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Understand the importance of Strategic Risk Benchmarks in controlling risk exposure and avoiding unsustainable debt portfolios. Key insights on risk benchmarking, methodology, and performance assessment discussed in this presentation by Jim Matsemela, Director of Market Risk at National Treasury. Learn how benchmarks help quantify cost and risk trade-offs in debt management and align strategies with objectives. Discover the significance of portfolio preferences and flexibility in risk benchmarks to manage economic shocks effectively. Explore guidelines and publications on using strategic benchmarks for optimal debt composition and risk management framework. Track the evolution of debt management objectives and strategies through historical perspectives. Gain insights into core cost indicators and their role in evaluating debt management performance.
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STRATEGIC RISK BENCHMARKS AS KEY TO CONTROL RISK/EXPOSURE AND AVOIDANCE OF UNSUSTAINABLE DEBT PORTFOLIO 9th FORUM ON AFRICAN PUBLIC DEBT MANAGEMENT AND BOND MARKETS Presenter: Jim Matsemela, Director: Market Risk, SRM Chief Directorate, ALM Division, National Treasury | 16 June 2015
Discussion Points • Introduction of Risk Benchmarks • Current debt management objectives and strategy • Old and new risk benchmarks • Process flow of the benchmark model • Brief description of the Core Cost and Risk Indicators • Brief description – methodology on shocks • Performance of the debt portfolio against risk benchmarks • Examples of Indicators in Charts • Conclusion
Defining & conceptualising Risk Benchmarks • Revised Guidelines for Public Debt Management, IMF/WB, 2014: • In terms of Guideline 1 – “Debt Management Objectives and Coordination” • Strategic risk benchmarks assist in quantifying the cost and risk trade-offs embedded in the main objective of debt management. • As may be inferred from Guideline 4 – “Debt Management Strategy” • Strategic risk benchmarks as comprising a set of indicators for the debt strategy operationalises the debt management objectives. • Benchmarks express the portfolio preference (debt structure) of Government in terms of maturity, interest rate and currency composition. • In terms of Guideline 5 – “Risk Management Framework” • Risk benchmarks need to be flexible as to accommodate economic and financial market shocks. • This help define tolerance levels to various exposures (short versus long-term debt; variable and/or inflation-linked versus fixed rate debt; local currency versus foreign currency debt) obviously driven by different (market) risk factors.
Other Notable Publications on Risk Benchmarks • Advances in Risk Management of Government Debt, OECD, 2005: • Strategic benchmark as a tool to control risk • Requires government to specify its risk tolerance and portfolio preferences regarding the trade-off between expected cost and risk. • Optimal debt composition • Derived through assessing the relative impact of the risk and costs of various debt instruments on the probability of missing a well-defined stabilization target. • Key roles of strategic benchmark • They provide guidance on the management of costs and risk. • Define a framework for assessing portfolio performance in relation to cost and risk.
Objectives, current & medium-term Debt Strategy • Before 1999: • Develop the domestic market • Promote a balanced maturity profile • After 1999: • Reduce cost of debt within acceptable risk limits • Ensuring government access to domestic and international financial markets • Diversify funding instruments • Prior to 2008/09 (Links to the Funding Strategy): • Annual funding strategy underpinned by risk guidelines to steer the debt portfolio in line with old risk benchmarks • After 2008/09 (Links to Funding Strategy & Fiscal Policy objectives): • Debt structure (composition) - insulate annual budget from volatility in interest expenditure caused by interest, inflation and exchange rates • Debt structure - assist in realising government’s fiscal policy objectives of debt sustainability and intergenerational fairness
Modified Risk Benchmarks – reviewed 2012-13 *ATM refers to average term to maturity and please note that the smooth maturity profile is retained throughout as a soft benchmark for refinancing risk
Structure of the Planned Model • OUTPUTS • Benchmark (sensitivity) Indicators • Share of ST debt maturing in 12 months - Limit • Share of LT debt maturing in 5 years - Limit • Share of Inflation-linked debt to domestic debt - Range • Average Time to Maturity • Fixed rate debt (incl. T-bills) - Range • Inflation linked debt - Range • Gross foreign debt as % of total government debt – Limit • Cost Indicators • Debt to GDP • Debt Service-cost to GDP • Debt Service-cost to Revenue • Debt Service Cost to Expenditure • INPUTS • Cash-flows • Primary Balance • Interest payments • Redemption payments • Financial (market) variables • Fiscal variables • Macro variables • PROCESS • Strategies • Shocks/Stress • Market Variables • Macro/Fiscal • Allocations
Core Cost Indicators – not benchmarks • There are Cost indicators which seek to measure the ratio of the debt stock in relation to a macro-economic variable of interest, e.g. GDP and • Cost indicators which measure the ratio of the Cost of servicing the stock of debt (flow variable) to a macro economic variable e.g. Revenue or Expenditure. The following 4 Cost Indicators were defined/selected: • Debt/GDP • Debt service cost/GDP • Debt service cost/Revenue • Debt service cost/ Expenditure
Core Cost Indicators & drivers Cost/Revenue • This cost measure is used to indicate how the cost of servicing the stock of debt fares to the cash inflow received or collected by the government. • The key drivers are the coupon rates of individual bonds, the outstanding stock of debt per individual bond/instrument and from the Revenue side, the amount of tax collected by the government. Therefore, the tax base of the government which market risk has no influence over is a crucial factor to this indicator. • In the model, we were able to administer shocks or stress Revenue by a parameter which measures volatility(standard deviation) calculated from historical data. Debt/GDP • It’s a widely used debt sustainability indicator or measure. • Both changes in the stock of debt and changes in the GDP figure affect the ratio of Debt to GDP. • In the model, this cost indicator was affected by changes in both stock variables, namely GDP as projected by Fiscal policy and the stock of debt which is a function of the borrowing requirement, revaluations on the CPI indexed debt and redemptions during a particular fiscal year.
