Managing New Risks from Non Concessional Borrowing
MOZAMBIQUE: ECONOMIC CHALLENGES AND OPPORTUNITIES
GOVERNMENT OF MOZAMBIQUEIN COLLABORATION WITH WORLD BANK AND IMF
Christian MulderIMF
Sovereign Asset & Liability Management DivisionMonetary and Capital Markets Department
March 22, 2010
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Overview of presentation
• Changing environment • External market borrowing • Experience of first time market issuers• Potential pitfalls, costs and risks of external
borrowing• Alternative borrowing venues • Mitigating strategies• Conclusion
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Changing environment
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Changing environment for AFR LICs• HIPC and MDRI reduced debt• Commodity price booms improved outlook• Better structural and macro policies create resilience • Need for more borrowing
– Public sector investment programs to help growth– Investments to achieve MDGs
• Improved outlook puts market borrowing in reach. – In 2007, highest ever volume of bond issuance ($2.8bn) by African
governments.• Challenge of maintaining debt sustainability in such a new
environment
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Concessional funding may not grow fast enough
• African post-HIPC countries: Increased access to and reliance on noncessional finance for post completion countries
010203040
5060708090
1990 1992 1994 1996 1998 2000 2002 2004
Concessional Non concessional
Post Completion Point HIPC Countries
(Sha
re in
per
cent
of t
otal
fina
ncin
g)
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External market borrowing
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Potential benefits of issuing internationally
• Potential benefits:– Supplements domestic savings– Offsets dwindling concessional sources– Cash borrowing allows for speedier project implementation – Establishes a pricing benchmark—if there are potential
domestic private issuers • But,
– higher costs….
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Investor interest in LICs has picked up
• Increase in portfolio investor interest in LICs in search of yields– LIC/EMC country risk easier to assess then “new” IC risks– Because of commodity booms better long-term prospects/lower
risk– Diversification and search for “high yield”
• Improved country economic policies and conditions
• Likewise offers for bi-lateral loans are increasing– Countries seeking to secure commodity flows
EMBI Global Index: LT improvement and convergence across regions
(spread over US Treasuries, percentage points)
0
500
1000
1500
2000
2500
3000
Global
Africa
Asia
Repeated periods of market closure/expensive borrowing
98 99 00 01 02 03 04 05 06 07 08 09 100
2
4
6
8
10
12
14
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18RUSSIA'S DEFAULT
ARGENTINA'S DEFAULT
BRAZIL'S DEVALUATION
BRAZIL'S ELECTIONLEHMAN'S COLLAPSE
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3Q 2003
4Q 2003
1Q 2004
2Q 2004
3Q 2004
4Q 2004
1Q 2005
2Q 2005
3Q 2005
4Q 2005
1Q 2006
2Q 2006
3Q 2006
4Q 2006
1Q 2007
2Q 2007
3Q 2007
4Q 2007
1Q 2008
2Q 2008
3Q 2008
4Q 2008
1Q 2009
2Q 2009
3Q 2009
4Q 2009
0
2000
4000
6000
8000
10000
12000
14000
Volume of Trading in African Debt Instruments by Foreign Dealers
Africa (excluding South Africa) Nigeria
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Recent experience of first-time issuers
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Recent debut bond issuesCountry Date Size ($
mln)Size (%
GDP)
Maturity
Spread at
issue
Yield at issue
Pakistan Feb-04 500 0.52% 5 370 6.86Indonesi
aMar-04 1000 0.39% 10 277 6.97
Vietnam Oct-05 750 1.42% 10 268 7.25Ecuador Dec-05 650 1.75% 10 623 11.06
Fiji Sep-06 150 5.00% 5 225 7.25Seychell
esSep-06 200 28.64
%5 470 9.30
Ghana Sep-07 750 4.99% 10 387 8.50Sri
LankaOct-07 500 1.85% 5 397 8.47
Gabon Dec-07 1000 9.80% 10 426 8.20Georgia Apr-08 500 6.46% 5 474 7.50Senegal Dec-09 200 1.5% 5 691 9.25
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A Rocky Road for new issuers• Ghana (B+) and Gabon (BB-) issued before the uptick in
spreads, Senegal (B+) after• Spreads are back to issue levels• Senegal reportedly pays >+1% for small issue size• More to follow? Kenya, Tanzania ?
