At the end of May, representatives of many of the quasi-independent agencies set up to manage the government debts of OECD and emerging market sovereigns gathered in St Petersburg to compare experiences. There was much to discuss: the meeting came just as diverse pressures are building up on the debt management offices (DMOs).
In emerging markets countries, especially those operating with managed exchange rates and capital controls, these pressures often centre on the urgent need to develop domestic debt markets as a means to fund budget deficits without incurring exchange rate risks. Even in many of the developed countries, notably in the eurozone, the overriding challenge is simply to execute large borrowing requirements in a crowded and fractured market.
These are the most immediate day-to-day tasks. And as these get tougher, debt management offices have had to rein in some of the forward-thinking projects. It is more than a decade since the New Zealand debt management office first captured the market’s imagination with its attempts to calculate a balance sheet for the entire economy, valuing not just roads and buildings but forests and other assets.
Its efforts at asset/liability management have become gradually less ambitious, focusing not on the economy but the government balance sheet and finally just on its financial assets and liabilities. After all, the most valuable asset of a government is its ability to raise taxes. But how do you value that on the balance sheet and against what tenor of liabilities should you match it?
DMOs might be the foremost financial market experts within government but even the highest regarded among them are not so very sophisticated. The UK DMO, for example, is only now developing a stochastic simulation model to quantify what would be the expected costs of its liability portfolio given different issuance strategies and interest rate environments. For a treasury at any of the leading capital market funders, such as the US agencies or large banks, that would be a basic tool. The UK DMO doesn’t even use interest rate derivatives. The Agence France Trésor suspended its derivatives programme in 2003.
So it’s perhaps unfortunate that more and more requests to risk manage disparate aspects of the public finances are falling to these agencies. While the AFT isn’t using interest rate derivatives, it is being asked to hedge in the oil market purchases by the defence ministry; it is managing currency risk for the French foreign ministry’s contributions to multinational agencies such as the UN; and it is now exploring currency hedging for the diverse costs of running the diplomatic service outside France.
There are even bigger issues looming, such as the whole question of contingent liabilities and off-balance-sheet exposures. It is now widely acknowledged, not least in various papers published by the IMF, that a driver behind the growing wave of public-private partnerships has been governments’ desire to bypass expenditure controls, move public investment off budget and move public debt off the balance sheet.
Such manoeuvres are not sustainable indefinitely. At some stage, guarantees are drawn, contingencies crystallize and public payments are triggered. So before that happens and until governments can agree a credible set of common accounting practices, can DMOs quantify, risk manage and even attempt to budget properly for these residual risks? It would be reassuring to think that some credible, accountable bodies are at least attempting this. Euromoney has argued in the past that many governments are asking bond investors to fund them on the basis of misleading financial accounts that would probably land a corporate CEO in jail.
The danger is in expecting DMOs to wave a magic wand, clean up the public accounts and resolve future liabilities, including the most troubling of all – provision for ageing populations. That requires tougher political choices and much sterner management of fiscal policy than most governments have shown themselves capable of – not financial market sophistication or sleight of hand. DMOs can do their bit for the annual government P&L by minimizing debt service costs: let’s not expect them to clean up the whole balance sheet.