Core Cost Indicators & drivers Debt service cost/Expenditure • This cost indicator seeks to reflect the proportion of debt service cost to the government’s overall expenditure. • In the model, expenditure is incorporated as given by Fiscal policy and no shocks or stresses were administered thereon. Debt service cost/GDP • The GDP figure during a particular fiscal year is a driver of this measure. • The outstanding stock of debt in a particular bond is also a driver, therefore, future allocations into the different funding instruments do affect the debt servicing flow. • In our model, we did not shock GDP, as we saw no element of randomness in italthough this can easily be accommodated.
Core Risk Indicators – New benchmarks • allocations were explored so as to track the response of the ATM • Share of debt maturing in 12 months • The share of debt maturing in 12 months plays a role in managing refinancing risk. • Allocations or funding across different segments of the maturity profile is one of the major sources of this indicator. • This indicator is further sensitive to the stock of the T-bill portfolio as a percentage of total debt. Average term to Maturity(ATM) • The stock of debt, outstanding amounts per individual instrument and allocations into funding instruments are sources and drivers of the Average term to maturity. • Because the outstanding debt stock is calculated on the nominal amount, interest rate factor/risk factor is a distant or non source. • The ATM for Linkers is further effected by the change in the CPI growth rate which then affects each individual bond Index ratio and ultimately the outstanding amount per instrument and the overall stock of debt • In the model, different sets of
Core Risk Indicators – New benchmarks Foreign debt as a percentage of total debt • Both the stock of foreign denominated debt and that of domestic debt are sources of this indicator. • Currency risk is the source for the stock of foreign denominated debt whereas on the domestic debt front, CPI inflation is the source as its variability drives the stock of debt (CPI inflation linked). Share of Linkers as a percentage of Domestic debt • The growth of the stock of ILB component of the domestic debt stock and the growth of other components of the domestic debt stock are factors which drive this indicator. • In the model, there is only one redemption (2017) on the linkers portfolio in the projection period (2014-21). • Therefore, the share of linkers as a % of domestic debt is increasing over the horizon, so is the total domestic debt.
Additional Cost & Risk Indicators – not benchmarks Additional Cost Indicators Inflation linked debt/ GDP: • The source of this indicator is both the monthly CPI index growth rate which impacts the stock of inflation linked debt and the GDP stock in a particular fiscal year. Foreign debt as a percentage of GDP: • The source is the outstanding amount of the foreign denominated debt and the stock of GDP. Additional Risk Indicators Fixed versus Linkers: • In nominal terms, CPI inflation is the key source or driver of the split between the two components. • In the model, the percentage of Fixed rate debt decreases from 2015 onward due to large fixed rate bond redemptions. Fixed vs. Floating: • In the model floating debt stock includes both T-bills and Inflation linked debt • New issuances in all debt components are key sources.
Methodology on Shocks • Shocks were administered on one macro variable being the Revenue • We calculated parameters from the change in historical revenue figures back from 2008 • A pooled standard deviation to capture the impact of small and large values was used as a shock • On yields – a 2* standard deviation of the change in nominal and real yields was used • On inflation – a shock of 100 basis points was applied across strategies up to fiscal year 2020/21
Performance of Debt Portfolio against Risk Benchmark Indicators
Example 2: Share of debt maturing in 5 years and share maturing in one year
Conclusion • Based on the analysis of risk factors driving different components of the debt portfolio the new risk benchmarks separates inflation linked from T-bills • Due to the unique features of the inflation linked bonds in the debt portfolio, an additional benchmark for inflation exposure (including revaluations) is applied in South Africa. • In line with common debt/risk management practice, the share of debt maturing in 12 months (T-bills only in South Africa) and share of debt maturing in 5 years (Fixed Rate and Inflation Linked Debt in South Africa) are used as part of refinancing risk. • Two Average Term to Maturity indicators, one for fixed rate debt (including T-bills) and the second one for inflation linked bonds apply in South Africa. • The foreign debt exposure is implemented and monitored as gross foreign debt (% Limit) of total government debt. • The current smooth maturity profile is to remain in place. • The descriptive indicators are recommended to be in place for 5 years, but the numeric benchmarks are reviewed annually against baseline and stressed changes in the macro, fiscal and market variables.
