Medium-Term Debt Management Strategy

Transcription

1 Medium-Term Deb Managemen Sraegy 2013 Minisry of Finance and Public Credi General Direcorae of Public Credi Naional Treasury

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3 y Medium-Term Deb Managemen Sraegy General Direcorae of Public Credi and Naional Treasury Depuy Direcorae of Risk Liberad Orden Minisry of Finance and Public Credi Republic of Colombia. Bogoá, D.C., 2013

4 Liberad y Orden Minisry of Finance and Public Credi Republic of Colombia. Bogoá, D.C., s Ediion March, 2013 Minisry of Finance and Public Credi Publishing and disribuion righs reserved Carrera 8ª No.6-64 Bogoá Colombia, Fax. (57-1) aención_usuario@minhacienda.gov.co; Legal deposi in accordance wih Law 44 of 1993 Parcial reprodicion of he conens of his work are permied, proper ciaion provided. Medium-Term Deb Sraegy ISBN Bogoá D.C., April, 2013 Cover design Camilo Medina Ediorial design Bernardo Arias Blanco Prining Dígios & Diseños Lda. Translaion and ediion Saniago Mora Colombia. Minisry of Finance and Public Credi. General Direcorae of Public Credi and Naional Treasury. Medium-Term Deb Sraegy Bogoá, D.C.: Miniserio, p. ISBN: Medium-Term Deb Sraegy 2. Benchmark porfolio 3. Deb porfolio currency composiion 4. Asse and Liabiliy Managemen 5. Cos-risk analysis 6. Fiscal policy I Melo Hernández, Helber Alonso II Díaz Zulea, Ana Carolina III Gómez Rubio, Germán IV Núñez Trujillo, Carlos Alejandro CDD 20ed CEP. Biblioeca José María Del Casillo y Rada 4

5 Liberad y Orden Minisry of Finance and Public Credi Republic of Colombia. Bogoá, D.C., 2013 Miniser of Finance and Public Credi Mauricio Cárdenas Sanamaría General Vice-miniser Germán Arce Zapaa Technical Vice-miniser Ana Fernanda Maiguashca Olano Secreary General Claudia Isabel González Sánchez Direcor General of Public Credi and Naional Treasury María Fernanda Suárez Londoño Depuy Direcor of Risk Helber Alonso Melo Hernández Wih he paricipaion of: Depuy Direcorae of Financing wih Mulilaeral Organisms and Governmens Depuy Direcorae of Inernaional Capial Markes Depuy Direcorae of Inernal Financing Depuy Direcorae of he Naional Treasury Wih he accompanimen of: World Bank Sae Secrearia for Economic Affairs SECO Medium-Term Deb Managemen March 2013 Technical Team Ana Carolina Díaz Zulea Germán Gómez Rubio Carlos Alejandro Núñez Trujillo In collaboraion wih: Saniago Mora Osorio Juan Guillermo Vélez Carmona 5

6 Minisry of Finance and Public Credi Conens Foreword 11 Inroducion 12 Execuive Summary 13 PART I: Medium-Term Deb Managemen Sraegy Concepual Framework Risks, coss and benefis analysis Benchmark Porfolio Benchmark Porfolio - Definiions Oher ools for deb managemen Hedging insrumens Inegraion of he MTDS wih macroeconomic policy Asse and Liabiliy Managemen approach Developmen and efficiency of domesic markes Colombian Case Sudy Objecives of he MTDS Background Medium-Term Deb Managemen Sraegy Formulaion of he MTDS Objecives Guidelines Public deb managemen reach Public deb managemen responsibiliies for he Naion Srucure of he Governmen of Colombia as deb manager CNG ousanding deb and mauriy profiles CNG oal ousanding deb Risk managemen analysis and he benchmark porfolio Benchmark porfolio Exchange rae indicaor Currency composiion 45 6

7 Mauriy indicaor Deb amorizaion profile Ineres rae indicaor Ineres rae composiion of he porfolio Financing sources of he Naional Governmen Raising deb in domesic capial markes Raising deb in foreign capial markes Foreign Governmen and Mulilaeral Organism Financing Invesor relaions program Naional Governmen Liabiliy Managemen Coordinaion wih fiscal and moneary policy Fiscal Policy Deb perspecives from he Naional Developmen Plan Deb managemen ineracion wih moneary policy Accomplishmens and deb oulooks 86 PART I I: Deb Forecasing Mehodology for MTDS MTDS Models Approaches and Objecives The foreign currency benchmark General assumpions Funding needs Currencies in he deb porfolio Prices and marke raes Fiscal Balance (FB) variables Furher definiions Firs Approach ALM Model ALM-1 Model: Minimizing he defici s presen value volailiy Preliminaries Facor idenificaion Framework Resuls ALM-2 model: Sabilizing fiscal impac (Ineress/Revenues) Preliminaries Objecive defininion Theoreical Framework Resuls ALM generales conclusions Resul summary ALM advanages ALM limiaions 124 7

8 Minisry of Finance and Public Credi 6. RCaR Cos v.s. Risk mehodology Model preliminaries Exchange rae volailiy coss and risks Deerminan Analysis Markowiz Porfolio Theory Deb indicaors Framework Idenifying indicaors Definiion of he remaining benchmarks Primary FB and oher macroeconomic variables Marke Variables Deb issuing Insrumens and financing needs Cos vs. Risk analysis Resuls Simulaed variables Cos vs. Risk Analysis General Resuls, Recommendaions and Perspecives Qualiaive improvemens in modeling Model resuls ALM ALM RCaR End remarks Furher remarks 154 References 155 8

