Risk Financing Immunization The case of Uruguay The case of Uruguay - - PowerPoint PPT Presentation

Risk Financing Immunization The case of Uruguay The case of Uruguay

Carlos Steneri Carlos Steneri October 26th, 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. I f t t il t ( t i t ) – Ignore fat tails events (uncertain events).

• 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. T i i f t h t i d b th – Triggering a sequence of events characterized by the 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 i i Immunization

• 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.

S – Stretching out maturities – Pre-financing short term amortizations ( cash holdings )

C h t b t t i t t

• Cash management becomes a strategic component to

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. A l l fi i i k i i ti i d

• As a general rule, financing risk immunization is done

cheaper through maturity extension than cash accumulation.

– Particularly in times when long term interest rates are low. – Carry trade on reserve holdings is high.

Th ti li i

• The respective policy sequence is

– 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 t St D bt P fil S th i First Step: Debt Profile Smoothening Second Step: Greenspan - Guidotti Rule implementation Rule implementation

First Step: Debt Profile Smoothening p g

2,000

2011: 2.5% GDP 2005: 7.9% GDP

As of December 2004 As of December 2004 As of September 2010 As of September 2010

1,200 1,400 1,600 1,800

2012: 1.5% GDP 2013: 0.9% GDP 2006: 8.8% GDP 2007: 5.8% GDP

400 600 800 1,000

2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036

200

2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 Source: Debt Management Unit, Ministry of Finance

Second Step: Greenspan - Guidotti R l i l i Rule implementation

• 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

• ccurrence probability.

Sh d d h i d h U Shadowed area show periods when Uruguay 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

5% 6%

Assets of CG Amortizations

4.50% 4% GDP 1.80% 2.50% 1.50% 2% 3% % of G 0.90% 0.70% 1.00% 0% 1% 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015

Sources: Ministry of Economy.

Uruguay pre-funding strategy allowed the t t t t f it l k t d i country to stay out of capital markets during the post Lehman episode (Sept 2008)

800 900 1000

EMBI Uruguay

400 500 600 700

bps EMBI Uruguay

100 200 300 400 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10

Source: Bloomberg - JP Morgan

I i d bt

Liability Management diminished financial vulnerabilities

Increasing share of

20% 25% 30% 35% 40% 85% 90% 95% 100%

Increasing debt with fixed rate

vulnerabilities

g domestic currency denominated debt

0% 5% 10% 15% 20% 70% 75% 80% Local currency denominated debt (% of Total) % of Debt with Fixed Rate 20

Significant

5 10 15 20 10% 15% 20%

Decreasing roll

• ver risk

g improvement in debt profile

5 0% 5% % Debt Due in One Year

Source: Debt Management Unit, Ministry of Finance

Average Time to Maturity (in years)