Speech

International Monetary Fund
Cairo, Egypt, February 8, 2007

Ladies and Gentlemen:

I am delighted to be with you in Cairo today and to have an opportunity to discuss debt and financing issues, at a time when there has been significant accumulation of financial assets by emerging market countries, particularly by countries in the region.

As we saw from this morning's discussion, improvements in macroeconomic conditions in many emerging market countries, combined with an ample supply of credit worldwide, have made it much easier for debt managers to secure financing on attractive terms. It has offered opportunities to refinance and improve the risk structure of debt portfolios, or pay back existing debt. The Middle East and Northern Africa region has benefited from this global trend. Many countries in this region have improved their debt profiles and reduced the stock of debt. On average, reflecting not only the positive impact of high oil prices but also fiscal consolidation and privatization, public debt in the region has declined to below 40 percent of GDP last year, from 60 percent of GDP five years ago.

Certainly, these developments have made for less vulnerability. But they, nevertheless, still raise several policy challenges for debt management. Notable among them are how best to manage the overall public sector balance sheet, and how best to develop local capital markets, which should be an explicit part of any well-developed debt management strategy.

We have also to remain aware that, despite today's favorable financing conditions, there are still risks. Emerging markets are still exposed to sudden shifts in investor sentiment and market volatility, especially in light of the increasing correlation in asset prices, which Jaime talked about earlier. Managing these risks effectively will require continued fiscal consolidation to maintain debt sustainability. It will require continued efforts to structure the debt portfolio to minimize balance sheet risk. As the choices facing debt managers continue to expand, debt management today is, perhaps, even more complex than it was in 2001 when the joint World Bank-IMF Guidelines for Public Debt Management were first produced.

The IMF is actively seeking to enhance its surveillance of these issues. This is an integral part of our medium-term strategy. We plan to strengthen our analysis of debt sustainability and sovereign balance sheet risks and better integrate these topics into our dialogue with our member countries. Here in Egypt, for example, we are looking forward to working with the authorities to review the debt management strategy and its implications for macroeconomic stability and capital market development, including the issues reflecting secondary market developments that the Minister of Finance emphasized this morning.

General market overview

But let me return to global conditions in sovereign debt markets that have been favorable and have facilitated active debt management operations, with the volume of debt swaps and buybacks reaching record levels in 2006. Countries, including many represented in this room, have pre-financed—particularly ahead of political events such as elections—and pre-paid multilateral and bilateral official debt, as well as private debt. The IMF has been particularly aware and supportive of these movements. The Philippines, Brazil, Argentina and Uruguay have all prepaid IMF loans.

Clearly, emerging markets have matured as an asset class. The continued search by global institutional investors for yield and portfolio diversification—combined with important improvements in many countries' macro-fundamentals—has led to a significant broadening of the investor base for emerging market assets. And these developments have led to an historic shift away from what is sometimes referred to as "original sin." For many, if not most countries in this room, the share of foreign currency denominated debt has declined sharply in the past several years, and the share of domestic debt has risen correspondingly to historically high levels. This transformation is an important factor in reducing debt-related balance sheet risks. The design of sovereign debt instruments is also evolving in interesting ways, which this forum will discuss. In this regard, I want to especially note the rapid rise in the issuance of Sukuks—both by sovereigns and corporates—that tap new sources of financing and increase instrument diversity for investors and borrowers alike. All these are very good news.

Developing a comprehensive debt strategy

But to be able to continue to effectively take advantage of market opportunities, debt managers need a clear perspective on their desired structure of the portfolio, and how they expect it to evolve. This is not just a question of how new debt should be structured—the "flow"—but also whether there are opportunities to change the composition of the debt stock at a faster pace than can be achieved through new financing flows alone.

As we will discuss tomorrow, determining a well-formulated debt management strategy is not a simple matter. It is a process that requires a measured view of costs and risks of different debt instruments over the medium-term. This goes beyond a one-dimensional analysis of nominal debt servicing costs, to encompass the relationship between debt servicing and the government's revenue base. It requires a consideration of the impact of a broad range of potential macro-economic shocks. Such type of analysis is in line with the integrated asset-liability management concept that we increasingly hear discussed, and that can help increase the robustness of the debt portfolio. In addition, as many of you can attest, public dissemination of that strategy is an important factor in strengthening investor confidence and enhancing your standing with the market.