9 Acronyms and Abbreviaions ALM APD BR CAF CBBD CCS CNG CONFIS COP CPI DGCP DGCPTN DGPM DNP FAE FB GCS GRS IDB BIRF Asse and Liabiliy Managemen Aspiring Primary Dealer Banco de la República Cenral Bank of Colombia Corporación Andina de Fomeno Developmen Bank of Lain America Cenral Bank Board of Direcors Cross Currency Swap Cenralized Naional Governmen Council for Fiscal Policy Colombian Peso Consumer Price Index General Direcorae of Public Credi General Direcorae of Public Credi and Naional Treasury General Direcorae of Macroeconomic Policy Naional Planning Deparmen of Colombia Saving and Sabilizaion Fund Fiscal Balance General Conribuion Sysem General Royaly Sysem Iner-American Developmen Bank IInernaional Bank for Reconsrucion and Developmen (IBRD) IMF MHCP MTDS MTFF NDP NFPS NGB PAC PD PDP RCaR SECO SFC SNA USD UVR WB WBT XCCS Inernaional Moneary Fund Minisry of Finance and Public Credi Medium-Term Deb Managemen Sraegy Medium-Term Fiscal Framework Naional Developmen Plan Non-Financial Public Secor Naional General Budge Monhly Basis Annual Cash Schedule Primary Dealer Public Deb Primary Dealers Program Relaive Cos a Risk Sae Secrearia for Economic Affairs Financial Superinendence of Colombia Single Naional Accoun Unied Saes Dollar Real Value Uni World Bank World Bank Treasury Exinguishable Cross Currency Swap 9

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11 MINISTRY OF FINANCE AND PUBLIC CREDIT Foreword Over he pas wo years, he Governmen of Colombia has accomplished considerable advances regarding fiscal policy. These breakhroughs, in hand wih a proper deb policy and a srong commimen o fiscal discipline led he counry o recover is invesmen-grade credi raing in 2011 and o hold a low risk premium when issuing deb ever since. Conscious of he grea responsibiliy and effec ha he Naion s deb managemen has on public finances, on he economy and he marke, he Governmen commied o designing he Medium-Term Deb Managemen Sraegy in line wih he Naional Developmen Plan Prosperiy for All By following hese guidelines over he pas wo years, he Minisry of Finance and Public Credi, led by he General Direcorae of Public Credi and Naional Treasury, creaed he guidelines for adminisraing he Cenralized Naional Governmen s public deb under he scope of efficien and inegral risk managemen. The purpose of his sudy is o deermine he characerisics and goals ha define wha an efficien deb porfolio managemen is. One of he bigges challenges faced in his sudy was o choose a model ha suied Colombia s deb needs and goals. For defining which mehodologies o use for finding efficien deb porfolios, he Minisry of Finance and Public Credi relied on is echnical eam, especially on he Depuy Direcorae of Risk, and on he World Bank s Treasury. Colombia is now considered o have adequae deb policies. This, along wih oher governmen policies and a favorable economic and marke environmen have shielded he Naion agains recen financial volailiy around he world. I is our hope ha his documen conribues o he analysis and debae on governmen deb adminisraion and ha i helps o srenghen Colombia s inernaional saus as an example of sound managemen. María Fernanda Suárez Londoño Direcor General of Public Credi and Naional Treasury 11

12 Minisry of Finance and Public Credi Inroducion This documen defines a new medium-erm deb sraegy, o be applied by he Cenralized Naional Governmen (CNG) and used as a compass on he subjec for he following years. For his purpose, he documen addresses he deb sraegy from a heoreical approach, in erms of objecives, risks, benefis and managemen efficiency. Addiionally, i presens mehodologies and examples ha validae he Naion s chosen deb managemen sraegy presened in he firs secion. In line wih his, he documen is divided in wo secions. The firs secion presens major issues ha governmen auhoriies mus consider in formulaing public deb managemen sraegy. Differen risks o be considered when developing issuance sraegies are analyzed as well as he sraegy s harmonizaion wih he governmen s economic policy. Addiionally, he evoluion and curren sae of Colombia s deb managemen is described. This secion ends wih a horough descripion of he curren design for deb sraegy in Colombia, boh in heory and pracice. Idenificaion of he marke agens involved and heir respecive responsibiliies, markes, funding sources and curren deb profiles are all described as well. The second secion focuses primarily on currency facors ha may hinder Colombia s public deb profile. We firs display wo models under which medium-erm deb managemen sraegies are designed, in accordance o CNG asse and liabiliy managemen guidelines. Aferwards, our analysis focuses on he deb porfolio s dynamic and weighs coss and risks wih he previously deermine ad hoc sraegies. These guidelines are resriced by he fac ha, for every period in ime, implemened sraegies are o mee he CNG s financing needs. Finally, resuls and improvemens in modeling mehodologies are presened, mainly hose regarding he model s reach and robusness. Simulaneously, furher consideraions ha may conribue o srenghen he effeciveness of deb policy are menioned. 12

13 MINISTRY OF FINANCE AND PUBLIC CREDIT Inroducion - Execuive Summary Execuive Summary A deb sraegy is a se of acions execued over a deb porfolio, ha seek for risk, cos, duraion, currency and ineres rae objecives in a specific period of ime. In Colombia, he oucome of fosering deb sraegies is a combinaion of indicaors ha define he srucure of a benchmark deb porfolio. Wihin he guidelines of his reference srucure, he Governmen manages is ousanding deb and deb issues. From he early nineeen nineies, Colombia has worked in improving he level of all deb indicaors, in order o miigae risks faced when raising deb. The aim is o do so a compeiive prices and wih a large, diversified pool of funding sources. The main deb porfolio indicaors used for defining deb sraegies in Colombia are: Marke of issuance Average life of he porfolio BENCHMARK PORTFOLIO Ineres rae Issuance marke class Currency denominaion Marke of issuance (inernal/exernal): This indicaor discriminaes he amouns of deb conraced in domesic markes and hose financed in foreign markes. This follows idenified marke limiaions as well as opporuniies for deepening he yield curve. The new implemened deb sraegy combines higher COP denominaed issuings (as a resul of he ALM model) wih a wide array of opporuniies for finding low cos and low currency risk deb in domesic markes 13

