Formulation and Implementation of Annual Debt Management Strategies in Turkey

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1 Formulation and Implementation of Annual Debt Management Strategies in Turkey M. Coşkun CANGÖZ Acting Director General of Public Finance Turkish Treasury

2 Annual Financing Program (Billion YTL) 2006 Prog I. Total Debt Service 168,4 Principal 126,2 Interest 42,2 Domestic Debt Service 144,5 Principal 108,8 Interest 35,7 External Debt Service 23,8 Principal 17,4 Interest 6,4 II. Financing Items 168,4 Non-Debt Resources 40,2 Primary Surplus 30,2 Privatization 7,0 Collections from On-lent Loans 3,1 Change in Bank Account 0,0 Total Borrowing 128,1 External Borrowing 16,7 Domestic Borrowing 111,4 Memo Item: Roll-over ratio for Domestic Borrowing 77,1% 1

3 Principles and Constraints Regulation on the Principles and Procedures of Coordination and Execution of Debt and Risk Management (Published in the Official Gazette dated September 1, 2002 and no ) Principles Article 4- The execution of public debt and risk management shall be based on the following principles: a) To follow a sustainable, transparent and accountable debt management policy that conforms to monetary and fiscal policies, in line with macroeconomic equilibriums, b) To address financing requirements with the lowest possible cost in the medium and long term, taking into account the risk level determined according to domestic and international market conditions. 2

4 Annual Financing Program (Billion YTL) I. Total Debt Service Principal Interest Lowest Possible Cost II. Financing Items Non-Debt Resources Primary Surplus Privatization Collections from On-lent Loans Change in Bank Account Fiscal Policy Macroeconomic and political performance Debt Management Policy Monetary policy Sustainability Total Borrowing External Borrowing Domestic Borrowing Memo Item: Roll-over ratio for Domestic Borrowing Accountability & Transparency Prudent Risk Level Market sentiment 3

5 Policy Objectives Monetary Policy -Price Stability - Financial Stability Reports - Analysis of macroeconomic and fiscal policies - Monitoring financial markets - Caring the Payment System - Credit facility by open market operations - Credit facility for extra ordinary situations Debt Management Policy - Meeting the Financing Requirement - Minimum cost with a prudent level of risk - Deepening the market - Widening the investor base - Setting a medium & long term financial horizon - Benchmark securities Fiscal Policy - Efficient use of public funds for the provision of social goods and services - Budget Document - Tax and transfer policies - Deficit financing -Setting the major macroeconomic targets 4

6 Strategy Formulation Fiscal Risk Change in FX Rates Change in Interest Rates Bank Deposit Financial Assets On-Lent Loans Undertaken Guarantees External Debt Domestic Debt Market Appetite / Demand Contingent Liabilities Loan Guarantees Performance Guarantees Banking Sector Guarantees Economic and Financial Conditions Legal Conditions 5

7 Strategy Formulation... (cont.) Cost at Risk Aims to identify probable limits within which the costs of debt may fluctuate (the degree of market risk) for a given strategy. Serves as a tool for comparison of alternative borrowing strategies in terms of expected costs and risks. 6

8 Strategy Formulation... (cont.) Simplicity (clear communication of the medium/long-term objectives of debt management) Applicability (should fit the market environment) Robustness (should not rely on too strict assumptions) Credibility (should have a good track record of performance) 7

9 Strategy Formulation... (cont.) Deterministic Simulation Model Cost of any borrowing strategies under the base scenario Borrowing Strategies Module Measurement of the costs of borrowing strategies under alternative scenarios including the base scenario. Cost Risk Scenario Cost Risk Base Scenario Base Scenario Time Risk: Cost differences between the alternative scenarios and the base scenario Time 8

10 Strategy Formulation... (cont.) Efficient Frontier Cost at Risk Cost Risk Expected Cost Relative Cost at Risk Absolute Cost at Risk 9

11 Strategy Formulation... (cont.) Fundamentals Public Sector Primary Balance (% of GNP) Public Sector Borrowing Requirement (% of GNP) (%) P (0.7) (1) 20 (2) 2006 (1) Estimation of realization by end of year (2) Program (%) Debt Service- Interest Expenditures / GNP Central Bank Reserves (Billion USD) (1) J M M J 02 S N J M M J 03 S N J M M J 04 S N J M M J S N J M 06 (Billion YTL) (1) Interest Expenditures (1) Program. 10

12 Strategy Formulation... (cont.) Market Structure Secondary Market Portfolio Preference of Financial Sector (% ) V M io Y T L Volume Liquidity in the Market Interest Rate (1) (1) As of March 31, 2006 Total YTL Portfolio Total Forex Portfolio Porfolio refers to deposits, repos, government bonds, investment funds Investor Base Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan- Jul- Jan-06 Jul-06 Mio YTL ,2 13,2 12,0 12,7 11,4 10,5 11, M 06 N 06 M 06 H 06 T 06 14,0 12,0 10,0 8,0 6,0 4,0 2,0 0,0 (%) Domestic Debt Stock Foreign Investors 11

13 Strategy Formulation... (cont.) The fulfillment of financing requirements at the lowest possible cost in the medium and long term in accordance with the levels of risk determined in consideration of domestic and external market conditions and cost factors. Strategic Benchmarks Raise funds mainly in TRL by issuing zero coupon and couponed bonds Use fixed rate instruments as the major source of borrowing and limit issuance of Floating Rate Notes Increase the average maturity of domestic borrowing, considering the market conditions, by using 5 year-bonds Have a strong cash reserve in Central Bank Full redemption of FX indexed local government bonds Max. 80 % roll-over of FX denominated local government bonds 12

