Medium-Term Debt Management Strategy

(1)

Ministry of Finance and Public Credit

General Directorate of Public Credit National Treasury

Management Strategy

(2)

(3)

General Directorate of Public Credit and National Treasury

Deputy Directorate of Risk

Libertady Orden

Ministry of Finance and Public Credit

(4)

Colombia. Ministry of Finance and Public Credit. General Directorate of Public Credit and National Treasury. Medium-Term Debt Strategy — Bogotá, D.C.: Ministerio, 2013.

180 p. — ISBN: 978-958-9266-82-3

1. Medium-Term Debt Strategy 2. Benchmark portfolio 3. Debt portfolio currency composition 4. Asset and Liability Management 5. Cost-risk analysis 6. Fiscal policy

I Melo Hernández, Helber Alonso II Díaz Zuleta, Ana Carolina III Gómez Rubio, Germán IV Núñez Trujillo, Carlos Alejandro CDD 20ed. 336.3046

CEP. Biblioteca “José María Del Castillo y Rada”

1st Edition March, 2013

Carrera 8ª No.6-64 Bogotá – Colombia, Fax. (57 - 1) 381 1700 atenció[email protected];

www.minhacienda.gov.co

Legal deposit in accordance with Law 44 of 1993

Parcial reprodiction of the contents of this work are permited, proper citation provided. Medium-Term Debt Strategy

ISBN 978-958-9266-82-3 Bogotá D.C., April, 2013 Cover design

Camilo Medina Editorial design Bernardo Arias Blanco Printing

Dígitos & Diseños Ltda. Translation and edition Santiago Mora

(5)

Minister of Finance and Public Credit

Mauricio Cárdenas Santamaría

General Vice-minister

Germán Arce Zapata

Technical Vice-minister

Ana Fernanda Maiguashca Olano

Secretary General

Claudia Isabel González Sánchez

Director General of Public Credit and National Treasury

María Fernanda Suárez Londoño

Deputy Director of Risk

Helber Alonso Melo Hernández

Technical Team

Ana Carolina Díaz Zuleta Germán Gómez Rubio Carlos Alejandro Núñez Trujillo

In collaboration with:

Santiago Mora Osorio Juan Guillermo Vélez Carmona

With the participation of:

Deputy Directorate of Financing with Multilateral Organisms and Governments

Deputy Directorate of International Capital Markets Deputy Directorate of Internal Financing

Deputy Directorate of the National Treasury

With the accompaniment of:

World Bank

State Secretariat for Economic Affairs SECO Medium-Term Debt Management

(6)

Foreword

Over the past two years, the Government of Colombia has accomplished considerable advances regarding fiscal policy. These break-throughs, in hand with a proper debt policy and a strong commitment to fiscal discipline led the country to recover its investment-grade credit rating in 2011 and to hold a low risk premium when issuing debt ever since.

Conscious of the great responsibility and effect that the Nation’s debt management has on public finances, on the economy and the market, the Government committed to designing the Medium-Term Debt Management Strategy in line with the National Development Plan “Prosperity for All 2010-2014”.

By following these guidelines over the past two years, the Ministry of Finance and Public Credit, led by the General Directorate of Public Credit and National Treasury, created the guidelines for administrating the Centralized National Government’s public debt under the scope of efficient and integral risk management. The purpose of this study is to determine the characteristics and goals that define what an efficient debt portfolio management is.

One of the biggest challenges faced in this study was to choose a model that suited Colombia’s debt needs and goals. For defining which methodologies to use for finding efficient debt portfolios, the Ministry of Finance and Public Credit relied on its technical team, especially on the Deputy Directorate of Risk, and on the World Bank’s Treasury.

Colombia is now considered to have adequate debt policies. This, along with other government policies and a favorable economic and market environment have shielded the Nation against recent financial volatility around the world. It is our hope that this document contributes to the analysis and debate on government debt administration and that it helps to strengthen Colombia’s international status as an example of sound management.

María Fernanda Suárez Londoño Director General of Public Credit and National Treasury

(12)

IntroductIon

This document defines a new medium-term debt strategy, to be applied by the Centralized National Government (CNG) and used as a compass on the subject for the following years. For this purpose, the document addresses the debt strategy from a theoretical approach, in terms of objectives, risks, benefits and management efficiency. Additionally, it presents methodologies and examples that validate the Nation’s chosen debt management strategy presented in the first section. In line with this, the document is divided in two sections. The first section presents major issues that government authorities must consider in formulating public debt management strategy. Different risks to be considered when developing issuance strategies are analyzed as well as the strategy’s harmonization with the government’s economic policy. Additionally, the evolution and current state of Colombia’s debt management is described. This section ends with a thorough description of the current design for debt strategy in Colombia, both in theory and practice. Identification of the market agents involved and their respective responsibilities, markets, funding sources and current debt profiles are all described as well.

The second section focuses primarily on currency factors that may hinder Colombia’s public debt profile. We first display two models under which medium-term debt management strategies are designed, in accordance to CNG asset and liability management guide-lines. Afterwards, our analysis focuses on the debt portfolio’s dynamic and weighs costs and risks with the previously determine ad hoc strategies. These guidelines are restricted by the fact that, for every period in time, implemented strategies are to meet the CNG’s financing needs.

Finally, results and improvements in modeling methodologies are presented, mainly those regarding the model’s reach and robustness. Simultaneously, further considerations that may contribute to strengthen the effectiveness of debt policy are mentioned.

(13)

executIve SuMMary

A debt strategy is a set of actions executed over a debt portfolio, that seek for risk, cost, duration, currency and interest rate objectives in a specific period of time. In Colombia, the outcome of fostering debt strategies is a combination of indicators that define the structure of a benchmark debt portfolio. Within the guidelines of this reference structure, the Government manages its outstanding debt and debt issues. From the early nineteen nineties, Colombia has worked in improving the level of all debt indicators, in order to mitigate risks faced when raising debt. The aim is to do so at competitive prices and with a large, diversified pool of funding sources. The main debt portfolio indicators used for defining debt strategies in Colombia are:

Market of issuance

average life of

the portfolio Interest rate

currency denomination Issuance market

class

BencHMarK PortFoLIo

• Market of issuance (internal/external): This indicator discriminates the amounts of debt contracted in domestic markets and those financed in foreign markets. This follows identified market limitations as well as opportunities for deepening the yield curve. The new implemented debt strategy combines higher COP denominated issuings (as a result of the ALM model) with a wide array of opportunities for finding low cost and low currency risk debt in domestic markets

(14)

• Interest rate: This indicator discriminates volumes of floating-rate issued debt securities from fixed-rate issues. Colombia has been relatively conservative in managing market risks, when raising debt. Consequently, a low percentage of the debt portfolio is tied to floating-rates, which usually imply risks of higher debt-servicing costs. In fact, the Government limited floating-rate debt to 5% of the total volume of outstanding debt, in part because of the availability of low cost-risk fixed-rate debt sources.

