Managing New Risks from Non Concessional Borrowing

44
Managing New Risks from Non Concessional Borrowing MOZAMBIQUE: ECONOMIC CHALLENGES AND OPPORTUNITIES GOVERNMENT OF MOZAMBIQUE IN COLLABORATION WITH WORLD BANK AND IMF Christian Mulder IMF Sovereign Asset & Liability Management Division Monetary and Capital Markets Department March 22, 2010

description

Managing New Risks from Non Concessional Borrowing. Mozambique: Economic Challenges and Opportunities Government of Mozambique in collaboration with World Bank and IMF Christian Mulder IMF Sovereign Asset & Liability Management Division Monetary and Capital Markets Department - PowerPoint PPT Presentation

Transcript of Managing New Risks from Non Concessional Borrowing

Page 1: Managing  New Risks  from  Non Concessional Borrowing

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

Page 2: Managing  New Risks  from  Non Concessional Borrowing

2

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

Page 3: Managing  New Risks  from  Non Concessional Borrowing

3

Changing environment

Page 4: Managing  New Risks  from  Non Concessional Borrowing

4

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

Page 5: Managing  New Risks  from  Non Concessional Borrowing

5

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)

Page 6: Managing  New Risks  from  Non Concessional Borrowing

6

External market borrowing

Page 7: Managing  New Risks  from  Non Concessional Borrowing

7

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….

Page 8: Managing  New Risks  from  Non Concessional Borrowing

8

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

Page 9: Managing  New Risks  from  Non Concessional Borrowing

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

Page 10: Managing  New Risks  from  Non Concessional Borrowing

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

16

18RUSSIA'S DEFAULT

ARGENTINA'S DEFAULT

BRAZIL'S DEVALUATION

BRAZIL'S ELECTIONLEHMAN'S COLLAPSE

Page 11: Managing  New Risks  from  Non Concessional Borrowing

11

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

Page 12: Managing  New Risks  from  Non Concessional Borrowing

12

Recent experience of first-time issuers

Page 13: Managing  New Risks  from  Non Concessional Borrowing

13

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

Page 14: Managing  New Risks  from  Non Concessional Borrowing

14

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

400

600

800

1000

1200

1400

1600

1800

2000

Performance of Recent Debut Issuers: EMBI Spreads

Gabon Ghana Senegal

Page 15: Managing  New Risks  from  Non Concessional Borrowing

15

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

Page 16: Managing  New Risks  from  Non Concessional Borrowing

16

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

Page 17: Managing  New Risks  from  Non Concessional Borrowing

17

Country experiences with first issues:Two opposites

Page 18: Managing  New Risks  from  Non Concessional Borrowing

18

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)

Page 19: Managing  New Risks  from  Non Concessional Borrowing

19

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

Page 20: Managing  New Risks  from  Non Concessional Borrowing

20

Potential pitfalls, costs and risks

Page 21: Managing  New Risks  from  Non Concessional Borrowing

21

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?

Page 22: Managing  New Risks  from  Non Concessional Borrowing

22

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

Page 23: Managing  New Risks  from  Non Concessional Borrowing

23

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.

Page 24: Managing  New Risks  from  Non Concessional Borrowing

24

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

Page 25: Managing  New Risks  from  Non Concessional Borrowing

25

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.

Page 26: Managing  New Risks  from  Non Concessional Borrowing

26

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.

Page 27: Managing  New Risks  from  Non Concessional Borrowing

27

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…

Page 28: Managing  New Risks  from  Non Concessional Borrowing

28

Alternative new borrowing venues

Page 29: Managing  New Risks  from  Non Concessional Borrowing

29

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..

Page 30: Managing  New Risks  from  Non Concessional Borrowing

30

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)

Page 31: Managing  New Risks  from  Non Concessional Borrowing

31

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?

Page 32: Managing  New Risks  from  Non Concessional Borrowing

32

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

Page 33: Managing  New Risks  from  Non Concessional Borrowing

33

Mitigating strategies

Page 34: Managing  New Risks  from  Non Concessional Borrowing

34

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

Page 35: Managing  New Risks  from  Non Concessional Borrowing

35

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

Page 36: Managing  New Risks  from  Non Concessional Borrowing

36

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)

Page 37: Managing  New Risks  from  Non Concessional Borrowing

37

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

Page 38: Managing  New Risks  from  Non Concessional Borrowing

38

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

Page 39: Managing  New Risks  from  Non Concessional Borrowing

39

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

Page 40: Managing  New Risks  from  Non Concessional Borrowing

40

Conclusions

Page 41: Managing  New Risks  from  Non Concessional Borrowing

41

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 ??

Page 42: Managing  New Risks  from  Non Concessional Borrowing

42

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)

Page 43: Managing  New Risks  from  Non Concessional Borrowing

43

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)

Page 44: Managing  New Risks  from  Non Concessional Borrowing

THANK YOU!