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Government Debt Management and Bond Markets
in Africa
Hans Blommestein and Greg Horman
This article presents highlights from the forthcoming OECD cross-country
study Public Debt Management and Bond Markets in Africa.
Debt managers from an increasing number of emerging market jurisdictions
face challenges similar to those of their counterparts from advanced
markets due to competitive pressures from global finance and the related
need to implement OECD leading practices in this policy area. The article
shows that OECD standards in public debt management and related market
operations are, therefore, of great importance for public debt management
and bond market development in Africa. Several African debt managers
have introduced the leading debt management practices of OECD countries,
use them for designing new debt strategies (including for managing
contingent liabilities), and have made impressive progress in developing
their local government securities markets. Many countries in the region are
taking advantage of debt reduction initiatives. Avoiding falling back into
positions of unsustainable debt is identified as a key challenge for many
African governments.
OECD financial policy makers are increasingly interested in developments
in emerging markets, including those on the African continent. Moreover,
emerging markets (including the latest emerging market region, Africa) are
an increasingly important asset class for investors from the OECD area.
Thus, the policy conclusions and priorities identified here are of interest to
not only African countries but also the OECD area and other emerging
market countries. Local bond markets in several African countries have
gained in strength in terms of liquidity and maturity structure, making them
more attractive for important categories of OECD investors and less
vulnerable to exchange rate shocks.
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Government Debt Management and Bond Markets
in Africa
Hans Blommestein and Greg Horman*
I.
Introduction and overview
OECD cross-country
study on public debt
management and bond
markets in Africa
This article presents highlights from the forthcoming
OECD cross-country study on public debt management and
bond markets in Africa.
1
The study benefited from the
policy conclusions and recommended strategic priorities
that emerged from the First OECD Forum on African
Public Debt Management, held in December 2006 in
Amsterdam,
2
and the suggested critical operational issues
in developing efficient and liquid primary and secondary
bond markets from the First Regional Workshop on African
Debt Management and Bond Markets, held in April 2007 in
Johannesburg.
3
Policy analysis draws
on leading practices
identified by the OECD
Working Party on Debt
Management
The policy analysis draws heavily on the leading
practices identified by the OECD Working Party on Debt
Management, as they serve in practice as a global standard
in this area of government financial management.
4
Debt
managers from an increasing number of emerging market
jurisdictions face challenges similar to those of their
counterparts from advanced markets due to competitive
pressures from global finance and the related need to
implement OECD leading practices in this policy area. The
article shows that OECD standards in public debt
*
The authors are from the Financial Affairs Division of the OECD Directorate for
Financial and Enterprise Affairs, where Hans Blommestein is the Head of the
OECD Public Debt Management and Emerging Financial Markets programmes
and Greg Horman is Consultant and the technical expert for the OECD project on
African Debt Management. The opinions expressed and arguments employed in
this article do not necessarily reflect the official views of the OECD or of the
governments of its member countries.
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management and related market operations are, therefore,
of great importance for public debt management and bond
market development in Africa. Several African debt
managers have introduced the leading debt management
practices of OECD countries, use them for designing new
debt strategies (including for managing contingent
liabilities), and have made impressive progress in
developing their local government securities markets.
Many countries in the region are taking advantage of debt
reduction initiatives. Avoiding falling back into positions of
unsustainable debt is identified as a key challenge for many
African governments.
Emerging markets are
an increasingly
important asset class,
including Africa
OECD financial policy makers are increasingly
interested in developments in emerging markets including
those on the African continent. Moreover, emerging
markets (including the latest emerging market region,
Africa) are an increasingly important asset class for
investors from the OECD area. Thus, the policy
conclusions and priorities identified here are of interest to
not only African countries but also the OECD area and
other emerging market countries. Local bond markets in
several African countries have gained in strength in terms
of liquidity and maturity structure, making them more
attractive for important categories of OECD investors and
less vulnerable to exchange rate shocks.
This article proceeds as follows. Section II identifies
some of the main policy issues and questions in debt
management and government securities markets in Africa.
Section III looks in closer detail at challenges for local-
currency bond markets in African countries and the
development of debt strategies. Both of these sections
include a cross-country overview and country examples.
Section IV considers the management of contingent
liabilities, drawing on principles developed in the OECD
area and the experience of South Africa. Section V closes
with policy recommendations and priorities.
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II.
Review of policy issues and questions
Cross-country overview
African economies are
diverse
At a single-country level, it is difficult to generalise
about debt management and government securities markets
in Africa. African countries are very diverse in terms of
their economies, debt situations, debt management
practices and capacity, and government securities markets.
Taking a cross-country perspective, however, allows a
number of common trends to be identified.
Figure 1. Macroeconomic performance of African countries
Mean
Petroleum-exporting
Non petroleum-exporting
a. GDP growth
0%
1%
2%
3%
4%
5%
6%
7%
8%
1 998- 20 04 2005 2 006 2 007 20 08
b. Inflation
0%
2%
4%
6%
8%
10%
12%
14%
1998-
2004
2005 2006 2007 2008
c. Current account balance
-6%
-3%
0%
3%
6%
9%
12%
15%
1998-
2004
2005 2006 2007 2008
d. Budget balance
-4%
-2%
0%
2%
4%
6%
8%
10%
1998-
2004
2005 2006 2007 2008
Source: OECD and African Development Bank, African Economic Outlook 2007.