• Currency denomination: This indicator reveals Colombia’s debt portfolio’s currency composition. The current strategy sets this indicator as the main subject of analysis due to its high risk and impact, given the present economic environment. Therefore, a large deal of effort is spent in searching for the appropriate volume of USD denominated debt. The effects of currency risk with the current maturity profile of the portfolio are thoroughly studied, as well as how this risk should be managed. After having eva-luated three different methodologies for estimating a proper currency composition, the study concludes that an optimal distribution is to hold 75% of the debt portfolio in COP, and 25% in USD denominated debt securities. This distribution minimizes costs and risks in the medium-term and is coherent with current macroeconomic policy.

• Issuance market class:This indicator discriminates whether debt is raised in capital markets or elsewhere in the financial system. Colombian Government has decided to concentrate its efforts in raising capital in open markets for two main reasons: i) there are issuance strategies for internal and external debt, and giving depth to the yield curve enables fund source diversification and cuts in costs, and ii) this deepening of the curve makes corporate debt less costly and more available. This is not, by any means, a restriction to contracting liabilities with multilateral organizations, but rather a search for an adequate balance in funding sources.

• Average life:This indicator encompasses maturity profile indices, which reflect amortization concentrations in each fiscal term. Its structure is a result of all of the former indicators, an upper bound for annual amortizations of 15% of total outstanding debt was set and the new strategy lowers it to 10%.

(15)

To illustrate how this works in Colombia, the following chart presents the evolution of each of these goal indicators is presented next:

2002 2007 2012 2017 (Strategy Outcome)

Market of issuance Internal 53% 67% 72% 70%

External 47% 33% 28% 30%

Interest rate composition Fixed-rate 90% 94% 94% 95%

Floating Rate 10% 6% 6% 5%

Currency composition COP 50% 67% 72% 75%

USD (others) 50% 33% 28% 25%

Liability class Bonds 69% 69% 87% 90%

Credit lines 31% 31% 13% 10%

Average life

Internal 4.5 4.2 5.1 7.0

External 6.2 9.9 10.8 12.0

Total 5.3 6.1 6.7 8.5

These results are meant to explain how the new debt management strategy was created. For this purpose, this document was divided in two parts. The first describes the current debt strategy, synthetized under the benchmark portfolio, maturity profiles, measured risks and the organizational model for managing debt. The second part goes deeper into the models that define currency compositions for the debt portfolio, given Colombia’s mining and energy boom; which is currently leading to appreciation of the COP.

The choice for a particular currency composition follows the results of two main approaches that examine different debt management considerations separately. The first approach is the Asset and Liability Management model. The second methodology, dubbed the Cost-Risk model, addresses ALM limitations under a cost risk scope, under different currency and interest rate compositions scenarios1_.

Transparence in the definition and implementation of a medium-term debt management strategy is key for reducing fiscal risks, in line with the CNG Fiscal Balance financial structure. In particular, the transparence guidelines have reinforced Colombia as a foreign market debt issuer and improved investor perspective towards Colombian debt in general.

(16)

The medium-term debt strategy explained throughout this document seeks to satisfy the need for currency matching within the Fiscal Balance and it constitutes the base on which debt will be managed in following years (in line with the National Development Plan, “Prosperity for all”). Results from the exercises and proposed policies are framed in a prudent and efficient debt management context. Following these admi-nistration principles guarantees debt sustainability and a proper accompaniment to public finance management.

(17)

Medium-Term Debt Management Strategy

(18)

1. Conceptual Framework

A debt strategy is a combination of debt instruments, structured as a portfolio. Such strategy seeks to establish policy guidelines defined by the Government. Before discussing debt strategy design, it is convenient to first describe relevant theoretical features of management mechanisms available to debt issuers. First, different types of risks that derive from debt strategies are assessed, as well as costs and benefits. Next, benchmark debt portfolio target indicators are described. Finally, other relevant aspects concerning debt are studied, such as the interaction of debt issues with other economic variables and market indicators.

1.1. Risks, costs and benefits analysis

Public debt management is the process of establishing and implementing strategies for administrating Centralized National Government (CNG) debt. The goal of public debt management policy is to insure that the Government’s financing needs are met and that payment of its liabilities is executed at the least costs and risks possible.

A Medium-Term Debt Management Strategy (MTDS) is an action plan; developed by the Government, for obtaining a desired debt portfolio structure, limited by public preferences regarding costs and benefits. The MTDS design makes emphasis in managing implicit risk exposures and enables the identification of possible fiscal cost variations with incidence on debt-servicing costs, macroeconomic volatility, market volatility or exogenous shocks that may hinder the aggregate economy. A proper design administrates portfolio risks, minimizes the debt burden on taxpayers and maximizes resources availability for other expenditures (FMI et al., 2009).

The three fundamental, mutually exclusive, defined goals of debt’s management (García, 2000) are: i. Minimizing average cost of debt

ii. Minimizing exposure to market risk

iii. Maximizing the debt’s average maturity, seeking a uniform debt maturity profile

Strategies with a relatively short maturity profile2_{may be intended for minimizing debt cost by reducing budget burdens associated with}

debt service in future interest payments. In this manner, a possible optimal debt policy would be only issuing short-term debt given that its costs are lower than longer term issuing, and future interest payments are avoided. In consequence, uncertainty coming from factors that would affect the debt’s value is reduced.

(19)

Figure 1.

Debt management goal triangle

Minimizing costs

Minimizing

market risk _{rollover risk}Minimizing

Source: García, 2000.

Leaving aside possible future risks, a narrow time window for issuing short-term liabilities would limit the government’s room for restructuring the debt portfolio towards lower costs. In fact, frequent refinancing leads to greater risks and the impairment of the current outstanding debt profile, as opposed to longer term debt rollover with lower interest rates.

Conversely, when external interest rates are lower than domestic ones, long-term debt issues in foreign currency denomination would be, a priori, more appealing to debt managers as a result of lower costs. Even though this second strategy would extend the general maturity profile of the debt portfolio reducing rollover risk, it does not incorporate the greater currency risk associated with foreign currency denominated debt3_.

3 _{The selection of a determined debt strategy reflects domestic market restrictions as well. Countries with deep fixed income markets, have a large enough worldwide pool of investors} who absorb the government’s financing needs making it unnecessary to issue debt in other currencies. Opposite to this, in many developing countries, where financing needs are not entirely met domestically, there is need of foreign currency denominated issuing.

(20)

If the chosen debt strategy aims to reduce market risk, then debt managers should increase the amount of fixed-rate debt issued on longer maturities. Thusly, impact of interest payments linked to long-term issued debt on the government’s budget is not optimized. Although these strategies tend to be costly, they are commonly found since they limit the uncertainty on cash flows resulting from unexpected market volatility. This volatility on debt-servicing costs has a high political cost: the government’s fiscal policy and its outcome may lead to increased revenues or reduced expenditure (García, 2000).

