  - the World Bank does not apply a credit charge in the swap;
  - there are no collateral calls, making arrangements operationally convenient.
- Private-sector providers (e.g., TCX and others) offer currency hedging solutions that address currency and interest risks in developing economies, broadening options for countries that meet preconditions for derivative use and enabling investors to lock in long-term finance.

### Implications for debt management systems and risk governance
- Use of derivatives increases operational risk and requires more comprehensive risk management and integrated debt management systems that can:
  - process derivative transactions;
  - maintain control of the debt portfolio structure;
  - identify, measure, monitor, and report multiple sources of operational risk.
- Advanced IT and back-office systems (example cited: Morocco) provide advantages in managing derivatives operations.

*Source: Annex IV, "Risk Management Framework for Using Derivatives in Sovereign Debt Portfolios," Managing Foreign Exchange Rate Risk: Capacity Development for Public Debt Managers in Emerging Market and Low-Income Countries, Working Paper No. WP/2024/167, INTERNATIONAL MONETARY FUND*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024167-print-pdf.pdf_