Jan-08
Jan-08Feb
-08
Mar-08
Apr-08
May-08
May-08Jun-08
Jul-08
Aug-08
Aug-08Sep
-08Oct-
08
Nov-08Dec-
08Dec-
08Jan
-09Feb
-09
Mar-09
Apr-09
Apr-09
May-09Jun-09
Jul-09Jul-0
9
Aug-09Sep
-09Oct-
09
Nov-09
Nov-09Dec-
09Jan
-10Feb
-10
Mar-10
0
200
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Performance of Recent Debut Issuers: EMBI Spreads
Gabon Ghana Senegal
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Spreads and Sovereign Ratings
Spreads and sovereign rating
BB-
A
BBBBBB
BBB
BBB-
BB+
BB+
BB+BB
BB-
B+
BB-B+
BB-
B-
B-
BB-
0
100
200
300
400
500
600
700
Sovereign rating (composite)
bond
spre
ad a
t iss
ue [b
ps]
Source: Bloomberg, Dealogic.
Cost of issue (spread) strongly depends on the sovereign credit rating
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Factors underlying spreads at issuance• Ratings, dominated (empirically) by:
– Investment/GDP– External debt/GDP or exports– Fiscal balance/debt sustainability– Reserve adequacy– Default history
• Favorable country prospects more generally are relevant– Growth, inflation, current account, fiscal stance in recent years– Sustainable levels of debt– Policy transparency and adequate data dissemination
• Data are now not easily accessible to the public (see Tanzania)• Data quality problems in key statistics
• Supportive market environment
• Successful marketing
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Country experiences with first issues:Two opposites
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Ghana (750 mln; 5% GDP; sep 2007)
• Market pressure for augmentation (500=>750)• Elections in 2008 • Expenditure up from 2007 to 2008 by 4% of GDP; deficit up
by 5%: – capital spending up only 1.3%; – wages up 1.2%; – interest cost up 0.8%; – grants down 1.4%
• External debt from 17.2 % of GDP in 2006 to 29.2 % in 2008• Current account from 9.9% of GDP in 2006 to 19.3% in 2008• The exchange rate depreciated about 50 percent during
2008 and the first half of 2009. RER depreciated by 8% => costly (when exchange rate is overvalued like Seychelles and
Argentina)
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Gabon (1000 mln; 10% GDP; dec 2007)
• Spendthrift despite Oil boom
• Budget surplus from 8 % in 2007 to 12.6% in 2008 …
• Gabon used its debt issuance to retire Paris Club debt
• => Debt down from 44.5 % in 2007 to 22 % of GDP in 2008
• Wage expenditure flat; interest expenditure down; capital spending up
• Extremely well prepared for oil price decline and non-oil, job intensive growth
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Potential pitfalls, costs and risks
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Typical practical pitfalls with external market borrowing (bonds or loans)
– Too large issue size• Carrying cost until it can be absorbed / spent• Market pressure for augmentation• Temptation to use cash proceeds not as intended• Senegal 200 mln on GDP of 14 bln is good example
– Dealing with bullet structure/repayment risk• Traditional concessional borrowing typically amortizing; bullet structure
new challenge; concentrates rollover risk at one point of time• Steps to mitigate – e.g. Gabon created sinking fund (do so upfront);
– Rushing to market• Unaware of cost (Latvia pulled out following road show) • Have you created enough investor awareness? Credible macro story?
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Typical practical pitfalls
– Is the use of proceeds clear? – are projects lined up; are alternatives available? Senegal good case (toll road 22 % return projection; project well vetted)
– Poor choice of lead manager/syndicate• They will “sell” themselves hard. Let them work hard for you• Only focusing on fees over other services
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What are cost pitfalls?
