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2. Key Challenges Facing Debt Management
2
Part 1
3. Determining Sustainable Level of Debt
Several debt measures are utilised by debt managers and
international investors to evaluate the sustainability of debt in a
given country
Debt-to-GDP
The public-sector-debt-ratio provides the clearest picture of a
countrys public sector debt stock as a percentage of annual
production. Generally a level over 60% is considered high.Those
countries with higher credit worthiness are able to borrow more
without affecting their sovereign ratings as can be seen by the
parabolic relationship between Debt-to-GDP and credit rating
Interest-to-Revenues
The ratio of public sector interest-to-general government revenues
is the most commonly used measure of interest affordability as it
provides an indication of the interest burden on annual fiscal
resources.One government may have a high level of debt, however,
through heavy concessional borrowing, might face a lower level of
interest than another government with a lowerlevel of debt
A ratio above 15% of revenues is generally considered high
External Short-Term Debt-to-Reserves
A metric of short-term external financing constraints, this ratio
describes short-term debt (current-year amortisations, money market
instruments, currency and deposits) as a percentage of central bank
international reserves
2009 Public Sector Debt-to-GDP vs.. Credit Rating
Interest-to-Revenues vs.. Credit Ratings
Part1:Key Challenges Facing Debt Managers
Jamaica
Greece
Iceland
Israel
Philippines
Ghana
Bolivia
Russia
Chile
AAA AAA BBB BBBCCC
Jamaica
Source:IIMF; S&P, Moodys; Fitch
Pakistan
Costa Rica
Iceland
Israel
Bolivia
AAA AAA BBB BBBCCC
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4. Credit Ratings and Debt Sustainability
S&P, Moodys and Fitch all factor debt sustainability into their
determination of credit ratings.These ratings then affect a
Governments ability to borrow externally.Additionally, ratings may
serve as country ceilings, which affect the borrowing cost of
private enterprises operating within a rated country
The level of a countrys indebtedness is a major factor affecting
its credit rating. While countries with historically strong
sovereign credit worthiness, like Japan and Spain, may be given
more flexibility in sustaining more debt, emerging market nations
have traditionally been perceived as riskier.
Recent events have called into question the debt sustainability of
those historically AA- and AAA-rated nations like Greece, Spain and
Portugal, which have faced downgrades in recent months
IFR; Bloomberg, all figures as of 04 May 2010
Aggregated Sovereign Credit Rating vs.. Borrowing Spread
Pakistan, 651bps
Greece, 643 bps
Ukraine, 551 bps
Iceland, 375 bps
Portugal, 275 bps
Romania, 233 bps
Philippines, 168 bps
AA A BBB BB B CCC
Part1:Key Challenges Facing Debt Managers
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5. Managing Rollover Risk
Many governments worldwide (particularly within Europe) face large
rollover requirements as a percentage of GDP in 2010before any
allowance for financing budgetary deficits
Debt rollover ratios exceed 20% of GDP for Belgium and Italy.
Spain, for instance, must issue EUR 225bn this year in order to
rollover its outstanding debts falling due in 2010, even though
Spain has a debt-to-GDP of only 54% compared with 125% for Greece
and 76% for Portugal.
In addition to the need to refinance maturing debt, many European
and other governments will need to increase their borrowings to
finance their budgetary deficits.
S&P has projected that European governments will be forced to
borrow a record 1,446b in 2010 due to deteriorating public
finances.
IMF, S&P
Advanced European Market Debt-Rollover Ratios
EMEA Debt-Rollover Ratios
Part1:Key Challenges Facing Debt Managers
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6. Rising Fiscal and Balance of Payments Deficits
Many governments face mounting fiscal and external financing
deficits as a result of the global economic turbulence.
Fiscal Deficits
Many governments are facing soaring fiscal deficits caused by poor
fundamentals and crisis-related response measures:
7. Decreased customs duties caused by a decline in global trade
8. Higher than anticipated expenditures caused by financial crisis
response measures such as bank takeovers and deposit guarantees 9.