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GDP growth continues
to be strong and
macroeconomic
conditions have
improved
Turning first to the macroeconomic background,
growth continues to be strongly on track in Africa.
5
From
being on average around 4% in the period of 1998 to 2004,
annual GDP growth since then has been between 5% and
6% (Figure 1a). Across the continent, the average inflation
rate is now around 9%, with markedly different experiences
between net exporters and net importers of petroleum
(Figure 1b). Current account balances show a diverse
picture but have improved for much of Africa, notably the
petroleum-exporting countries (Figure 1c). At the same
time, budget balances have improved. They are materially
positive for petroleum-exporters and have remained
stabilised at a deficit of between 2% and 3% of GDP for the
others (Figure 1d).
Figure 2. Currency composition of government debt in African countries
0%
25%
50%
75%
100%
125%
150%
175%
200%
Local-currency debt Foreign-currency debt
Source: IMF, country authorities, authors’ calculations.
Debt levels are still a
problem
Over recent years, a number of countries have
benefited from external debt relief under multilateral debt
relief initiatives. That said, in many countries, debt levels
are still a problem, especially in view of structural
vulnerabilities. Similarly, after debt relief, risk-based debt
sustainability needs to remain a focus of debt strategy,
supported by sound macroeconomic policies.
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Foreign-currency debt
predominates, and
local-currency debt is
mainly short-term
Foreign-currency debt predominates in African
countries (Figure 2). This situation is typically a
consequence of a reliance on concessional multilateral and
bilateral funding and rudimentary domestic markets, but
some African countries now have good access to the
international capital markets or have begun to develop their
domestic markets. Local-currency debt is predominantly
short-term (Figure 3), but some countries successfully issue
across the yield curve and out to long tenors. The issuance
of local-currency debt in some countries is erratic and in
small volumes, leading to problems in developing fungible
and liquid instruments and benchmarks. These
considerations raise the question of what are the priorities
and appropriate policies for developing market-based
funding.
Figure 3. Tenor of local-currency government debt securities in African countries
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Source: Standard and Poors’, country authorities, authors’ calculations.
Domestic market needs
to be developed
Local commercial banks tend to be the main holders of
domestic securities. This reflects weaknesses in the
commercial lending operations and, in some cases,
excessive requirements to hold government securities.
Some countries, however, have relatively vibrant pension
funds and other institutional investors, which encourages
more diverse ownership. Non-resident holdings are
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typically low. Domestic market infrastructure, including
settlement and custody systems, is often weak. These
considerations raise the question of what priority should be
given to developing the domestic market and investor base
and the correct sequencing of steps for doing so.
Local-currency debt is
relatively costly but
minimises exchange
rate risk
Interest payments on local-currency debt often
consume a larger share of revenues than those on foreign-
currency debt, even though foreign-currency debt
predominates in nominal terms (Figure 4). This is because
local-currency debt is more costly than foreign-currency
debt (Figure 5), reflecting the availability of externally
sourced funding on concessional terms and high real
interest rates in the domestic market. The policy question
arises concerning the appropriate balance between
minimising cost and minimising risk, in particular taking
account of the major risks (interest rate, exchange rate, and
refinancing) and possibility of other budgetary shocks, such
as from a sudden drop-off in aid inflows.
Figure 4. Interest payments on government debt in African countries
0%
5%
10%
15%
20%
25%
30%
35%
40%
Local-currency debt Foreign-currency debt
Source: Standard and Poors’, country authorities, authors’ calculations.
Quasi-government debt
is a common feature
Quasi-government debt is a feature in many African
countries. For instance, some central banks issue their own
bills to manage liquidity or implement monetary policy.
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This may be a consequence of an absence of a sufficient
supply of government securities, but the question arises
whether the existence of central bank bills impedes the
development of the government securities market.
Similarly, there may be pricing anomalies or fragmented
liquidity when government securities and central bank bills
co-exist. Some debt of state-owned enterprises, other
government agencies, or even the private sector is
guaranteed as well. With some exceptions, guarantees are
not well managed or accounted for in African countries,
albeit that situation is not unique to Africa.
Figure 5. Implicit interest rate on government debt in African countries
0%
5%
10%
15%
20%
25%
Local-currency debt Foreign-currency debt
Source: Standard and Poors’, country authorities, authors’ calculations.
Institutional
frameworks are often
weak
Turning to institutional problems and issues, African
countries generally have explicit legal requirements
governing debt contracting and servicing, but the
framework is not always clearly defined and adequately
implemented. The legal requirements for transparency and
accountability are often limited. The resources available to
debt management are constrained in many countries, again
a situation not unique to Africa. This includes the quantity
of staff, their skill levels, and technological resources for
managing the debt stock and new debt issuance on a
professional basis.
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Debt management has
links with fiscal and
monetary policy
Given the interdependencies between their different
policy instruments, it is important that debt managers, fiscal
policy advisers, and central bankers share an understanding
of the objectives of debt management, fiscal, and monetary
policies. The role of central banks is of special relevance
for Africa, where many debt management activities
continue to be performed by central banks.