• Overall … need to ensure apparent short-term gains does not blind to longer-term consequences / costs– E.g. developments in RER or ToT means ex-post cost much
higher than anticipated (HIPC exports stagnated in eighties and nineties in nominal dollar terms)
• Dutch disease (bond receipts crowd out other activity)– use external financing only for import content of projects
otherwise exports are crowded out; – use complementary domestic savings for local content of
projects
• Cost is high compared to concessional funding, so use to supplement or to offset delays in concessional lending.
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External borrowing also presents new risks
• Refinancing risk are higher due to abrupt changes in general market conditions..
• Market discipline can be faster and harsher than official sector conditionality
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Is it Worth it? Micro analysis critical to ensure overall Debt Sustainability
• An Example – Borrow $200 million (2% of GDP)– Maturity 5 year (bullet)– Interest rate of 9% (0.18% of GDP)– what is output effect? ICOR of 4?
=> 0.5 % additional GDP growth. – Tax revenue 14% of GDP=> 0.14*0.5% = 0.07% of GDP
more tax receipts. – Wage expenditure 8% of GDP => 0.08*0.5% = 0.04% of
GDP.
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Is it Worth it? Micro analysis critical to ensure overall Debt Sustainability
• Issues– Need a source for paying interest: 5 * 0.18% of GDP. General
revenue will not keep up, even if ICOR is 2.5.– Need a source to repay loan. E.g. 3 * 0.66% of GDP. If not
feasible loan needs to be longer.– Sinking fund forces repayment discipline – Interest may need to be marked up to compensate early
repayment into sinking fund. – eventually repayment flows to new projects and evolving
borrowing.– Project soundness is critical. Needs to earn sufficient return.
Need to avoid Dutch disease etc. Also will impact ICOR.
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Is it Worth it? Micro analysis critical to ensure overall Debt Sustainability
• Concrete– Toll-road in urban area (Senegal):
• Cash rate of return of 22 percent: 0.4 % of GDP. Project pays itself in 5 years
• Growth effect could be 1 % of GDP projected (efficiency gain double payment)
– Toll road with little use (“bridge to nowhere”): • Rate of return 0 percent (revenue = maintenance cost). • Permanent growth effect 0.2 % of GDP ? • Tax gain 0.03%. Need permanent budget savings of 0.15%,
and keep rolling over loan…
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Alternative new borrowing venues
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What are the other borrowing opportunities available?
• Bilateral loans
• Deeper/longer-term domestic markets..
• PPPs are potentially a significant source of financing for infrastructure.
• Don’t count out multilateral aid..
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Bilateral loans
• Newer bilateral creditors are offering loans• Determining cost not always straightforward:
“hidden cost” – Impact of any “tied” aid:
• Benefits may be limited because of country specific inputs (how to maintain projects?)
• Does it require any preferential treatment? If so, does that mean other revenues are foregone?
– They can have special terms (e.g. one way bets for creditor on the exchange rate)
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Develop domestic markets
• Developing market reduces potential for “crowding out” private sector
• Consider steps to encourage greater savings/facilitate financial sector deepening– E.g. greater penetration of banking (e.g. mobile phone banking), wider range of
savings products
• Cost is the nominal interest rate minus inflation (at the short end lower than MT foreign loans) ; what is RER trend; overvaluation?
• Macro linkages are important:– A floating exchange rate regime reduces roll-over risks associated with domestic debt– Policies to support low inflation essential to develop longer term domestic markets– Is inflation indexed debt or some other protection options feasible in the mean time?
