The ongoing sovereign debt crisis underlines the need to broaden the scope of debt management co-ordination

Transcription

1 Evidence from previous post-crisis debt reduction episodes suggests that the advanced economies will on an average take six to eight years to reduce their debt to the pre-crisis levels. Flickr/withassociates The ongoing sovereign debt crisis underlines the need to broaden the scope of debt management co-ordination By Arindam Roy, Head, Debt Management Section, Special Advisory Services Division (SASD), Commonwealth Secretariat The contours of sovereign debt management have changed significantly, requiring a strategic framework with closer co-ordination to deal with the inter-linkages of associated risks between the balance sheets of the sovereign, financial, corporate and household sectors. The global financial and economic crises have brought public debt management to the centre of macroeconomic policy. The dynamic of sovereign debt problems in advanced economies carries potential for spillover effects and consequent policy challenges for many indebted developing countries, including those in the Commonwealth. It has widened the canvas for future management of sovereign debt liabilities, and bears important lessons for developing economies. Surging debt in advanced economies and the sovereign debt crisis Following the global financial crisis which erupted in 2008, gross public debt in the advanced economies increased by nearly 30 per cent of gross domestic product (GDP) due to unprecedented fiscal stimulus and financial support measures. Public debt in these economies now exceeds their national income and is projected to further increase to 107 per cent of GDP by 2015 (IMF, Fiscal Monitor, April 2011). In addition to the growing debt burden, these economies are saddled with a high proportion of the population in older age groups, increasing the pressure on unfunded liabilities relating to healthcare and pension spending. With persistent and growing fiscal deterioration in some countries fuelled by global macroeconomic imbalances, a boom-bust cycle in private sector debt in many advanced economies led to a migration of risk during the financial crisis from the financial and sometimes corporate sectors to the sovereign balance sheet. This has significantly escalated concerns about the sustainability of their sovereign debt in the medium term. Evidence from previous post-crisis debt reduction episodes suggests that the advanced economies will, on average, take six to eight years to reduce their debt to the pre-crisis levels (IMF 2010). This implies that looking ahead in the medium term, the world will have to live with an era of high public debt. The surge in government borrowing requirements during the crisis period in many advanced economies has made it necessary for public debt to be managed through active co-ordination with macroeconomic policies, including support through monetary accommodation. Despite the advanced economies having in place a deep and liquid government debt market with stable investor base, during the crisis 72 l Commonwealth Ministers Reference Book 2011

2 period most of these economies chose to adapt and innovate their issuance architecture to raise resources from the primary market. Some of the countries revisited their strategy by skewing their borrowing at very short maturities. Despite periods of volatility in the government securities market in both the primary and secondary market segments, and instances of auctioning failure in some countries, most advanced economies were successful in meeting their public debt management objectives under challenging market and fiscal conditions. Most of the advanced economies with a significant share of ultra long-term bonds in their portfolio have proved to be relatively resilient in meeting the borrowing targets. Overall, during the crisis period government bond markets in most economies remained broadly stable although recently pressures are mounting in some European countries. The task of public debt management, however, has become more challenging in some small economies within the Eurozone periphery countries, leading to crises in such countries as Greece, Ireland and Portugal, necessitating emergency loan packages from multilateral sources to avoid sovereign debt default. With growing investor concerns, the interest rates in these economies have hardened significantly, leading to a temporary halt in market borrowings. Since the end of 2009 through May 2011, yields on 10-year government bonds trebled by nearly 900 basis points in Greece and doubled by more than 500 basis points in Ireland and Portugal. In these economies, the dynamics of high fiscal deficit, the level of public debt, the short to medium maturing debt and the interest rate feedback through hardening cost of financing implied the likely failure of meeting the borrowing requirement including refinancing the debt service obligations. Deterioration in the indebtedness position have prompted downgrades unthinkable some time before for a few advanced economies from their highest quality AAA sovereign ratings. Renewed market concern about sovereign debt default has resulted from ongoing political uncertainty about the fiscal adjustment and structural reforms in the crisis-ridden countries, along with the stalemate on the bailout and resolution of the debt overhang in these Eurozone periphery economies. The high incidence of foreign investor holdings of local currency debt in some of these countries has resulted in significant cross-country exposure. This has added to policy challenges in the short term; the resolution of the debt problem through bailouts and possible haircuts for investors within the Eurozone economy has increased the potential for transmission of shocks from sovereigns to banks in the core Euro area. The crisis of market confidence is best reflected in the widening risk insurance on default provided to investors on such government securities. Credit default swap (CDS) spreads during 2011 have so far widened by 600 basis points for Greece and by points for Ireland and Portugal. Elevated level of CDS spreads within the Eurozone economy also suggest possible contagion to other Euro countries. Although greater bilateral and multilateral coordination measures have so far ensured avoiding a systemic disruption of the government securities market in these economies, given the large rollover of public sector debt coming due in 2011, some governments within the Euro area may face challenges raising needed finance, and consequently suffer debt problems, if there is any further erosion of investor confidence. Under extreme market conditions this could open the possibility of a spillover of such debt problems beyond the euro area to developing countries, through cross-border exposure and retrenchment of foreign capital flows. The indebtedness of developing countries The global events that unfolded in the advanced economies also took their toll on many developing countries. The worldwide economic slowdown prompted many developing countries to resort to fiscal stimulus measures. This paid dividends in terms of maintaining the growth momentum within the developing and emerging market economies (EMEs). This is the first time that developing countries as a group were better prepared to face a global economic crisis through adequate policy buffers built up in recent years. Despite this, as many as 50 developing countries, including some EMEs, had to resort to borrowing from various lending windows assembled by the IMF to help them tide over the crisis by providing temporary liquidity. With the fiscal expansion, much of the resilience in these countries, assiduously built up in recent years through sound macroeconomic policies, lower levels of debt and prudent debt management policies, has now been exhausted. As a group, the public debt of the developing and EMEs has remained moderately stable at 35.5 per cent of GDP, representing a 2 per cent increase in the debt level since the crisis. However, there are sharp differences across and within regions. Although the global crisis has not escalated the risks of sustainability of public external Economic Growth and Investment Commonwealth Ministers Reference Book 2011 l 73

