[GAO-02-14 ] Debt Management: Insights and Tools From Selected Nations , Part 1/2
in...@www.gao.gov
MIME-Version: 1.0
Debt Management: Insights and Tools From Selected Nations
(21-NOV-01, GAO-02-14).
The United States had budget surpluses for four years that
resulted in decreasing debt levels. Although the current economic
situation and the challenges of combating terrorism will prompt
deficits in the short term, the budget may again return to
surpluses. Surpluses will be needed in the future to prepare for
long-term costs due to the baby boom generation. GAO studied five
nations--Australia, New Zealand, Norway, Sweden, and the United
Kingdom-- whose recent experiences with debt management in times
of surpluses might be relevant to the United States. The
countries GAO studied experienced both budget surpluses and
deficits from 1988 through 2000. Recent budget surpluses
contributed to falling public debt levels in absolute terms and
as a share of the economy in these countries. Whether government
debt is increasing or decreasing, debt managers' objectives are
(1) to ensure that the government's financing needs are met, (2)
to minimize the government's cost of financing, (3) to promote
efficient markets, and (4) to keep risk at an acceptable level.
However, tradeoffs among these objectives are not always
compatible. During budget deficits, a primary consideration is
making government securities more attractive to potential
investors. On the other hand, periods of surpluses pose
challenges to maintain liquid benchmark issues and reduce
borrowing costs. Some nations used debt reduction and investment
in financial assets to help achieve national goals and prepare
for demographic changes. The Congress may want to consider
various debt management tools used by other countries during
cycles of budget surpluses and deficits.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-14
ACCNO: A02476
TITLE: Debt Management: Insights and Tools From Selected Nations
DATE: 11/21/2001 SUBJECT
******************************************************************
** This file contains an ASCII representation of the text of a **
** GAO Testimony. **
** **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced. Tables are included, but **
** may not resemble those in the printed version. **
** **
** Please see the PDF (Portable Document Format) file, when **
** available, for a complete electronic file of the printed **
** document's contents. **
** **
******************************************************************
GAO-02-14
A
Report to Congressional Requesters
November 2001 DEBT MANAGEMENT Insights and Tools From Selected Nations
GAO- 02- 14
a
GAO United States General Accounting Office
Page 1 GAO- 02- 14 Debt Management
November 21, 2001 The Honorable Bill Thomas Chairman Committee on Ways and
Means House of Representatives
The Honorable E. Clay Shaw, Jr. Chairman, Subcommittee on Social Security
Committee on Ways and Means House of Representatives
The Honorable Pete V. Domenici Ranking Minority Member Committee on the
Budget United States Senate
For 4 years, the United States has had a budget surplus that has resulted in
decreasing debt levels. Debt held by the public fell approximately $453
billion from the end of fiscal year 1997 to the end of fiscal year 2001. 1
Although it appears now that the economy and the challenges of combating
terrorism will prompt deficits for the short term, we may again return to
surpluses. In fact, we and others have argued that surpluses will be needed
in the future to prepare for the long- term costs of the baby boom
generation.
As we have previously reported, deficits and surpluses present different
challenges for debt management. Earlier this year 2 we provided you with
information on how the U. S. Treasury has been managing debt as the budget
was in surplus. Given the possibility for budget deficits in the near term,
the Treasury is likely to face new and persistent challenges in debt
management.
1 Gross federal debt includes debt held by the public and debt held by
government accounts, such as the Social Security trust funds. Despite the
current budget surpluses, gross federal debt continues to grow because debt
held by government accounts has increased at a faster rate than debt held by
the public has declined. Because debt held by government accounts is an
intragovernmental transaction, it is not the focus of this report.
2 See Federal Debt: Debt Management Actions and Future Challenges (GAO- 01-
317, February 28, 2001). See also Federal Debt: Debt Management in a Period
of Budget Surplus (GAO/ AIMD- 99- 270, September 29, 1999).
United States General Accounting Office Washington, DC 20548
Page 2 GAO- 02- 14 Debt Management
A number of other nations experienced a cycle of budget deficit and surplus
before the United States. You asked us to examine the experiences of some of
these nations looking for insights and lessons learned for the United
States. You asked that we pay particular attention to the various techniques
used, including the use of ?debt buybacks.? As discussed with your staff, we
selected five nations- Australia, New Zealand, Norway, Sweden, and the
United Kingdom- whose recent approaches and experiences with debt management
in times of surplus might have relevance to or provide useful information
for the United States.
To obtain information on the experiences of these other nations in managing
sovereign debt, we interviewed government officials, capital market
participants, academics, and others to discuss fiscal and debt management
goals, the relationship between budget changes and debt policies and
actions, and the nature of the capital markets in these nations. We also
gathered and analyzed documents and publications on debt management in these
five nations. With respect to United States debt policy, we interviewed
officials and gathered data from the Department of the Treasury, Federal
Reserve Board of Governors and Federal Reserve Bank of New York, and private
sector market participants in Washington, D. C., and New York City. We did
our work in accordance with generally accepted government auditing standards
from March 2000 through October 2001. The Treasury and the Congressional
Budget Office (CBO) generally agreed with this report and provided technical
comments that we have incorporated as appropriate.
The five countries in our study experienced both budget surpluses and
deficits during the period from 1988 through 2000. Recent budget surpluses
contributed to falling sovereign public debt levels in absolute terms and as
a share of the economy. Fiscal strategies, including clearly defined targets
of debt to the overall economy, helped achieve budget surpluses in several
countries. Setting targets that measure the size of gross or net debt 3 to
the economy allowed decisionmakers to track progress toward fiscal health
and provided justification for continued fiscal discipline.
Whether government debt is increasing or decreasing, debt managers?
objectives remain the same. The objectives are (1) ensuring that the
3 Net debt is defined as gross debt minus financial assets. Results in Brief
Page 3 GAO- 02- 14 Debt Management
government?s financing needs are met, (2) minimizing the government?s cost
of financing, (3) promoting efficient markets, and (4) keeping risk at an
acceptable level. However, the trade- offs among the objectives may be
different and the objectives themselves are not always compatible. During a
budget deficit, a primary consideration is making government securities more
attractive to potential investors, which includes deciding whether to
introduce new instruments. On the other hand, periods of budget surpluses
pose challenges to maintaining liquid 4 benchmark issues and reducing
borrowing costs. Declining levels of publicly held debt would present
challenges in supporting liquid markets across the yield curve of
securities. 5 Tensions between minimizing financing cost and supporting
domestic markets could be accentuated.