Some components of a good debt management strategy are: debt sustainability analysis, balance sheet analysis, local market development, maintaining a good investor base, links to monetary and fiscal policies.

Debt sustainability analysis

The development of a debt management strategy is directly linked with the analysis of debt sustainability—a link the IMF will be increasingly emphasizing in its surveillance work. Maintaining debt sustainability and improving sovereign creditworthiness is primarily a responsibility of policy makers in charge of macroeconomic management. But debt managers have also an important role to play. The debt manager needs to communicate any concerns he or she may have about the implications of fiscal policy on the cost and risk of feasible financing options. And, fiscal policy makers should be ready to adjust fiscal policy to relieve pressures identified by the debt managers.

The main point is that debt sustainability analysis should be at the core of a medium-term debt management strategy. Debt managers will benefit by augmenting traditional debt sustainability frameworks, both through inclusion of details on the term structure of debt and through the use of more tailored risk assessment techniques to better analyze the portfolio risks. Many of you are already making rapid progress in this regard, and our staff at the IMF is also actively working on these extensions.

Public sector balance sheet

A second important component of a debt management strategy is to analyze the public sector balance sheet.

In the current climate—with large holdings of financial assets in the form of sovereign wealth funds and a general increase in international reserves, taking a holistic view of the public sector balance sheet becomes particularly important to allow debt managers to minimize currency and cash-flow mismatches.

The asset accumulation we have seen also raises the question of when these assets should be used to retire government debt. Of course, when a country has an ample level of reserves, not rolling over or retiring foreign currency debt, will typically appear to be a profitable option. However, the issue of whether to retire domestic currency debt using excess reserves is a different one, and requires a careful analysis of its implications for exchange rate and monetary policies, and its potential impact on the functioning and development of local money and bond markets.

Domestic capital market development

This brings me to the third link I wish to emphasize, which is the link of debt management with domestic capital market development.

We are now at an opportune time to make significant inroads in developing local capital markets, a topic, I know, many of you attach high importance to. Deeper and more liquid domestic markets facilitate further improvements in the structure of portfolios. For example, the successful introduction last year of 30-year domestic bonds in Mexico and the Czech Republic, which reflects the pay-off from a concerted effort to develop the local market. Similarly, the Middle East and North Africa region has been achieving some maturity extension, along with some instrument diversification, including the use of Islamic securities.

We at the IMF very much welcome a broader development of local capital markets that goes beyond the government bond markets to include derivative and other fixed income markets, which facilitate growth and better distribution of risks throughout the economy. The IMF is collaborating with many countries, both in this region and more broadly, to support further progress in these areas.

Debt managers clearly have an active role to play in the development of local capital markets, but you cannot do it alone. You need to work with regulatory bodies, the central bank and other market-related private sector bodies to ensure that efforts are coordinated and mutually reinforce one another. For example, regulatory restrictions on institutional investors can, by creating a one-way market, have the unintended consequence of reducing liquidity in the secondary markets, thus hindering effective price formation. An example from my own country of a broad-based and cooperative approach is the "BEST" program-, a joint government-private sector initiative to achieve excellence in securities transactions.

Investor base

The fourth component of a debt management strategy I would like to touch on is the investor base, which we reported in last April's Global Financial Stability Report is becoming more diverse for both external and domestic debt. The proportion of domestic debt held by banks has declined, with a corresponding increase in debt held by long-term strategic foreign and domestic institutional investors. Such investor diversification will enhance liquidity and, as many of you have found, provides scope for new instruments and maturities to be introduced. It has also been accompanied by strengthened market practices, with improvements in accounting regulations, transparency and communication by issuers.

As I know myself from my experiences in Brazil, establishing strong relationships with your investor base—built on a foundation of transparency—is an important aspect of investor diversification. And the IMF has worked actively with several of you in this area. Effective two-way communication will allow you to better understand investors' objectives and practices, allowing a better assessment of demand conditions and helping you anticipate (and mitigate) any associated risks. Similarly it will ensure that investors fully understand your strategy and modality of operation, reducing the likelihood of misinformation destabilizing market conditions.

