1. UNCTAD, World Bank and IMF Workshop Geneva, February 06-10 2017
Baseline Projections and Risks in Key Policy Areas: Fiscal, Monetary and Externals Sectors
UNCTAD, World Bank and IMF Workshop
Geneva, February

2. Outline
What are the links between macroeconomic policy and the formulation of debt management strategy?
How do these links operate in practice?
Baseline projections
Risks
Structural factors
Feedback from MTDS and macroeconomic policy
Risk mitigation
DM Strategy can improve the functioning of the financial system

3. 1. Broad linkages between mtds and the macro policy framework

4. Why looking at links between MTDS and Macro Framework
Mexico 1994/5
Sudden devaluation of the peso led to capital flight and a run on reserves of the Central Bank and government debt crisis exacerbated by a large stock of short-term debt and high level of dollar denominated debt =>IMF bailout to resolve liquidity
Argentina 2001/2:
External current account deficit (5% of GDP) high in terms of exports (100%) and currency peg meant overvaluation of the peso and costly gov. FX debt=>200% depreciation/debt restructuring.
Greece 2010:
Mainly primary deficit problem but non transparent fiscal/debt accounting and significant reliance on short- term and variable rate funding aggravated situation

5. EM Crisis tend to emulate supply side shock
Often characterized by twin deficit:
Fiscal expansion (G↑) leading to increasing fiscal deficit and current account deficit as imports increase (M↑).
If exchange rate is flexible, local currency depreciates and exports increases (X↑) and restores balance of payments.
If exchange rate is fixed, central bank intervenes to defend the currency, and reserves are depleted unless there is additional FDI and portfolio inflows. Need domestic devaluation (P↓) or fiscal tightening to restore balance of payments.
As local currency depreciates, domestic prices tend to rise due to pass through effect. This leads to monetary tightening and high domestic interest rates. Risk premium demanded by investors will also rise.
when economy is doing badly, inflation and interest rates tend to go up, and local currency tend to depreciate.
optimal debt structures would minimize exposure to inflation, interest rate and exchange rate shocks

6. Why balance sheet structures of other parts of the economy matter
Asian financial crisis 1998/1999
Ireland and Iceland 2008
Even if central government debt is low, implicit contingent liability can materialize

7. 2. MTDS: How do these linkages operate in practice?
Baseline projections
Risks
Long-term structural factors

8. Concrete links to Macroeconomic Framework
Use MTEF for baseline projections of macroeconomic variables.
Projections need to be part of a consistent macroeconomic framework.
Source: macro unit, budget department, central bank
Baseline market variables should be consistent with macroeconomic framework
Nominal exchange rate projection should be consistent with outlook for real exchange rate projections based on competitiveness of the economy
Nominal interest rate should be consistent with inflation outlook

9. Baseline Projections: 4 Sectors- Key Macro & Market Variables
Real sector
Fiscal policy
External sector
Monetary policy
GDP: denominator in cost /risk indicators and affects financing needs (revenue may fall and expenditure increase with decrease in GDP);
Primary balance = Revenues – Non-interest expenditures
Exchange rate
Balance of Payments and external financing needs
Reserves accumulation and ability to roll-over debt
Interest rates
Inflation outlook and variability
Real interest rate

10. National Accounts (local currency, flows)
REAL SECTOR
GENERAL GOVERNMENT
National Accounts (local currency, flows)
Private consumption General government consumption
(Wages + Purchases of goods and services) Private investment General government investment Exports of goods and nonfactor services Imports of goods and nonfactor services
Fiscal Accounts (local currency, flows)
Revenues Grants Expenditures Current Capital Overall balance Financing Domestic financing (net) Banking system Nonbanking sector External financing (net)
EXTERNAL SECTOR
MONETARY SECTOR
Balance of Payments (US dollars, flows)
CURRENT ACCOUNT Exports of goods and nonfactor services Imports of goods and nonfactor services Factor services (net) Transfers (net) Official Private
CAPITAL & FINANCIAL ACCOUNT Direct investment Medium/long-term capital (net)
Private sector
Government
Short-term capital (net) Private sector
Overall balance Reserves (Change in net foreign assets)
Monetary Auth (local curr., stocks)
Net foreign assets Net domestic assets: Net credit to government sector Credit to banks Other items (net) Reserve money
Currency
Banks’ reserves
DMBs (local currency, stocks)
Net foreign assets Banks' reserves Net domestic assets: Net credit to government sector Credit to nongovernment sector Other items (net) Liabilities to monetary authorities Private sector deposits

11. Fiscal MTDS DSA BOP Monetary Schematic diagram* 1 3 1 4 2 5
Primary balance
Interest payments 2 3
Total debt service, new financing source & its terms
External debt service 4
Government debt holdings by financial system 5
* Abstracts from other linkages.

12. MTDS → Fiscal 2016 2017 2018 2019 Gross financing requirement
Primary Balance
Interest Payments
existing debt
new debt
Principal Repayment
Financing sources
Multilateral
Bilateral
Commercial
Domestic
Financing gap
MTDS → Fiscal

13. MTDS → BOP 2016 2017 2018 2019 Overall balance Current Account Balance
Trade balance
Service and income (net)
o/w interest payment
new debt
Capital account balance
Financial account balance
FDI
Portfolio investment (Eurobond & nonresidents)
Other investment (Loans)
Financing sources
Gross official reserves
Multilateral credit
Bilateral credit
Financing gap
MTDS → BOP

14. MTDS → monetary 2016 2017 2018 2019 Central Bank Net foreign assets
Net domestic assets
Credit to the public sector (net)
Capital and other asset (net)
Base money
Commercial Banks
Credit to the private sector (net)
Other assets