Good governance is
important
The specific institutional structure for debt
management is less important than ensuring that there is
good governance and that there are forward-looking
policies focused on risk-based debt sustainability. It is
worth noting, however, that institutional responsibilities are
often fragmented across front and back office functions,
across local-currency and foreign-currency debt, and across
agencies in Africa countries. In several countries, the focus
of debt management as a distinct activity is still heavily on
debt recording and servicing. The middle office functions
of debt strategy formulation and risk management are often
absent. All these factors impede taking an integrated
approach to debt management. Co-ordination between debt
management and macroeconomic policies is often weak.
Formal debt strategies
should be developed
Some African countries have developed formal debt
strategies. A formal strategy explicitly balances cost and
risk, takes account of demand constraints but often
incorporates initiatives to develop the market and new
funding sources, and supports macroeconomic stability and
debt sustainability. For most African countries, though,
debt strategy remains ad hoc. Admittedly, the range of
funding sources is often narrow, and discretion in terms of
the risk characteristics of new debt may be limited. The
critical issue here is that opportunities may be missed, at
the margin, to improve the structure of the debt or widen
the range of funding sources. For countries that have
benefited from debt relief, the lack of a formal debt strategy
increases the risk of a return to an unsustainable debt
position in future.
Country examples
South Africa
In South Africa, the Reconstruction and Development
Programme in 1993 was the first socio-economic policy
and development planning framework for rebuilding South
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Africa post-apartheid. It focused on meeting basic needs,
developing human resources, building the economy, and
democratising the state and society. It was followed in 1994
by a white paper on reconstruction and development,
which, however, was seen as inadequate to deliver the
required economic growth without further macroeconomic
and structural policies to accelerate growth. This paved the
way for South Africa’s current macroeconomic policy, as
set out in the 1996 growth, employment, and redistribution
(GEAR) strategy. The GEAR strategy established
economic targets, including a budget deficit target, and
outlined additional financial reforms, such as
improvements in revenue collection. An important focus of
GEAR was on restoring the international credibility of the
economy.
The picture on the debt side over the past decade in
South Africa has been impressive. The budget deficit as a
percentage of GDP has declined. Debt has increased in
gross nominal terms, but net debt has fallen as a percentage
of GDP, as have debt servicing costs. The debt portfolio is
diversified across instruments and tenors but is dominated
by bonds issued in the domestic market, which are
attractive from a risk-reduction standpoint. Liquidity in the
domestic bond market has grown significantly, while
spreads to yields in developed markets have declined.
There are both fully developed nominal and real
government yield curves.
Debt management arrangements in South Africa are
characterised by sound fiscal and monetary policies, co-
ordination between debt strategy and monetary policy,
stability in the macroeconomy and financial sector, strong
credibility of the government in both domestic and external
markets (reflected, for example, in an investment-grade
credit rating), and high-level buy-in of the debt strategy at
cabinet level. An ongoing challenge is to build operational
debt management capacity in the finance ministry.
Nigeria
Recent restructuring has resulted in significant amounts
of debt in Nigeria being cleared. On the domestic side, debt
is accounted for by, among other things, $10 billion of
securities and still over $12 billion of arrears to contractors
and others. A strong grasp on contingent liabilities is
lacking. Successful initiatives regarding domestic securities
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have included lengthening the maturity structure and
smoothening the redemption profile. There is a system of
primary dealers and market makers. While in general the
selection of dealers has been careful, dealers have not
always behaved well. Banks dominate holdings of
government securities, but holdings by pension funds have
grown. Much of domestic issuance is undertaken not to fill
a funding gap but, instead, to provide securities to the
market for its development. Challenges for Nigeria include
an economy subject to macroeconomic volatility and the
need to improve governance, improve data collection and
data quality, strengthen the legal framework for debt
management, develop the local market, widen the investor
base, and improve the sovereign credit rating.
Kenya
The authorities in Kenya began a five-year reform
programme in 2005. The current situation is characterised
by weak institutional arrangements, scattered organisation,
ad hoc strategy, and serious understaffing accompanied by
high turnover. There is weak co-ordination of debt
management with monetary and fiscal policy, which leads
to several problems, including a lack of clarity regarding
which agency is responsible for domestic debt
management. Co-ordination with cash management is poor
as well. Until recently, debt recording was not
comprehensive and reliable, or the information was not
fully exploited. Kenya has benefited from the assistance of
MEFMI and other international organisations. There is a
need in Kenya to establish a long-term perspective on the
domestic market and build relationships with the market.
Also needed is high-level political ownership to drive
through change in debt management, in particular in
securing wide stakeholder participation and buy-in.
Uganda
Uganda has begun formalising its debt management
arrangements. Peculiarities of the situation there discourage
development of the domestic market. Almost half of the
budget is donor funded, and post-debt relief the country is
attractive as an external borrower. More participants need
to be attracted to the domestic market. There is concern that
the situation is dangerous without a formal debt strategy,
though. Currently, no one in the government is working on
a formal debt strategy, due to limited resources. The
authorities identify a need to develop a long-term
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sustainability path, better analysis of the debt, and better
ability to manage risk in future. Separation of fiscal and
monetary policy is needed as well. The quality of
information on the debt is poor, despite much duplication
of effort.
Domestic government securities in Uganda are
currently used only for monetary policy operations. Since
2004, the central bank has issued 2, 3, 5, and 10-year
government bonds, but issuance of the 5 and 10-year bonds
is going to be suspended. Treasury bills are also issued for
liquidity management. In conducting monetary policy, the
yields on bonds are generally higher than yields on treasury
bills, reflecting the term premium for longer-dated
securities. Further reliance on long-term securities would
increase the budgetary cost of liquidity management.
