New benchmarks put SA in better position to identify risk

THE collaboration between the Treasury and the World Bank in the area of sovereign-debt management enables SA to also share its experiences with sovereign-debt management practitioners across Africa in the interest of contributing towards the development of their respective economies.

On September 22, the World Bank reported that SA had “made significant progress to improve the financial risk management of its public debt portfolio, thanks to a tailor-made model designed to analyse the costs and risk factors”.

Before the new debt portfolio benchmarks were introduced in the 2014-15 financial year, only two strategic benchmarks informed the government’s risk management of its debt portfolio. These were a limit on the share of foreign currency debt (not to exceed 20% of total debt) and a ratio of 70:30 target for the domestic debt portfolio distribution between fixed-rate (defined as fixed-income bonds) and floating-rate (defined as T-bills or TBs and inflationlinked bonds or ILBs) debt instruments.

The overall purpose of those benchmarks is to clearly identify and separate the main risk exposures of the government debt portfolio. This separation supports a clear strategic focus with regard to the future evolution of the debt portfolio, making it clear how each of the new benchmarks seek to mitigate the various financial risks.

The new benchmarks are also seen as an effective communication tool. The five benchmarks listed in this article convey the key dimensions of the government’s debt portfolio in an organised and concise manner. By focusing on standard metrics widely used across the world by sovereign debt practitioners, communication with investors, international peers, ratings agencies and civil society, is made easier.

The World Bank report further mentions that SA is now “better positioned to absorb fiscal shocks going forward”. The size of the government’s net debt as a percentage of GDP grew significantly following the 2008-09 global financial crisis from about 23% before to 44.3% in 2015-16. This development, together with increased use of inflation-linked debt instruments, given the credibility of inflation-targeting by the Reserve Bank, required that new debt portfolio risk benchmarks be introduced to better manage the financial risks arising from SA’s sovereign debt. These include, among others, currency risk, refinancing risk, liquidity risk and inflation risk.

Importantly, the new risk benchmarks introduce separate targets for refinancing risk (the frequency with which debt matures and therefore in need of being rolled over or redeemed) and inflation risk (debt that grows at the rate of inflation), which was previously managed by the 70:30 benchmark referred to earlier. Two additional benchmarks were introduced for weighted average term-to-maturity (ATM), both for nominal (fixed-income bonds and TBs) and ILBs, given the inherently different nature of the risk of these two debt portfolios.

The weighted ATM of the debt portfolio describes the “depth” of the domestic capital market and summarises the redemption profile of the portfolio in a single number. The higher (in years) the weighted ATM, the more sophisticated the domestic capital market, indicating investor willingness to invest its assets in government bonds over an extended period of time.

This confidence in the investor community is achieved over many years of consistent and predictable debt-management practices. SA has one of the highest weighted ATMs of its government debt portfolio when compared globally.

The following are the new approved strategic portfolio risk benchmarks for the debt portfolio of the government that informs the current funding strategy:

Short-term debt maturing in 12 months (TBs) as a share of total domestic debt not to exceed 15%. This is a measure of refinancing risk particularly focusing on shortterm (money market) debt that is also an important cash management instrument. TBs are issued in three-, six-, nine- and 12month duration, and therefore, while the cost of funding is usually lower than other funding instruments, it requires significant and frequent refinancing, negatively affecting the government’s predictability in meeting its budgeted annual interest bill and, therefore, the 15% limit;

Long-term debt maturing in five years as a share of fixed-rate and ILBs not to exceed

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25%. This is a measure of refinancing risk focusing on the bond portfolio (debt of more than one-year duration). By keeping within this benchmark, the government avoids debt from being concentrated within the next five-year horizon, allowing for a “smoother” maturity profile of its debt and therefore greater predictability of its annual funding plans from one year to the next;

ILBs as a share of total domestic debt to be kept within the range of 20% to 25%. This is a measure of inflation risk within the debt portfolio, which protects investors against inflation shocks and, if inflation gets “out of control”, will result in significantly higher revaluation of government’s debt and subsequent higher interest payments;

Foreign debt as a share of total government debt not to exceed 15%. This is a

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measure of currency risk, that, given the volatility of the rand, results in unpredictable foreign currency commitments when denominated in local currency. Fortunately, about 90% of government debt is denominated in rand and is therefore not affected by currency movements. The low exposure to currency risk (10% of the portfolio) is a positive feature of our debt dynamics;

Weighted ATM of fixed-rate bonds plus TBs to be kept within a range of 10 to 14 years and for ILBs within 14 to 17 years. A portfolio with higher weighted ATM will typically involve less medium-term refinancing risk (positive), but at the expense of somewhat higher expected debt-service costs (negative). A range for weighted ATM is a concise way to convey the chosen cost/risk trade-off for the portfolio. This is a result of multiple scenarios generating various cost and risk outcomes.

The composition of the government’s debt portfolio remains well within these prudent ranges and limits, which allows for optimal management of government debt including ensuring acceptable predictability and reasonable cost of the significant interest bill of the state budgeted for annually.

For 2016-17, debt service cost is estimated to be R147.7bn, projected to rise to R178.6bn in 2018-19.

Managing debt service cost in this manner, the government is able to free up funding of its limited resources (debt and tax revenues) and direct it towards priority government expenditures in the areas of health, education, social development, protection services and infrastructure aimed at inclusively growing the South African economy in pursuit of tackling the triple challenges of poverty, inequality and unemployment experienced by so many South Africans every day.

Further work is under way on assessing credit risk stemming from government guarantees.

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The composition of the government’s debt portfolio remains well within prudent ranges and limits

Anthony Julies is deputy directorgeneral of assets and liability management at the Treasury

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