derrill allatt sovereign debt

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Evaluating Sovereign Risk: Debt and Capital Markets. Derrill Allatt, Managing Partner, NewstatePartners, LLPThe panel will address the current state of sovereign capital markets, the realities of issuing government debt, and the future state of financing government expenditure.


  • 1. Current Perspectives on Sovereign Debt
    2010 ICGFM Miami Conference

2. Key Challenges Facing Debt Management
Part 1
3. Determining Sustainable Level of Debt
Several debt measures are utilised by debt managers and international investors to evaluate the sustainability of debt in a given country
The public-sector-debt-ratio provides the clearest picture of a countrys public sector debt stock as a percentage of annual production. Generally a level over 60% is considered high.Those countries with higher credit worthiness are able to borrow more without affecting their sovereign ratings as can be seen by the parabolic relationship between Debt-to-GDP and credit rating
The ratio of public sector interest-to-general government revenues is the most commonly used measure of interest affordability as it provides an indication of the interest burden on annual fiscal resources.One government may have a high level of debt, however, through heavy concessional borrowing, might face a lower level of interest than another government with a lowerlevel of debt
A ratio above 15% of revenues is generally considered high
External Short-Term Debt-to-Reserves
A metric of short-term external financing constraints, this ratio describes short-term debt (current-year amortisations, money market instruments, currency and deposits) as a percentage of central bank international reserves
2009 Public Sector Debt-to-GDP vs.. Credit Rating
Interest-to-Revenues vs.. Credit Ratings
Part1:Key Challenges Facing Debt Managers
Source:IIMF; S&P, Moodys; Fitch
Costa Rica
4. Credit Ratings and Debt Sustainability
S&P, Moodys and Fitch all factor debt sustainability into their determination of credit ratings.These ratings then affect a Governments ability to borrow externally.Additionally, ratings may serve as country ceilings, which affect the borrowing cost of private enterprises operating within a rated country
The level of a countrys indebtedness is a major factor affecting its credit rating. While countries with historically strong sovereign credit worthiness, like Japan and Spain, may be given more flexibility in sustaining more debt, emerging market nations have traditionally been perceived as riskier.
Recent events have called into question the debt sustainability of those historically AA- and AAA-rated nations like Greece, Spain and Portugal, which have faced downgrades in recent months
IFR; Bloomberg, all figures as of 04 May 2010
Aggregated Sovereign Credit Rating vs.. Borrowing Spread
Pakistan, 651bps
Greece, 643 bps
Ukraine, 551 bps
Iceland, 375 bps
Portugal, 275 bps
Romania, 233 bps
Philippines, 168 bps
Part1:Key Challenges Facing Debt Managers
5. Managing Rollover Risk
Many governments worldwide (particularly within Europe) face large rollover requirements as a percentage of GDP in 2010before any allowance for financing budgetary deficits
Debt rollover ratios exceed 20% of GDP for Belgium and Italy.
Spain, for instance, must issue EUR 225bn this year in order to rollover its outstanding debts falling due in 2010, even though Spain has a debt-to-GDP of only 54% compared with 125% for Greece and 76% for Portugal.
In addition to the need to refinance maturing debt, many European and other governments will need to increase their borrowings to finance their budgetary deficits.
S&P has projected that European governments will be forced to borrow a record 1,446b in 2010 due to deteriorating public finances.
Advanced European Market Debt-Rollover Ratios
EMEA Debt-Rollover Ratios
Part1:Key Challenges Facing Debt Managers
6. Rising Fiscal and Balance of Payments Deficits
Many governments face mounting fiscal and external financing deficits as a result of the global economic turbulence.
Fiscal Deficits
Many governments are facing soaring fiscal deficits caused by poor fundamentals and crisis-related response measures:

  • Falling tax revenues as a result of lower real incomes, higher unemployment and decreased consumer spending

