Potential Sources of Financing : Step 3 Joint Vienna Institute, Vienna, Austria February 23 27, 2015
Step 3: Potential Instruments & Characteristics Objective Identify potential sources of finance, their financial characteristics, availability and desirability of use Output An assessment of the characteristics, including the cost and risk, of all available and potential financing instruments and sources. Identification of any constraints, particularly on issue size Note: Identify steps necessary to improve access to or terms of these instruments 2
Current Financing Environment Slowing traditional concessional resources but remains an option Low interest rates are favorable to financing, but are only a part of the overall picture Growing role of domestic markets Good macro policies are essential to supporting market access 3
Overview of Potential Sources of Financing Nonmarketable Concessional loans Semi-concessional loans Commercial loans Other nonmarketable sources Marketable International bond Domestic securities 4
Non-marketable 5
1. Concessional Lender type Multilateral and bilateral official creditors Cost characteristics Low cost (minimum grant element 35% for multilateral) depending on exchange rate path Risk characteristics Interest rate exposure limited typically long-term, fixed rate Exchange rate exposure mitigated by amortizing structure Rollover exposure mitigated by amortizing structure
1. Concessional Amount typically linked to allocation rule Factors that may influence the amount available Income level, quality of institutions, access to market financing Size of multilateral balance sheet Economic developments Other considerations Use of funds may be constrained to specific purpose Project loans may require co-financing element Indirect costs? e.g., conditionality, volatility and delays in disbursement
Example: Current IDA terms 8
2. Semi-Concessional Lender type Multilateral and bilateral official creditors Cost characteristics Often low cost at a discount to market financing - but be wary of indirect cost [exchange rate; purchase conditions=>quantify this] Risk characteristics In specific cases, there may be scope to negotiate more customized terms Interest rate exposure may be floating rate Exchange rate exposure mitigated by amortizing structure Rollover exposure mitigated by amortizing structure 9
2. Semi-Concessional Amount can depend on allocation rules Factors influencing availability Economic developments in bilaterals Other considerations Use of funds may be constrained to specific purpose: cost of tied aid Project loans may require co-financing element Faster disbursement? 10
3. Commercial Bank Loans Lender type Domestic and international banks Cost characteristics At market rates (typically more expensive than bonds, but cost of carry may be lower through tailoring disbursement and repayment ) Competition amongst lenders can help contain costs Risk characteristics May be scope to negotiate customized terms Interest rate exposure typically shorter tenors, often floating rate Note may be marketable through syndication (in which case fees increase) 11
3. Commercial Bank Loans Amounts depends on allocated credit line Can be augmented through syndication Factors influencing quantity available General health of banking system (global and domestic) Local and global liquidity conditions Other considerations Documentation can be relatively straightforward Need to consider scope for crowding out private sector 12
4. Other Non-Marketable: Retail debt Lender type Retail investors through savings bonds, lottery bonds, etc. Cost characteristics Depends on pricing framework - flexible Administrative costs can be significant Risk characteristics Rollover risk mitigated by nature of investor base Typically no exchange rate exposure Interest rate exposure depends on instrument design Difficult to determine extent of demand 13
4. Other Non-Marketable: Retail debt Amount depends on savings in the economy Factors influencing quantity available Degree of financial literacy Level of banking sector penetration Other considerations May be other objectives involved (e.g., provide savings vehicle accessible to all) May be in direct competition with banking sector May cannibalize demand for wholesale instruments Tax incentives and distortions (political dominance) 14
4. Other Non-Marketable: Central Bank Borrowing from CB can lead to fiscal dominance this undermines credibility of monetary policy and inflation objectives results in indirect cost because of a high inflation risk premium in the domestic interest rate, and lower ratings on external debt 15
Summary Non-Marketable Cost and risk of non-marketable instruments may not always be obvious or directly observable Availability may depend on external factors affecting creditors own financial health Need to consider impact on market development of extensive use of domestic non-marketable sources 16
Marketable 17
5. International Sovereign Bonds Lender type International and domestic institutional investors Cost characteristics Market determined Depends on credit rating, reflecting quality of macro policies and institutions, track record on debt servicing, etc. Can also depend on size of issue (small size may add about 50 bp) Can be relatively cheaper than domestic market