14 Minisry of Finance and Public Credi Ineres rae: This indicaor discriminaes volumes of floaing-rae issued deb securiies from fixed-rae issues. Colombia has been relaively conservaive in managing marke risks, when raising deb. Consequenly, a low percenage of he deb porfolio is ied o floaing-raes, which usually imply risks of higher deb-servicing coss. In fac, he Governmen limied floaing-rae deb o 5% of he oal volume of ousanding deb, in par because of he availabiliy of low cos-risk fixed-rae deb sources. Currency denominaion: This indicaor reveals Colombia s deb porfolio s currency composiion. The curren sraegy ses his indicaor as he main subjec of analysis due o is high risk and impac, given he presen economic environmen. Therefore, a large deal of effor is spen in searching for he appropriae volume of USD denominaed deb. The effecs of currency risk wih he curren mauriy profile of he porfolio are horoughly sudied, as well as how his risk should be managed. Afer having evaluaed hree differen mehodologies for esimaing a proper currency composiion, he sudy concludes ha an opimal disribuion is o hold 75% of he deb porfolio in COP, and 25% in USD denominaed deb securiies. This disribuion minimizes coss and risks in he medium-erm and is coheren wih curren macroeconomic policy. Issuance marke class: This indicaor discriminaes wheher deb is raised in capial markes or elsewhere in he financial sysem. Colombian Governmen has decided o concenrae is effors in raising capial in open markes for wo main reasons: i) here are issuance sraegies for inernal and exernal deb, and giving deph o he yield curve enables fund source diversificaion and cus in coss, and ii) his deepening of he curve makes corporae deb less cosly and more available. This is no, by any means, a resricion o conracing liabiliies wih mulilaeral organizaions, bu raher a search for an adequae balance in funding sources. Average life: This indicaor encompasses mauriy profile indices, which reflec amorizaion concenraions in each fiscal erm. Is srucure is a resul of all of he former indicaors, an upper bound for annual amorizaions of 15% of oal ousanding deb was se and he new sraegy lowers i o 10%. 14

15 MINISTRY OF FINANCE AND PUBLIC CREDIT Inroducion - Execuive Summary To illusrae how his works in Colombia, he following char presens he evoluion of each of hese goal indicaors is presened nex: (Sraegy Oucome) Marke of issuance Inernal 53% 67% 72% 70% Exernal 47% 33% 28% 30% Ineres rae composiion Fixed-rae 90% 94% 94% 95% Floaing Rae 10% 6% 6% 5% Currency composiion COP 50% 67% 72% 75% USD (ohers) 50% 33% 28% 25% Liabiliy class Bonds 69% 69% 87% 90% Credi lines 31% 31% 13% 10% Average life Inernal Exernal Toal These resuls are mean o explain how he new deb managemen sraegy was creaed. For his purpose, his documen was divided in wo pars. The firs describes he curren deb sraegy, synheized under he benchmark porfolio, mauriy profiles, measured risks and he organizaional model for managing deb. The second par goes deeper ino he models ha define currency composiions for he deb porfolio, given Colombia s mining and energy boom; which is currenly leading o appreciaion of he COP. The choice for a paricular currency composiion follows he resuls of wo main approaches ha examine differen deb managemen consideraions separaely. The firs approach is he Asse and Liabiliy Managemen model. The second mehodology, dubbed he Cos- Risk model, addresses ALM limiaions under a cos risk scope, under differen currency and ineres rae composiions scenarios 1. Transparence in he definiion and implemenaion of a medium-erm deb managemen sraegy is key for reducing fiscal risks, in line wih he CNG Fiscal Balance financial srucure. In paricular, he ransparence guidelines have reinforced Colombia as a foreign marke deb issuer and improved invesor perspecive owards Colombian deb in general. 1 ALM resuls are one of hese sudied combinaions. 15

16 Minisry of Finance and Public Credi The medium-erm deb sraegy explained hroughou his documen seeks o saisfy he need for currency maching wihin he Fiscal Balance and i consiues he base on which deb will be managed in following years (in line wih he Naional Developmen Plan, Prosperiy for all ). Resuls from he exercises and proposed policies are framed in a pruden and efficien deb managemen conex. Following hese adminisraion principles guaranees deb susainabiliy and a proper accompanimen o public finance managemen. 16

17 PART I Medium-Term Deb Managemen Sraegy 17

18 Minisry of Finance and Public Credi 1. Concepual Framework A deb sraegy is a combinaion of deb insrumens, srucured as a porfolio. Such sraegy seeks o esablish policy guidelines defined by he Governmen. Before discussing deb sraegy design, i is convenien o firs describe relevan heoreical feaures of managemen mechanisms available o deb issuers. Firs, differen ypes of risks ha derive from deb sraegies are assessed, as well as coss and benefis. Nex, benchmark deb porfolio arge indicaors are described. Finally, oher relevan aspecs concerning deb are sudied, such as he ineracion of deb issues wih oher economic variables and marke indicaors Risks, coss and benefis analysis Public deb managemen is he process of esablishing and implemening sraegies for adminisraing Cenralized Naional Governmen (CNG) deb. The goal of public deb managemen policy is o insure ha he Governmen s financing needs are me and ha paymen of is liabiliies is execued a he leas coss and risks possible. A Medium-Term Deb Managemen Sraegy (MTDS) is an acion plan; developed by he Governmen, for obaining a desired deb porfolio srucure, limied by public preferences regarding coss and benefis. The MTDS design makes emphasis in managing implici risk exposures and enables he idenificaion of possible fiscal cos variaions wih incidence on deb-servicing coss, macroeconomic volailiy, marke volailiy or exogenous shocks ha may hinder he aggregae economy. A proper design adminisraes porfolio risks, minimizes he deb burden on axpayers and maximizes resources availabiliy for oher expendiures (FMI e al., 2009). The hree fundamenal, muually exclusive, defined goals of deb s managemen (García, 2000) are: i. Minimizing average cos of deb ii. Minimizing exposure o marke risk iii. Maximizing he deb s average mauriy, seeking a uniform deb mauriy profile Sraegies wih a relaively shor mauriy profile 2 may be inended for minimizing deb cos by reducing budge burdens associaed wih deb service in fuure ineres paymens. In his manner, a possible opimal deb policy would be only issuing shor-erm deb given ha is coss are lower han longer erm issuing, and fuure ineres paymens are avoided. In consequence, uncerainy coming from facors ha would affec he deb s value is reduced. 2 Perhaps one budge cycle. 18