Fiscal stimulus measures required to meet social needs and combat
recessionary unemploymentBalance of Payments (External financing
deficits)
Many countries face severe balance of payment shortfalls that have
forced Governments to deplete reserves, devalue the national
currency or resort to IMF lending:
10. Some governments are borrowing abroad in order to guarantee
that they have adequate forex for their central banks 11. The
inability to service or rollover large foreign-denominated debt
payments (public sector or otherwise) 12. Those Governments
situated in currency unions may face additional pressure due the
inflexibility of monetary controls and the inability to devalueTwin
Deficits
Part1:Key Challenges Facing Debt Managers
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13. Contagion
Contagion describes the phenomena whereby financial shocks are
transmitted from one economy to other interdependent economies.The
term came into wide use during the late 1990s when financial crises
spread across emerging market economies, affecting nations with
healthy fundamentals and sound fiscal, monetary and exchange rate
policies
Various theories exist to explain why contagion occurs including:
real links such as trade, the pass through of higher/lower market
interest rates, a herd mentality among investors, and operations of
multinational financial institutions spreading economic distress
and investors selling debt of one country to fund losses elsewhere
in the portfolio
The threat of contagion is very real to debt managers as exogenous
events can lead to the transmission of higher interest rates,
reduced financing options and speculative exchange rate attacks
that undermine the external balance and cause any number of other
economic distress factors
Bloomberg
CDS Lockstep Movements Among Emerging Market Peers
Part 1:Key Challenges Facing Debt Managers
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14. Reaching Investment Grade
IFR May 8 2010, Moodys, S&P, Fitch
Why are some emerging market countries perceived as less risky than
their peers?
Part1:Key Challenges Facing Debt Managers
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15. Reaching Investment Grade
Over the past decade, a handful of emerging market governments have
beaten the odds to achieve the necessary fiscal , debt and external
sustainability associated with investment-grade sovereign credit
ratings.There are a number of discernable trends among those
countries that have risen several notches despite global
adversity:
16. Decreasing dependence on commodity exports (Kazakhstan,
Trinidad & Tobago) 17. Taking advantage of higher growth to
improve fiscal position and to reduce debt (Russia) 18.
Implementation of Investor Relations Programmes (IRPs) (Brazil)
Because of the recent turmoil surrounding the European sovereign
debt crisis, a number of emerging market countries arenow being
perceived as less risky than advanced country peers.For instance,
Chiles CDS has recently been trading below UKs. CDS for Brazilian,
Mexican and Polish bonds are trading below those of Portugal
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Part1:Key Challenges Facing Debt Managers
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Source:S&P
S&Ps sovereign ratings methodology categories
19. Part 2
Some Solutions and Strategies
10
20. Sources of Funding
Bilateral and multilateral borrowing increased dramatically in the
sovereign borrowing mix in 2008 and through much of 2009 due to
reduced availability of external commercial financing
Many Governments have sought IMF assistance in the form of a
stand-by-arrangement (SBA) or drawn on the IMFs Flexible Credit
Line
Some sovereigns with SBAs and FCLs have already returned to the
international capital markets - even before the availability of
official sector funding ends as was the case of Hungary in July
2009 and January 2010
Part 2: Some Solutions and Strategies
IMF
CurrentIMF Programmes(as of 29 April 2010)
11
21. An Effective External Debt Issuance Strategy
With US interest rates at historic lows, widespread tightening of
credit spreads from crisis levels, and increased demand for
sovereign bonds, many Governments haveturned to the capital markets
in recent months.Eurobond issuance provides access to external
financing at market rates and can have knock-on benefits for the
sovereign issuer
Eurobond issuance is a key source of financing for governments.If
conducted prudently, Eurobonds can have beneficial benchmarking
effects on a countrys finances and provide a variety of
benefits:
22. Extending the countrys yield curve 23. Encouraging greater
investor interest (placingthe country on the map) in other
sectorsDuring 2009, sovereigns out-issued corporates US$129b to
US$115b, with the bulk of issuance coming in the second half of the
year. Sovereign bond issuance is already up by more than two-thirds
in the first quarter of 2010
Thompson Reuters, Development Prospects Group
Part 2: Some Solutions and Strategies
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24. Appointing Lead Managers
For a major international issue by a sovereign,there is typically a
single lead manager or bookrunner or two lead managers (joint
bookrunners), who take responsibility for the transaction.They will
have an active participation in the transaction including
distribution and most importantly from the investors perspective,
providing a continuing secondary market throughout the life of the
issue