5. International Sovereign Bonds Risk characteristics Rollover risk and exchange rate exposure aggravated by bullet structure Choose amortizing structure? Sinking fund? Exposed to sudden stops in international capital markets Tenors and interest rate structure can be customized Can be longer tenors than available in domestic market But reflects nature of market demand Helps diversify investor base (but be aware of fickleness of external investors)
5. International Sovereign Bonds Amount typically a minimum (e.g. $500mn), maximum depends on market conditions Factors influencing quantity of financing available Established track record of good economic performance over the preceding few years, with a positive mediumterm outlook Credit rating Investors risk appetite/global market conditions
5. International Sovereign Bonds Other considerations Disbursement immediate May lead to cost of carry. 1 year carry can add 100bp per year for a 5 year loan Tailor size to needs Minimize cost of carry and rollover risk through smaller size Scope to re-open? Closer credit monitoring by international market can help maintain process of economic and structural reform High transaction cost Establishes a pricing benchmark for private sector
Financing Environment Debut Spreads Region Country Date Year Yield at issue Size ($ mn.) Tenor (years) Currency Governing Laws Africa Senegal 15-Dec-09 2009 9.5 200 5 USD England Eastern Europe Belarus 26-Jul-10 2010 9.2 600 5 USD England Eastern Europe Montenegro 7-Sep-10 2010 8.0 254 5 EUR England Eastern Europe Albania 28-Oct-10 2010 7.6 407 5 EUR England Middle-East Jordan 8-Nov-10 2010 4.2 750 5 USD England Africa Nigeria 21-Jan-11 2011 7.1 500 10 USD England Africa Namibia 27-Oct-11 2011 5.8 500 10 USD England Africa Zambia 13-Sep-12 2012 5.6 750 10 USD England Latin America Bolivia 22-Oct-12 2012 4.9 500 10 USD n.a. Asia Mongolia 29-Nov-12 2012 5.2 1,000 10 USD New York Asia Mongolia 29-Nov-12 2012 4.2 500 6 USD New York Latin America Paraguay 17-Jan-13 2013 4.6 500 10 USD n.a. Latin America Honduras 12-Mar-13 2013 7.5 500 10 USD New York Africa Tanzania 27-Feb-13 2013 6.5 600 5 USD n.a. Africa Rwanda 25-Apr-13 2013 7.0 400 10 USD England Eastern Europe Armenia 20-Sep-13 2013 6.3 700 7 USD England Asia Azerbaijan 10-Mar-14 2014 5.0 1,250 10 USD England Africa Kenya 24-Jun-14 2014 6.9 1,500 10 USD England Africa Kenya 24-Jun-14 2014 5.9 500 5 USD England Asia Kazakhstan 14-Oct-24 2014 4.1 1,500 10 USD England Asia Kazakhstan 14-Oct-24 2014 5.1 1,000 30 USD England
Financing Environment Debut Spreads
Financing Environment 2013 Tanzania, February, 6y, $600m, spread 600 Honduras, March, 10y, $500m, spread 548 Rwanda, April, 10y, $400m, spread 516 Nigeria, July 5y, $500m, spread 400 10y, $500, spread 415 Ghana, July, 10y, $750, spread 524 Bolivia, August, 10y, $500, spread 348 Armenia, September, 7y, $700, spread 423 Honduras, December, 7y, $500, spread 635
Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 IMF-WB Medium Term Debt Management Strategy Emerging Market Issuance 18.0 800 16.0 14.0 12.0 10.0 8.0 6.0 Emerging IDA Blend EMBI spread (right axis) 700 600 500 400 300 4.0 200 2.0 100 0.0 0
6. Domestic Securities: T-bills Lender type Domestic (banks, mutual funds, pension, and insurance) and international investors Cost characteristics Market rates Risk characteristics Interest rate risk high (given refinancing) Rollover risk given short-term nature of instrument Quantum and factors influencing availability Size of banking sector General degree of market development
6. Domestic Securities: T-bills Other considerations Simple instruments Significant demand from banking sector Used to meet reserve ratios, liquidity management, etc. Captive market? Often tool of monetary policy Can help avoid fragmentation of the short end of the market Potential conflict between debt management and monetary policy objectives
6. Domestic Securities: T-bonds What? Instruments with maturities longer than T-bills Fixed, floating, or indexed Cost characteristics Typically, market rates Longer tenors requires risk premium to be paid Inflation, liquidity, etc. Depends on credibility of macro-policies Depends on depth of market
6. Domestic Securities: T-bonds Risk characteristics Interest rate risk Reduced relative to Tbills, but high if variable rate If indexed, exposed to other price indicators (e.g., inflation) Rollover risk Aggravated given typical bullet structure of the instrument Available tenors reflect general degree of market development and nature of investor base Exchange rate exposure limited unless FX-indexed bond, aggravated by bullet structure
6. Domestic Securities: T-bonds Amount depends on market conditions and size of financial assets in economy General degree of market development Confidence in independence of price index (for indexed bonds) Ability of instrument to match investors own liabilities Banks floating rate instruments Pension / life insurance long-term bonds, inflation-linked bonds Other considerations Health of domestic banking sector Risk of crowding out the private sector Strategy of supporting market development?