During periods of surplus, falling debt levels have caused debt managers in
all study countries to concentrate a large number of diverse debt issues
into fewer, but larger, benchmark issues that are also expected to lower the
governments? financing costs. These fewer, more liquid benchmark issues
generally have initial maturities ranging from 2 to 15 years. The U. S.
Treasury announced on October 31, 2001, that it was suspending issuance of
the 30- year nominal and inflation- indexed bonds. A Treasury official noted
that the market?s attention and action have shifted away from the 30- year
bond toward the 10- year note. The Treasury?s action will leave three
Treasury benchmarks ranging from 2 to 10 years- similar to most study
countries. Lower debt levels and resulting decreases in newly issued
government securities also caused central banks to modify investment
decisions. Central banks in most countries we studied generally held a
smaller share of their portfolio in government securities and generally held
an increasing share of outstanding government debt.
While we examined debt management approaches when all study countries and
the United States were in budget surplus, some of these tools could be used
during budget deficits as well. All study countries have deployed a number
of debt management tools that the United States has used. These include debt
buybacks, reopening of outstanding issues, and reducing or eliminating
certain maturities of debt. Debt managers noted
4 A liquid debt issue is one that is large enough to be traded at will and
one for which the offer and purchase prices differ only slightly. Benchmark
issues are used by other financial services to price their products.
5 A yield curve is a graphical depiction of the current relationship between
interest rates and time to maturity, holding all other factors (such as
credit risk) constant.
Page 4 GAO- 02- 14 Debt Management
that reverse auctions are a way to consolidate government debt into
benchmark maturities and allow issuance of new bonds to meet market demand.
While we examined buybacks used in the study countries and the United States
when their budgets were in surplus, buyback results also could be achieved
in times of budget deficits. Debt buybacks can have the advantage of
allowing debt managers to change the characteristics of outstanding debt as
well as to create larger benchmark issues. The experiences of other
countries suggest that it can be difficult to manage and predict the costs
of reverse auctions.
Each of the countries, except Norway, used reverse auctions 6 that bought
back debt before it matured. Unexpected changes in key information about the
amount of debt repurchases and a compressed time schedule caused Sweden?s
buyback operations in 2000 to be more costly than expected. Australian
officials said that buying back debt through means other than a reverse
auction may lower costs to the government. The Reserve Bank of Australia
(RBA), Australia?s central bank, has conducted bond repurchases on behalf of
the Australian Office of Financial Management (AOFM) for several years.
However, an RBA official said that the success of these operations is a
function in part of the liquidity of the bond and the level of information
about the operations themselves. Debt managers in the United Kingdom planned
to buy back debt using a combination of reverse auctions and open market
repurchases to guard against the risk that it might be progressively more
expensive to acquire securities as reverse auctions continued.
All study countries, as well as the United States, used other tools to
increase market efficiency and allow increased issuance of benchmark
securities. However, the other nations used a broader range of tools: open
window repurchases, debt exchanges, buybacks without canceling debt, switch
auctions, taps and reverse taps, and swaps.
The additional debt management tools used regularly in other nations may
hold promise for the United States. Australia and the United Kingdom allow
investors to offer securities to the government for repurchase at the
government?s option. Called ?open window repurchases,? these programs
provide an opportunity for the government to buy back debt at market
6 In a reverse auction, the government receives offers from market
participants to sell securities at a specific price. In the United States,
the Treasury accepts the most competitive offers.
Page 5 GAO- 02- 14 Debt Management
rates. A variation of this approach allows investors to offer only
securities nearing their maturity dates for repurchase at the government?s
option. These programs act as both debt management and cash management
tools- reducing outstanding debt and smoothing cash flows by giving debt
managers another opportunity to use excess cash flows in surplus months that
may occur even in a budget deficit year. The government can choose which
issues to repurchase in both a reverse auction and an open window
repurchase. From the investor?s perspective, open window repurchases can be
advantageous because they are an opportunity for the investor to switch its
funds to another investment before the security matures. While the amount of
debt repurchased may be lower in an open window program, these programs may
provide a lower cost buyback because the government can choose to buy when
it believes market prices are advantageous. Open window repurchases likely
can be done more frequently than reverse auctions and may have lower
administrative costs. Debt management offices in Australia and the United
Kingdom have used open window repurchases to supplement reverse auction debt
buybacks.
Debt exchanges are used in three of the five study countries to promote
liquidity of benchmark securities by exchanging outstanding debt securities
for the newly issued, more liquid benchmark securities. Exchange offers are
opportunities for investors to convert one debt security into another- for
example, an older, nonbenchmark security into a new benchmark bond- at a
ratio to be determined by the debt management office. The U. S. Treasury now
is studying the advisability and feasibility of debt exchanges.
The United Kingdom has used switch auctions- a recent innovation- to build
up liquid benchmark securities in a time of low issuance and when the Debt
Management Office wished to obtain a share of a debt issue that was too
large to have been considered for a debt exchange. In a switch auction, the
debt management office offers to buy a certain amount of a nonbenchmark bond
against the issue of a further amount of a benchmark bond, with the exchange
ratio to be determined by the accepted bids. Switch auctions also may hold
promise for the U. S. Treasury in supporting the creation of large benchmark
issues without increasing outstanding debt.
Some debt management tools used abroad hold less promise for the United
States because they may be difficult to implement in a way consistent with
the value of equal access, or may require the government to assume credit
risk. One- on- one offers to buy or sell debt securities between the debt
management office and an individual market participant
Page 6 GAO- 02- 14 Debt Management
are used in all study countries. Another tool- swaps of securities between
the government and a capital market participant- may provide the opportunity
for lower cost financing, but requires the government to assume the risk
that the swap partner may default.
When some study countries experienced budget surpluses, their governments
decided to continue to maintain their sovereign debt markets to keep a role
for the central government in debt markets and/ or to facilitate potentially
higher levels of borrowing in the future. As a consequence, these countries
have had excess cash to invest in financial assets. Particular investment
decisions have been influenced by both the size of the current surplus and
projections about its level over time. Two of the five nations in our study
have chosen to place this excess cash in short- term, liquid accounts in
either the central bank or the domestic banking system. Pending the further
development of strategies, Australia has placed surplus funds in an account
at the central bank. The United Kingdom initially invested the surplus in
money market instruments, including liabilities of banks, using the cash to
reduce net debt. Sweden and New Zealand used excess cash to offset their net
government debt denominated in foreign currencies. They bought back some of
their debt denominated in foreign currencies and increased foreign currency
assets to offset their net remaining foreign currency denominated debt.