Consequently, it is convenient that cost and risk evaluations of the MTDS consider full business cycles4_{, so that interconnections between}

the aforementioned goals are incorporated in all stages of design5_.

Aside from fixed rate long-term debt portfolios, governments may use inflation indexed debt issuing as an alternative strategy. These bonds provide investors with hedging tools for future price volatility, implying lower interest rates and longer maturities on issuance. In fact, the advantages can be significant in cases where the government’s forecasted inflation is below market estimates.

The effective design and implementation of a MTDS requires the existence of financial instruments and bonds; and financial market depth. Such instruments should provide enough capital to satisfy the Nation’s funding needs and the Government’s objectives regarding fiscal and macroeconomic policy, as well as fulfilling all of the portfolio managers’ interests.

1.2. Benchmark Portfolio

Government debt management consists in designing and implementing a debt portfolio that adequately balances the following characteristics (in accordance with previously set policy objectives):

I. Currency composition of the debt portfolio, II. Debt maturity structure,

III. Interest rate composition of the debt portfolio,

IV. Index composition of the debt portfolio (whether it is inflation indexed, or linked to other market or macroeconomic variables6_).

Debt managers have other tools available, which allow them to modify the mentioned characteristics when needed. These do not necessarily imply debt issuance, and seek to improve the general public debt maturity profile. The portfolio’s composition may be transformed by the means of swaps and other hedges, buybacks or debt exchanges. Based on these four characteristics and with the use of instruments, governments implement their debt management strategies.

4 _{Other country’s experience shows how they contemplate 3 to 5 year time horizons.}

5 _{If full business cycles are taken into account, scenarios with higher short-term interest rates are incorporated, as well as strong Exchange rate volatility, thus increasing cost of debt.} 6 _{It’s worth mentioning that in Colombia, there are two types of domestically traded bonds: i) TES B bonds indexed to real value units (UVR for its acronym in Spanish) where par value is}

(21)

1.2.1. Benchmark Portfolio - Definitions

With the aim of establishing time enduring public debt policies, goal indicators are introduced. Four main indicators are defined as follows:

I. Foreign currency. This indicator determines the optimal issuace level of foreign currency denominated debt and its resulting effect on the outstanding debt balance. The indicator is fundamental when assessing CNG total revenue under a relative debt cost outlook and under an assets and liabilities management view of the FB.

II. Maturity. This indicator defines the different ideal time horizons on which debt is issued7_.

III. Interest Rate. This indicator represents the distribution of the debt portfolio between fixed rate and variable rate issues.

IV. Indexing. This indicator determines the distribution of the debt portfolio different issues indexed to, mainly domestic macroecono-mic variables. The most common among them is CPI indexing.

These indicators lay guidelines for the ideal structure of debt portfolios in terms of a risk-benefit equilibrium. Other desirable benchmark portfolio characteristics include consistency with government financing strategies and long-term sustainability, offering insight on sound debt management.

These indicators allow the manager to monitor the achievement of the debt management strategy goals. Structural differences between the current debt portfolio and the benchmark portfolio indicate how successful debt managers are in replicating the strategy; i.e., the desired debt portfoio composition.

In creating the benchmark portfolio, it is key for the criteria used to be neutral to current market conditions. It is central that criterion does not reflect any particular sentiment on macroeconomic or market variables from the government or those involved in the debt manage-ment process. In fact, the benchmark portfolio could be extremely harmful, if not specified and implemanage-mented carefully (Wheeler, 2004). When designing benchmark portfolios, or specifying and implementing debt issuance strategy, it is also important to acknowledge that debt’s behavior responds differently to a variety of economic shocks. Establishing whether a country is prone to supply or demand shocks tends to be difficult, but it is known that negative shocks on demand trigger falls in prices and economic downturns. With falling prices, inflation-indexed debt-servicing costs would strengthen the government’s fiscal stance against Government income drops and surges in public expenditure demand.

7 _{Concerning bonds and vanilla instruments, maturities depend on factors like the destination market, and reflect the government’s preference in regard to where in the yield curve liquidity} should be provided. As for tailored instruments like bilateral debt, finding maturities that suit a particular strategy is harder, as it is implementing it.

(22)

In this manner, a hedge for debt-servicing costs against negative supply shocks (characterized by falls in gross product and rising prices) can be achieved by indexing fixed-rate debt. These price indexed fixed-rate instruments are countercyclical by nature, meaning they turn out to be less costly in economic crisis scenarios when tax revenue drops (Togo, 2007).

As it was explained before, the detailed definition of goal indicators, address the macroeconomic and fiscal environment and the deve-lopment of financial markets as well. The recognition of needed indicators is unique to each country, and each one should identify what variables are relevant for its economy and design benchmark portfolios that answer to the behavior of these variables, thus achieving sound debt management strategies. This book aims to address this analysis for the Colombian economy.

1.2.2. other tools for debt management – Hedging instruments

The implementation of derivative transactions, particularly currency and interest rate swaps, is necessary for the MTDS to achieve its objectives. Debt portfolio currency composition is managed by rebalancing outstanding debt, transforming it with currency and interest rate swaps.

The implementation of derivative instruments makes it possible to draw a clear distinction between issuance strategy and risk manage-ment. If a chosen strategy incurs in hedging costs, then combining long-term bond issues and Cross Currency Swaps (CCS) minimizes market and rollover risks when increasing short-term debt is desired. It also contributes to keeping a stable and predictable issuance strategy, this being central for the National Government (a crucial agent in the local market)8_.

1.3. Integration of the MTDS with macroeconomic policy

Defining debt management policy and debt strategies are necessary but not sufficient for a government to have an overall sound ma-nagement of the Nation’s liabilities. On the contrary, policies adopted have to guarantee coherence between public debt mama-nagement and the general macroeconomic background. In consequence, understanding the links and coordination mechanisms between the two is essential, so that the effects of debt management strategies and other macroeconomic policies are amplified into the overall performance of the economy (See Figure 2).

8 _{Denmark’s government has succesfully implemented CCS for their debt management strategy for nearly thirty years. These swaps provide the government with debt management} flexi-bility, drawing a clear line that separates issuance policy from interest rate risk management. As a result, the main target of debt issuance policy is to create high liquidity for outstanding debt, as well as a broad set of instruments available for investors and low financing risks for the government (Danmarks Nationalbank, 2010).

(23)

Figure 2.

Links between MTDS and the macroeconomic policy

Debt Strategy

Financing Plan Macroeconomic framework/

Debt sustainability Financing sources/ market development

Macroeconomic and market limitations

Coherence/ limitations

Information on costs and risks

Budget forecast

Convenient debt instrument composition

Demand limitations/pricing factors

Market development factors Market depth iniciatives

Information on costs and risks

Cost-Risk Analysis

Source: IMF et al. 2009.