The main problem faced by new or infrequent issuers is ensuring
that the issuer retains control throughout the issuance process.It
is important to remember that lead arrangers have two sets of
clients, investors as well as the issuer. Only by remaining active
in the process, can the sovereign issuer ensure that its interests
are being placed ahead of those of thelead managers investors
Key Criteria for Appointment of a Lead Manager(s) for International
Bond Issue
The appointment of the bookrunning manager(s) is a key decision in
approaching the international bond market. To ensure maximum
transparency in the process, an issuer should arrange a beauty
contest for the award of the mandate
As there will be a period of up to three months between awarding
the mandate on the one hand and the pricing and launch of the
transaction on the other, the mandate for the issue should not be
awarded solely on the basis of price as market conditions may
change substantially in the intervening period
The most important criteria for the appointment of the lead manager
for an international bond issue include:
25. The quality of economic and sovereign credit research and,
most importantly, understanding of the country, its economic and
political conditions and its creditworthiness 26. Experience in
lead managing similar sovereign issues, including for example
experience in bringing sub-investment grade sovereign borrowers to
market 27. Distribution capability and willingness to support the
transaction in the aftermarket 28. Individual character of the team
assigned to the transaction; level of senior resources to be
allocated, degree of familiarity with the countryPart 2: Some
Solutions and Strategies
13
29. Case Study: Russian Federation
Situation Overview
After recovering from its debt crisis in 1998, the Russian economy
sustained ten years of economic growth in excess of 5% through
2008. Oil receipts enabled the Russian authorities to accumulate
assets in their National Wealth Fund and Fiscal Reserve Fund, which
stood at US$88.8bn and US$40.9bn respectively as of 1 May
2010.These assets were instrumental in propping up the Russian
private sector when the global financial crisis caused the Russian
economy to contract by 7.9% GDP in 2009.No Russian credits suffered
international bond defaults, in part due to well-timed
interventions by the Russian authorities
Prior to the most recent issues, Russia hadnt issued in the
international capital markets for many years, and its return
required the development and implementation of a detailed
medium-term external funding strategy that began in mid-2009 in
order to obtain the lowest pricing possible
Issuance Strategy
The Russian Federation returned to the capital markets in order to
provide corporate and sovereign-related entities with new sovereign
benchmarks that would enable them to tighten their own credit
spreads.Russia sought to raise US$5.5bn from five and 10-year
issuances
The Russian authorities took a hard-line on the pricing of the new
bonds.Issuance at the tightest possible spreads was prioritised
over achieving a high oversubscription ratio.The book size was
deliberately kept under wraps in order to prevent investors from
inflating orders
Outcome
Russias five- and ten-year issues were priced in line with official
guidance at 125bps and 135bps wide of US Treasuries respectively
and the bonds were two times oversubscribed, even in the face of a
weak market. The ten-year yield fell inside of the Italian and
Spanish sovereign yield curves. The issuance achieved the Ministrys
objectives of repricing the sovereign curve and establishing
benchmarks for future supply
Russia MoF
Part 2: Some Solutions and Strategies
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30. Domestic Eurobonds
While a Eurobond is a bond governed by a foreign law to foreign
investors and issued in foreign currency, some governments have
sought to issue bonds governed by a foreign law to foreign
investors but denominated in their domestic currency as a means of
widening their investor base. This would provide an issuing
government with several benefits:
31. Issuances could be simultaneously placed on domestic and
foreign markets allowing for the widest possible investor base 32.
Domestic issuance develops the domestic local-currency debt markets
33. Widely available local-currency bonds could pave the way for
foreign investors to increasingly invest on local-currency
exchanges and in private sector corporates 34. Local-currency bonds
help governments insulate debt obligations from the risk of large
fluctuations in global exchange ratesThere are also a number of
risks associated with local-currency external issuance:
35. Domestic-currency bonds could be dumped rapidly by global
investors causing more volatile price movements. More sophisticated
investors may be located abroad, leaving domestic holders to bear
the brunt of any depreciation in government debt assets 36. In
order to have a successful local-currency issuance, capital
controls must be limited or scaled back, which is a concern in some
economies 37. External issuance of a domestic instrument is more
expensive as legal costs, clearing mechanisms, road-shows and
investor relations take on global proportionsPart 2: Some Solutions
and Strategies
15
38. Investor Relations Programme (IRP)
Investor Relations Programmes help Governments develop debt
issuance programmes and ensureawareness among the emerging market
investor base.They do not serve as a substitute for sound
policies.