Norway, with substantial although declining oil activity receipts projected
to continue at least through 2004, created a Petroleum Fund that holds
predominantly longer- term assets (bonds and equities) and assumes more
risk.
The budgetary surpluses of recent years that were achieved by fiscal
discipline and strong economic growth positioned us well to respond to both
the events of September 11, 2001, and to the economic slowdown. Although the
budget may dip into deficit in the short term, once the economy rebounds the
nation may again return to surplus. For example, the Senate and House
Committees on the Budget, on a bipartisan basis, endorsed a long- term
fiscal policy to maintain surpluses equal to the Social Security surplus.
For the long term, sustained budgetary surpluses bolster the nation?s
economic capacity to afford the burgeoning costs of the baby boom
retirement. Other nations have used debt reduction and investment in
financial assets as a way to achieve national goals and to prepare for
future demographic changes. Several study nations have recognized potential
governance issues associated with ownership of longer- term assets. The
United States might be faced with similar issues in the future should we
return to surpluses.
Page 7 GAO- 02- 14 Debt Management
All of the study countries and the United States had budget deficits give
way to budget surpluses in the 1990s. Debt changes closely followed the
budget changes for four of the study countries. Debt and budget surplus
targets were used as fiscal goals in some countries. Maintaining government
debt at prudent or stable levels is a fiscal goal pursued in most of the
countries we studied. While in budget surplus each of the study nations
decided, for reasons particular to its own political and economic
considerations, to maintain some level of government debt to retain a
presence in the capital market. This choice may facilitate the borrowing
increase that may be caused by the recent global economic downturn.
Table 1 below shows the pattern of surpluses and deficits from 1988 through
2000. Four of the study countries- all but New Zealand- experienced a cycle
of budget surpluses, followed by deficits and then a return to surpluses in
the last 13 years. Budget surpluses were achieved in the 1990s as a result
of budget consolidations and economic growth. 7 For the United States, there
was a gap of nearly 30 years between its 1969 and 1998 unified surpluses.
The current global economic downturn may cause some nations to return to
deficits and increase debt levels.
Table 1: Budget Deficits and Budget Surpluses as Percentages of GDP, 1988
Through 2000 Country 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
1999 2000
United States -3.1% -2.8% -3.9% -4.5% -4.7% -3.9% -2.9% -2.2% -1.4% -0.3%
0.8% 1.4% 2.4% United Kingdom 0.7% 3.0% 1.3% 0.1% -2.3% -5.9% -7.1% -5.3%
-4.4% -3.0% -0.4% 0.6% 1.0% Australia 0.6% 1.8% 1.7% 0.1% -2.9% -4.0% -3.8%
-2.8% -2.0% -1.0% 0.2% 0.7% 2.0% New Zealand -4.8% -3.7% -4.7% -3.8% -3.3%
-0.6% 3.0% 3.1% 3.6% 2.0% 2.6% 1.8% 1.4% Norway 2.7% 1.8% 2.6% 0.1% -1.7%
-1.4% 0.4% 3.5% 6.6% 7.9% 3.6% 4.9% 14.0% Sweden 0.7% 1.9% -1.0% -4.1% -9.7%
-13.6% -8.5% -8.1% -1.2% -0.3% 0.5% 4.1% 4.9%
Notes: Budget surplus/ deficit measures and source documents are listed in
the footnote. 8 Budget deficits are shaded.
7 Our report, Budget Surpluses: Experiences of Other Nations and
Implications for the United States (GAO/ AIMD- 00- 23, November 2, 1999),
describes the economic changes and fiscal efforts that resulted in budget
surpluses during the 1980s and 1990s.
8 United States - ?federal surplus or deficit,? CBO, The Budget and Economic
Outlook FY 2002- 2011; United Kingdom - ?public sector net cash
requirement,? HM Treasury, Budget 2001; Australia - ?commonwealth general
government cash surplus,? Commonwealth Budget 2001- 2002; New Zealand -
budget measure is ?financial balance? in 1988- 1995,
OECD Economic Outlook, December 2000, and ?operating balance? in 1996- 2000,
Financial Statements of the Government of New Zealand, June 30, 2000; Norway
- ?financial
balance,? OECD Economic Outlook, December 2000; and Sweden - ?central
government budget balance,? Statens Finanser, Ekonomistyrningsverket. Budget
Surpluses,
Fiscal Policies, and Debt Levels
The Pattern of Surpluses and Deficits and Related Debt Levels
Page 8 GAO- 02- 14 Debt Management
Debt changes closely followed the budget cycles for four of the study
countries. Debt reductions were achieved with the budget surpluses in the
late 1980s, but debt levels increased sharply when governments borrowed to
finance the budget deficits in the early and mid- 1990s. (See figure 1.)
Figure 1: Gross Debt as a Percentage of GDP, 1988 Through 2000
Note: Gross debt measures and source documents are listed in the footnote. 9
The gross debt trends 10 for the six countries show the response of debt
levels to budget balances and economic changes. The ratios of debt to GDP in
figure 1 closely track the cycles of budget surplus and deficit shown in
table 1. All of the study countries except Sweden and the United
9 United States - ?federal debt held by the public,? CBO, The Budget and
Economic Outlook FY 2002- 2011; United Kingdom - ?general government gross
debt,? HM Treasury, Budget 2001; Australia - ?government securities on
issue,? Australian Office of Financial Management, Annual Reports and The
Treasury: Commonwealth Debt Management; New Zealand - ?Crown gross debt? in
New Zealand?s 2001 Economic and Fiscal Update and
?gross total debt? in New Zealand?s Debt Management Office?s Web site www.
nzdmo. govt. nz; Norway - ?general government gross financial liabilities,?
OECD Economic Outlook, December 2000; and Sweden - ?central government debt?
in Swedish National Debt Office?s Web site www. rgk. se.