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Exploit available aid and concessional financing
• Multilateral support for infrastructure is recovering
– The share of support for infrastructure in total ODA declined from 60 to 30 percent during the 1990s, but is increasing again
– The share of infrastructure in total IDA credits has risen from 18 percent to 33 percent in the current decade
– Sub-Saharan Africa is the largest beneficiary, with its share of IDA credits for infrastructure increasing from 38 to 62 percent of total
– IDA resources for infrastructure are expected to increase
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Mitigating strategies
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Building institutional capacity
• Traditional focus of debt manager in LICs is on recording and tracking repayment
• With more choices in funding DM function needs to develop. It is beneficial to ensure – Strong institutional frameworks. Cooperation traditional
project management (planning ministry/MoE) with finance side/debt office (MoF finance division). E.g. Debt Coordination Committee
– Strong operational risk management frameworks: middle office function in DMO/division
– Integration with DSA (debt sustainability analysis) is critical
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Building institutional capacity• Requires different skill / mind set
– More risk focused– More market aware– Financial analysis important
• Debt recording still critical– Active risk management needs information on payment profiles as
input in simulations
• Needs high level commitment and engagement– Ministers and senior officials need to take strong ownership of process
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Develop a Medium Term Debt Strategy... desirable more generally
• MTDS defines – desired public debt composition and – a plan to achieve this composition
• Objective: Meet government financing need at lowest cost consistent with a prudent degree of risk
• Embedding decisions in sound MTDS framework can mitigate risk of poor choices on financing; build on DSA and build on project analysis
• Ensure the right scope (include e.g. the Road Fund)
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Develop a Medium Term Debt Strategy... desirable more generally
• Fund/Bank have developed 8 step MTDS framework plus spreadsheet tool
• MTDS framework forces sound assessment of – overall macro vulnerabilities – close coordination of DM with other aspects of macro policy, – supported by strong analysis of cost and risks at portfolio level– including micro details of each instrument and capacity to compare
and contrast specific instruments (e.g. loans from 2 different creditors)
• See e.g. Zambia, Kenya, Tanzania
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8-step approach
Identify
objectives & scope
Identify cost & risk of existing
debt
Identify potential funding sources
Identify baseline projections & risks – fiscal, monetary &
market
Step 1 Step 2
Step 3Step 4
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8-step approach
Step 5 Step 6
Step 7Step 8
Review key structural
factors
Identify cost risk trade-off for
alternative debt management
strategies
Review implications for macroeconomic
policies & market
Recommend MTDS for approval
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Conclusions
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Main lessons on non-concessional external borrowing: A Pragmatic View
• Don’t rush and consider all options first. • Do analysis at both the macro and project level
– Be wary of seemingly attractive offers by bilateral development banks– What projects return more than say 15% and yield revenue?
• Mistakes can be huge• How will interest payment be generated—budget has little
leeweigh• How will the loan be repaid (amortization?; high returns; or
roll-over=> roll-over risk, and no truly new projects)• Where can your scarce time best be focused?
• Developing domestic markets; improving aid disbursements; engaging new bilateral creditors; tapping external commercial markets ??
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Main lessons on non-concessional external borrowing: A Pragmatic View
• Move gradual, so you can learn. Do not issue more debt than needed. Pick size in line with debt strategy and plans for proceeds.
• Build institutional capacity: debt management unit; DSA unit • Combine project and financial risk management expertise• Plan ahead, so as to be ready when rates are favorable• In any case (first) formulate a debt strategy • Be savvy: play investment bankers and the bi-lateral development
banks after you have decided on a strategy. Do not focus on fees and rates alone
• Be wary of the details: including the cost of the initial cash surplus and the cash buffers needed for repayment; the small print in bi-lateral loans
• Improve your position. Prepare well for issuance (e.g. through pre-deal road-shows and good and accessible data)
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Acknowledgements and sources
• World Economic Outlook, Africa Regional Outlook (IMF) • “Strategic Considerations for First Time Sovereign Bond Issuers”
(IMF WP )• Draft Guidance Note for MTDS and MTDS spreadsheet
tool • “Sovereign Issuers: Entering International Markets. A Cross
Country Study” (by Blitzer)
THANK YOU!