3 debt for Highly Indebted Poor Country (HIPC) beneficiaries, a quarter of the 30 post-completionpoint HIPC countries which received comprehensive debt relief are still considered to be at high risk of debt distress. At the same time, a 2010 study from the IMF and World Bank covering 13 non-hipc countries suggest that two countries are in debt distress and nine countries (including five Commonwealth member states) are in high risk of debt distress. The global economic crisis saw as many as nine countries within the Commonwealth experiencing rises in their public debt level by more than 10 per cent of GDP. This reflects the significant vulnerability of the small island economies to external global shocks. Within the Commonwealth, 10 small state economies, mostly from the Caribbean region, had a public debt level exceeding 70 per cent of their national income in Further, debt levels fully exceeding national income indicate that debt consolidation measures are now urgent for these vulnerable economies. The overall indebtedness position of the Commonwealth developing countries suggests the need for immediate policy priority by national authorities to keep debt at sustainable levels and also managed prudently, given the large exposure to the national balance sheet. At the same time Commonwealth countries need to remain vigilant of the potential spillover impact on the global financial market resulting from the ongoing Eurozone debt crisis. Countries with significant reliance on external market borrowings will be especially at risk. At the same time, increasing inflation in developing countries through higher food and fuel prices may not only increase borrowing requirements but also add to future borrowing costs. Policy priorities for sovereign debt management in Commonwealth countries The global financial crisis bears important lessons for debt management in developing countries. While a number of new lessons relating to the links between sovereign debt management and the sectoral balance sheet of the economy as a whole have emerged as a prime consideration, many of the acknowledged sound practices relating to sovereign debt management have been reinforced. The contours of sovereign debt management have changed significantly. Closer macroeconomic management of the inter-linkages of associated risks between the sectoral balance sheets of the sovereign, financial, corporate and household sectors has become necessary. Appropriate macro prudential policy tools at a national level will be required to control excessive vulnerability within one sector, as also to manage the likelihood of such risks transmitting into other sectors, particularly on the sovereign balance sheet. When the risks are transferred to the government s finances, it will not only entail debt sustainability issues arising out of the increased liability but also debt management considerations for the financing of such liabilities, especially under uncertain market conditions. Institutionally, this will imply that management of government debt, fiscal policy, monetary policy and policy actions of other key regulatory agencies need to be closely co-ordinated within a strategic framework to preserve debt sustainability and financial stability. The recent blurring of policy measures between fiscal, debt and monetary policies stemming out of financial stability issues and fiscal need underscores the need to put in place an institutional mechanism to manage sovereign debt beyond the realm of government finances. Depending on the state of vulnerability, Commonwealth countries with public debt exceeding 60 per cent of GDP in Change in public debt during (% of GDP). Source: IMF Global Economic Outlook Database, April l Commonwealth Ministers Reference Book 2011

