esm risk management (rima) dsa framework · 7 the rima dsa complementsthe standard dsa by...
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ESM Risk Management (RiMa) DSA framework
Marialena Athanasopoulou
ESM DSA Workshop
12 December 2018
Overview of the presentation
1
Overview of the ESM DSA framework
Funding assumptions: How important are for assessing debt sustainability?
Risk management in the DSA
Conclusions
ESM RiMa DSA building blocks
2
Deterministic DSA
Stochastic DSA
DSA with optimal funding strategy
Uncertainty
Risk management & Optimal funding strategy
Ris
kM
an
ag
em
en
t(R
iMa
)D
SA
Other (short-term and medium) indicators
Flow metric in DSA: Gross financing needs
(GFN)
DSA with optimal funding strategy – Motivation
3
Assessing debt sustainability has moved from stocks… to
flows. *
*/ C. GABRIELE ET AL (2017), DEBT STOCKS MEETS GROSS FINANCING NEEDS: A FLOW PERSPECTIVE INTO SUSTAINABILITY. WORKING PAPER SERIES NO. 24, EUROPEAN STABILITY MECHANISM, LUXEMBOURG, 2017. ** / CORSETTI, G., ERCE, A., AND T. UY (2017), DEBT SUSTAINABILITY AND THE TERMS OF OFFICIAL SUPPORT. MIMEO WORKING PAPER. *** / CORSETTI (2018), DEBT SUSTAINABILITY ASSESSMENTS: THE STATE OF THE ART, EUROPEAN PARLIAMENT (STUDY).
Liquidity crisis can translate into solvency issues as …
…countries with larger refinancing needs face higher risks of losing
market access.
How important are funding assumptions for assessing debt sustainability?
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Indicative example: Identical macro and fiscal assumptions, fixed interest rates, flat yield curve.
Funding strategy: Only 5Y bonds
Funding strategy: Only 5Y WAM
Note: Values in the heat map refer to end-period for debt and period maximum for GFN. Colours refer to period maxima: Green for Debt (GFN) below 70% of GDP (15%), Yellow for Debt (GFN) above 70% of GDP (15%), but below 100% (20%), and Red for Debt (GFN) above 100% of GDP (20%). These thresholds are broadly in line with IMF empirical findings for advanced economies (Baldacci et al., 2011).
GFN graph
Debt % GDP
GFN % GDP
Short term Med. term Long term
14.3 13.6 24.6
2019 2020-23 2024-30
100.3 94.9 87.8
Debt % GDP
GFN % GDP
Short term Med. term Long term
14.3 18.3 21.7
2019 2020-23 2024-30
100.3 94.9 87.8
Example with debt at 120%
DSA with optimal funding strategy– Implementation
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Key element of the evolution of debt dynamics is the financing decisions• Neglecting this aspect undermines the
importance on debt flows
We extend standard DSA models to incorporate optimal debt-financing decisions for an economy facing uncertainty
We optimize the maturity of debt instruments to trade off borrowing costs with refinancing risks
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2019 2025
10-25th, 75-90th 25-75th GFN % GDP
Optimal funding strategy
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Op
tim
al fu
nd
ing
s
tra
teg
y
Minimize Interest costs
Such that:
Debt remains on a declining path
Tail risks on GFN are limited
Risk tolerance (alpha)
Refinancing risks (omega)
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70
90
110
130
2019 2025
10-25th, 75-90th 25-75th Debt % GDP
Optimizing DSA – New elements in assessing debt sustainability
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The RiMa DSA complements the standard DSA by reflecting refinancing risks and costs of trade-offs
Cost and benefits of reducing refinancing risks.
Debt dynamics under an optimal funding strategy.
Size and timing for addressing potential hot spots
Quantifying the trade-off: Costs and benefits from reducing refinancing risks
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Reducing refinancing risks, increases interest costs (unless the yield curve is inverted) and weighs on debt.
2.6
2.8
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3.2
3.4
3.6
3.8
15 20 25 30 35
imp
licit
Rat
e.m
ean
Refinancing risks
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15 20 25 30 35
Deb
t.fi
nal
Refinancing risks
Refinancing risks and implicit interest rate (in %, lhs) and debt (in % of GDP, rhs)
0
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201
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0
202
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202
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202
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203
0
Fixed strategy Optimal funding strategy
Indicative example: Debt dynamics under the optimal funding strategy.
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Fixed strategy: 5y WAM, interest rates with feedback loop
With optimal funding strategy
Explaining the resultsDebt % GDP
GFN % GDP
Short term Med. term Long term
14.3 22.3 24.8
2019 2020-23 2024-30
100.3 93.3 82.7
Debt % GDP
GFN % GDP
Short term Med. term Long term
14.3 17.9 21.1
2019 2020-23 2024-30
100.3 93.8 84.6 Funding strategy (in years)
What if there is no solution to our optimization problem?