In developing a debt strategy, different market, government and private agent tensions and incentives are to be kept into account, given their incidence on decision making. The goal is to achieve policies that are neutral to all interests and lead to overall soundness of debt management.

For example, fiscal authorities are in charge of managing the Nation’s debt, in which case they prefer to keep the debt-servicing costs at a low level under the principle of creating fiscal room for other purposes in the short-term. However, doing so would increase future debt-servicing cost volatility, forcing the government to cut expenditure or raise taxes.

Other scenarios may also raise concern regarding tensions between debt managers and economic policy. For instance, a government with high fiscal deficits and a high debt-to-GDP ratio may want to reduce debt-servicing cost volatility by increasing the amount of fixed interest rate instruments within the portfolio. Alternatively, the government could seek to reduce the burden of debt-servicing by issuing short term debt, provided their belief of low debt rollover risk and costs (Wheeler, 2004).

(24)

Another cause for concern is compatibility of debt management policy with monetary policy. The main goal of monetary authorities is to achieve price stability9_{, but when they also play the role of debt managers some conflicts of interest may rise. They may be inclined}

to keep interest rates low so that debt-servicing costs are kept low as well, with no regard for inflationary risks. Conversely, monetary authorities may find it convenient to issue CPI index-linked debt to heighten its credibility, but simultaneously intensify debt-servicing cost volatility (Togo, 2007).

Monetary policy regimes, the instruments used by the authorities, and the authority’s credibility, all affect the debt management policy. In this sense, the MTDS contributes to improving credibility and reduce country risk premiums due to inflation. In fact, credibility could be considered relevant for the definition of debt strategies, since it somehow affects internal debt cost for both short and long-term issues. On the contrary, the absence of credible monetary policy leads to high inflation risk premiums and makes long-term maturity debt excessively expensive.

Sterilization actions undertaken to reduce excessive liquidity originated by foreign capital flows, have led some central banks to consider issuing assets and repo agreements themselves. Further enlargement of quasi-fiscal deficits and the possibility of replacing central bank debt for Central Government debt are some concepts that must be taken into account when formulating MTDS (IMF et al., 2009). Similarly, careful examination of the government’s exchange rate policy and foreign currency benchmarks is advisable. Foreign currency denominated debt issuing requires a detailed knowledge of Balance of Payments trends and therefore coordination with exchange rate policy. For example, exchange rate uptrends or high volatility might raise external debt costs and lead debt-service payments to surge. A more natural way of including exchange rate and other macroeconomic considerations into the optimal debt strategy design consists in incorporating the government’s assets dynamic into the debt analysis10_.

1.3.1. Asset and Liability Management approach

One of the approaches for debt strategy design is the Asset and Liability Management (ALM) model. It offers a coherent framework for identifying and managing the debt portfolio’s underlying risks. It also sheds light on the linkage between fiscal policy, monetary policy and debt management. The ALM suggests that FB volatility risk appears when there is no conformity between financial characteristics of assets and liabilities, and therefore risk is minimized when income structures match those of expenses.

As mentioned by Wheeler (2004), defining benchmark portfolios that reduce the risk of government balance sheet mismatches; considering the characteristics of cash flows meant for servicing debt is viable. In countries where exports represent a large percentage of GDP (as is the case of oil producing countries), the government’s income is largely denominated in USD as well. In that event, external debt issued in foreign currency can be serviced with revenues with the same denomination, thus balancing the debt composition to some degree. In any case, it is common for tax revenue in domestic currency to take up a larger percentage of Government income, and are

9 _{For this purpose, inflation targeting, interest rates, monetary aggregates and exchange rates are managed with open market operations or regulatory controls like provisioning} requirements.

(25)

greatly used for servicing creditors and debt. For this reason, the better cost-risk alternative is finding external debt currency compositions that are highly correlated with local currency.

This process usually requires finding an external debt portfolio currency composition with the lowest possible variance relative to the local currency. This answers to the fact that in many countries, tax revenue (the biggest source for Government debt-servicing funds) is denominated in local currency.

The ALM approach also suggests that debt should be structured in a way that debt-servicing installments decrease when facing primary deficit and increase with surpluses. This countercyclical structuring of debt helps to offset risks derived from surges in tax rates, cuts in expenditure or debt defaults during financial crises. When debt is structured to match fiscal assets, debt management serves as an instru-ment for minimizing budget volatility and fiscal policy acts as an economic stabilizer for the country.

The method identifies which debt instruments have suitable characteristics for the Government to achieve its purposes of reinforcing the FB. Particularly, debt with payments conditioned to the accomplishment of primary surpluses could strengthen the FB against negative shocks to fiscal assets. A clear example of the above is GDP-indexed debt. With gross income acting as a proxy for tax revenue, managers insure that debt service installments follow the Nation’s income dynamics.

Another aspect that could lead to mismatches between the income and expenditure sides of the Government’s balance sheet is the financial effect of risk premiums. For instance, in emerging economies, crises elevate risk aversion and are associated with higher risk premiums, thus leading to procyclicality of debt and its costs.

These traits of the risk premium are closely related to the cyclical properties of foreign capital flows. The implications of procyclical risk pre-miums and capital flows on the debt managing make it appropriate to keep financing needs controlled during crises. Given the difficulty of forecasting crises, it is clear that issuing long-term debt and minimizing concentration of maturities in a given fiscal term is advisable from a risk management perspective.

Market agents in charge of formulating government policy must have clarity on what are the objectives and the real extent of their chosen debt strategy. As such, debt managers should not expect for the sole implementation of a debt strategy to lead to the accomplishment of fiscal goals, albeit the relation of the two.

1.3.2. Development and efficiency of domestic markets

The disjunctive for economic authorities is often between raising funds domestically or finding financing in foreign markets, and is en-twined with how deep and developed internal public debt markets are.

Governments introduce a series of policies and regulations for consolidating primary and secondary markets for internal debt and for pro-moting adequate conditions for the Nation’s funding in capital markets. It focuses its efforts in providing a smooth functioning of secondary markets under different market conditions and therefore tries to carry through predictable and transparent primary market operations.

(26)

Provided that the debt manager’s purpose is to finance its budget at the lowest cost-risk ratio, having a deep secondary market becomes relevant11_{. Market depth also results in public financing strategies and macroeconomic policies that do not interfere with each other.}

Moreover, depth improves financial market dynamics, and amplifies liquidity while giving relevance to public debt and enabling the identification of a robust and liquid yield curve.

Debt management strategy provides a set of tools for analyzing and identifying challenges faced when addressing market depth issues. In fact, proper medium-term debt management strategies may even deepen the market for securitized public debt by making it transparent and predictable, bolstering the development and implementation of new debt based instruments12_.

2. Colombian case study

2.1. objectives of the MTDS

In recent years, multiple factors took the Colombian economy through structural changes that motivated a review and update of current debt management guidelines (proposed during the nineteen nineties and last revised at the beginning of the last decade).

