Risk Financing Immunization The case of Uruguay The case of Uruguay Carlos Steneri Carlos Steneri October 26 th , 2010
Lessons from experience Lessons from experience • Recent debt crises taught that roll over risk is the • Recent debt crises taught that roll over risk is the most important challenge debt managers have to deal with. • Sudden capital reversals are the usual trigger of debt crises, mainly when the debtor’s profile amortization has a high concentration of short term amortization has a high concentration of short term maturities. • Debt management strategies that are biased • Debt management strategies that are biased towards reducing financing costs without a proper risk evaluation are prone to enter in this trap. p
• Funding is concentrated in the short term because debt Funding is concentrated in the short term because debt managers: – Take for granted short term funding availability under any circumstances. – Underestimate the probability of fiscal or financial crisis (external or domestic). – Dismiss the real dimension of international contagion. – Ignore fat tails events (uncertain events). I f t t il t ( t i t ) • Once Roll Over constraints appear, policy makers begin to r n the facts from behind run the facts from behind. – Accepting higher financing costs. – Shortening maturities even more. – Triggering a sequence of events characterized by the T i i f t h t i d b th increase in risk aversion and liquidity stringency which deepen the crisis. • That scenario could degenerate in a solvency problem , that eventually lead to default.
Principles in Roll Over Risk I Immunization i i • Financing risk prevention is always less expensive than Financing risk prevention is always less expensive than crisis resolution costs. This principle must be included in any Debt Management Strategy. • Adequate Liability Management (LM) is the crucial tool to achieve that goal. – Stretching out maturities S – Pre-financing short term amortizations ( cash holdings ) • Cash management becomes a strategic component to C h t b t t i t t strengthen financing risk immunization. • The implementation of some sort of Greenspan-Guidotti rule is suitable to achieve that goal.
Principles in Roll Over Risk p Immunization • The optimal policy mix between extension and cash The optimal policy mix between extension and cash accumulation depends on market conditions. • As a general rule, financing risk immunization is done A l l fi i i k i i ti i d cheaper through maturity extension than cash accumulation. – Particularly in times when long term interest rates are low. – Carry trade on reserve holdings is high. • The respective policy sequence is Th ti li i – Look for maturity extension through swaps and buybacks in the short end of the curve and then – Implement some sort of Greenspan-Guidotti rule – Implement some sort of Greenspan-Guidotti rule.
Roll Over Risk Immunization in Roll Over Risk Immunization in Uruguay Fi First Step: Debt Profile Smoothening t St D bt P fil S th i Second Step: Greenspan - Guidotti Rule implementation Rule implementation
First Step: Debt Profile Smoothening p g As of December 2004 As of December 2004 As of September 2010 As of September 2010 2011: 2.5% GDP 2005: 7.9% GDP 2,000 2012: 1.5% GDP 2006: 8.8% GDP 1,800 2013: 0.9% GDP 2007: 5.8% GDP 1,600 1,400 1,200 1,000 800 600 400 200 0 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 Source: Debt Management Unit, Ministry of Finance
Second Step: Greenspan - Guidotti R l Rule implementation i l i • PRINCIPLES PRINCIPLES – Fiscal gap is financed with debt. – Macroeconomic policy could be affected by p y y uncertainty (fat tails, sudden Stops, unexpected events). – Cash accumulation to cover short term debt service Cash accumulation to cover short term debt service (interest + amortization). • SETTING THE RULE SETTING THE RULE – Value at Risk model to determine bad states of nature occurrence probability.
Shadowed area show periods when Uruguay Sh d d h i d h U faced financing stringency Source: Ministry of Finance.
DMU DMU´ ´s s studies studies show show that that Markets Markets were were closed closed up up to to: : i) i) 9 9 months months with with a 95% a 95% probability probability; ; ii ii) 14 ) 14 months months with with a 99% of a 99% of probability probability
Results Results • Central Government cash holdings Central Government cash holdings equivalent to: – 9 months protects against 95% of capital reversal risk – 14 months cover 99% of that risk
Uruguay´s Central Government cash Uruguay s Central Government cash holdings could easily cover both events 6% Assets of CG Amortizations 5% 4.50% 4% GDP % of G 3% 2.50% 1.80% 2% 1.50% 1.00% 0.90% 1% 0.70% 0% 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 Sources: Ministry of Economy.
Uruguay pre-funding strategy allowed the country to stay out of capital markets during t t t t f it l k t d i the post Lehman episode (Sept 2008) 1000 900 800 EMBI Uruguay EMBI Uruguay 700 600 bps 500 400 400 300 200 100 0 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Source: Bloomberg - JP Morgan
Liability Management diminished financial vulnerabilities vulnerabilities Increasing share of g I Increasing debt i d bt domestic currency 100% 40% with fixed rate denominated debt 35% 95% 30% 90% 25% 85% 20% 20% 80% 15% 75% 10% 5% 70% 0% Local currency denominated debt (% of Total) % of Debt with Fixed Rate Significant g 20 20 improvement in 20% Decreasing roll debt profile 15 over risk 15% 10 10% 5 5 5% % Debt Due in One Year 0 0% Average Time to Maturity (in years) Source: Debt Management Unit, Ministry of Finance
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