Treasury should change its debt management strategy

The National Treasury’s public debt management strategies are increasingly misaligned with actual public debt portfolio outcomes. Looking at outstanding public debt stock, it is evident that the portfolio is currently grappling with three core risks.

First is cost (escalation) risks: that the cost of servicing outstanding public debt is gradually rising, to a extent that interest payments as a share of government’s total revenues has sharply risen to 27 percent in 2018, from 16 percent as at end of fiscal year 2015/16—largely in line with the rise in weighted average interest rate of outstanding public debt stock, from 6.9 percent to 7.7 percent in the same period. Additionally, the average time to repricing of floating-rate borrowings has narrowed from 8.6 years in 2014 to 7.3 years in 2018.

Second, refinancing risks also abound, largely associated with high domestic debt repayments falling due. In 2014, the average time to maturity (ATM) of outstanding public debt portfolio stood at 8.4 years.

It narrowed to 7.4 years in 2018. Additionally, the share of debt maturing within a year (as a percentage of total debt) has risen to 27 percent in 2018, from 8.6 percent in 2014.

Finally, let’s not forget foreign exchange (FX) risks, as half of outstanding public debt is in foreign currencies (and have to be repaid in such currencies).

In fact, 71 percent of outstanding foreign currency debt were US dollar denominated, meaning the nominal price of USD vis-à-vis the shilling is a key debt point. Conceptually, a sound debt management strategy must robustly address these three risks.

However, it appears it is impossible to douse all the three risks simultaneously, as Treasury’s own scenario modelling of cost and risk indicators under what it calls alternative debt management strategies have shown. In fact, it is an exercise akin to the economic concept of impossible trinity (or trilemma).

Let’s look at some examples. In 2017, the Treasury envisioned a 60 percent external borrowing and 40 percent domestic borrowing medium term deficit financing strategy. Of the 60 percent allocated to external borrowing, it would comprise 20 percent on concessional terms, 30 percent on semi-concessional terms and 10 percent on commercial terms.

While this mix would help alleviate refinancing and cost risks, it wouldn’t de-elevate exchange risks. In the current fiscal year 2018/19, Treasury proposed a mix comprising 57 percent external borrowing and 43 percent domestic borrowing.

On the external debt, it proposed borrowing on concessional terms at 23 percent, semi-concessional 12 percent and commercial 22 percent. Again, while this would bring down debt costs, refinancing and exchange risks would remain elevated.

In the upcoming fiscal year 2019/20, the Treasury has proposed a 38 percent gross external debt financing and a 62 percent gross domestic financing mix. On the external debt, it has proposed the share of debt on concessional terms at 26 percent, semi-concessional 8 percent and commercial 4 percent. This strategy doesn’t appear capable of dousing exchange rate risks.

Consequently, in my assessment, Treasury should dump these alternative debt management strategies and instead opt for a targeting approach.

Every fiscal year, and probably over a medium term basis, the National Treasury should be setting targets for public debt cost and risk indicators, such as interest payments as share of revenues/GDP, share of debt maturing within 12 months, share of foreign currency debt, or even average time to maturity.

Consequently, fiscal activities during the year (or period) should be aligned with the pre-set targets, which could present an optimal execution path.