10 For this report, gross debt refers only to debt held by the public.
0 14
28 42
56 70
84 United States United Kingdom Australia New Zealand Norway Sweden Years
1988- 2000 Percentage
Page 9 GAO- 02- 14 Debt Management
Kingdom show debt- to- GDP ratios in 2000 lower than at any time in the
period from 1988 through 2000.
Net debt- to- GDP ratios in the period 1988 through 2000 are shown in figure
2 for the study countries and the United States. Norway?s and Sweden?s large
asset holdings make their net debt substantially lower than their gross
debt. Since Norway?s assets are larger than its debt, it had negative net
debt- to- GDP ratios in this period. After Norway, Sweden had the lowest net
debt- to- GDP ratio (2 percent in 2000), although its gross debtto- GDP
ratio (61.2 percent in 2000) was the highest among the study countries and
the United States.
Page 10 GAO- 02- 14 Debt Management
Figure 2: Net Debt- to- GDP Ratios, 1988 Through 2000
Note: Net debt measures and source documents are listed in the footnote. 11
As noted in our study of the fiscal policy experiences of study nations,
debt and budget targets were used as fiscal goals in some countries.
Maintaining government debt at prudent or stable levels is a fiscal goal
pursued in most of the countries we studied. Debt objectives can be defined
in both nominal amounts and relative terms. Gross debt as a
11 United States - ?federal debt held by the public,? CBO, The Budget and
Economic Outlook FY 2002- 2011, and ?financial assets,? U. S. Treasury,
Financial Report of the United States Government; United Kingdom - ?public
sector net debt,? HM Treasury,
Budget 2001; Australia - ?commonwealth general government net debt,?
Commonwealth Budget 2001- 2002; New Zealand - ?net Crown debt? in New
Zealand?s 2001 Economic and Fiscal Update; Norway - ?general government net
financial liabilities,? OECD Economic Outlook, December 2000; and Sweden -
?general government net financial liabilities,?
OECD Economic Outlook, December 2000. Some Countries Used
Fiscal Targets
-56 -42
-28 -14
0 14
28 42
56 70
United States United Kingdom Australia New Zealand Norway
Sweden Years 1988- 2000 Percentage
Page 11 GAO- 02- 14 Debt Management
percentage of GDP compares debt to the size of the economy. Governments
measure the extent to which they have accumulated financial assets by
reviewing goals they have set for ?net debt?- which is defined as gross debt
minus financial assets. (See table 2.)
Table 2: Fiscal Targets Used in Study Countries Country Fiscal targets Notes
Australia Reduce net debt, with a projected negative net debt in fiscal year
2004- 2005, while maintaining liquidity in benchmark securities. New Zealand
Maintain relatively stable long- term
targets for net and gross debt below 20 percent and 30 percent of GDP,
respectively, on average over the economic cycle.
Gross debt would increase in nominal terms from 2001 through 2005 to finance
financial and physical assets.
Norway Keep revenue and expenditure at sustainable levels consistent with
stable prices and long- term fiscal sustainability, which is the primary
fiscal objective.
Short- term fluctuations in oil prices should not affect economic policy.
Sweden Maintain 2 percent of GDP budget surplus on average over an economic
cycle.
Sweden has a nominal ceiling for central government expenditures for 3 years
ahead. United Kingdom Maintain net debt at a sustainable
level, below 40 percent of GDP. The ratio of net debt to GDP was forecasted
to fall to
about 34 percent of GDP in fiscal year 2001- 2002, and remain at about that
level for the next 4 years.
Sources: Data from study countries obtained in early September 2001.
The amount of general government net debt in Australia has fallen
consistently since the mid- 1990s, from a peak of almost 19 percent of GDP
in fiscal year 1995- 1996 to an expected 5.4 percent in fiscal year 2001-
2002. Using the policy settings in the fiscal year 2000- 2001 budget, net
debt could be eliminated in fiscal year 2004- 2005. New Zealand?s 2001
Economic and Fiscal Update projects net debt- to- GDP levels of from 15.8
percent to 18 percent from 2001 through 2005.
In Europe, the Maastricht Treaty provides for a target ratio of gross
general government debt to GDP at market prices of 60 percent and budget
deficits of not more than 3 percent of GDP at market prices. Sweden and the
United Kingdom subsequently adopted fiscal policies and debt targets that
would enable them to achieve and maintain these levels.
Page 12 GAO- 02- 14 Debt Management
Sweden?s fiscal policy anchor is a budget surplus of 2 percent of GDP on
average over an economic cycle. This fiscal policy goal was adopted to
reduce general government debt in preparation for demographic changes and to
allow Sweden to achieve and maintain Maastricht?s convergence criteria. The
United Kingdom?s fiscal targets, 12 adopted in 1998, included a sustainable
investment rule that called for holding public sector net debt as a
percentage of national income at a ?stable and prudent? level over the
economic cycle. However, the United Kingdom achieved a net debt- toGDP ratio
of 31.6 percent in 2001, below the level of 40 percent of GDP referenced in
1998. The 2001 budget projects a steady ratio around 30 percent in the next
5 years.
While in budget surplus, each of these five nations also decided, for
reasons particular to its own political and economic considerations, to
maintain some level of government debt and the ability to issue debt by
retaining a presence in the capital market. The reasons given for keeping
some government debt include
preparing for the possibility that the government may need to borrow again
(New Zealand);
strengthening the domestic capital market (Australia, New Zealand, and
Norway); and
providing a secure, long- term investment vehicle for pension and
insurance funds (United Kingdom).
Both structural differences in domestic capital markets and the relative
size of government debt in the world and domestic bond markets affect
options available to government decisionmakers and debt managers. For
example, some nations where government bonds comprise a large share of bond
markets found it important to maintain some level of debt to ensure
continued viability of a market for government bonds. Table 3 shows the
relative market shares of government securities by country.
12 The United Kingdom?s fiscal targets are described in the Finance Act 1998
and the Code for Fiscal Stability 1998. Study Countries Decided
to Maintain Government Debt
Page 13 GAO- 02- 14 Debt Management
Table 3: Relative Market Share of Government Securities by Country Country
Share of each country?s government bonds in world
bond market Share of central government
bonds in each country?s bond market
United States 7.34% 15.0% Australia 0.21% 35.5% New Zealand 0.04% 61.9%
Norway 0.05% 35.0% Sweden 0.24% 49.0% United Kingdom 1.33% 39.1%
Note: World bond market includes government, corporate, foreign, and
Eurobond issuers. Source: Merrill Lynch, Size and Structure of the World
Bond Market: 2001, April 2001 (data as of December 31, 2000).