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The model, gives us when and by how much GFN need to be reduced in order to obtain an optimal solution given the constraints.
Hot spots
Hot spots are a powerful tool for…
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-0.2
0
0.2
0.4
0.6
0.8
1
1.2
15 17 19 21 23 25
Refinancing risks
Red
ucti
on
in
GF
N (
% G
DP
)…identifying the size of the necessary reduction on GFN under the constraints.
Hot spots are a powerful tool for…
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Red
ucti
on
in
GF
N (
% G
DP
)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.402
021
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23
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20
25
Refinancing risks at 20% Refinancing risks at 18% Refinancing risks at 16%
…identifying the time and size of the necessary reduction on GFN under the constraints.
Hot spots are a powerful tool for…
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Red
ucti
on
in
GF
N (
% G
DP
)
0
1
2
3
4
5
6
7
2020
2021
2022
2023
2024
2025
Central
For example: What if we want debt decreasing by 5% until 2023 and non increasing thereafter while GFN remain below 20% of GDP?
…programme design.
Conclusions
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- Funding assumptions are key for assessing debt sustainability as debt flows give important insights regarding the sovereign’s vulnerabilities.
- Our model complements the standard DSA frameworks as it allows us to assess debt sustainability under an optimal funding strategy.
- Debt dynamics under this strategy could reveal different vulnerabilities.
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Thank you …
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Annex
DSA assumptions – central
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Avg 2019-2030
Nominal GDP % growth 3.5
Primary surplus % of GDP 1.0
Market rates % 3.5
Annex. Central scenario: GFN under fixed strategy, fixed rates
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0
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5y BONDS 5Y WAM
Return
Annex. DSA with higher starting debt
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Indicative example: Identical macro and fiscal assumptions, fixed interest rates, flat yield curve but debt starts at 120%.
Funding strategy: Only 5Y bonds
Funding strategy: Only 5Y WAM
Note: Values in the heat map refer to end-period for debt and period maximum for GFN. Colours refer to period maxima: Green for Debt (GFN) below 70% of GDP (15%), Yellow for Debt (GFN) above 70% of GDP (15%), but below 100% (20%), and Red for Debt (GFN) above 100% of GDP (20%). These thresholds are broadly in line with IMF empirical findings for advanced economies (Baldacci et al., 2011).
Debt % GDP
GFN % GDP
Short term Med. term Long term
15.9 15.2 28.2
2019 2020-23 2024-30
120.9 116.0 107.4
Debt % GDP
GFN % GDP
Short term Med. term Long term
15.9 20.6 24.3
2019 2020-23 2024-30
120.9 116.0 107.40
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5y BONDS 5Y WAM
Return
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100
105
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
Fixed strategy Optimal funding strategy
Indicative example: Explaining the results
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GFN-to-GDP (%)
0
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Fixed strategy Optimal strategy
Debt-to-GDP (%)
Return
Indicative example: Higher risk tolerance
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- Higher risk aversion implies longer maturities—if possible—which implies higher debt.
- Targeting the same level of debt, requires the sovereign to accept higher refinancing risks.
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Deb
t.fi
nal
Refinancing risks
Risk tolerance = 0.1 Risk tolerance = 0.05
Return
Indicative example: What if higher macroeconomic uncertainty?
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Higher macroeconomic uncertainty pushes optimal strategy to longer maturities which weighs on debt. In our example, increased uncertainty makes the optimization problem infeasible.
Allowing for hot spots the model gives us the time and size of the necessary reduction in GFN in order to obtain an optimal solution.
Indicative example: What if higher macroeconomic uncertainty?
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Red
ucti
on
in
GF
N (
% G
DP
)
0
2
4
6
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10
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14
15 17 19 21 23 25 27 29
Refinancing risks
Return
Indicative example: Shorter maturity
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With optimal funding strategy
Debt % GDP
GFN % GDP
Short term Med. term Long term
14.3 22.3 24.8
2019 2020-23 2024-30
100.3 93.3 82.7
With shorter maturities
Shorter maturity of existing debt pushes optimal strategy to longer maturities when debt payments are high…
Debt % GDP
GFN % GDP
Short term Med. term Long term
26.8 23.3 25.2
2019 2020-23 2024-30
100.3 93.1 82.3
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Optimal funding strategy Shorter maturity
Return
Indicative example: What if we want debt decreasing by 5% until 2023?
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Red
ucti
on
in
GF
N (
% G
DP
)
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Central Higher uncertainty
Ongoing work
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On the model: - Enrich the yield curve with feedback loop that includes debt flows and the
interaction of stocks and flows.
On the RiMa DSA framework:- Fully operationalize the model including the thresholds relevant for assessing debt sustainability as well as other risk indicators.