Member countries of
MEFMI
Six of the 13 member countries of MEFMI are
beneficiaries of debt relief, and for them there is a need to
avoid falling back into unsustainable debt positions in
future. As a general rule, domestic debt funds the budget
deficit on a residual and gap-filling basis, after all forms of
grants and concessional external borrowing have been
exhausted, although the lower middle-income countries,
which are ineligible for concessional borrowing, tend to
rely more on their domestic markets. Consequently, there is
a need to develop local markets, which currently are
characterised as undiversified, small, and lacking in
benchmarks, secondary market activity, and institutional
investors. MEFMI puts forward that regional harmonisation
would contributed to deeper, more liquid, and more
diversified sources of borrowing for member countries.
Within countries, there are institutional and legal
bottlenecks. Finance ministries have few resources for debt
management, and staff skills are low and often non-existent
in terms of middle office functions. Developing capacity
in-house is difficult, especially with high turnover and
salaries that are uncompetitive with the private sector. Data
and debt recording systems are poor, especially for
domestic debt. The legal frameworks for debt management
are out-dated, but updating them is a lengthy, cumbersome
process. MEMFI member countries have received technical
assistance from many providers, but it has not always been
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effective.
Tanzania
In Tanzania, the finance ministry lacks the capacity to
perform debt management functions on its own. High staff
turnover retards continuity of capability, and there are
difficulties in recruiting new staff. As a consequence, the
ministry relies heavily on staff from the central bank to
carry out debt management functions. The government also
lacks the capacity to perform cash management. Persistent
seasonal excess liquidity characterises the market. The
market, however, anticipates the mopping up operations,
leading to a high cost of doing so. The introduction of new
tradable instruments may alleviate the problem and enable
further diversification of the debt portfolio. Tanzania
already issues bonds across the yield curve, by means of
auctions done using an in-house auction system.
Mauritius
In Mauritius, the central bank performs a number of
debt management functions on behalf of, and in co-
ordination with, the government. The roles and objectives
for debt management and monetary policy are specified,
allowing for a separation of accountabilities. The central
bank issues its own bills for monetary policy purposes but,
according to central bank authorities, the existence of
central bank bills alongside treasury bills has not posed
problems. The central bank advises the fiscal authorities of
the effects of government debt levels on the achievement of
monetary objectives.
Conclusions
Sound debt
management reduces
the cost and risk of
debt
Sound debt management practices and robust securities
markets can help reduce the cost of managing public debt
and maintaining it at sustainable levels. Prudent debt
management, fiscal, and monetary policies can reinforce
one another in helping to reduce the risk premium in the
structure of long-term interest rates. Borrowing limits and
sound risk management practices can help to protect the
government’s balance sheet from debt servicing shocks.
International
standards have become
of greater importance
International standards in public debt management and
related market operations have become of greater
importance to African debt managers. They have
introduced the leading debt management practices of
OECD countries, have made impressive progress in
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developing their local government securities markets, and
are taking advantage of debt reduction initiatives. An
important challenge for many African countries is to avoid
falling back into positions of unsustainable debt.
An integrated view on
debt management is
desirable
The division of work for debt management functions
across agencies, including the central bank, is less
important than ensuring that all the functions (strategy
formulation, auctions and other methods of issuance, risk
management, debt recording and servicing, and so on) get
done as professionally as possible. An integrated view on
debt management is desirable. Concentrating debt
management activity in one agency may facilitate that, and
separation of debt management from the central bank
would be consistent with that. African countries, however,
are likely to need to rely on central banks to perform some
functions over the near and medium term. To that end, clear
agency agreements and delineations of responsibilities and
decision rights are essential.
Strengthening debt
management should be
an ongoing process
Strengthening debt management should be undertaken
as an ongoing process, not a one-off exercise. It also needs
to be seen as part of a country’s wider monetary and fiscal
development. High-level policy makers have to be brought
on board. The delivery of technical assistance to-date has
not been uniformly effective and has often lacked good co-
ordination across providers.
III.
Bond markets and debt strategy
Cross-country overview
Challenges for bond markets and debt strategy in
Africa include weaknesses in monetary policy, the structure
of local banking sectors, and capital account regimes.
Weaknesses exist in
monetary policy
Monetary policy frameworks in Africa are more
complex than in the past. Although there is less reliance on
an exchange rate anchor, most countries still have a de
facto exchange rate regime. This means that monetary
policy is not transparent, which generates risk. Formal and
informal restrictions, including on interest rates, are still
widespread. A persistent liquidity overhang remains
unaddressed. These weaknesses can retard development of
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the domestic debt market and can contribute to high interest
rates.
Banking sectors are
generally non-
competitive
The banking sectors in African countries are generally
non-competitive. Non-competitive banking sectors
typically do not pressure for financial innovation, may
collude in auctions of government securities, tend to hold
securities to maturity, and are less likely to build secondary
markets. These factors also contribute to high interest rates.
Most countries still
restrict portfolio flows
Most African countries still restrict portfolio flows.
They justify those restrictions on the grounds of reducing
macroeconomic volatility. In the absence of investment
options, the controls arguably have a benign effect, but the
situation in Africa is changing. The conclusion is that
African countries should review their capital account rules
and the impact of foreign participation on the sustainability
of their debt markets.