The experience of moving between budget surpluses and deficits has
influenced current debt management policy and practices in the countries we
visited. Government officials told us their current debt management is based
on the assumption that borrowing needs may increase in the future.
Although the five study countries and the United States do not have
identical objectives in managing their sovereign debt, debt management
objectives in all of these countries generally fall into four categories:
ensuring that the government?s financing needs are met,
minimizing the cost of financing,
supporting domestic capital markets, and
keeping risk at an acceptable level. Debt management objectives may remain
the same regardless of whether a government?s budget is in deficit or
surplus. However, debt managers may use different strategies to pursue these
goals when budget surpluses allow lower debt levels than when deficits cause
debt to increase. Additionally, while debt managers continually make
decisions on the composition of government debt, balancing the objectives
becomes more challenging when the amount of debt outstanding is being
reduced. This is because the objectives, while interrelated, are not always
entirely compatible.
Ensuring that the government?s financing needs are met is a critical
objective and achieving it is the result of successful debt and cash
management. The cycles for issuing bills, notes, and bonds are determined
Countries Have
Similar Debt Management Objectives
Page 14 GAO- 02- 14 Debt Management
largely by the government?s cash management needs. Short, variable term
bills can be issued as needed to cover low points in available cash.
Minimizing the cost of borrowing usually is viewed as a medium- to longterm
objective. Debt management offices use different approaches toward achieving
lowest long- term cost. For example, debt management offices like those in
our study have decided to maintain regular, predictable operations and to
maintain broad and deep markets, while others with small operations may time
their actions to take advantage of market conditions. Taking advantage of
market conditions can include issuing a particular type of security only
when conditions (such as price) are advantageous to the government.
Supporting domestic markets is important because efficient, liquid- defined
as broad and deep- markets that address investor demands also contribute to
achieving the first two objectives. The U. S. Treasury advances its goal of
efficient markets by issuing debt with various maturities and in sufficient
amounts to appeal to the broadest range of investors. One way the United
Kingdom?s Debt Management Office has supported its domestic market is by
issuing relatively more long- term debt to meet strong and increased demand
caused in part by regulatory and tax factors and because the demographic
profile is becoming older and pension funds are demanding more nominal
bonds. 13 According to the United Kingdom?s Treasury, meeting this demand
will benefit both the government and investors. Insurance companies and
pension funds acquire the relatively longer- term government securities to
meet their portfolio needs, and the government may get cheaper financing
because it is issuing where demand is high. However, this government
strategy means that there is less relatively new debt in the shorter
maturity ranges sought by other capital market participants. Sweden?s
National Debt Office also helped to strengthen the domestic capital market
by its strategy of issuing securities in kronor and executing a swap
agreement wherein the government pays interest in foreign currency, and
receives payment in kronor equal to the cash flow for a krona- denominated
bond. Thus, Sweden gets a lower borrowing cost than if it sold bonds
denominated in a foreign currency and this results in improved liquidity in
the domestic
13 Institutional and regulatory factors included the ?Minimum Funding
Requirements? that created incentives for pension funds to hold long- dated
government securities. The Government has announced that these Requirements
will be abolished. Other factors include the ?Advance Corporation Tax,?
abolished in April 1999, and the dividend tax credit, abolished in the 1997
budget.
Page 15 GAO- 02- 14 Debt Management
government securities market. Debt management offices in the countries we
studied believed it was important to consult with market participants about
such issues as market conditions and investor demand.
Keeping risks at an acceptable level is key to success in each of the other
objectives. Debt management offices encounter and manage the following types
of risk:
Funding risk is the possibility that a debt management office would not be
able to access markets or raise funds at an acceptable cost. For example,
rates may be unacceptably high when the government needs to issue debt to
cover a budget deficit.
Liquidity risk is the possibility that market conditions might shift in
such a way as to not allow for quick or cost- effective liquidation of
securities or positions. For example, the government may face liquidity risk
when it repurchases outstanding marketable debt prior to maturity if it
causes a substantial change in prices.
Market risk is the possibility that, once debt has been issued, adverse
changes in interest rates or foreign currency exchange rates could cause
either debt service costs to increase directly or the opportunity to reduce
debt service costs to be missed. For example, the funding cost may be higher
on new debt than on maturing debt.
Portfolio concentration risk is created when a portfolio is unduly
affected by one specific instrument, individual transaction, industry, or
country.
Operational risk includes, among other things, the possibility of errors
in transactions, failures of internal controls, breaches of legal
requirements, and disruption of markets from external events such as natural
disasters.
Debt management offices that use swaps in managing their debt also face
credit risk. Credit risk is the possible default or lowered credit rating of
a financial institution participating in a swap operation with the
government.
Debt managers? assessments of the risks inherent in each of the debt
management tools are one factor used when deciding among several tools that
could address the same objective. For example, debt managers could use debt
buybacks coupled with greater new issuance, switch auctions,
Page 16 GAO- 02- 14 Debt Management
and debt exchanges to change the average maturity/ duration 14 of
outstanding debt, as is done in the United Kingdom. These tools, explained
later in more detail, may affect market risk or liquidity risk differently.
The relative market share of a government?s securities in the world and
domestic capital markets is one factor that affects the amount of risk
associated with particular debt management tools. For example, United States
government securities represent a smaller share of the domestic capital
market than do the securities of the study nations. The relatively deep,
liquid private capital market in the United States accounts in part for the
statement of a Treasury official that the market could adjust to declines in
the supply of Treasury securities in times of budget surpluses. However, as
we noted in an earlier report, the changes may not be either seamless or
without cost.
Debt management in some study countries is driven by policy decisions on
debt targets and portfolio benchmarks. Further, differences in the size and
depth of capital markets affect options available to debt managers.
Many of the study nations set formal debt maturity or duration targets to
assist debt managers in managing risk. For example, during periods of budget
surplus, governments generally reduce debt or issue less debt than in
deficit periods. Thus, the maturity profile or the average duration is
determined more by the character of outstanding debt than the composition of
new issues. These maturity profile issues are important because debt
maturity can have a significant influence on the government?s cost of
financing as it affects interest payments and market liquidity. While the
United States does not have formal debt targets, operationally the Treasury
considers objectives similar to those of the study countries. (See table 4.)