19 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I Figure 1. Deb managemen goal riangle Minimizing coss Minimizing marke risk Minimizing rollover risk Source: García, Leaving aside possible fuure risks, a narrow ime window for issuing shor-erm liabiliies would limi he governmen s room for resrucuring he deb porfolio owards lower coss. In fac, frequen refinancing leads o greaer risks and he impairmen of he curren ousanding deb profile, as opposed o longer erm deb rollover wih lower ineres raes. Conversely, when exernal ineres raes are lower han domesic ones, long-erm deb issues in foreign currency denominaion would be, a priori, more appealing o deb managers as a resul of lower coss. Even hough his second sraegy would exend he general mauriy profile of he deb porfolio reducing rollover risk, i does no incorporae he greaer currency risk associaed wih foreign currency denominaed deb 3. 3 The selecion of a deermined deb sraegy reflecs domesic marke resricions as well. Counries wih deep fixed income markes, have a large enough worldwide pool of invesors who absorb he governmen s financing needs making i unnecessary o issue deb in oher currencies. Opposie o his, in many developing counries, where financing needs are no enirely me domesically, here is need of foreign currency denominaed issuing. 19

20 Minisry of Finance and Public Credi If he chosen deb sraegy aims o reduce marke risk, hen deb managers should increase he amoun of fixed-rae deb issued on longer mauriies. Thusly, impac of ineres paymens linked o long-erm issued deb on he governmen s budge is no opimized. Alhough hese sraegies end o be cosly, hey are commonly found since hey limi he uncerainy on cash flows resuling from unexpeced marke volailiy. This volailiy on deb-servicing coss has a high poliical cos: he governmen s fiscal policy and is oucome may lead o increased revenues or reduced expendiure (García, 2000). Consequenly, i is convenien ha cos and risk evaluaions of he MTDS consider full business cycles 4, so ha inerconnecions beween he aforemenioned goals are incorporaed in all sages of design 5. Aside from fixed rae long-erm deb porfolios, governmens may use inflaion indexed deb issuing as an alernaive sraegy. These bonds provide invesors wih hedging ools for fuure price volailiy, implying lower ineres raes and longer mauriies on issuance. In fac, he advanages can be significan in cases where he governmen s forecased inflaion is below marke esimaes. The effecive design and implemenaion of a MTDS requires he exisence of financial insrumens and bonds; and financial marke deph. Such insrumens should provide enough capial o saisfy he Naion s funding needs and he Governmen s objecives regarding fiscal and macroeconomic policy, as well as fulfilling all of he porfolio managers ineress Benchmark Porfolio Governmen deb managemen consiss in designing and implemening a deb porfolio ha adequaely balances he following characerisics (in accordance wih previously se policy objecives): I. Currency composiion of he deb porfolio, II. Deb mauriy srucure, III. Ineres rae composiion of he deb porfolio, IV. Index composiion of he deb porfolio (wheher i is inflaion indexed, or linked o oher marke or macroeconomic variables 6 ). Deb managers have oher ools available, which allow hem o modify he menioned characerisics when needed. These do no necessarily imply deb issuance, and seek o improve he general public deb mauriy profile. The porfolio s composiion may be ransformed by he means of swaps and oher hedges, buybacks or deb exchanges. Based on hese four characerisics and wih he use of insrumens, governmens implemen heir deb managemen sraegies. 4 Oher counry s experience shows how hey conemplae 3 o 5 year ime horizons. 5 If full business cycles are aken ino accoun, scenarios wih higher shor-erm ineres raes are incorporaed, as well as srong Exchange rae volailiy, hus increasing cos of deb. 6 I s worh menioning ha in Colombia, here are wo ypes of domesically raded bonds: i) TES B bonds indexed o real value unis (UVR for is acronym in Spanish) where par value is expressed in real erms, and ii) TES indexed o CPI where ineress are indexed o inflaion. 20

21 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I Benchmark Porfolio - Definiions Wih he aim of esablishing ime enduring public deb policies, goal indicaors are inroduced. Four main indicaors are defined as follows: I. Foreign currency. This indicaor deermines he opimal issuace level of foreign currency denominaed deb and is resuling effec on he ousanding deb balance. The indicaor is fundamenal when assessing CNG oal revenue under a relaive deb cos oulook and under an asses and liabiliies managemen view of he FB. II. Mauriy. This indicaor defines he differen ideal ime horizons on which deb is issued 7. III. Ineres Rae. This indicaor represens he disribuion of he deb porfolio beween fixed rae and variable rae issues. IV. Indexing. This indicaor deermines he disribuion of he deb porfolio differen issues indexed o, mainly domesic macroeconomic variables. The mos common among hem is CPI indexing. These indicaors lay guidelines for he ideal srucure of deb porfolios in erms of a risk-benefi equilibrium. Oher desirable benchmark porfolio characerisics include consisency wih governmen financing sraegies and long-erm susainabiliy, offering insigh on sound deb managemen. These indicaors allow he manager o monior he achievemen of he deb managemen sraegy goals. Srucural differences beween he curren deb porfolio and he benchmark porfolio indicae how successful deb managers are in replicaing he sraegy; i.e., he desired deb porfoio composiion. In creaing he benchmark porfolio, i is key for he crieria used o be neural o curren marke condiions. I is cenral ha crierion does no reflec any paricular senimen on macroeconomic or marke variables from he governmen or hose involved in he deb managemen process. In fac, he benchmark porfolio could be exremely harmful, if no specified and implemened carefully (Wheeler, 2004). When designing benchmark porfolios, or specifying and implemening deb issuance sraegy, i is also imporan o acknowledge ha deb s behavior responds differenly o a variey of economic shocks. Esablishing wheher a counry is prone o supply or demand shocks ends o be difficul, bu i is known ha negaive shocks on demand rigger falls in prices and economic downurns. Wih falling prices, inflaion-indexed deb-servicing coss would srenghen he governmen s fiscal sance agains Governmen income drops and surges in public expendiure demand. 7 Concerning bonds and vanilla insrumens, mauriies depend on facors like he desinaion marke, and reflec he governmen s preference in regard o where in he yield curve liquidiy should be provided. As for ailored insrumens like bilaeral deb, finding mauriies ha sui a paricular sraegy is harder, as i is implemening i. 21