The challenge of reviewing the strategy guidelines is undertaken by the National Government, led by the Ministry of Finance and Public Credit (MHCP), and falls into the specific tasks set by the National Development Plan (PND), “Prosperity for All”. Accordingly, debt policy draws the rules for optimal management of the Nation’s assets and risks as well as for the efficient administration of the budget. In accordance with article 334 of Colombia’s Constitution, the State is in charge giving direction to the Nation’s economy, assuring fiscal sustainability, necessary in a Social Welfare State. As such, the MHCP includes the MTDS into its tasks.

The Ministry’s strategy is one of the drivers that lead to economic growth. It makes the Nation’s debt sustainable by carrying a prudent management with fewer budgetary burdens in each fiscal term. This outline is vital for a country like Colombia, where its FB faces struc-tural risks associated with the size of the debt, net external income volatility, Terms of Trade volatility and a dependency on particular productive sectors or other commodity producing economies.

Debt managers might make wrong decisions on new issuing if there is no framework or guideline to do so. Therefore, if clear objectives for debt management are not set, there is a chance of facing market volatility and uncertainty in finding funding sources13_{. For the Ministry}

to develop a MTDS, it first defines guidelines for sound public debt management and set goals for integral risk management.

11 _{Investors would rather have government bonds with easily observable prices in a liquid market. This could reflect security finding costs that make non-standardized debt instruments} more expensive (Leong, 1999).

12 _{Incorporating new nodes to the yield curve is possible when there is certainty of medium-term financing sustaniability through continuous issuing.}

(27)

2.2. Background

For more than twenty years, the government has recognized the importance of adequate management of the Nation’s debt portfolio and its impact on fiscal and economic stability. In 1993, a process of improvement of the tools with which the Nation managed debt began, with the enactment of Decree 268114_{. In fact, these regulatory breakthroughs set Colombia as a pioneer and an example on}

debt management to the international community15_.

In 1997, the designing stage of the “Liability Management” program ends and so the implementation stage begins. The project; led by the General Directorate of Public Credit (DGCP) in hand with consultants from Salomon Brothers, aimed to develop a benchmark portfolio for external debt. As a result, the first in-house Risk Workgroup was created within the Ministry of Finance, as well as a Public Debt Advisor Committee16_{in charge of analyzing and defining external and internal debt policy. In the process, risk guidelines were}

proposed, and the benchmark portfolio under which public debt would be managed for the following years along with external debt management strategy were put forward.

In 1998, the Primary dealers program was launched by the MHCP and the BR, boosting the development of domestic public debt markets. In 1999, the financial risk valuation methodology for public debt was established. It was named Debt-servicing at Risk – SDeR for its acronym in Spanish17_{, and it still serves as a tool for analyzing and supporting the Nation’s (and other entities) liability}

management.

In 2001, benchmark debt portfolios were revised and updated, thus initiating a case study on Colombian debt, carried out with the aid of the IMF and the WB. The purpose of this study was to fashion a new document where public debt management guidelines were delivered. In consequence, the new valid goal indicators for designing debt strategy are as follows:

• Maturity Profiles: through a proper maturity profile design, risks of high concentration of annual amortizations are controlled. Current policy considers that an ideal annual maturity profile is 10% to 15% of the total outstanding debt. The average life of the portfolio should be of 5 or more years.

• Interest Rates: this indicator seeks to give direction on how to control interest rate volatility, establishing a limit to variable interest rate issued debt. This should not overpass 30% of the outstanding debt.

14 _{This Decree regulates public credit operations and debt portfolio management operations, as well as debt issuing.}

15 _{This recognition is given in the WB and IMF 2003 publication: “Guidelines for Public Debt Management – Accompanying Document and Selected Case Studies”: In it, Colombia is} presented as a success case study for the sound managing of debt.

16 _{The Committee is composed by the Minister of Finance and Public Credit, the Vice minister of Finance and Public Credit, the Director General of Public Credit and National Treasury, the} Central Bank’s Deputy Manager for Monetary Affairs and International Reserves, plus advising guests relevant for specific subjects. The Central Bank’s presence is due to conjoined management of the Nation’s Assets and Liabilities by the two entities.

17 _{The valuation methodology was developed by the DGCP and it is very similar to the BaR, “Budget at Risk”: and the CaR, “Cost at Risk”. It consists in estimating the present value of the} highest expected surge in debt-servicing costs, given a confidence level and time horizons of one, three and ten years.

(28)

• Currency: this indicator is meant to suggest how to control exchange rate volatility risk. According to it, 83% of the National Government’s external debt portfolio should be denominated in USD, 13% in Euro or other European currency, and 4% in Yen. Later, in 2003, risk hedging credit operations were regulated with the enactment of Decree 2283. In 2004, the government consulted with the Colombian Agency for International Cooperation and Los Andes University, resulting in the document “Revisión y desarrollo de benchmark de deuda interna” (Review and development of an internal debt benchmark). The consultancy had the aim of proposing a restructuring of the Nation’s debt portfolio composition favoring internal debt issuing, following WB recommendations and adhering to the Colombian Fiscal Strengthening Program. Despite the study’s recommendations, the adoption of an internal debt benchmark portfolio was never substantiated as policy.

In 2010, the Government enacted the National Development Plan (NDP) “Prosperity for All”, with the purpose of pushing the Nation’s five productive engines forward; these are housing, infrastructure, agriculture, technologic innovation and the mining and energy sector. These engines are meant to drive the economy for the next four years. In this regard, the MTDS aims to optimize public finance management in a highly sophisticated market, so that the engines run.

Colombia’s debt portfolio of the early nineteen nineties was highly concentrated in domestic debt securities with limited liquidity18_.

None-theless, this structure is now shifting towards a local currency standardized bond portfolio, issued both internally and externally, keeping a close look to market and rolling over risks and cost reduction. To move to a different portfolio structure, issue policy, Liability Management

operations, hedges and debt trades, among other strategies, have taken place.

Debt management guidelines of the nineties were revised at the turn of the century, giving birth to new standards. These new guidelines gave debt a new framework of sustainability, reduced fiscal risk and better debt portfolio risk management, all of which remain valid to date.

In spite of this, the Colombian economy has come across multiple factors that structurally changed it in recent years, motivating the Government to update past debt management methodologies. Some of the aspects worth mentioning are the financial crisis the Nation went through at the very end of last century, the establishment of a floating exchange rate regime, the rapid accumulation of international reserves of the past few years, price stability thanks to the BR’s inflation targeting, the deepening of Colombia´s financial markets along with sustained economic growth driven by the NPD’s “train engines” (see Figure 3). Other external aspects somehow affected the economy as well. Some of them were international financial crises, along with elevated market volatility and a surge in oil prices.

(29)

Figure 3.