Recap: Summary for Non-marketable Debt Structure Issues Cost Principal Risk Exposure Official sector loans Fixed or floating, amortizing, longterm Size constraint; volatility and speed of disbursement; may be conditions attached Very low cash cost; indirect costs; LT RER trend. FX risk mitigated by LT Commercial bank loans Variable, bullet Domestic, international Short-term Liquidity conditions; health of banking sector (domestic) Market based FX where relevant; roll-over; refixing Retail debt Fixed or variable Need efficient sales network. Reliable source. Can be competitive Uncertainty as to quantum of supply Other nonmarketable Depends Non-transparent; hampers market development Cost born indirectly Hidden costs; abuse
Recap: Summary of Marketable Debt Tbills Tbonds Structure Issues Cost Discount, bullet Fixed / variable, bullet Simple; robust demand from banking sector Market development will impact demand Low, except in liquidity crisis LT can be expensive (inflation risk premium). Deflation is costly. Principal Risk Exposure Rollover and refinancing risk Depends on tenors achieved, may be some rollover and refinancing. Refixing if variable rate. Inflation indexed Indexation structure Requires reliable index. Can secure maturity extension. But complex instrument. Depends on credibility of monetary policy Depends on inflation, supply-side shock. Reduces roll-over risk. Internationa l bond Fixed / variable, bullet Large size, timing risk, excess cash at issuance Credit rating. Depends on exchange rate trend FX, rollover risk
Some Domestic Market Development Considerations
Why Develop the Domestic Debt Market? Enhances supply of financing to government Lowers cost of financing May be high cost in the short-run Facilitates use of wider range of instruments Greater resilience at time of financial crisis Mitigates risk of sudden stops Enhances diversification of financing sources Broader economic benefits Encourages efficient allocation of capital Promoting growth Deep and liquid markets reduce cost of capital more generally
Market Development: Broad Perspective Key requirements for liquid government bond market Well-functioning and competitive primary market Market infrastructure to facilitate secondary market Mix of market participants Market development: A dynamic process based on Continued macroeconomic and financial sector stability Adequate institutional and regulatory reforms
Developing the Domestic Debt Market Requires development on a number of fronts: Supply side issues Debt manager has lead role here Demand side issues Intermediaries Market infrastructure, regulatory and tax framework Debt manager can support efforts here In general, keep it simple Step by step; avoid complexity Value of transparency
General Pre-Requisites Credible and stable government Sound regulatory and legal framework Robust payment and settlement systems Supportive tax regime Macroeconomic & financial stability Essential to avoid risk premia Sound fiscal and monetary policies Commitment to contain inflation Efficient bond market strengthens macroeconomic stability
Supply Side Issues: Instrument Design Standard design Enhances familiarity Reduces costs issuer and investor Benchmarks? Fungible issues/re-openings Enhances liquidity in secondary market But increases roll-over risk Can be managed by buy-backs, pre-funding and other liquidity management techniques Market conventions (Act/Act; coupon period)
Supply Side Issues (cont.) Issuance techniques Market-based willingness to accept market rates Auctions most typical Uniform price Multiple price Transparency Issuance calendar Publication of results and other key data Price dissemination Sharing of debt management strategy Provide a forum to facilitate dialogue with market participants
Demand Side Issues: Investor Base Diversification helps liquidity and reduces volatility Different time horizons, risk preferences and trading motives Commercial banks often dominant investors. Inhibits development of demand for longer term securities Risks to banking system High margins (compensate for maturity transformation) Banks useful as intermediaries brokers, market makers
Robust Financial Market Infrastructure Clarity and fairness in regulatory and legal framework builds confidence in the integrity of the market Requirements include: Adequate and well-enforced contracts Insolvency procedures Accounting and disclosure standards Appropriate market infrastructure Efficient settlement, custody and payments systems Efficient and well-regulated market place Non-distortionary taxation regime
Sequencing the Development Phase 1: Initial priority to strengthen short-end of market Emphasis on market related issuance techniques Development of intermediaries, market infrastructure and secondary market Phase 2: Move to longer-term instruments Ensure interaction with development of Money market, especially repo market (source of financing and demand) Secondary market Fungibility, benchmark bonds