22 Minisry of Finance and Public Credi In his manner, a hedge for deb-servicing coss agains negaive supply shocks (characerized by falls in gross produc and rising prices) can be achieved by indexing fixed-rae deb. These price indexed fixed-rae insrumens are counercyclical by naure, meaning hey urn ou o be less cosly in economic crisis scenarios when ax revenue drops (Togo, 2007). As i was explained before, he deailed definiion of goal indicaors, address he macroeconomic and fiscal environmen and he developmen of financial markes as well. The recogniion of needed indicaors is unique o each counry, and each one should idenify wha variables are relevan for is economy and design benchmark porfolios ha answer o he behavior of hese variables, hus achieving sound deb managemen sraegies. This book aims o address his analysis for he Colombian economy Oher ools for deb managemen Hedging insrumens The implemenaion of derivaive ransacions, paricularly currency and ineres rae swaps, is necessary for he MTDS o achieve is objecives. Deb porfolio currency composiion is managed by rebalancing ousanding deb, ransforming i wih currency and ineres rae swaps. The implemenaion of derivaive insrumens makes i possible o draw a clear disincion beween issuance sraegy and risk managemen. If a chosen sraegy incurs in hedging coss, hen combining long-erm bond issues and Cross Currency Swaps (CCS) minimizes marke and rollover risks when increasing shor-erm deb is desired. I also conribues o keeping a sable and predicable issuance sraegy, his being cenral for he Naional Governmen (a crucial agen in he local marke) Inegraion of he MTDS wih macroeconomic policy Defining deb managemen policy and deb sraegies are necessary bu no sufficien for a governmen o have an overall sound managemen of he Naion s liabiliies. On he conrary, policies adoped have o guaranee coherence beween public deb managemen and he general macroeconomic background. In consequence, undersanding he links and coordinaion mechanisms beween he wo is essenial, so ha he effecs of deb managemen sraegies and oher macroeconomic policies are amplified ino he overall performance of he economy (See Figure 2). 8 Denmark s governmen has succesfully implemened CCS for heir deb managemen sraegy for nearly hiry years. These swaps provide he governmen wih deb managemen flexibiliy, drawing a clear line ha separaes issuance policy from ineres rae risk managemen. As a resul, he main arge of deb issuance policy is o creae high liquidiy for ousanding deb, as well as a broad se of insrumens available for invesors and low financing risks for he governmen (Danmarks Naionalbank, 2010). 22

23 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I Figure 2. Links beween MTDS and he macroeconomic policy Cos-Risk Analysis Macroeconomic and marke limiaions Informaion on coss and risks Coherence/ limiaions Marke deph iniciaives Macroeconomic framework/ Deb susainabiliy Informaion on coss and risks Deb Sraegy Demand limiaions/pricing facors Financing sources/ marke developmen Budge forecas Convenien deb insrumen composiion Marke developmen facors Source: IMF e al Financing Plan In developing a deb sraegy, differen marke, governmen and privae agen ensions and incenives are o be kep ino accoun, given heir incidence on decision making. The goal is o achieve policies ha are neural o all ineress and lead o overall soundness of deb managemen. For example, fiscal auhoriies are in charge of managing he Naion s deb, in which case hey prefer o keep he deb-servicing coss a a low level under he principle of creaing fiscal room for oher purposes in he shor-erm. However, doing so would increase fuure deb-servicing cos volailiy, forcing he governmen o cu expendiure or raise axes. Oher scenarios may also raise concern regarding ensions beween deb managers and economic policy. For insance, a governmen wih high fiscal deficis and a high deb-o-gdp raio may wan o reduce deb-servicing cos volailiy by increasing he amoun of fixed ineres rae insrumens wihin he porfolio. Alernaively, he governmen could seek o reduce he burden of deb-servicing by issuing shor erm deb, provided heir belief of low deb rollover risk and coss (Wheeler, 2004). 23