International Reserves (uSD Mln), Inflation yoy and Exchange rate

Source: Banco de la República, DANE – July 31st_{, 2012.}

Before continuing with the definition of new guidelines, some of the current valid strategy goals are revised, such as:

• Formally defining a desired composition for the debt portfolio, subject to currency exchange risk. Simultaneously the market whe-re bonds awhe-re issued (internal or external debt) has to be distinguished from its curwhe-rency denomination, particularly when diwhe-rect external debt can be issued and derivatives can be traded.

• Defining a clear goal for the debt portfolio’s composition in terms of inflation indexed securities.

• Defining a maturity profile for the debt portfolio, so that it is smooth and concentrations of maturities make refinancing risk tole-rable and current financing viable.

• Identifying the need for financing from different sources and developing benchmark yield curves that deepen domestic money markets and derivative markets. The access to domestic and international capital markets by entities of subnational order seeking funding should also be sought after.

As mentioned, the behavior of financial variables in the FB may cause fiscal shocks. Because of this, evaluating the nature of cash flows generated by the Nation’s assets and liabilities and their susceptibility to interest rate changes or exchange rate fluctuations is key, as

(30)

well as vulnerabilities to changes in Terms of Trade. The former directly implies the need for classifying assets and liabilities according to risk exposures, so that full hedges can be designed by restructuring the FB composition and other risks and other risks can be managed. All of these notions formed the design guidelines for debt management strategies of the past decades, concepts that will be dealt in more detail in Section 3.8.

3. Medium-Term Debt Management Strategy

3.1. Formulation of the MTDS

The review of the CNG’s debt strategy is a necessity for the current Administration, in the sense that it leads to defining new guidelines for global debt portfolio structures, tending to the adequate financing of budget appropriations, to diminishing medium-term debt costs under sensible risk exposures and contributes to the development of the local capital market. (PND, Article 257). According to this, the characteristics that define the MTDS are described next.

3.1.1. Objectives

The main purpose for contracting debt is to opportunely fund the National General Budget (NGB). As such, the design of a MTDS is subject to:

• Finance budget needs in every fiscal term.

• Minimize medium-term cost of debt with reasonable risk exposures. • Give depth to domestic capital markets.

3.1.2. Guidelines

Along with the aforementioned objectives, additional elements strengthen and broaden the MTDS reach. These are: • Following explicit debt sustainability and refinancing criteria.

• Clearly determining the objectives for MTDS, and periodically reviewing them in order to guarantee coherence with other public policies.

(31)

• Establishing transparence and information disclosure procedures that guarantee the adequate fulfillment of responsibilities and accountability.

3.1.3. Public debt management reach

The CNG debt portfolios are composed by internal and external debt, and credit lines with multilateral and bilateral banking institutions. These liabilities are the subject of management for which the MTDS is created.

3.1.4. Public debt management responsibilities for the Nation

Debt management emphasizes on the following items:

• Defining public debt policy that makes medium-term debt sustainable and fills the debt issue limits approved by Congress.

• Issuing public debt securities and negotiating credit, guaranteeing fund availability in accordance with current regulation.

• Contracting new efficient public credit operations that enable the CNG to manage financial risk and help maintain or improve the debt portfolio maturity profile.

• Recommending liability management operations that comply with the designed MTDS and allow proper and timely manage-ment of financial risks of the debt portfolio, and that cause low fiscal impact on the Nation’s Budget.

• Managing the CNG debt portfolio’s risks, following the MTDS.

• Diversifying funding sources while minimizing currency risk, interest rate risk and debt refinancing risk.

• Disclosing public debt policy information and economic environment conditions of domestic markets to investors.

• Registering and following through with the Nation’s transactions and with State Entity debt warranted by the Nation.

3.1.5. Structure of the Government of Colombia as debt manager

The MHCP, through the DGCPTN, is responsible for efficiently and optimally managing NGB liquid assets and adequately handling public debt. In its role as debt manager, the DGCPTN establishes public debt policy, prioritizing sustainability and adequate balancing

(32)

of risks. It advises to the MHCP on public financing, policies regarding multilateral organisms, risks policies and procedures for public credit operations.

To successfully fulfill all of these functions, the DGCPTN is structured in a way that gives clarity to the market on what it does. Specifically, in what regards the MTDS, the Directorate’s organization is described in the following subsections19_.

3.1.5.1.

Front Office

Deputy Directorate of National Treasury (SDTN): department in charge of directing, administrating and performing treasury operations (mainly trades and issues). These operations are intended to raise funds and issue debt, directly or through intermediaries specialized in managing excess liquidity for portfolios unrelated with National Budget, when the budget is earmarked.

Deputy Directorate of Internal Financing (SFIN): department in charge of structuring and directing the Nation’s financing strategies with local capital market resources. It gives support to other State Entities searching for resources in domestic capital markets on their debt strategy.

Deputy Directorate of International Capital Markets (SFEN): department in charge of structuring and directing the Nation’s financing strategies in external capital markets and with foreign banks. It gives support to other State Entities on how to find capital resources in foreign markets.

Deputy Directorate of Financing with Multilateral Organizations (SFOMG): department in charge of structuring and directing financing strategies with resources from multilateral banking institutions, foreign governments and development banking institutions. It aids other State Entities in their credit negotiations with the mentioned organizations.

3.1.5.2.

Middle Office

Deputy Directorate of Risk (SR): department in charge of defining risk guidelines, policies and strategies concerning the Nation’s public credit, market and liability management. It establishes guidelines for managing the Nation’s warranties, counter-warranties and contingent liabilities. Regarding debt strategy, the SR is in charge of developing the published MTDS document and looking after its fulfillment, in hand with the other deputy directorates. The SR is also in charge of the managing risks associated with contingent liabilities, given the great fiscal impact they have upon the occurrence of contingencies. Due to this high risk, activities aimed to manage these risks are dealt separately from public debt management strategies20_.

19 _{Additionally, the Deputy Directorate of Investment Banking and the Deputy Directorate of Financing for Other State Entities give support to the other deputy directorates and to the} DGCPTN.

(33)

3.1.5.3.

Back Office

Deputy Directorate of Operations: department in charge of coordinating allocations and managing the Single National Account (SNA) with the Monthly Basis Annual Cash Schedule (PAC for its acronym in Spanish).It also controls, executes and registers all the operations undertaken by the DGCPTN.

BOX A. Strategic support departments

Legal Affairs: department in charge of advising and giving legal accompaniment to all of the DGCPTN Deputy Directorates, so that all of the public credit operations, and related operations, are within current regulations.

Deputy Directorate for Investor Relations: proposes and advises on the Nation’s strategy for approaching market agents, investors and other parties interested in concurring in public debt operations. Its purpose is to improve information disclosure; the overall perception on Colombian public debt, its economy and investment opportunities in the country. It contributes in broadening Colombia’s possibilities of raising capital and financing.