14 Average maturity and average duration indicate the level of market and
funding risk a government might face. Modified duration of outstanding debt
is the percentage change in the debt?s market value arising from a 1-
percent change in the nominal interest rate. Two study nations use duration
targets and two do not use any targets. A Treasury official noted that the
United States does not have a formal target. However, it monitors average
maturity rather than using duration because the United States does not match
assets and liabilities. Debt Management
Approaches Differ
Page 17 GAO- 02- 14 Debt Management
Table 4: Debt Targets of Study Countries Country Debt maturity or duration
targets-
domestic currency nominal debt Notes
United States No formal target. Operationally, the United States spreads
issuance over the yield curve and maintains a limited number of liquid
benchmarks.
The Treasury monitors the average length of marketable debt, and Treasury
officials said that buybacks have prevented its lengthening by about 2 to 3
months. The average length of marketable debt was 5. 9 years as of September
30, 2001. Australia A modified debt duration range of 3
to 3.5 years for domestic debt and 1 to 1.5 years for United States
dollardenominated debt. New Zealand Spread issuance over yield curve, up
to 12 years. Debt maturity profile is kept relatively smooth to reduce
funding and market risks. Norway Build up and maintain a limited
number of liquid benchmark bonds with maturities up to 10 to 11 years.
Borrowing is done to provide funds for net lending, equity investments, debt
amortization, and central bank monetary operations. Sweden 3.5 years +/- 0.
5 years duration.
No more than 25 percent of the central government debt will mature within 1
year.
The duration of the combined domestic and foreign currency debt is shorter-
2.7 years, +/ 0.3 years. United Kingdom No formal target. Operationally,
issuance has, in the recent past, been biased toward long maturity bonds in
response to strong demand for these bonds from investors. Issuance in fiscal
year 2000- 2001 was 65 percent long- term fixed bonds and 35 percent index-
linked bonds.
Sources: Information supplied by study countries.
A flatter debt maturity profile, with approximately equal amounts of debt in
benchmark issues across the maturity curve, helps to reduce both funding and
market rate risks. For example, as a result of concentrating debt issuance
in fewer benchmark securities, New Zealand?s debt profile in August 2001 was
approximately horizontal with eight benchmark securities (out of 10 total
debt issues) of roughly similar size.
In the United States, approximately 50 percent of total outstanding
marketable debt will mature in 2 years or less. Such a profile may present
countries with less- developed capital markets or less demand for government
securities than in the United States with significant funding
Page 18 GAO- 02- 14 Debt Management
risk. 15 The United States is less likely to incur this funding risk because
the United States? government bond market is the largest in the world and
its securities enjoy high demand.
Four of the countries we studied- Australia, New Zealand, Norway, and
Sweden- develop hypothetical ?benchmark portfolios? that target the
composition of their debt portfolios and the nature of portfolio exposures
(or market risks) that are most efficient in the long term. In Sweden, the
Ministry of Finance works with the central bank and debt management office
to develop these targets. The Australian Office of Financial Management
develops its benchmark portfolio with the assistance of external portfolio
management consultants. Once the benchmarks are set, debt managers design
strategies to achieve or maintain this portfolio structure over the long
term. Oversight and accountability for debt management offices with
portfolio benchmarks can be more direct and transparent since they may
report at year- end on their portfolios and how they differ from the
targets. Some governments publish annual reports with assessments of debt
management. For example, in Sweden the government decides on such portfolio
benchmarks as the average duration of the nominal krona- denominated debt,
and the amount of inflationindexed and foreign currency- denominated debt.
The government?s decisions and supporting analysis as well as the Swedish
National Debt Office?s proposals and central bank?s comments are published
annually. Swedish law requires the government to evaluate the management of
central government debt in a written communication to the parliament.
Evaluation is both quantitative (differences in the absolute costs compared
with the government?s guidelines) and qualitative (day- to- day management
of the debt, including market maintenance efforts).
The countries? disparate experiences significantly influence the
implementation of debt management- that is, their choices of debt management
tools. Market share, market structure, and the preferences of capital market
participants can shape the choices available to debt managers. Differences
in balancing cost and risk also shape debt management choices. Further, the
size and timing of an actual or projected budget deficit or surplus can
affect choices about whether and how to hold financial assets. Some examples
of factors shaping debt management abroad follow.
15 Funding risk presents the possibility that there may not be sufficient
market demand for government securities or the government could not sell
them at an acceptable price.
Page 19 GAO- 02- 14 Debt Management
Australia does not need to issue debt in foreign currencies because of its
deep domestic government securities market. However, it has taken on foreign
currency exposure because this can provide long- term cost and risk
advantages.
In contrast, in New Zealand the focus of debt management from 1994 to the
present has been to reduce its large volume of foreign- currency denominated
debt and thus eliminate net foreign currency risk.
The Norwegian government returned to surplus in 1996 on the strength of
surging oil revenues, economic improvements, and fiscal restraint. It then
was faced with the decision whether to maintain its domestic government
securities market and, if so, how to invest these receipts in assets.
In Sweden, debt managers had to coordinate debt issuance and asset swaps
as the government undertook concurrent reform of the national pension
system. The AP funds (national pension scheme) were restructured and SEK90
billion was transferred to the central government budget during fiscal year
1999- 2000 and SEK155 billion in 2001. The government will use these
receipts to reduce debt.
The United Kingdom has a strong institutional demand for long- term
government securities that significantly influences debt managers? choices.
The five countries in our study generally used similar debt management tools
to reduce the level of outstanding debt during budget surpluses. Some
countries reduced issuance of new debt securities. The study countries
employed similar tools to improve liquidity and concentrate new debt into
fewer, larger benchmark issues. These include eliminating certain
maturities, changing the frequency of auctions of certain debt instruments,
and adding new debt to existing issues (called reopening) rather than
creating new issues. At the same time, some study countries also
reconsidered issuance of inflation- linked securities and increased issuance
of short- term bills with varying maturities. Further, all study countries
bought back debt before it matured. The United States also used these tools
in its debt management. (See table 5.) Some Debt
Management Tools Are Common to All Study Countries and the United States,
but Implementation Varies
Page 20 GAO- 02- 14 Debt Management
Table 5: Debt Management Tools by Country Tool United
States Australia New Zealand Norway Sweden United
Kingdom
Reduce net issuance X X X X Concentrate issuance into benchmarks X X X X X X
Eliminate certain maturities X X X X X X Reopen issues X X X X X X Buy back
outstanding debt before maturity through reverse auctions X XX XX Reduce or
eliminate issuance of inflationlinked securities X XX X Increase issuance of
short- term bills with varying maturities X X
Offer standing repurchase of debt nearing maturity offered by investors X X
X Sell or buy securities between auctions
Taps/ reverse taps X X X X Open window X X X X X Use swaps to hedge domestic
interest rate risk X X Use swaps to hedge currency risk X X X Use swaps to
increase issuance in domestic currency while creating foreign currency debt
X X X Use debt exchanges X X X Use switch auctions X
Sources: GAO interviews with government officials in study countries and
publications from study nations and the United States.