There are problems at
the micro-structure
level
At a more micro-structure level, there are a number of
general problems with bond markets throughout African
countries. They include a small number of listings, a lack of
longer-term maturities, low market turnover, and a lack of
investors. Among other things, one consequence is the lack
of reliable yield curves, pricing benchmarks, and other
financial products to hedge risk. There are solutions, or at
least mitigations, to those problems. Macroeconomic and
political stability are important prerequisites. Developing
market infrastructure, including trading, information
dissemination, settlement, and custody systems, is
important, as well as putting in place incentives that
reinforce good market participation. Building a yield curve
of government securities is beneficial to the rest of the
financial market.
Split responsibilities, a lack of staff capacity, the
relationship with the macroeconomic framework, and a
lack of access to domestic markets are further
complications for African countries in developing a debt
strategy. Africa shares these challenges with other
emerging markets, but the difference is one of degree.
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Country examples
South Africa
The bond markets in South Africa are relatively
advanced. There is a well developed market for
government securities, and corporate bonds have seen
significant growth in recent years, although the latter still
account for only 10% of the bond market. An issue for
South Africa is to ensure that the government does not
crowd out the corporate market.
Nominal government bonds are highly liquid. Liquidity
in the government’s inflation-linked securities is not so
strong, reflecting buy-and-hold investor behaviour, but the
bonds have been cost-effective for the government as
issuer. This is an experience commonly seen in other
countries with inflation-linked bonds, including several
OECD countries. There is no futures market in South
Africa. An active repo market exists, however, and market
participants see no real downside risk to the lack of a
futures market. South Africa’s settlement and clearing
systems are compliant with international best practice,
which reinforces participant confidence. An attempt to
launch an electronic trading platform failed, probably
attributable in the main to timing, as a central counterparty
was lacking at the time. A central counterparty is a
necessary, although not sufficient, pre-condition for
success.
Non-resident holdings are an important part of the
government securities market. The country’s investment-
grade sovereign rating contributes to that. Non-residents
have exhibited an abiding interest in the market and have
not withdrawn from the market over the medium and long
term even when there has been market volatility.
South Africa has a primary dealer system. One question
currently under consideration is whether primary dealers
must be domiciled locally, as all currently are, or whether
remote participation should be allowed. Interestingly,
anecdotal evidence is that much of the market for South
African government securities occurs in London. A lack of
good data means that it is not possible yet to establish just
how extensive that offshore trading actually is.
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Franc zone countries
The franc zone consists of 14 countries across the West
African Economic and Monetary Union (WAEMU) and
Central African Economic and Monetary Union (CAEMU)
areas. Government debt portfolios in the franc zone are
dominated by multilateral and bilateral external loans on
concessional terms. To-date, priority has been given to
external funding because of the low savings rate in the
region, as well as monetary rules that firmly limit the
monetisation of public deficits. Development of the
domestic debt market started in the WEAMU in 2001
following the adoption of a new regulation on the issuance
of treasury bonds. Although a similar regulation was
adopted in the CAEMU region, only one issuance has been
organised to date.
As a general rule, in franc zone countries, there are no
formal debt policies and benchmarks, aside from IMF
conditionality on new loans (for instance, a minimum grant
element of 35%), regional convergence criteria (such as the
avoidance of new arrears and a limit on total public debt of
70% of GDP), and limits on direct monetary financing of
national treasuries (20% of fiscal revenue in the previous
fiscal year). That said, national public debt committees
have been set up in some countries. In principle, they are in
charge of designing debt strategy and policy, as well as
ensuring its implementation by having to approve future
loans.
There are several challenges to formulating and
implementing a debt strategy in the franc zone countries.
The lack of a holistic vision on debt results in
fragmentation of debt management. External debt, domestic
debt, and contingent liabilities are managed without co-
ordination or consistency with transparent benchmarks.
Regulation in respect of the responsibility for contracting
new debt and contingent liabilities, information flows,
transparency, audit, and so on, is lacking, although there
have been some reforms in this regard. It is argued that
within the franc zone, but not exclusive to it, some
countries exhibit complacency, even post-debt relief, about
accumulating debt to finance development and poverty
reduction regardless of the sustainability of debt levels.
The need for capacity building is a major element in
improving debt management practices. This includes
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sensitising authorities so as to build political will for debt
management initiatives and securing training on debt
strategy formulation consistent with macroeconomic
policies and long-term sustainability targets. A regional
approach to regulation and debt crisis prevention would
offer benefits as well.
Tanzania
Main challenges for a formal debt strategy in Tanzania
are a background of macroeconomic instability and the
need to maintain debt sustainability. The question arises of
how to link the debt strategy, and debt management in
general, with other macroeconomic policies. This is made
more difficult by the existence of other challenges already
mentioned, including sub-optimal institutional structures,
problems retaining skilled staff, and quality problems with
data on the debt stock. There is also the question of how to
develop the market further to the next level, particularly in
light of a capital account that is not yet fully liberalised.
Kenya
In Kenya, the government has successfully restructured
much of the domestic debt stock since 2001. The portfolio
went from being predominantly short-term to around 70%
medium and long-term today. Transparency about the
government’s borrowing intentions was a major contributor
to the success of the restructuring. The Kenyan practice is
to publish the volumes, tenors, and calendar of securities to
be auctioned. The market in turn responds with information
about its demand for volumes and maturities. There are also
monthly consultations with investors and intermediaries on
planned bond issuance.