15. MTDS → DSA 2016 2017 2018 2019 Public Debt Stock Domestic debt
For LIC DSA - existing and new debt
For MAC DSA - existing debt
External debt
For LIC & MAC DSA – existing debt
Debt Service
External principal and interest payment
Domestic principal and interest repayment
For LIC DSA – existing and new debt
For MAC DSA – existing debt
Consistent new debt assumptions

16. Macroeconomic Framework: Main Risks?
Having established the baseline we need to ask what are the most likely risks (deviations from the realistic baseline)
RISK SOURCE
IMPACT ON
DEBT-RELATED RISK
GDP decline
Taxes and revenues
Weak debt repayment capacity
Deterioration fiscal position
Primary balance
High financing needs
Current Account Deficit & FDI reduction
Balance of Payments
Need for external financing (private / public)
Inflation and credit rating
DX interest rates
High DX debt service
Currency depreciation
Exchange rate
High FX debt service
Sudden stops of flows (reversal)
Balance of Payments Exchange rate
Limits the choice of financing sources High FX debt service
Terms of Trade
Commodities prices Exchange rate

17. Relation to Debt Sustainability Analysis (DSA)
DSA role is to gauge the level of the debt. Does it lead to future debt servicing difficulties (over indebtedness)?
Derive advice on the (max.) primary fiscal balance based on DSA.
Inputs on refinancing risks
MTDS role is to derive the composition of debt
Debt structure, and interest rate structure often crudely modeled in DSA. This is the role of MTDS
If MTDS leads to a revision in debt strategy implicit in MEF/DSA this should be fed back into MEF/DSA [when updated].
DSA feeds the macro variables of the MTDS, it does not work the other way

18. Fiscal Baseline Projections
DM should be clear about
Expected path of Primary Balance
Gross Financing Needs:
Government Deficit = Primary Balance + Interest + Debt Repayments
For LICs:
grants depend on donor policies and economic prospects (a declining source of revenues as countries develop - a structural factor to consider)
From DSA whether there is considerable risk in terms of sustainability
composition policy should help to reduce risk
unsustainable debt cannot be mitigated with a better debt portfolio structure

19. Monetary Baseline Projections
Short-term interest rates driven by monetary policy.
Other nominal rates driven by inflation expectations.
Unstable monetary regime and inflation will lead to high inflation risk premiums for medium-long-term fixed rate instruments
Inflation indexed debt requires trusted index not subject to political “intervention”

20. Baseline Projections: External Sector
Balance of Payment defines the external financing needs (BoP gap) in the short- term (for given exchange rate/reserves target)
Current account drives the path of the exchange rate which is a key variable in cost-risk of external vs domestic funding
Reserves are key for roll-over risk especially under a fixed exchange rate regime where authorities will defend a predefined level

21. Exchange rate shock impact

22. Longer-term Structural Factors
Examples of structural factors:
structural changes in monetary policy (inflation targeting), in the long term reduce borrowing cost
development of domestic debt markets (reforms)
changing trends in prices of commodities
long term trends in exchange rates due to productivity improvements
Long-term structural factors influence the debt strategy through their effects on the baseline macro scenario and on the mix of available instruments

23. 3.feedback from MTDS and macroeconomic policy

24. The Challenge
Public debt management should be an integral part of a country’s comprehensive policy agenda (often not the case), including among others:
prudent fiscal policy measures
appropriate policy mix, with a consistent monetary policy framework
adequately regulated and supervised financial system, in particular the banking sector
Public debt management should be an additional policy tool, consistent with the general macroeconomic policy framework.

25. Mitigating Fiscal Vulnerabilities
Choice of strategy can reduce liquidity risk and therefore, reduce the likelihood of crisis
Longer debt maturity helps reduce fiscal vulnerabilities: reduces roll-over risk and slows the pass through of increasing spreads / interest rates
More domestic funding reduces foreign exchange rate risk exposure
Similarly, reducing variable rate debt can reduce budgetary uncertainty and exposure to shifts in market’s assessment of credit risk (credit risk impacts the interest rates)
Liquidity risk as opposed to solvency risk which is a fiscal issue

26. Mitigating difficulties in the implementation of Monetary Policy
Longer domestic debt maturities may help reduce the conflict between monetary and debt management objectives
CB can more freely set high nominal short-term interest rates to achieve monetary objectives
Public debt management can help develop efficient fixed-income markets
Facilitates move to indirect instruments of monetary policy (open market operations)
Improves size and liquidity of Bonds issues reduces the cost of borrowing.

27. Mitigating Balance of Payments Vulnerabilities
Lengthening external debt maturities reduces roll-over and potential drain on reserves/ pressure on the balance of payments through capital flight.
Switching to domestic can reduce pressure on the BoP, but this could crowd out effects to domestic private borrowing. However,crowding out domestic sector can be mitigated by developing savings market.
Maximizing concessional borrowing reduces pressure to borrow for BoP support.

28. Link to Financial System
More generally, public debt management can effectively support the development of more robust financial markets, improving the functioning of the financial system
Facilitating corporate debt markets
Providing a benchmark for the private sector
Providing scope for securitization of banks’ assets (i.e. mortgage loans)
Facilitate repo market development
Improving liquidity of banks’ balance sheets (provide collateral)
Facilitate development of derivatives markets
Allowing for more effective risk management within the economy

29. Conclusions
The overall aim of public debt management is to minimize costs to the budget, taking account of potential vulnerabilities
Composition of debt stock can help mitigate vulnerability of budget to shocks thus enhancing macroeconomic stability
Reducing rollover risk is an important mitigating factor to address broad range of vulnerabilities
To achieve its intended objectives, public debt management should be performed in close coordination with the rest of the macroeconomic policy
Despite public debt management’s policy impact on macroeconomic stability, financial stress and crisis may still occur, but amplitude of such events will not be exacerbated.