As budget surpluses resulted in lower debt levels, all five study countries
restructured their debt portfolios to better achieve debt management
objectives. All of the countries in our study- as well as the United States-
have taken steps to concentrate debt issuance into fewer, larger benchmark
issues. These larger issues allow governments to capture a liquidity premium
16 in the market that reduces their costs of financing.
When governments run budget deficits and have large borrowing needs, debt
managers may be able to issue new debt in issues large enough to be liquid
(or efficient in the market). However, when governments with budget
surpluses reduce borrowing, new issues become smaller and less
16 A liquidity premium is the incremental price market participants are
willing to pay for securities that are part of large issues that can be
easily traded. Concentration of New and
Outstanding Debt Into Fewer Issues
Page 21 GAO- 02- 14 Debt Management
liquid. Continuing with many small issues is less efficient, and the
governments? financing costs may rise as the bond markets seek to offset
this lower liquidity. Therefore, as debt levels have fallen, debt managers
have concentrated new issuance into fewer, larger, benchmark issues. The
market rewards this increased liquidity by paying premiums that reduce the
governments? costs of borrowing.
The study countries all have reduced the number of new issues and used debt
management tools to concentrate borrowing into fewer, more liquid
benchmarks. The five nations in our study- and the United States- have from
3 to 12 benchmark issues that range from 1 to 30 years in maturity.
Recently, only the United Kingdom and the United States have had benchmark
bonds that mature in 30 years. The U. S. Treasury announced on October 31,
2001, that it was suspending issuance of the 30- year nominal and inflation-
indexed bonds. The announcement acknowledged that market interest and
actions have shifted from the 30- year bond to the 10- year note. The
benchmark maturities in other countries generally range from 1 to 15 years.
(See table 6.)
Page 22 GAO- 02- 14 Debt Management
Table 6: Benchmark Securities in Selected Countries as of August 2001
Country
Number of nominal coupon benchmarks and terms to maturity Comments
United States Number: 3
Terms: 2, 5, and 10 years The U. S. Treasury announced on October 31, 2001,
that it was suspending
issuance of the 30- year nominal bond. Australia Number: 12
Term: 13 years New Zealand Number: 8
Terms: almost 5 years to almost 12 years
The 5- year bond, original issue NZD$ 150 million and February 2005 maturity
was reopened seven times and increased to NZD$ 1,272 million at end of June
2001.
The 12- year bond, original issue NZD$ 175 million and November 2011
maturity was reopened 20 times and increased to NZD$ 2,871 million at end of
May 2001. Norway Number: 5
Terms: 1 to 11 years Norway normally issues a new domestic bond
approximately every 2 years that
matures after 11 years. Bonds with remaining maturity less than 1 year are
no longer regarded as benchmarks. Sweden Number: 12
Terms: 2 to 15 years These securities are offered in several tranches during
the whole term of the bonds,
until they lose their benchmark status 1 year before redemption. United
Kingdom Number: 3
Terms: 5, 10, and 30 years Nominal issuance in recent years has been solely
30- year gilts responding to strong
institutional demand. Sources: Data from study countries and the U. S.
Department of the Treasury and interviews with country officials.
In the study countries, creating new issues each time the government goes to
the debt market may result in small, less liquid issues. Consequently, some
of these countries establish new issues only when needed to provide
borrowing across the yield curve. Because these new issues generally are too
small to serve as benchmarks when they are issued, debt managers then add to
them when the government needs to borrow again in the future until they
reach benchmark status. This practice, called reopening, is used in all
study countries to increase the size of outstanding benchmark issues. By
contrast, while U. S. Treasury securities have been sufficient in size to be
considered benchmarks when issued, the U. S. Treasury has implemented a
program of regular reopenings to maintain their size.
Page 23 GAO- 02- 14 Debt Management
All study countries and the United States implemented debt management
strategies to increase concentration of new issuance into fewer, larger
issues. However, the number of outstanding issues differs markedly and
reflects historical differences. Benchmark issues represent a much larger
proportion of total outstanding issues in Australia, New Zealand, Norway,
and Sweden than they do in the United States and the United Kingdom. In New
Zealand and Norway all government borrowing is concentrated into benchmark
issues. According to an official in the United States, many of their fixed-
coupon nominal issues had benchmark size when they were issued and some
issues still retain benchmark size although they are not the most currently
traded issues. Other study countries had smaller original issues and
reopened the issues to create benchmarks. (See table 7.)
Table 7: Number of Outstanding Government Bond Issues as of August 2001
Country
Number of outstanding government fixed- coupon
nominal issues Of which: number of benchmarks
United States 148 3 Australia 19 12 New Zealand 8 8 Norway 5 5 Sweden 14 12
United Kingdom 51 3
Sources: Government publications and interviews with and data provided by
government officials.
Another reason the United States and the United Kingdom have more
outstanding issues is that they are the only two countries we studied that
have recently issued nominal debt maturing in 30 years. 17 Issuing such
long- term debt over several decades results in a large number of individual
issues outstanding at any given time. In addition, some of the study
countries began to concentrate outstanding debt into benchmark securities
earlier than the United States, and these study countries also use a wider
range of tools to accomplish this goal.
Three of the five study countries have reduced or eliminated issuance of
inflation- linked debt. These securities are a valuable tool for debt
managers because they expand the range of savings opportunities in the
17 The U. S. Treasury announced on October 31, 2001, that it was suspending
issuance of the 30- year nominal and inflation- indexed bonds.