24 Minisry of Finance and Public Credi Anoher cause for concern is compaibiliy of deb managemen policy wih moneary policy. The main goal of moneary auhoriies is o achieve price sabiliy 9, bu when hey also play he role of deb managers some conflics of ineres may rise. They may be inclined o keep ineres raes low so ha deb-servicing coss are kep low as well, wih no regard for inflaionary risks. Conversely, moneary auhoriies may find i convenien o issue CPI index-linked deb o heighen is credibiliy, bu simulaneously inensify deb-servicing cos volailiy (Togo, 2007). Moneary policy regimes, he insrumens used by he auhoriies, and he auhoriy s credibiliy, all affec he deb managemen policy. In his sense, he MTDS conribues o improving credibiliy and reduce counry risk premiums due o inflaion. In fac, credibiliy could be considered relevan for he definiion of deb sraegies, since i somehow affecs inernal deb cos for boh shor and long-erm issues. On he conrary, he absence of credible moneary policy leads o high inflaion risk premiums and makes long-erm mauriy deb excessively expensive. Serilizaion acions underaken o reduce excessive liquidiy originaed by foreign capial flows, have led some cenral banks o consider issuing asses and repo agreemens hemselves. Furher enlargemen of quasi-fiscal deficis and he possibiliy of replacing cenral bank deb for Cenral Governmen deb are some conceps ha mus be aken ino accoun when formulaing MTDS (IMF e al., 2009). Similarly, careful examinaion of he governmen s exchange rae policy and foreign currency benchmarks is advisable. Foreign currency denominaed deb issuing requires a deailed knowledge of Balance of Paymens rends and herefore coordinaion wih exchange rae policy. For example, exchange rae uprends or high volailiy migh raise exernal deb coss and lead deb-service paymens o surge. A more naural way of including exchange rae and oher macroeconomic consideraions ino he opimal deb sraegy design consiss in incorporaing he governmen s asses dynamic ino he deb analysis Asse and Liabiliy Managemen approach One of he approaches for deb sraegy design is he Asse and Liabiliy Managemen (ALM) model. I offers a coheren framework for idenifying and managing he deb porfolio s underlying risks. I also sheds ligh on he linkage beween fiscal policy, moneary policy and deb managemen. The ALM suggess ha FB volailiy risk appears when here is no conformiy beween financial characerisics of asses and liabiliies, and herefore risk is minimized when income srucures mach hose of expenses. As menioned by Wheeler (2004), defining benchmark porfolios ha reduce he risk of governmen balance shee mismaches; considering he characerisics of cash flows mean for servicing deb is viable. In counries where expors represen a large percenage of GDP (as is he case of oil producing counries), he governmen s income is largely denominaed in USD as well. In ha even, exernal deb issued in foreign currency can be serviced wih revenues wih he same denominaion, hus balancing he deb composiion o some degree. In any case, i is common for ax revenue in domesic currency o ake up a larger percenage of Governmen income, and are 9 For his purpose, inflaion argeing, ineres raes, moneary aggregaes and exchange raes are managed wih open marke operaions or regulaory conrols like provisioning requiremens. 10 Obligaions arising from issued deb are classified under Liabiliies, while he funds raised hrough deb serve specific expenses in every fiscal erm. 24

25 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I grealy used for servicing crediors and deb. For his reason, he beer cos-risk alernaive is finding exernal deb currency composiions ha are highly correlaed wih local currency. This process usually requires finding an exernal deb porfolio currency composiion wih he lowes possible variance relaive o he local currency. This answers o he fac ha in many counries, ax revenue (he bigges source for Governmen deb-servicing funds) is denominaed in local currency. The ALM approach also suggess ha deb should be srucured in a way ha deb-servicing insallmens decrease when facing primary defici and increase wih surpluses. This counercyclical srucuring of deb helps o offse risks derived from surges in ax raes, cus in expendiure or deb defauls during financial crises. When deb is srucured o mach fiscal asses, deb managemen serves as an insrumen for minimizing budge volailiy and fiscal policy acs as an economic sabilizer for he counry. The mehod idenifies which deb insrumens have suiable characerisics for he Governmen o achieve is purposes of reinforcing he FB. Paricularly, deb wih paymens condiioned o he accomplishmen of primary surpluses could srenghen he FB agains negaive shocks o fiscal asses. A clear example of he above is GDP-indexed deb. Wih gross income acing as a proxy for ax revenue, managers insure ha deb service insallmens follow he Naion s income dynamics. Anoher aspec ha could lead o mismaches beween he income and expendiure sides of he Governmen s balance shee is he financial effec of risk premiums. For insance, in emerging economies, crises elevae risk aversion and are associaed wih higher risk premiums, hus leading o procyclicaliy of deb and is coss. These rais of he risk premium are closely relaed o he cyclical properies of foreign capial flows. The implicaions of procyclical risk premiums and capial flows on he deb managing make i appropriae o keep financing needs conrolled during crises. Given he difficuly of forecasing crises, i is clear ha issuing long-erm deb and minimizing concenraion of mauriies in a given fiscal erm is advisable from a risk managemen perspecive. Marke agens in charge of formulaing governmen policy mus have clariy on wha are he objecives and he real exen of heir chosen deb sraegy. As such, deb managers should no expec for he sole implemenaion of a deb sraegy o lead o he accomplishmen of fiscal goals, albei he relaion of he wo Developmen and efficiency of domesic markes The disjuncive for economic auhoriies is ofen beween raising funds domesically or finding financing in foreign markes, and is enwined wih how deep and developed inernal public deb markes are. Governmens inroduce a series of policies and regulaions for consolidaing primary and secondary markes for inernal deb and for promoing adequae condiions for he Naion s funding in capial markes. I focuses is effors in providing a smooh funcioning of secondary markes under differen marke condiions and herefore ries o carry hrough predicable and ransparen primary marke operaions. 25

