MEXICO: Strategic Guidelines for Public Debt Management

1
MEXICOStrategic Guidelines for Public Debt
Management

• September 2005

2
Agenda

• Debt Management during the current Administration
• Strategic Guidelines for Public Debt Management
• Public Debt Policy for 2006
• Final remarks

3
The current Administration has placed great
emphasis on the management of public debt

• In general, public debt management strategy has
  followed three main lines of action
• The public deficit has been financed entirely
  with domestic sources of funding, and since 2004,
  a net decrease in public sector external
  indebtedness of at least 500 million has been
  established in the economic programs.
• Local currency financing has been achieved in an
  orderly fashion, relying mostly in long-term
  fixed-rate securities.
• The overall funding of public sector needs in the
  local market has allowed the Federal Government
  to implement a proactive debt strategy aimed at
  improving conditions of its external debt.

1
2
3
4
This strategy has achieved the following goals

• More efficient mix between domestic and external
  debt
• Improved external debt composition
• Development of local markets
• Reduced vulnerability to adverse shocks

5
More efficient mix between domestic and external
debt
FEDERAL GOVERNMENTS NET DEBT
( of GDP)
( of total)
100
External
Domestic
6
Improved external debt composition
UMS DOLLAR YIELD CURVE
FEDERAL GOVERNMENTS GROSS EXTERNAL
DEBT (billion dollars)
UMS 31
UMS 26
UMS 19
UMS 34
UMS 15
UMS 14
UMS 12
UMS 10
UMS 33
UMS09
UMS 22
UMS 08
UMS 16
UMS 13
UMS 11
UMS 08N
UMS 07
UMS 06

• / As of September 9, 2006. The number inside the
  bubble corresponds to the size of the issue in
  USBn.

7
Development of Local Markets

• Infrastructure
• Legal and regulatory framework
• Clearing and settlement infrastructure
• Price vendors
• Market makers program

• Supply Oriented Policies
• Communication strategy
• Development of benchmark issues
• Improvement of the market microstructure

• Demand Oriented Policies
• Institutional Investors
• Growth of domestic financial savings
• Promotion of local market among foreign investors

8
Reduced vulnerability to adverse shocks
LONG-TERM SOVEREIGN DEBT RATING IN FOREIGN
CURRENCY BY AGENCY
SOVEREIGN RISK/ (January 2001 September 2005)
Moodys
SP
Baa1
BBB
Baa2
BBB
Baa3
BBB-
Ba1
BB
Ba2
BB
/ Spread over United States Treasury Bonds (bps)
Source Bloomberg y JP Morgan
9
All these achievements have been reached together
with a reduction in the financial cost of the
Federal Governments debt
FEDERAL GOVERNMENTS NET FINANCIAL COST ( of GDP)
Av. 11.15
Av. 5.23
Av. 3.27
Av. 2.53
10
These achievements have provided the necessary
foundations for executing a debt management
policy consistent with international best
practices

• The Federal Government has worked intensively in
  the design and implementation of an integral debt
  management strategy based on the general
  objective of minimizing its long-term financing
  costs, subject to a prudent level of risk.

11
Agenda

• Debt Management during the current Administration
• Strategic Guidelines for Public Debt Management
• Public Debt Policy for 2006
• Final remarks

12
Risk management of the Federal Governments debt

• The Federal Government has undertaken substantial
  efforts to consolidate its institutional and
  technological capacity to quantify, monitor and
  manage all the risks inherent in the nature of
  public debt.
• Risks are separated in three main categories
• Market risk and refinancing risk
• Credit risk
• Operational risk

13
Market risk and refinancing risk

• The conceptual framework of the Federal
  Governments risk management strategy draws on
  three complementary modules to identify,
  evaluate, and manage its risks
• Objective indicators. These are metrics that
  provide information on the structure and sources
  of the different dimensions of risk. Among the
  main indicators it is worth mentioning the
  following composition of debt between its
  internal and external components, the duration,
  the amortization profile and the interest rate
  re-fixing of its portfolio.
• Deterministic analysis. It refers to the
  simulation of specific issuing scenarios coupled
  with a specific behavior of the main financial
  variables that affect the debt servicing costs.
• Stochastic modeling. This module quantifies some
  market and refinancing risks through stochastic
  simulations techniques (CaR models). They allow
  to stress-test the portfolio and to asses the
  long-term sustainability of public debt.

14
Stochastic modeling Cost at Risk (CaR)

• The CaR analysis quantifies the maximum financial
  cost in a given year for certain statistical
  confidence level. The principal indicators that
  it provides are
• Expected cost The mean of the calculated
  interest cost scenarios in a given year.
• Absolute CaR The maximum interest-rate cost in a
  given year for certain statistical confidence
  level.
• Relative CaR The difference between the expected
  interest-rate cost and the absolute CaR. This
  measure indicates the maximum increase in costs
  relative to the mean in a given year for certain
  statistical confidence level.

15
Stochastic modeling Portfolio efficiency

• This module analyzes the efficiency of the debt
  portfolio in its cost and risk dimensions. This
  provides information about the existent trade-off
  between cost and risk.

Variable-rate debt
.
If a certain number of fixed-rate instruments are
exchanged for floating-rate instruments, the
expected financial cost will decrease in Y, while
the risk will increase in X.
Financial Cost (millions of pesos)
Minimum variance portfolio
.
.
Y
X
Standard deviation (millions of pesos)
16
Stochastic modeling Portfolio efficiency and CaR

• The CaR can be used together with the portfolio
  efficiency analysis.
• If it is assumed that the financial cost follows
  a normal distribution, the average financial cost
  can be described using the following equation
• µ CaR 1.645 s
• Using this equation it is possible to find the
  efficient portfolio de minimizes the CaR.