7. Decreased customs duties caused by a decline in global trade 8. Higher than anticipated expenditures caused by financial crisis response measures such as bank takeovers and deposit guarantees 9. Fiscal stimulus measures required to meet social needs and combat recessionary unemploymentBalance of Payments (External financing deficits)
Many countries face severe balance of payment shortfalls that have forced Governments to deplete reserves, devalue the national currency or resort to IMF lending:

  • Economic weakness in historic trading partners has cut currency inflows and led to a shortfall in foreign exchange

10. Some governments are borrowing abroad in order to guarantee that they have adequate forex for their central banks 11. The inability to service or rollover large foreign-denominated debt payments (public sector or otherwise) 12. Those Governments situated in currency unions may face additional pressure due the inflexibility of monetary controls and the inability to devalueTwin Deficits

  • Some countries face combined fiscal and current account deficits, such as Spain and Iceland, which require external financing

Part1:Key Challenges Facing Debt Managers
13. Contagion
Contagion describes the phenomena whereby financial shocks are transmitted from one economy to other interdependent economies.The term came into wide use during the late 1990s when financial crises spread across emerging market economies, affecting nations with healthy fundamentals and sound fiscal, monetary and exchange rate policies
Various theories exist to explain why contagion occurs including: real links such as trade, the pass through of higher/lower market interest rates, a herd mentality among investors, and operations of multinational financial institutions spreading economic distress and investors selling debt of one country to fund losses elsewhere in the portfolio
The threat of contagion is very real to debt managers as exogenous events can lead to the transmission of higher interest rates, reduced financing options and speculative exchange rate attacks that undermine the external balance and cause any number of other economic distress factors
CDS Lockstep Movements Among Emerging Market Peers
Part 1:Key Challenges Facing Debt Managers
14. Reaching Investment Grade
IFR May 8 2010, Moodys, S&P, Fitch
Why are some emerging market countries perceived as less risky than their peers?
Part1:Key Challenges Facing Debt Managers
15. Reaching Investment Grade
Over the past decade, a handful of emerging market governments have beaten the odds to achieve the necessary fiscal , debt and external sustainability associated with investment-grade sovereign credit ratings.There are a number of discernable trends among those countries that have risen several notches despite global adversity:

  • Structural reformsto achieve economic-financial stability (Botswana)

16. Decreasing dependence on commodity exports (Kazakhstan, Trinidad & Tobago) 17. Taking advantage of higher growth to improve fiscal position and to reduce debt (Russia) 18. Implementation of Investor Relations Programmes (IRPs) (Brazil) Because of the recent turmoil surrounding the European sovereign debt crisis, a number of emerging market countries arenow being perceived as less risky than advanced country peers.For instance, Chiles CDS has recently been trading below UKs. CDS for Brazilian, Mexican and Polish bonds are trading below those of Portugal
Part1:Key Challenges Facing Debt Managers
S&Ps sovereign ratings methodology categories
19. Part 2
Some Solutions and Strategies
20. Sources of Funding
Bilateral and multilateral borrowing increased dramatically in the sovereign borrowing mix in 2008 and through much of 2009 due to reduced availability of external commercial financing
Many Governments have sought IMF assistance in the form of a stand-by-arrangement (SBA) or drawn on the IMFs Flexible Credit Line
Some sovereigns with SBAs and FCLs have already returned to the international capital markets - even before the availability of official sector funding ends as was the case of Hungary in July 2009 and January 2010
Part 2: Some Solutions and Strategies
CurrentIMF Programmes(as of 29 April 2010)
21. An Effective External Debt Issuance Strategy
With US interest rates at historic lows, widespread tightening of credit spreads from crisis levels, and increased demand for sovereign bonds, many Governments haveturned to the capital markets in recent months.Eurobond issuance provides access to external financing at market rates and can have knock-on benefits for the sovereign issuer
Eurobond issuance is a key source of financing for governments.If conducted prudently, Eurobonds can have beneficial benchmarking effects on a countrys finances and provide a variety of benefits:

  • Creating a benchmark for the external cost of borrowing for private sector enterprises

22. Extending the countrys yield curve 23. Encouraging greater investor interest (placingthe country on the map) in other sect


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