The Kenyan authorities cite a number of problems
with, or that have an impact on, the government securities
market: wide fluctuations in macroeconomic variables,
unstable government expenditure patterns, limited money
and capital markets, opaque pricing due to a lack of
benchmark bonds, limited market participation due to a
lack of connectivity with the central securities depository, a
lack of formal mechanisms to ensure that government
funding requirements are met at least cost and risk, and
barriers to market integration within the sub-region.
Malawi
Malawi provides an example of the problem of public
perceptions. A treasury bill market there flourished in the
early 2000s. The public perception, however, was that the
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well-connected subscribed to all the stock, and the funds
raised were used by the government on poor-quality
investment that also benefited the same people.
Conclusions
Debt managers need a
multiple objectives
framework
For Africa especially, there is a trade-off between, on
the one hand, relying on market-based funding and
developing the domestic market versus, on the other hand,
simple cost and risk considerations. Consequently, debt
managers need a framework for dealing with multiple
objectives. In many African countries, debt sourced in the
domestic market is not currently an active policy choice
but, instead, a consequence of donor inflows. Domestic
debt can sterilise inflows or satisfy a funding gap when
those inflows trail off. Ideally, the debt strategy would
encompass the entire debt and also take account of
guarantees and on-lending. A comprehensive approach like
that takes time to develop, so it is appropriate to start with
the biggest sources of risk first. The development and
implementation of a holistic debt strategy, including for
guarantees and on-lending, is facilitated if all the activities
are centralised and controlled in one agency.The strategy
should include an explicit link to debt sustainability.
Legal frameworks need
to be improved
More work needs to be done on improving the legal
framework for debt management. In most countries, who is
allowed to borrow is adequately defined. Reform should be
focused on transparency requirements and accountability
and the requirement to develop a debt strategy. Debt
strategy needs to link up with macroeconomic policy, and
middle offices have a role to play in that. The quality of
debt matters, while securing and maintaining a sovereign
credit rating can be effective in disciplining policy makers.
Countries should
develop debt strategies
A good first step for many countries in developing a
debt strategy would be to codify the existing implicit, or de
facto, debt strategy. Incremental improvements over time
and the use of straightforward analysis, as opposed to
sophisticated models, are appropriate too. In all cases, the
resulting strategy and sequencing measures need to be
tailored to country-specific circumstances. There is a real
need to ensure debt sustainability even after debt relief is
granted and even if all borrowing is on concessional terms.
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Considerations in developing, communicating, and
evaluating the debt strategy include the appropriate time
horizon. The time horizon needs to be realistic, given the
macroeconomic background. Likewise, the strategy needs
to answer whether the benchmarks adopted represent hard
rules versus targets around which some discretion is
allowed and, if the latter, to what degree. This has
implications for predictability, transparency, and
accountability. Communication is important. It is important
to present the strategy in a way that is simple,
straightforward, and convincing for policy makers, the
financial markets, and the public.
Countries should
restrict their debt
management activity to
simple instruments
The debt instruments and more complex products, such
as swaps, used in implementing the approved debt strategy
need to be well understood by debt managers, and the risks
associated with them need to be able to be managed. This
suggests that, for the time being, most African countries
should initially restrict their debt management activity to
simple instruments. As a consequence, they will at first not
be able to separate the risk characteristics of actual
borrowings from the preferred risk composition of the debt
portfolio, as many OECD countries have been able to do
through the use of derivatives. Later on, when the debt
strategy and associated operations are firmly in place, the
use of derivatives can be considered. However, their
introduction should be accompanied by a governance
system with sound risk controls based on OECD best
practices.
Higher risk of default
could be better
managed through
dialogue with
stakeholders
The risk of default, or (less dramatically but still with
important implications for funding costs) of downgrades, is
higher for many countries in Africa than in other emerging
markets. This disciplines policy makers. It also raises the
question of whether African countries would benefit from
policy dialogue with other countries on how best to interact
with credit rating agencies and to manage relationships
with them.
Wider macroeconomic
and institutional
reforms are needed
Debt market development needs to be part of wider
macroeconomic and institutional reforms, and a priority is
to increase the transparency and consistency of monetary
policy. Eliminating structural obstacles will lead to greater
efficiency in the financial sectors in African countries.
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IV.
Management of contingent liabilities
Perspective of the OECD Working Party on Debt
Management
Contingent debt is a
latent form of
government debt
An experts group within the OECD Working Party on
Debt Management has formulated a set of best practices in
managing explicit contingent liabilities.
6
The best practices
are written from the perspective of debt managers, but they
also address how guarantees should be treated more
generally, in particular in budget legislation. Government-
guaranteed debt is similar to conventional government debt
in many ways. Contingent debt is a latent form of
government debt. Like conventional bonds, contingent debt
is based on contract and is serviced, if necessary, at
expense to the taxpayer. Thus, measures of cost and risk
should apply jointly to conventional debt and guaranteed
debt. Debt managers are well positioned to manage the
risks of the joint portfolio.