If CaR 1 is acceptable Efficient Portfolios A
and C
.
CaR 1
Minimizing CaR CaR 2 Efficient Portfolio
B
A
CaR 2
.
µ
CaR f(s)
.
B
C



s standard deviation
17
Additionally, the Federal Government manages
others types of risk related to public debt

• Credit Risk. In order to mitigate this risk, the
  Federal Government
• Distributes its credit risk by executing
  derivative operations with different
  counterparties that have only the highest
  international credit ratings
• Monitors carefully the market value evolution of
  all derivative positions.
• Operational risk. Among the most important
  measures taken in recent years it is worth to
  mention the following
• Transparency
• Coordination
• Separation of functions
• Procedures
• Internal and External Controls
• Informational Systems
• Backup Systems

The public debt policy for 2006 is enclosed
within this integral approach for risk management.
18
Agenda

• Debt Management during the current Administration
• Strategic Guidelines for Public Debt Management
• Public Debt Policy for 2006
• Final remarks

19
Public debt policy for 2006 General Objective
Obtain the financial resources to cover the
amortizations of its outstanding debt and its net
financing needs under the most favorable cost
conditions in the medium and long term, subject
to a prudent level of risk.
20
Public debt policy for 2006 Main guidelines

• The Federal Governments net financing needs will
  be obtained mainly through the auction program of
  government securities in the domestic market,
  relying mostly, as in previous years, in the
  issuance of long-term nominal fixed rate bonds.
• The Federal Government will start auctioning
  long-term inflation indexed instruments
  (Udibonos) on a regular basis, complementing the
  current issuance strategy of 10 year Udibonos.
  The lower net financing needs for 2006 of the
  Toll Road Rescue Trust (FARAC) allows the Federal
  Government to anticipate that the FARAC will
  conclude this year its issuance program of
  long-term inflation-indexed bonds.
• The pre-funding strategy of market external debt
  implemented in recent months implies that the
  Federal Government does not need to consider in
  the Economic Program for 2006 the issuance of
  external debt in the international capital
  markets for refinancing purposes, notwithstanding
  Mexicos good credit quality.

21
Public debt policy for 2006 Additional actions

• The Federal Government will analyze the
  convenience of reducing the number of on the
  run tenors currently issued and their auction
  frequency, with the purpose of improving
  efficiency conditions of the local market.
• In this context, the Federal Government will also
  evaluate if the prevailing conditions in the
  national and international financial markets are
  appropriate to start issuing on a regular basis a
  nominal fixed rated bond with a 30 year tenor.
• Also, the Federal Government, via Banco de México
  (Banxico), will issue before the end of this year
  the rules for the exchange program of fixed-rate
  instruments. The exchange program, which will
  contribute to smooth the amortization profile of
  domestic debt, will continue to be executed
  throughout 2006.
• The precise information about the supply by type
  of instrument will be disclosed in the quarterly
  government auction calendar.

22
Public debt policy for 2006 Additional actions

• It is expected that the amortizations of external
  debt related to International Financial
  Institutions (IFIs) will be totally refinanced
  through new operations with IFIs, while the
  amortizations of restructured, bank and external
  trade debt will be mainly refinanced with issues
  in the local market.
• The Federal Government will continue to perform
  the necessary liability management operations to
  strengthen its public debt structure and to
  assure the most favorable cost conditions in the
  medium and long term, subject to a prudent level
  of risk.

23
External debt will decline to 6.8 of GDP at the
end of 2006, its lowest level since 1969
FEDERAL GOVERNMENTS NET DEBT
( of GDP)
( of total)
100

External
Domestic
24
The duration and interest rate refixing
indicators are expected to improve substantially
in 2006.
INTEREST RATE RE-FIXING
DURATION OF GOVERNMENT SECURITIES ISSUED IN THE
LOCAL MARKET(years)

e/ Estimated
25
The CaR of Mexico will continue reducing in 2006
CaR OF THE FEDERAL GOVERNMENT DEBT INTEREST RATE
(Absolute CaR/Average cost expected)
CaR OF THE FEDERAL GOVERNMENT DEBT EXCHANGE
RATE (Absolute CaR/Average cost expected)
26
The positive behavior of these indicators will
translate into further decreases in the
sensitivity of financial costs to movements in
interest rates and exchange rates
INCREASE OF THE FINANCIAL COST OF THE FEDERAL
GOVERNMENTS GROSS EXTERNAL DEBT TO A 50 CENT
INCREASE IN THE EXCHANGE RATE ( of GDP)
INCREASE OF THE FINANCIAL COST OF THE FEDERAL
GOVERNMENTS GROSS DEBT TO A 100 BPS INCREASE IN
INTEREST RATES( of GDP)
27
Agenda

• Debt Management during the current Administration
• Strategic Guidelines for Public Debt Management
• Public Debt Policy for 2006
• Final remarks

28
Final remarks

• The current Administration has decided to frame
  its public debt policy within a risk-averse
  approach, considering that all the risk inherent
  in debt management is in the end transferred to
  the tax-payers.
• The public debt management strategy implemented
  during the current Administration has provided
  the necessary foundations for establishing an
  integral debt management policy based on the
  general objective of minimizing long-term
  financial costs, subject to a prudent level of
  risk.
• The Federal Government has worked intensively in
  strengthening its institutional and technological
  capabilities to rigorously quantify and manage
  all the risks of public debt.
• The Economic Program establishes some indicative
  figures for the main risk management metrics. It
  is expected that as this institutional process
  consolidates, the Federal Government will be able
  to set specific quantitative targets and limits
  to these indicators.