For several countries, foreign investors hold a significant proportion of domestic debt. The role of foreign investors in domestic debt markets represents a welcome opportunity. They bring a different perspective, and can spur the development of local expertise and systems through technology transfer. However, their entrance does not come without some attendant risks—as the events of last May-June have borne out. Sudden capital outflows can lead to a sharp drop in demand for certain instruments, and leave you exposed to sudden financing shortfalls. Strong two-way communication can mitigate some of these consequences and facilitate a reversal.

Similarly, strong communication channels will allow debt managers to monitor relevant developments in the banking sector as a principal holder of domestic debt in many countries, and help address emerging risks. This is important, as this sector can impact both the demand for and the supply of public debt.

Macroeconomic policy

And finally, when determining the appropriate strategy, debt managers also need to be sensitive to the interaction of their choices with other economic policies, and in particular, the links to monetary and exchange rate policy.

Since the crises of the late 1990s, countries have moved increasingly to greater exchange rate flexibility. On the face of it, this may appear to increase the risk associated with foreign currency debt. However, this risk was always there, and may be hidden with a pegged exchange rate—as some countries realized the hard way. So, viewed in this context, more flexible exchange rate regimes encourage more active risk management—both by the public sector and, importantly, by the private sector—reducing overall vulnerability to sudden devaluations and mitigating the contingent liability represented by the private sector's exposure to foreign currency debt.

Similarly, central banks are increasingly moving towards a greater use of indirect monetary policy instruments, such as repos. This not only increases the overall attractiveness of government securities as collateral, enhancing demand, but can enhance the development of financial markets more generally, improving the transmission of monetary policy. More effective monetary policy implementation, on the other hand, will enhance policy credibility. Consequently, it should reduce the overall cost of debt and facilitate maturity extension.

Initiatives in the IMF

As I mentioned at the start, the IMF is enhancing its focus on debt management issues —both from the perspective of improving debt sustainability, and of supporting the development of local capital markets. To anchor this work, two new divisions have been established within the Monetary and Capital Markets Department at the IMF—the Sovereign Asset and Liability Management Division and the Capital Markets Development Division. They will work with other divisions and area departments in the IMF to ensure that debt management and market development issues are better integrated into the relevant IMF policies and activities. They will also be actively engaged with a range of partners— including the World Bank and the OECD—to develop and disseminate good practice in these areas.

We have had the pleasure of working with a number of you here in this room on these various issues, and I hope this partnership will continue to be a source of ideas for all of us. We will further develop our thinking on how countries should take a more effective approach to managing together sovereign liabilities and assets. We shall look at the technical modalities of developing an effective medium-term debt management strategy and continue to provide technical advice to countries on these issues.

The IMF is actively involved with several market development initiatives in this region. Our Managing Director, Rodrigo de Rato, recently participated in an important and productive conference on financial sector reforms and financial integration in the Maghreb. Through the IMF's Maghreb Financial Integration Initiative, we will be working with countries of the region, to assess money markets, including the market for short-term government securities, and to further strengthen market functions and financial integration within the region. Progress in promoting efficient and well-integrated financial systems in Maghreb countries will help these countries reach a higher sustained growth path that will enable them to reduce unemployment, and, in time, to close the development gap in the Euro-Mediterranean region. We have also opened a dialogue with the Arab Monetary Fund on bond market development in Arab countries, with the objective of strengthening capital markets in these countries, and are participating, in collaboration with the Islamic Financial Services Board, in an international effort to develop standards for Islamic money market instruments.

Conclusion

Debt managers have very successfully taken advantage of market opportunities to improve the structure of their debt portfolios. This provides the impetus to address the work still to be done. Leveraging current opportunities requires a comprehensive oversight of the broader set of public financial assets and liabilities. The IMF attaches a high priority to maintain debt sustainability and improve creditworthiness. This is why we attach high importance to events such as this forum. I hope that this will continue to be an effective two-way dialogue with debt managers, so that we can build our understanding of the challenges you face, and share with you our own perspectives on these developments.

Given the continued ample supply of credit, accessing finance may no longer be the most pressing issue on your agenda. However, there are still many questions left to be resolved, and you can be assured that the IMF will continue to be a partner in the relevant policy discussions to address these challenges.

Thank you.