26 Minisry of Finance and Public Credi Provided ha he deb manager s purpose is o finance is budge a he lowes cos-risk raio, having a deep secondary marke becomes relevan 11. Marke deph also resuls in public financing sraegies and macroeconomic policies ha do no inerfere wih each oher. Moreover, deph improves financial marke dynamics, and amplifies liquidiy while giving relevance o public deb and enabling he idenificaion of a robus and liquid yield curve. Deb managemen sraegy provides a se of ools for analyzing and idenifying challenges faced when addressing marke deph issues. In fac, proper medium-erm deb managemen sraegies may even deepen he marke for securiized public deb by making i ransparen and predicable, bolsering he developmen and implemenaion of new deb based insrumens Colombian case sudy 2.1. Objecives of he MTDS In recen years, muliple facors ook he Colombian economy hrough srucural changes ha moivaed a review and updae of curren deb managemen guidelines (proposed during he nineeen nineies and las revised a he beginning of he las decade). The challenge of reviewing he sraegy guidelines is underaken by he Naional Governmen, led by he Minisry of Finance and Public Credi (MHCP), and falls ino he specific asks se by he Naional Developmen Plan (PND), Prosperiy for All. Accordingly, deb policy draws he rules for opimal managemen of he Naion s asses and risks as well as for he efficien adminisraion of he budge. In accordance wih aricle 334 of Colombia s Consiuion, he Sae is in charge giving direcion o he Naion s economy, assuring fiscal susainabiliy, necessary in a Social Welfare Sae. As such, he MHCP includes he MTDS ino is asks. The Minisry s sraegy is one of he drivers ha lead o economic growh. I makes he Naion s deb susainable by carrying a pruden managemen wih fewer budgeary burdens in each fiscal erm. This ouline is vial for a counry like Colombia, where is FB faces srucural risks associaed wih he size of he deb, ne exernal income volailiy, Terms of Trade volailiy and a dependency on paricular producive secors or oher commodiy producing economies. Deb managers migh make wrong decisions on new issuing if here is no framework or guideline o do so. Therefore, if clear objecives for deb managemen are no se, here is a chance of facing marke volailiy and uncerainy in finding funding sources 13. For he Minisry o develop a MTDS, i firs defines guidelines for sound public deb managemen and se goals for inegral risk managemen. 11 Invesors would raher have governmen bonds wih easily observable prices in a liquid marke. This could reflec securiy finding coss ha make non-sandardized deb insrumens more expensive (Leong, 1999). 12 Incorporaing new nodes o he yield curve is possible when here is cerainy of medium-erm financing susaniabiliy hrough coninuous issuing. 13 By designing pruden deb managemen sraegy wih clear end goals, credi risk premiums, liquidiy, and ineres rae premiums on he Naion s ousanding deb are reduced 26

27 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I 2.2. Background For more han weny years, he governmen has recognized he imporance of adequae managemen of he Naion s deb porfolio and is impac on fiscal and economic sabiliy. In 1993, a process of improvemen of he ools wih which he Naion managed deb began, wih he enacmen of Decree In fac, hese regulaory breakhroughs se Colombia as a pioneer and an example on deb managemen o he inernaional communiy 15. In 1997, he designing sage of he Liabiliy Managemen program ends and so he implemenaion sage begins. The projec; led by he General Direcorae of Public Credi (DGCP) in hand wih consulans from Salomon Brohers, aimed o develop a benchmark porfolio for exernal deb. As a resul, he firs in-house Risk Workgroup was creaed wihin he Minisry of Finance, as well as a Public Deb Advisor Commiee 16 in charge of analyzing and defining exernal and inernal deb policy. In he process, risk guidelines were proposed, and he benchmark porfolio under which public deb would be managed for he following years along wih exernal deb managemen sraegy were pu forward. In 1998, he Primary dealers program was launched by he MHCP and he BR, boosing he developmen of domesic public deb markes. In 1999, he financial risk valuaion mehodology for public deb was esablished. I was named Deb-servicing a Risk SDeR for is acronym in Spanish 17, and i sill serves as a ool for analyzing and supporing he Naion s (and oher eniies) liabiliy managemen. In 2001, benchmark deb porfolios were revised and updaed, hus iniiaing a case sudy on Colombian deb, carried ou wih he aid of he IMF and he WB. The purpose of his sudy was o fashion a new documen where public deb managemen guidelines were delivered. In consequence, he new valid goal indicaors for designing deb sraegy are as follows: Mauriy Profiles: hrough a proper mauriy profile design, risks of high concenraion of annual amorizaions are conrolled. Curren policy considers ha an ideal annual mauriy profile is 10% o 15% of he oal ousanding deb. The average life of he porfolio should be of 5 or more years. Ineres Raes: his indicaor seeks o give direcion on how o conrol ineres rae volailiy, esablishing a limi o variable ineres rae issued deb. This should no overpass 30% of he ousanding deb. 14 This Decree regulaes public credi operaions and deb porfolio managemen operaions, as well as deb issuing. 15 This recogniion is given in he WB and IMF 2003 publicaion: Guidelines for Public Deb Managemen Accompanying Documen and Seleced Case Sudies : In i, Colombia is presened as a success case sudy for he sound managing of deb. 16 The Commiee is composed by he Miniser of Finance and Public Credi, he Vice miniser of Finance and Public Credi, he Direcor General of Public Credi and Naional Treasury, he Cenral Bank s Depuy Manager for Moneary Affairs and Inernaional Reserves, plus advising guess relevan for specific subjecs. The Cenral Bank s presence is due o conjoined managemen of he Naion s Asses and Liabiliies by he wo eniies. 17 The valuaion mehodology was developed by he DGCP and i is very similar o he BaR, Budge a Risk : and he CaR, Cos a Risk. I consiss in esimaing he presen value of he highes expeced surge in deb-servicing coss, given a confidence level and ime horizons of one, hree and en years. 27