It is important to assess
guarantees against
alternative
arrangements
Before guarantees are granted, it is important to assess
them against alternative arrangements, particularly to
explicit on-lending. The conclusion made in many OECD
countries is that guaranteed debt typically has higher
funding costs and may entail higher financial risks for the
government. In some cases, though, guarantees may offer
sufficient benefits, such as the possibility to use them in a
way that allows the government to share credit risks with
lenders. There may also be administrative benefits from
involving outside lenders in a government-sponsored
programme.
Use of guarantees
necessitates a sound
governance system
The use of guarantees necessitates a sound governance
system. There should be rules for the transparent reporting
of the costs of guarantees. The portfolio of guarantees
should be published regularly, although it is recognised that
this is a challenge for many public accounting systems. The
same protocols for decision-making on the direct use of
state resources should apply to guarantees as well. This is
likely to involve the use of explicit fees reflecting their
market value, so as to avoid implicit subsidies.
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Application in South Africa
Sophisticated scheme
for managing
contingent liabilities is
in place
South Africa has in place a sophisticated scheme for
managing contingent liabilities. The legal framework
requires that the minister of finance approve all guarantees
and indemnities, just as he must with conventional debt. As
part of the framework, an appropriate system for credit
administration, measurement, monitoring, and control
around guarantees must be maintained. This is backed by
high-level political support for limiting the issuance of
guarantees, levying fees to equalise their perceived benefits
and true borrowing costs, and encouraging entities to
borrow on the strength of their own balance sheets and not
that of the government.
Principle of optimal
management of
contingent liabilities
applies
The principle of optimal management of contingent
liabilities applies. This includes assessing the credit risk of
the guaranteed entity, monitoring concentrations of risk,
adhering to a limit for total liabilities, and having a holistic
view of all contingent liabilities. By principle, guarantees
are issued only where appropriate risk management
procedures exist, legislative requirements have been met,
legal advice has been sought, time limits and termination
clauses apply, there is a maximum limit on claims, and
there is a demonstrable need for the government to accept
such risks.
Applicants for
guarantees must
supply information
Applicants for guarantees, typically state-owned
enterprises, must supply information to the treasury. This
includes the rationale for the guarantee (that is, how
achieving its corporate plan will be enhanced with the
guarantee in place), the proposed amount required, the use
of the guaranteed funds, the repayment schedule and
maturity of the underlying debt, and financial data from
past years and projections for future years. A fee regime
applies, the objective of which is to ensure that financially
stable state-owned enterprises find borrowing with a
guarantee more expensive than borrowing without one, and
that less financially stable firms find borrowing too
expensive without a guarantee. The fee itself includes a
guarantee fee payable annually, based on the nominal value
of the underlying debt, and an administration fee payable
up-front.
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Contingent liabilities
framework has
reporting requirements
The contingent liabilities framework also has reporting
requirements. A register of guarantees is maintained, and
recipients of guarantees must supply updated information
to the treasury on a quarterly basis. New figures are
compared with previous figures to ensure completeness and
accuracy, with deviations investigated. The register itself is
subject to annual audit. Comprehensive information on the
portfolio of guarantees is reported publicly in the
government’s accounts. Future work in respect of
guarantees includes reviewing the appropriate level of
contingent liabilities, measuring and managing the
contingent liabilities of public-private partnerships and
implementing information delivery enhancements.
V.
Policy recommendations and priorities
Sound debt
management is a key
component of a correct
policy mix
African countries are diverse in terms of their debt
situation, debt management practices, and government
securities markets. Sound debt management is a key
component of a correct policy mix. Debt management
alone cannot solve macroeconomic imbalances or structural
problems, but an appropriate debt level and debt structure
can contribute to reducing vulnerabilities.
Challenges in
implementing sound
debt management
practices and
developing domestic
government securities
markets are especially
acute for Africa
African countries face a number of challenges in
implementing sound debt management practices and
developing liquid domestic government securities markets.
These challenges are shared with other emerging market
countries but, in many cases, are especially acute for
Africa. The structure of outstanding debt is complex.
Volatility in the macroeconomic environment is high, and
economies lack natural stabilising structural characteristics
that allow the use of effective counter-cyclical policies.
Many countries are still subject to original sin and currently
have limited scope to benefit from international risk-
sharing. As a consequence, debt managers in Africa face
greater and more complex risks in managing their public
debt portfolios and executing their funding strategies.
Adopting a risk-based
approach would be an
important
innovation…
Adopting a risk-based approach to debt strategy and
debt management operations, however, would be an
important innovation. Such an approach supports achieving
strategic debt targets based on transparent benchmarks,
managing public debt in an integrated manner, and
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assessing costs and risks to provide information for
decisions regarding an optimal debt structure and a
sustainable debt position.
…with implications for
both primary and
secondary market
operations
This approach has implications for both primary and
secondary market operations. For the primary market, it
encourages market-based issuance of government securities
at optimal maturities and with an optimal mix of domestic
versus external funding, the predictable issuance of
benchmark bond lines, the development of a wide and
diversified investor base, and potentially the use of a
primary dealer system. For the secondary market, it
encourages the development of liquid benchmark bond
lines alone the yield curve, including out to long maturities,
with liquidity boosted by a diverse community of investors
and intermediaries. The establishment of interest rate and
currency benchmarks would help improve the transparency,
predictability, and liquidity of the wider domestic fixed
income market, with government securities providing both
pricing references for other financial instruments and tools
for interest rate risk management.