3.2. CNG outstanding debt and maturity profiles

The DGCPTN debt strategy is focused on minimizing the debt portfolio vulnerability to internal and external shocks, so that it becomes stable and the Nation’s funding programs are fulfilled with good management indicators. This section analyzes the debt portfolio’s struc-ture and its evolution for a time span ranging from June 2002 to July 2012 (see Table 1).

(34)

Table 1.

CNG debt portfolio evolution (Annual averages)

CNG DEBT PORTFOLIO EVOLUTION 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Market of issuance Internal 53% 51% 51% 62% 65% 67% 69% 67% 70% 71% 72% External 47% 49% 49% 38% 35% 33% 31% 33% 30% 29% 28% Currency denomination External debt USD 82% 83% 83% 82% 81% 78% 79% 82% 81% 81% 79% Euro* 13% 14% 14% 12% 9% 8% 4% 3% 2% 1% 0% Yen 4% 4% 2% 2% 2% 2% 2% 2% 3% 3% 3% COP 0% 0% 0% 4% 8% 13% 15% 13% 14% 15% 18% Internal debt COP 69% 68% 70% 74% 76% 77% 76% 75% 77% 76% 75% UVR 27% 28% 28% 25% 24% 22% 24% 24% 23% 24% 24% USD 5% 4% 2% 1% 0% 0% 0% 0% 0% 0% 0%

Interest rate External debt Fixed 78% 80% 80% 81% 83% 83% 82% 85% 82% 80% 80%

Floating 22% 20% 20% 19% 17% 17% 18% 15% 18% 20% 20% Financing source External debt Bonds 61% 58% 55% 57% 59% 58% 57% 56% 56% 56% 57% Multilateral credit 30% 36% 39% 37% 40% 41% 42% 43% 44% 43% 42% Other 9% 6% 6% 5% 2% 1% 1% 1% 1% 1% 1%

Internal debt TES 78% 81% 83% 87% 89% 91% 93% 94% 95% 97% 98%

Other** 22% 19% 17% 13% 11% 9% 7% 6% 5% 3% 2%

Average

portfolio life Internal debt (TES)External debt

6.2 7.1 7.3 7.4 8.3 9.4 9.9 10.3 10.7 10.1 10.8

4.5 4.1 3.8 3.9 3.9 4.0 4.2 4.7 4.9 5.1 5.2

* Including debt denominated in other currencies.

** Including Law 546/99 bonds, farming bonds, peace bonds, security bonds, debt reduction securities, treasury notes, among others.

3.2.1.

CNG total outstanding debt

The CNG outstanding gross debt as of July 31st_{2012 amounted to COP 213 trillion, of which COP 154 trillion are internal debt and}

(35)

behaviors (see Figures 4a and 4b). This is largely a result of fluctuations in exchange rates, where appreciations of the local currency lower the value of CNG debt in COP.

Figure 4.

CNG Gross outstanding Debt (CoP Billion) and Total Debt variation (yoy)

Figure 4a. Figure 4b.

Source: Deputy Directorate of Risk DGCPTN – July 31 2012

During the last decade, the National Government kept the debt-to-GDP ratio around 40% in average, with a downward trend going from 45% to 35% (see Figure 5). The weight of internal debt relative to total debt outstanding has remained relatively stable along the decade, amounting to 28.5% of GDP in 2005, but averaging 25% overall. On the other hand, external debt as a percentage of GDP has shown negative variations of up to 11% between 2002 and 2011, settling at a level of 10.4% at the end of the latter year. Needless to say, this reduction of debt-to-GDP ratios is consistent with the Government’s fiscal responsibility policy and debt sustainability criteria.

(36)

Figure 5.

CNG Debt to GDP (%)

Source: DGPM – July 31 2012

The past decade witnessed a restructuring of the CNG debt portfolio. While in 2002, 50% of all liabilities were internal debt, by the end of the first quarter of 2012, 72% of the portfolio was composed by internal debt and 28% external debt (see Figure 6). The proportion of internal debt in the debt portfolio has increased due to active policy oriented towards larger domestic issuance, thus reducing currency risk.

(37)

Figure 6.

CNG Debt market of issuance (CoP Billions)

Source: Deputy Directorate of Risk DGCPTN – July 31, 2012

In Colombian markets, internal public debt securities – TES are the most commonly used debt securities. These issues are gaining mo-mentum and are now the Nation’s main source for funding (see Figure 7). The majority of TES issues are fixed rate, COP denominated securities, and sum up to 74% of all issues. In 2011, the CNG raised COP 4 trillion with this instrument. Moreover, 59% of outstanding TES bonds have medium to long-term maturities and only 3% of them are due on dates shorter than a year (these last securities are issued on discount21_).

External debt is composed by Global TES securities and external bonds, and together, these represent as much as 57% of the Nation’s external debt, followed by credit lines with multilateral credit institutions. In spite of this, external gross debt in COP has decreased as a result of two main factors: i) currency risk reduction strategies, and ii) the effect currency appreciation on outstanding debt (see Figure 8).

(38)

Figure 7.

CNG Debt composition by instrument

Source: Deputy Directorate of Risk DGCPTN - July 31 2012

Figure 8.

uSD-CoP exchange rate (TRM

22

)

(39)

As far as currency composition goes, CNG debt is largely COP denominated (59%). A smaller portion is USD denominated (19%) and UVR denominated (18%). The remaining portion of the portfolio is denominated in other currencies, such as Yen and Euro (see Figure 9).

Figure 9.

Gross debt currency composition

Moving on, since early 2004, the MHCP through the DGCPTN decided to modify the debt portfolio’s currency composition, in search of increasing the percentage of COP denominated debt in the portfolio over the observed 50%. The goal of doing so was to reduce currency risk in the debt portfolio.

In more detail, while Global TES securities are mainly issued at fixed-rates, interest rates for loans with multilateral banking institutions are generally floating. By the end of the first quarter of 2012, 90% of debt paid interests at fixed-rates, revealing a preference for interest rate risk by debt portfolio managers in Colombia (see Figure 10).

(40)

Figure 10.

CNG Debt composition by interest rate

3.3. Risk management analysis and the benchmark portfolio

The main risks to which the National Governemnt is exposed when contracting debt are refinancing or rollover risk and market risk23_(see

Table 2, where the main risks to which the CNG is exposed are defined). Monitoring them properly is essential for insuring adequate risk management and reducing impact on the fiscal balance.

Table 2.

Public debt management associated risks

Market Risk The possible variation in debt-servicing costs and outstanding debt as a result of interest rate or exchange rate _{volatility or inflation surges.} Rollover Risk The limited acces to credit in terms of availability and credit terms.

(41)

The weight of COP denominated debt inside the portfolio has increased in past years, leading to lower currency risk exposures in line with the Government’s objectives for debt management. In this manner, by the end of 2002, the debt portfolio was composed of 35% COP denominated debt, 14% UVR, and the remaining 52% of debt denominated in other currencies. More recently, as of July 31st_2012,

59% of the debt was denominated in COP, 23% in other currencies and 18% in UVR.