28 Minisry of Finance and Public Credi Currency: his indicaor is mean o sugges how o conrol exchange rae volailiy risk. According o i, 83% of he Naional Governmen s exernal deb porfolio should be denominaed in USD, 13% in Euro or oher European currency, and 4% in Yen. Laer, in 2003, risk hedging credi operaions were regulaed wih he enacmen of Decree In 2004, he governmen consuled wih he Colombian Agency for Inernaional Cooperaion and Los Andes Universiy, resuling in he documen Revisión y desarrollo de benchmark de deuda inerna (Review and developmen of an inernal deb benchmark). The consulancy had he aim of proposing a resrucuring of he Naion s deb porfolio composiion favoring inernal deb issuing, following WB recommendaions and adhering o he Colombian Fiscal Srenghening Program. Despie he sudy s recommendaions, he adopion of an inernal deb benchmark porfolio was never subsaniaed as policy. In 2010, he Governmen enaced he Naional Developmen Plan (NDP) Prosperiy for All, wih he purpose of pushing he Naion s five producive engines forward; hese are housing, infrasrucure, agriculure, echnologic innovaion and he mining and energy secor. These engines are mean o drive he economy for he nex four years. In his regard, he MTDS aims o opimize public finance managemen in a highly sophisicaed marke, so ha he engines run. Colombia s deb porfolio of he early nineeen nineies was highly concenraed in domesic deb securiies wih limied liquidiy 18. Noneheless, his srucure is now shifing owards a local currency sandardized bond porfolio, issued boh inernally and exernally, keeping a close look o marke and rolling over risks and cos reducion. To move o a differen porfolio srucure, issue policy, Liabiliy Managemen operaions, hedges and deb rades, among oher sraegies, have aken place. Deb managemen guidelines of he nineies were revised a he urn of he cenury, giving birh o new sandards. These new guidelines gave deb a new framework of susainabiliy, reduced fiscal risk and beer deb porfolio risk managemen, all of which remain valid o dae. In spie of his, he Colombian economy has come across muliple facors ha srucurally changed i in recen years, moivaing he Governmen o updae pas deb managemen mehodologies. Some of he aspecs worh menioning are he financial crisis he Naion wen hrough a he very end of las cenury, he esablishmen of a floaing exchange rae regime, he rapid accumulaion of inernaional reserves of he pas few years, price sabiliy hanks o he BR s inflaion argeing, he deepening of Colombia s financial markes along wih susained economic growh driven by he NPD s rain engines (see Figure 3). Oher exernal aspecs somehow affeced he economy as well. Some of hem were inernaional financial crises, along wih elevaed marke volailiy and a surge in oil prices. 18 The Primary Dealer Program gave liquidiy o local secondary markes of Colombian deb insrumens. This deb issuing program offers clear srucuring condiions o invesors. 28

29 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I Figure 3. Inernaional Reserves (USD Mln), Inflaion YoY and Exchange rae Source: Banco de la República, DANE July 31 s, Before coninuing wih he definiion of new guidelines, some of he curren valid sraegy goals are revised, such as: Formally defining a desired composiion for he deb porfolio, subjec o currency exchange risk. Simulaneously he marke where bonds are issued (inernal or exernal deb) has o be disinguished from is currency denominaion, paricularly when direc exernal deb can be issued and derivaives can be raded. Defining a clear goal for he deb porfolio s composiion in erms of inflaion indexed securiies. Defining a mauriy profile for he deb porfolio, so ha i is smooh and concenraions of mauriies make refinancing risk olerable and curren financing viable. Idenifying he need for financing from differen sources and developing benchmark yield curves ha deepen domesic money markes and derivaive markes. The access o domesic and inernaional capial markes by eniies of subnaional order seeking funding should also be sough afer. As menioned, he behavior of financial variables in he FB may cause fiscal shocks. Because of his, evaluaing he naure of cash flows generaed by he Naion s asses and liabiliies and heir suscepibiliy o ineres rae changes or exchange rae flucuaions is key, as 29

30 Minisry of Finance and Public Credi well as vulnerabiliies o changes in Terms of Trade. The former direcly implies he need for classifying asses and liabiliies according o risk exposures, so ha full hedges can be designed by resrucuring he FB composiion and oher risks and oher risks can be managed. All of hese noions formed he design guidelines for deb managemen sraegies of he pas decades, conceps ha will be deal in more deail in Secion Medium-Term Deb Managemen Sraegy 3.1. Formulaion of he MTDS The review of he CNG s deb sraegy is a necessiy for he curren Adminisraion, in he sense ha i leads o defining new guidelines for global deb porfolio srucures, ending o he adequae financing of budge appropriaions, o diminishing medium-erm deb coss under sensible risk exposures and conribues o he developmen of he local capial marke. (PND, Aricle 257). According o his, he characerisics ha define he MTDS are described nex Objecives The main purpose for conracing deb is o opporunely fund he Naional General Budge (NGB). As such, he design of a MTDS is subjec o: Finance budge needs in every fiscal erm. Minimize medium-erm cos of deb wih reasonable risk exposures. Give deph o domesic capial markes Guidelines Along wih he aforemenioned objecives, addiional elemens srenghen and broaden he MTDS reach. These are: Following explici deb susainabiliy and refinancing crieria. Clearly deermining he objecives for MTDS, and periodically reviewing hem in order o guaranee coherence wih oher public policies. 30

31 MINISTRY OF FINANCE AND PUBLIC CREDIT Medium-Term Deb Managemen Sraegy PART I Esablishing ransparence and informaion disclosure procedures ha guaranee he adequae fulfillmen of responsibiliies and accounabiliy Public deb managemen reach The CNG deb porfolios are composed by inernal and exernal deb, and credi lines wih mulilaeral and bilaeral banking insiuions. These liabiliies are he subjec of managemen for which he MTDS is creaed Public deb managemen responsibiliies for he Naion Deb managemen emphasizes on he following iems: Defining public deb policy ha makes medium-erm deb susainable and fills he deb issue limis approved by Congress. Issuing public deb securiies and negoiaing credi, guaraneeing fund availabiliy in accordance wih curren regulaion. Conracing new efficien public credi operaions ha enable he CNG o manage financial risk and help mainain or improve he deb porfolio mauriy profile. Recommending liabiliy managemen operaions ha comply wih he designed MTDS and allow proper and imely managemen of financial risks of he deb porfolio, and ha cause low fiscal impac on he Naion s Budge. Managing he CNG deb porfolio s risks, following he MTDS. Diversifying funding sources while minimizing currency risk, ineres rae risk and deb refinancing risk. Disclosing public deb policy informaion and economic environmen condiions of domesic markes o invesors. Regisering and following hrough wih he Naion s ransacions and wih Sae Eniy deb warraned by he Naion Srucure of he Governmen of Colombia as deb manager The MHCP, hrough he DGCPTN, is responsible for efficienly and opimally managing NGB liquid asses and adequaely handling public deb. In is role as deb manager, he DGCPTN esablishes public deb policy, prioriizing susainabiliy and adequae balancing 31