7
Debt strategy should
emphasise the
importance of risk
management…
Formulating and implementing a debt strategy is a
significant analytical and communication exercise. It is
complicated in much of Africa by wide fluctuations in
macroeconomic and fiscal variables. The range of funding
sources is often narrow, and discretion may be limited in
terms of the risk characteristics of new debt. It may be
helpful to frame the objective as one of minimising risk
subject to cost considerations, as opposed to the more
typical formulation of minimising cost subject to risk as
one way of emphasising the importance of risk
management as an integral part of debt management.
…incorporate all
debt…
A good start, however, would be to codify the existing
implicit debt strategy, identify the most critical and
significant risks first, and then make incremental steps
toward managing and reducing them. Over time, it should
be possible to develop a more integrated strategy that
incorporates domestic and external debt, contingent
liabilities, and related financial assets such as on-lending. It
is important to present policy choices to decision makers in
a way that is simple and straightforward, but analytically
robust and convincing. The sophisticated modelling
techniques used by some debt managers in the OECD area
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and in other emerging market countries are not a
prerequisite for doing that.
…and encourage debt
sustainability
Debt sustainability depends in part on ensuring that the
funds raised are used for high-quality investment. This
raises the issue of how to create an effective policy
environment for addressing the appropriate level of debt,
public investment, budget balance, and so on.
Reporting
requirements should be
strengthened
More timely and reliable data, as well as reporting, on
the stock of debt and guarantees is required. For guarantees
especially, the data are often completely lacking. Greater
control over guarantees depends on securing political will.
Legal reforms are
needed
In terms of institutional issues and problems, while the
authority to borrow is generally adequately defined in
African countries, there are serious weaknesses around
transparency, accountability arrangements, and the
requirement to develop a debt strategy. Legal reforms are
needed.
There is a need to
develop human
capacity, both
externally and
internally
There is a need to develop human capacity, both
externally and internally, to move forward. The former
includes sensitising policy makers about the importance of
good debt management. The latter includes finding
solutions to problems in recruiting and retaining staff with
the appropriate skills to carry out debt management in a
professional manner, as well as securing training and
technical assistance on, among other aspects, debt strategy
formulation and implementation that is consistent with
macroeconomic reform and long-term risk-based debt
sustainability. Currently, it often falls to central banks to
perform debt management functions, which complicates
debt management, as well as monetary, fiscal, and
macroeconomic policy. There is a need for high-level
political leadership and sustained commitment to move to
more professional debt management in African countries.
International
organizations have a
role to play in
strengthening debt
management in Africa
There is a role for international organisations to do
more to strengthen capacity for professional debt
management in Africa, while ensuring that the activities of
the individual institutions complement, and not duplicate,
one another. In this context, it was suggested to circulate at
future OECD forum meetings on Africa the critical
elements of the work programmes of international and
regional organisations involved in debt management and
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bond markets in Africa. This was welcomed by African
officials, arguing that this would strengthen co-operation
among the OECD, IMF, World Bank, African
Development Bank, Commonwealth Secretariat, and other
organisations.
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Notes
1
Hans Blommestein and Greg Horman, Public Debt Management and
Bond Markets in Africa, OECD, Paris, forthcoming. Some of the data
prepared by the authors for the study and highlighted in this article also
appear in OECD and African Development Bank (2007), African
Economic Outlook, OECD, Paris.
2
The forum is part of the non-member outreach activity of the OECD
Working Party on Debt Management and was sponsored by the Swedish
International Development Co-operation Agency (SIDA). It is one
component of a wider project whose main objective is to develop a policy
dialogue with African debt managers. The purpose of the annual forum is
to acquaint senior debt managers and other financial officials involved in
public debt management and government securities markets in African
countries with OECD best practices. The forum focuses on specific
problems, issues, and debt management policies of particular relevance to
African countries. It provides African debt management officials the
opportunity to link up with the global network of debt managers and to
exchange ideas and experiences with peers from the region, OECD
members, and other developing countries. The OECD works in
consultation with the IMF, World Bank, and other agencies in preparing
the agenda so as to complement their technical assistance activities.
3
The regional workshops are one component of an OECD policy dialogue
with African countries on public debt management and government
securities markets. They follow, but are distinct from, the OECD Forum
on African Public Debt Management (like the one held in Amsterdam in
December 2006). The forum in Amsterdam focused on strategic policy
issues, whereas the emphasis of the regional workshop in Johannesburg
was on operational and technical aspects of interacting with and
developing markets. The workshops provide African debt management
officials the opportunity to exchange practical ideas and experiences with
peers from the region. The initiative for these complementary workshops
came from the African participants themselves.
4
The working party has as an objective to create awareness of the major
policy issues in developing sound debt management policies and to share
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and learn from country case studies and practices. In this way, debt
managers from emerging markets become better acquainted with OECD
policies, techniques, and experiences in the field of public debt
management and government securities markets.
5
OECD and African Development Bank (2007), African Economic
Outlook, OECD, Paris.
6
Lars Horngren et al. (2005), “Explicit Contingent Liabilities in Debt
Management,” Advances in Risk Management of Government Debt, Hans
Blommestein (ed.), OECD, Paris.
7
Hans Blommestein (2007), “A New Strategy for Developing African
Bond Markets,” presentation for the G7 High-Level Workshop on
Developing Bond markets in Emerging Market Economies, Frankfurt, 9-
10 May 2007.