Interest rate risk, on the other hand, is the variation on servicing costs of floating-rate issued debt on a fiscal year, resulting of interest rate volatility plus maturities under a year of expiration that have to be refinanced (see Figure 11). Even though the debt portfolio is highly concentrated in fixed-rate securities (see Figure 10), the debt cost refixing indicator is around 15% in average, as a result of expiries under a year time.

Lastly, the majority of the portfolio has a remaining mean life of 5 years (about the same percentage of UVR and COP issues, where most of the portfolio is concentrated). On the other side of the portfolio, the easiness of issuing with longer maturities in foreign markets and prepayment conditions of loans with multilateral banks stretch the length of the life of the portfolio (see Table 1).

Figure 11.

Debt cost refixing indicator

(42)

It is also worth noticing how the average life of the portfolio increased, due to debt portfolio restructuring operations and the creation of new nodes of the yield curve for new maturities, both domestically and internationally (see Figure 12; and for more detail Section 3.5).

Figure 12.

Average Life (yrs)

As for amortization profiles for CNG debt, maturities of the portfolio are highly concentrated around 2012, implying high rollover risk (see Figure 13). However, in the analyzed time lapse, due dates of the outstanding debt are still below the recommended 15% of total debt. In some cases, they even rest under 10%. Despite the lack of uniformity of the debt amortization profile, improvements are observed because of higher percentages of the portfolio issued on long-term maturities.

When analyzing the evolution of rollover risk exposures classified by type of debt, the effect of a deeper domestic capital market. Likewise, greater accessibility to issuing long-term debt in international markets has shaped internal and external debt portfolio maturity profiles (see Figure 14 and Figure 15).

(43)

Figure 13.

Annual CNG debt portfolio amortizations percentage

Figure 14.

CNG debt portfolio maturity profile

(44)

Debt management has positively affected domestic market depth and improved the world’s perception on the risks of investing in Colom-bia. Furthermore, the Nation has stretched its yield curve by adding new long-term debt nodes. On that account, it is now possible to issue 15 year COP denominated bonds and 20 year UVR denominated bonds in domestic public debt markets, 20 year COP denomi-nated bonds and 30 year USD denomidenomi-nated sovereign debt abroad.

Figure 15.

CNG external debt portfolio maturity profile

3.4. Benchmark portfolio

In accordance with current regulations, the DGCPTN is responsible of developing policy for efficiently managing and administrating public debt and its servicing. Hence, it identifies, quantifies and controls the portfolio’s exposure to financial risk.

In virtue of this faculty, the SR of the DGCPTN controls negative shocks that outstanding debt and debt-servicing costs may have on the macroeconomic environment and the Nation’s Budget. It is in charge of insuring that financing requirements are met and that obligations derived from liabilities are delivered at the least cost possible, with reasonable exposures to risk in a medium to long-term spectrum. The SR implements goal indicator methodologies for managing the debt portfolio. These indicators encompass the desired structure of the debt portfolio in terms of expected costs and risk tradeoff. They help to hedge and control the Nation’s risk exposures. Therefore, benchmark portfolios are defined next.

(45)

3.4.1. Exchange rate indicator – Currency composition

Currency composition of the debt portfolio is a direct indicator for the magnitude of currency risk exposures. The second part of the book elaborates on this subject. There, methodologies for measuring and mitigating this type of risk are exposed. The technical exercise that shows the portfolio’s currency composition under the ALM or the Cost-Risk approach is explained.

As a result, an ideal currency composition for the debt portfolio of 75% local currency (COP and UVR) and 25% foreign currency (USD) was found. Maintaining said composition requires the definition of a specific debt issuance strategy of 80%-20% local-foreign currency placement for 2012-2017.

3.4.2. Maturity indicator – Debt amortization profile

As mentioned earlier, refinancing risk is one of the largest exposures of the Nation’s debt portfolio. As such, in consideration of fiscal responsibility, the SR defines the rollover portfolio, meant for controlling risk by bounding maturity concentrations in single fiscal terms. Current DGCPTN policy asserts that an ideal level for annual maturity concentrations is 10% of outstanding debt and sets the upper bound at 15%. Under these assumptions, average life of the Nation’s outstanding debt exceeds the 5 year mark, which is the minimum mean maturity profile lifespan recommended in debt management literature.

For verifying this fact, consider the following definition for the average remaining life of a liability with principal P, to be paid back in

n

periods and installments { :1Pi £ £i n}:

1 n i i i

P

ML

t

P

=

å

×

where

t

_i is time in years. Now, assuming scenarios where the principal is repaid during the first 10 years of life of the liability24_and

annual maturities do not exceed 10% of the portfolio, then payments P Pi/ are equal to 10%25. With this, the average life ML would be:

1

(10%)

7 yrs

n i i

ML

t

=

å

× =

Issuance strategies with longer maturity structures under the 10%-15% threshold would equate longer average maturity profiles.

24 _{This is a stressed scenario for it implies that the CNG is forced to honor all of its liabilities in a 10 year timeframe. Nonetheless, from previous sections the existence of longer maturities} is clear (see Figures 13, 14 and 15).

(46)

3.4.3. Interest rate indicator– Interest rate composition of the portfolio

This indicator measures exposure to fluctuation in interest rates. For controlling said risk, limits are established to the amount of floating-rate debt issued. The current valid indicator states that this set of issues should only amount up to 30% of total outstanding debt (see Chapter 2). Currently, 20% of the external debt portfolio is floating-rate liabilities. Credit lines with multilateral banking institutions and other governments usually have tailor made structures and interest rates that serve the particular purpose of the raised debt and each of the credit terms. As for internal debt portfolios, the percentage of liabilities indexed to fl

Medium-Term Debt Management Strategy

Ministry of Finance and Public Credit

CoNTENTS

Foreword

IntroductIon

Medium-Term Debt Management Strategy

Figure 1.

1.2. Benchmark Portfolio

1.2.1. Benchmark Portfolio - Definitions

1.2.2. other tools for debt management – Hedging instruments

Figure 2.

1.3.1. Asset and Liability Management approach

1.3.2. Development and efficiency of domestic markets

2. Colombian case study

2.2. Background

Figure 3.

3. Medium-Term Debt Management Strategy

3.1.2. Guidelines

3.1.4. Public debt management responsibilities for the Nation

3.1.5. Structure of the Government of Colombia as debt manager

Front Office

Middle Office

BOX A. Strategic support departments

Table 1.

CNG DEBT PORTFOLIO EVOLUTION 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CNG total outstanding debt

Figure 5.

CNG Debt market of issuance (CoP Billions)

CNG Debt composition by instrument

Figure 10.

Table 2.

Figure 11.

Figure 13.

Figure 15.

3.4.1. Exchange rate indicator – Currency composition

3.4.3. Interest rate indicator– Interest rate composition of the portfolio