The main benefit of an IRP to a Government is in crisis prevention
and resolution.It provides an appropriate institutional framework
to convey information on macroeconomic policy objectives, economic
performance and policy implementation
An IRP facilitates constructive dialogue between authorities and
investors and enhances the decision making process through the
provision of timely information
A well formulated Investor Relations Programme:
39. Provides a channel for interacting with market participants
and investors 40. Helps judge the potential timing of issuance in
global capital markets, especially in instances of prolonged
absences from the markets 41. Contributes to a more positive
perception of the country by investors when making decisions to
either maintain or increase exposure to the country, even in the
face of increasing external payments pressures 42. Increases
transparency and engenders credibility and good faith 43. Helps
promote the development of domestic capital markets 44. Helps
reduce vulnerability to adverse shifts in market sentiment, whether
caused by country-specific concerns or by market-induced contagion
45. Corrects inaccurate information and dispels rumours 46. Helps
monitor capital flows into the countryPart 2: Some Solutions and
Strategies
16
47. Investor Relations Programme (IRP) (cont)
A countrys sovereign debt is one of a large number of competing
investment opportunities.Investors expect authorities to provide
and support the same level of access to information as corporates
are required to provide.Authorities are expected to provide data in
a timely manner to help creditors better assess risks
Creditors and Investors expect an Investor Relations Programme
to:
48. Disseminate concise data on macroeconomic and financial
policies, as well as information about structural issues 49.
Provide a direct channel of communication with government officials
and decision-makers 50. Provide clarification and financial updates
as necessary 51. Provide detailed information on the sovereigns
macroeconomic position, updated forecasts and insight on financing
plans and other forthcoming events 52. Provide forward looking
information on medium-term macroeconomic objectives and proposed
policy measures, including future financing needs, debt position,
amortisation schedules, future debt issuance, etcAn IRP needs to
create formal communication channels for two-way exchange of views
and information between sovereign debtors and market
participants
Part 2: Some Solutions and Strategies
17
53. Investor Relations Programme (IRP) (cont)
Many sovereigns have been rewarded for the transparency of their
investor relations efforts during the implementation of policy
reforms.In the cases of Brazil, Turkey, and South Korea, for
instance, the proper conveyance of their reform agenda through well
established IRPs helped reduce borrowing costs.As can be seen
below, the introduction of an IRP lowered the USD yield curve at
5-years by an average of 164bpsfor the sampled countries
Sovereigns with developed programmes have fared better than those
without.There is correlation between the rating of a countrys
programme and its ability to withstand external shocks
As can be seen below, those countries having the higher rated IRPs
had lower 5-Year CDS spreads.This is indicative of the benefit of
an open and transparent relationship between the sovereign issuer
and investors
Effect of IRP on Spread to USD Swaps
09 IIF Weighted Score vs.. CDS Spread (13 May 2010)
Venezuela
Pakistan
Ukraine
Institute for International Finance, Bloomberg
Dom. Republic
Part 2: Some Solutions and Strategies
Philippines
Turkey
Brazil
Peru
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54. Domestic vs.. External Borrowing
Domestic vs.. external debt financing should aim at minimising cost
and risks for the overall economy
There is no optimal approach for all circumstances as it depends on
the availability of financing, economic environment, institutional
framework and the degree of development of the domestic financial
markets.However, there are a handful of factors that should be
reviewed when deciding whether to borrow domestically or
externally:
Part 2: Some Solutions and Strategies
19
55. Debt Reprofiling
Debt reprofiling describes the process whereby a government
consults with creditors to adjust the maturity or coupon structure
of outstanding debt obligations in order to better meet the
governments external or fiscal payment calendar.Often, this is done
through the creation of a new instrument or instruments, which are
then exchanged for the old instrument
Important Considerations
56. The preventative approach is suitable in those countries,
which are able to anticipate and publicly acknowledge the existence
of a liquidity problem before it becomes a solvency problem 57. In
outright solvency crises, voluntary debt exchanges are more
difficult to achieve 58. A candid dialogue is essential in order
togauge creditor tolerance for an NPV reduction, obtain feedback on
how to improve a proposal and generate an atmosphere of trust 59.