14 Strategy Implementation 2006 Borrowing Strategy Improve the predictability by announcing monthly auction calendar Introduction of benchmark borrowing Increase the liquidity of the securities by reducing the number of issuances and re-openings Monthly issuance of YTL denominated fixed and floating rate semi-annual couponed securities Introduce buy-back auctions Introduce inflation indexed bonds Close coordination with market participants and primary dealers 13

15 Strategy Implementation (cont.) Interest Rates on Issuance (%) Maturity on Issuance (Month) J F M A M J J A S O N D J 06 F M A M J J A J F M A M J J A S O N D J 06 F M A M J J A Composition of Domestic Borrowing Balance of Treasury Account % Total Borrowing Fixed Rate Floating Rate Total Borrowing TRL Borrowing Fixed Float FX Borrowing Fixed Float Jan Jul ,1 28, ,1 70,3 18,8 10,9 0,8 10,1 Jan Jul ,7 32, ,7 67,7 31,0 1,3 0,0 1,3 180% 160% 140% 120% 100% 80% 60% Jan Feb Mar Apr May Jun Jul Aug Deposit / Monthly Debt Service Deposit / Monthly Domestic Debt Service 14

16 Strategy Implementation (cont.) Yield Curve Construction Interest Rate (%) Interest Rate (%) Days Days Interest Rate (%) Interest Rate (%) Days Days 15

17 Strategy Implementation (cont.) Domestic Debt Stock by Instruments July FX Indexed 20% FX 14% FX Indexed 1% FX 16% YTL 64% YTL 85% YTL FX FX Indexed YTL FX FX Indexed 16

18 Strategy Implementation (cont.) Debt Service- Interest Expenditures / GNP (1) Public Net Debt Stock / GNP (%) (%) 90,4 55, ,4 78, ,8 70,3 30,5 38,2 63,4 25, ,3 14, TL Foreign Exchange 17

19 Strategy Implementation (cont.) Increasing Endurance for Vulnerabilities (%) FX Denom / FX Indexed TL Floating TL Fixed 18

20 Strategy Implementation (cont.) Elasticity 10 % Real Depreciation/ Appreciation of TRL 300 bps Increase / Decrease in Real Interest Rates of TRL Borrowing 1 % Increase / Decrease in GNP Growth 1 % Increase / Decrease in Primary Surplus BASED ON STOCK COMPOSITION IN 2002 CHANGE IN DEBT STOCK / GNP BASED ON STOCK COMPOSITION IN 20 CHANGE IN DEBT STOCK / GNP + / Per cent + / Per cent + / Per cent + / Per cent + / - 0,8 Per cent + / - 0,6 Per cent + / Per cent + / Per cent 19

21 Strategy Revision Central Bank Interest Rates (%) TRL/$ Rates Jan- Mar- May- Jul- Sep- Nov- Jan-06 Mar-06 May-06 Jul-06 (% ) FED Rates EMBI + Index 6,0 (bp) 450 5, ,0 3, , , A 04 O Ş M N M H T A E E E K A O 06 Ş 06 M 06 EMBI+ EMBI+ Türkiye - N 06 M 06 H 06 T 06 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan- Mar- May- Jul- Sep- Nov- Jan-06 Mar-06 May-06 Jul-06 %

22 Strategy Revision Continue announcement of monthly auction calendar Reduce maturity Shorten the maturity of 5-year floating rate semi-annual coupon securities Suspend monthly issuance of 5-year YTL denominated fixed semi-annual coupon securities Increase the number of zero coupon bonds up to one year maturity Reduce roll over ratio Introduce domestic bond exchange auctions Postpone Introduction of inflation indexed bonds Increase coordination with market participants and primary dealers Introduce PD expectations survey Change tax regime of government borrowing instruments 21

23 Managing Fiscal Risks Guarantee Limit Limit for On-lent loans Risk Account - A reserve for unexpected payments Guarantee Fee On-lent Fee Partial Guarantee 22

24 Managing Fiscal Risks (cont.) Credit Risk Model Quantitative spreadsheet models where the behaviors of guaranteed institutions are simulated under different macroeconomic conditions Credit Scoring Model Model that forecasts default one period ahead through a linear weighted combination of observable explanatory variables 23

25 Managing Fiscal Risks (cont.) Probability of Loss 1 Liability EL 99% MPL ML Possible Loss, x EL: Expected (Average) Loss MPL: Maximum Probable Loss ML: Maximum Loss EL portfolio =ΣEL i MPLportfolio ΣMPLi MPLCi<=MPLi 24

26 Managing Fiscal Risks (cont.) Credit Risk Model Macro Scenarios Electricity Model... Model Municipality Model Portfolio Module GDP Net Income Loss Distribution Year Reserves Year Recovery Distribution Inflation Exchange Rates Year Debt Payment Year Expected Loss Max Probable Loss $27 $156 25

27 Managing Fiscal Risks (cont.) Credit Scoring model Statistical Tests Z-score equation Risk Account Financial Ratios Company Default Information Probability of Default Expected Loss Guarantee Fee Past Collection Performance 26

28 Comprehensive Debt Management Approach Prudent Macroeconomic Policies and Strong Fundamentals Strong Debt Management Capacity Accountability Transparency Increased Financial Stability Foreseeable Debt Management Policies Improved Borrowing Conditions Increased Market Confidence Broader Investor Base 27

29 Thank You 28

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