4 the scope of government debt sustainability should be reassessed under the multiple lenses of general government debt (which includes debt of sub-national and local governments), public sector debt (including state-owned enterprises, SOEs) and eventually national debt (which includes debt of the private sector entities). For developing countries including many Commonwealth countries with a significant public sector presence not only within the corporate but also the financial sector, the scale of contingent liabilities, both explicit and implicit, needs to be reassessed under stress test conditions to provide early estimates of the possible scale of future liabilities that may be assumed by the government through higher debt. In recent years, many developing countries have resorted to public-private partnerships (PPPs) for attracting private investment, thereby exposing the government to significant contingent liabilities. Appropriate risk management policies and procedures to deal with explicit contingent liabilities needs to be put in place to manage the issue of sovereign guarantees on borrowings by non-government entities, as well as performancerelated guarantees issued by the sovereign state as part of PPPs. At the same time, depending on the fiscal arrangements for the support provided to SOEs and the inherent financial strength of each entity, a risk-based policy framework for financial management of the entire public sector, particularly for SOE borrowings, could limit materialisation of implicit contingent liabilities as real liabilities for the government. In a similar vein, in countries where the private sector increasingly relies on external finance, appropriate institutional arrangements should be adopted to closely monitor the external debt liabilities of the private sector. Public debt management in many Commonwealth countries is still undertaken without a strategic framework based on detailed risk management considerations. As a starting point, it is therefore imperative that countries should undertake their future borrowing decisions within a medium-term debt management strategy framework that aims to minimise the long-term cost of government borrowings while limiting risk to acceptable quantified limits. Moreover, given that many governments engage in sizeable asset creation through lending operations associated with their borrowings, the liability management framework needs to be gradually expanded into an asset-liability management framework that would reflect its effective risk considerations. Expanding the management of government debt into an asset-liability framework would also make sense for those governments having significant financial assets and revenue earnings from the minerals and mining sector, the prices of which remain exposed to global market volatility. Sovereign debt management to be undertaken in a prudent risk management framework and embedded within strategic policy involves sophisticated analysis of the entire debt portfolio by a dedicated unit usually termed the middle office. However, in most Commonwealth countries, the role of the middle office is virtually absent within the existing institutional arrangement for public debt management. Although public debt management roles and responsibilities may be divided between the Ministry of Finance and the Central Bank, there is an urgent need to review the institutional arrangements and put in place a dedicated middle office unit, which drives the risk analysis functions shaping borrowing strategies and policy co-ordination. Recent events have demonstrated that countries where the local debt market was dominated by resident investors could better manage a crisis condition through its own domestic policies. Given that many Commonwealth countries are still grappling with the challenge of deepening their domestic debt market and have opened investment in government securities to foreign investors, countries need to closely monitor and manage the volume of foreign investment in these instruments, in tune with its external capital account management priorities. Moreover, countries should undertake further measures to expand their local currency debt market by diversifying its investor base, especially the institutional sector within the economy. This will not only avoid currency risk for public debt, but also limit its refinancing risk though extended maturities. Prudent public debt structure for a country is a necessary condition to avoid debt vulnerabilities and provide resilience to withstand unanticipated shocks, both domestic and external. It is essential that there is a renewed priority in developing countries to rebuild the fiscal space through appropriate macroeconomic policies to withstand any future shocks. Progress with fiscal consolidation and assurance of debt sustainability could be best achieved through credible fiscal rules based on cyclically-adjusted benchmarks and backed by fiscal responsibility and management legislations. This remains the only long-term solution to correct macroeconomic imbalances, thereby paving the way for indebted economies to grow out of debt. The existing high debt burden of many small state economies within the Commonwealth needs to Economic Growth and Investment Commonwealth Ministers Reference Book 2011 l 75

5 be addressed urgently. This would require a multipronged strategy including some short-term and long-term measures. In countries where stagnation in economic growth has exacerbated the debt sustainability problem, some reform-oriented debt relief measures from the creditors will be required to break the nexus between the high debt burden and low growth. However, given the current global economic environment, debt relief may not be forthcoming in a significant manner in the near future. For these countries, in the short-term, debt restructuring on the lines of the recent debt exchange operation undertaken in Jamaica could be considered as a possible option; this did not involve a haircut for resident investors, although the debt maturity was significantly elongated, providing the necessary medium-term space to deal with future fiscal consolidation issues. As a mediumterm strategy, the commercial borrowings should also be substituted with borrowings through the government securities market with potential for long-term cost savings and elongation of maturity. The medium-term priority should be to strengthen the institutional arrangements and capacity for better public financial and debt management. Finally, the long-term objective should be to implement a fiscal consolidation plan to ensure future debt sustainability. Contact Details Arindam Roy has been heading the Commonwealth Secretariat Debt Management Section, Special Advisory Services Division since April 2008 and spearheads the Commonwealth Secretariat s debt management programme. He joined the Commonwealth Secretariat in March 2005 as an advisor on debt management. The Special Advisory Services Division (SASD) focuses its assistance in four main areas, namely Debt Management, Economic and Legal Services, Enterprise and Agriculture, and Trade. The section provides advisory services aimed at building institutional capacity in the debt field. Special Advisory Services Division Commonwealth Secretariat, Marlborough House, Pall Mall, London SW1Y 5HX, UK Tel: +44 (0) Fax: +44 (0) a.roy@commonwealth.int Website: 76 l Commonwealth Ministers Reference Book 2011