In any voluntary debt exchange, free-riding holdout creditors are a
problem.A number of legal mechanisms including the Collective
Action Clauses (CAC) and Exit Consents exist to address the holdout
problemPhases
60. Identify Creditors 61. Build the case for debt relief 62.
Consultation Process 63. Exchange Offer 64. Bring in remaining
investorsPart 2: Some Solutions and Strategies
20
65. Case Study: Belize
Situation Overview
Belizes public sector debt stock rose rapidly from 2000 to 2005,
driven by increased borrowing from private sector sources in order
to finance the cost of emergency relief and the reconstruction
process following a series of natural disasters in the periodfrom
1998-2002.Repeated refinancing operations in previous years led to
a consistent rise in borrowing costs: the effective weighted
average interest rate on the external commercial debt stood at
approximately 11.25% in mid-2006
In mid-2006, Belizes public debt burden stood at approximately
US$1.1b, which was equal to over 90% of estimated GDP.Interest on
the public debt was due to exceed 27% of fiscal revenue in
2006.Servicing the external debt absorbed an average of 46% of
Belizes annual foreign currency earnings from exports of goods and
services since 2002.Furthermore, debt service due to external
commercial creditors was characterised by spikes caused by bullet
maturities, some of which were linked to put options held by
creditors
Macroeconomic projections, undertaken in conjunction with the IMF,
showed that Belizes debt burden would contribute to acute twin
financing shortfalls in the short- to medium-term
IMF, Belize MoF
Debt Stock Before Restructuring (June 2006)
Savings Generated by Debt Exchange Offer
Part 2: Some Solutions and Strategies
21
66. Case Study: Belize (cont)
Exchange Strategy
Belize pursued a strategy based on:
The full and early engagement of creditors through open and
constructive dialogue
A policy of transparency in the dissemination of all economic and
financial data and assumptions
A willingness to find a solution that would address Belizes needs
in a credible manner but that would also be perceived as fair by
creditors
The support of the IMF, the IADB, and the CDB
Before entering into dialogue with creditors, Belize built a case
for debt relief by producing detailed macroeconomic projections
that took into account the impact of the authorities economic
reforms and the financial assistance expected from multilateral and
bilateral lenders.The authorities presented creditors with a number
of indicative debt restructuring scenarios, all comparable in NPV
terms
In December 2006, Belize announced the broad terms of its exchange
offer and simultaneously suspended interim debt service payments.In
order to ensure comparable treatment in NPV terms for all
participating creditors, Belize incorporated exchange ratios into
the exchange offer.Special legal procedures were put in place to
encourage the reconstitution of stripped instruments as well as the
use by participating creditors of the collective action clauses
(CACs) embedded in some of the affected instruments
Outcome
Holders of 96.8% of the affected debt tendered their claims. The
new debt service profile for the external commercial debt was
radically different from the original one.Between 2007 and 2015,
Belize will benefit from cash flow savings equal to
US$482m.Additionally, consolidation of the countrys external
commercial debt into a single benchmark-size (US$547m) instrument
encouraged trading in Belizean instruments and broadened the
countrys investor base
A major economic crisis was averted and Belize now has a debt
burden that has proven sustainable.The countrys credibility and
standing in the international financial community was preserved:
creditors acknowledged that Belize conducted itself in a
transparent and responsible manner in very challenging
circumstances
IMF
Part 2: Some Solutions and Strategies
22
67. Discussion: Greece
Greece faces what is arguably the most significant financial crisis
in an advanced economy in recent memory.There are a number of
pertinent issues, which the Greek authorities must now
face:
68. Will the markets be successfully persuaded that Greece can
achieve debt sustainability without a comprehensive or partial debt
restructuring? 69. If a restructuring of Greeces debt becomes
inevitable, will the Government have missed out on an opportunity
to take a decisive and pre-emptive debt reprofiling action while it
still had funds at its disposal?Part 2: Some Solutions and
Strategies
23
70. Contact Us
For further information, please contact:
Derrill Allatt
Managing Partner
Newstate Partners LLP
33 Cavendish Square
London W1G 0PW
Phone: +44 (0) 20 7182 4641
E-mail: [email protected]
Website: www.newstatepartners.com
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