Customers at a bank in Tokyo: a country’s financial risks can overwhelm its economy (photo: Yuriko Nakao/Reuters)
GOVERNMENT DEBT
In the wake of the recent crisis, new analysis from the IMF shows officials need to recalibrate their approach to debt management, prepare to adjust plans quickly, and keep open lines of communication with investors.
The IMF brought together debt managers from 25 countries as well as central bankers, representatives from the private sector, and other international financial organizations for the 11th Annual Debt Managers’ Forum in Seoul, Korea on June 22–23.
“The legacy of high public debt and elevated sovereign risk stemming from the crisis carries far reaching implications and challenges for debt managers, as well as for debt markets and investors,” said Jan Brockmeijer, deputy director of the IMF’s Monetary and Capital Markets Department at the forum’s opening.
High levels of government debt are a concern because countries with problems in their financial sector and little economic flexibility have run into trouble meeting their financing needs.
Some of these countries’ in Europe face high debt costs that impose heavy burdens on their populations and run the risk of severe disruptions in their economies.
The IMF analysis identified five key lessons for debt management:
• Manage roll-over risk. Billions of dollars in public debt fall due every year and needs to be refinanced, or “rolled over.” This imposes potentially big risks if investors for some reason lose their appetite.
• Maintain operational flexibility in debt management. As practice has taught, issuance needs to respond to specific demand, which may include temporarily issuing more short-term debt or selling debt privately, which means it is sold to a small number of investors rather than publicly on the open markets.
• Ensure ongoing communication with investors. Investors need to know the plan of action. The communication needs to be two way as well: debt managers need to listen carefully to the market’s concerns.
• Debt managers need to collaborate with banking supervisors and fiscal authorities to ensure the consistency of debt management policies with financial sector and macroeconomic policies.
• Risk management needs to be updated and augmented. When a country’s financial sector is large compared to the size of its economy, the financial risks can impact a country’s overall economic risk profile, and debt structures can help offset these. The cost -risk analysis of debt structures can be deepened by taking into account y the a country’s ability to backstop liquidity problems
Debt managers in the eye of the storm
Public debt managers are the officials who decide how best to borrow money for a government and manage the accumulated debt, including its associated financial risks. Their actions also directly affect a country’s bond market, as well as international capital markets. Their primary goal is to minimize government borrowing costs over the medium term, subject to prudent levels of risk.
In issuing government securities, debt managers interact with a wide range of domestic and international investors, including banks and other financial institutions; institutional investors, such as central banks, pension funds, insurance companies, and the general public.
The crisis was unprecedented for most debt managers. Many were caught in the eye of the biggest global financial storm since the 1930s. They were faced with three things they’d never seen before:
• Debt issuance frameworks were severely strained; issuance calendars had to be adjusted and ad hoc funds had to be raised.
• The assumption of automatic access to financing in financial markets by advanced countries was tested.
• Some classes of investors deserted government securities of some countries altogether, meaning that issuers had to find other buyers, which drove up the cost of funding.
Country challenges
For several advanced countries, the challenge is to restore normalcy in the financial markets. Others need to focus on strengthening debt market conditions by restoring the sustainability of public debt levels by reducing government debts and deficits and by increasing growth.
Emerging market economies can make use of the current favorable market conditions, reflected in sizable capital inflows, to continue improving their debt structures. Some of those inflows can be tapped for investment in longer term government bonds to reduce the risk of reversals and strengthen the debt structures.
In countries gaining access to international financial markets for the first time, the challenges are different. Their capacity to evaluate financing options is limited, but very important to avoid costly mistakes in accessing debt markets. They need to focus on shovel ready projects to avoid misusing finances or having the lie idle.
For these countries it is worthwhile to invest in building-up the capacity of their debt office to evaluate debt strategies and options and to deepen domestic debt markets that can then function as an alternative source of investment finance.