Page 24 GAO- 02- 14 Debt Management
market, may produce cost savings for the government, and enhance the
credibility and conduct of monetary policy. Inflation- linked securities may
provide the government with lower- cost funding because investors receive
lower interest rates in return for protection against inflation. In return
for potentially lower costs, the government assumes the risk of unexpected
price increases and the government?s incentives to inflate are reduced.
Inflation- linked securities can be useful to policymakers interested in
damping inflation in the future. Inflation- linked securities have some
negative attributes as well- low participation and lower liquidity. These
qualities can decrease market efficiency and can increase the cost to the
government as the market charges an illiquidity premium. Of the five
countries we visited, Australia, Sweden, and the United Kingdom actively
issue inflation- linked securities, as does the United States. A Norwegian
official told us that, given the small size of Norway?s debt, diversifying
into inflation- linked securities would reduce the amount of nominal
benchmark bonds (which is close to the level needed to maintain acceptable
liquidity in each bond). A New Zealand official told us that New Zealand
stopped issuing inflation- linked securities because of lack of investor
interest and the cost of issuance relative to other alternatives.
Although the nations in our study were moving toward generally similar debt
portfolios, we would not expect to see convergence into identical portfolio
structures. A recent report from the World Bank stressed that there is no
single portfolio design appropriate for all countries. 18 Debt portfolios
must respond to national priorities and market conditions.
By selectively reducing the outstanding amount of particular securities,
debt buybacks are a powerful tool to manage liquidity or the average
maturity of outstanding debt. Debt buybacks can be used as an end in
themselves- to reduce outstanding debt- or as a way to allow the debt
management office to issue more new debt without increasing overall debt
levels. Thus, debt buybacks can be used in periods of budget deficits as
well as budget surpluses. Debt buybacks can be implemented in a number of
ways. They can be used alone or in tandem with new debt issuance. They also
can be completed with different degrees of transparency, regularity, and
access by investors. Every study nation has used buybacks
18 Sound Practice in Sovereign Debt Management, The World Bank, Financial
Products and Services Department, July 12, 2000. Debt Buybacks Are a
Flexible Tool
Page 25 GAO- 02- 14 Debt Management
at some point in the debt reduction process, although they have designed and
managed their programs differently from the United States.
The number of outstanding issues that are not benchmarks is one indicator of
the ?buyback potential? in each country. As shown earlier in table 7, the
United States has a larger number of nominal fixed- coupon government bond
issues than any of the five study countries, with 145 that are not benchmark
issues. The portfolio structures in the United States and the United Kingdom
show significantly more potential for buybacks than other study countries
when using this measure.
While all study nations have done debt buybacks, they generally use them
differently from the United States. The United States has used a program of
ongoing, regularly scheduled reverse auctions to buy back debt. In a reverse
auction, market participants submit offers and the government accepts the
most competitive offers. The study countries- except Norway- have done
reverse auction buybacks, but they are not a routine part of debt management
abroad. Recently some study nations used reverse auctions episodically- to
reduce debt levels using one- time large receipts from the sale of
government assets. In contrast, the United States holds reverse auctions
twice a month and uses them both to reduce debt levels and to manage average
maturity and market liquidity.
In the late 1990s, the U. S. Treasury had to devise strategies for managing
large, continuing surpluses. If U. S. debt managers had used cash surpluses
to reduce debt rollover without taking other steps, they would have faced
large changes in average maturity and liquidity that could have increased
the government?s cost of financing. Because a debt buyback program of
regular reverse auctions can operationally handle relatively large volumes
and because the U. S. Treasury values regularity and predictability, the
Treasury chose to implement a debt buyback program of regular reverse
auctions with advance announcements of the size and targeted issues.
In March 2000, the Treasury held the first in a series of reverse auctions
to repurchase outstanding debt before it matured. In May 2000, the United
States implemented a program of regularly scheduled reverse auctions. The
dates and amounts of the transactions and the maturity ranges being targeted
for repurchase are announced in advance. In calendar year 2000, the Treasury
completed 20 reverse auctions and bought back $30 billion (par value) in
bonds. The Treasury?s buybacks through the end of December 2000 targeted
bonds maturing from 2010 to 2027. In calendar year 2001, the Treasury has
announced quarterly buyback amounts for its reverse auctions. The Treasury
bought back $25 billion (par value) in The United States Buyback
Program
Page 26 GAO- 02- 14 Debt Management
bonds from January through August 2001. Because reverse auctions were
suspended for the month of September, the calendar year 2001 buyback level
is projected to be $34 billion (par value). While this is lower than the
earlier projection of $37 billion for 2001, it is still $4 billion higher
than in 2000. On October 31, 2001, the Treasury announced that regular
buybacks would continue through calendar year 2001. However, an official
noted that there will be no buybacks in January 2002 and that in February
2002 they will begin quarterly announcements as to whether the Treasury will
do buybacks over the next 3- month period and also the size of any planned
operations. Decisions will be based on three factors: (1) projections of the
federal government?s annual unified budget surplus or deficit, (2)
projections of the cash position for the 3- month period, and (3) analysis
of how best to minimize borrowing costs over time.
When the budget was in surplus, the Treasury bought back longer maturity,
off- the- run securities. As a result, the Treasury was able to avoid
lengthening the average maturity by about 2 months that would have occurred
from debt redemptions without a buyback program. The buybacks also enabled
the Treasury to issue new debt in liquid benchmarks favored by the market.
Buybacks have been a routine part of debt management in most of the study
countries. However, unlike the United States, the study nations generally
also used tools other than debt buybacks to manage liquidity and average
maturity/ duration of outstanding debt.
The study nations have used a variety of buyback tools and did not rely as
heavily on reverse auctions as has the United States. Reverse auctions were
used by some study countries in the 1980s primarily to buy back debt
denominated in foreign currencies. In recent years, reverse auctions have
been used episodically, generally in connection with large, one- time
revenues such as those from auctions of the communications spectrum or
privatization of a government enterprise. Debt buybacks abroad are not
always announced in advance, are not always open to all market participants,
or are not always reported until after they have been concluded.
Other countries? experience illustrates that buybacks are an important tool
but one that potentially can be costly. These nations have used several
strategies to mitigate this potentially increased cost. They include the
episodic rather than routine use of reverse auctions and the use of reverse
auctions in combination with other tools, such as open market repurchases,
to buy back debt. Debt Repurchases by Study
Nations
Page 27 GAO- 02- 14 Debt Management