Daniel Dominioni, Central Bank of Uruguay Latin American Network of Central Banks and Ministries of Finance BID, October 20-21, 2005 SOVEREIGN DEBT: EVOLUTION AND STRATEGIES IN URUGUAY The views expressed in this paper are those of the author and do not necessarily represent those of Central Bank of Uruguay

Summary Context Optimal currency composition Maturity problem The future

Evolution of debt to GDP ratio: main explanations Exogenous shocks –Regional capital flows reversion –Argentinean financial crisis and devaluation –Brazilian devaluation –Foot and mouth disease –Terms of trade fall Internal causes –Procyclical fiscal policy –Debt dollarization –Concentration of debt amortizations

Debt dollarization Local currency denominated debt was almost zero before the crisis Long inflation history: –Time inconsistency –Local currency denominated debt very costly Exchange rate based stabilization plan induced foreign currency indebtness –Reputation –Implicit insurance

Debt in the nineties

Reversion of capital flows Debt to Gdp ratio rises more than 80 points 70% devaluation and 16% inflation in four months 20% decrease in GDP in four years 4% fiscal deficit four years in a row

Optimal currency composition of public debt Licandro and Masoller (2.000) Tax nivelation model (Bohn, Missale, Barro) Government loss function –Increasing in tax volatility –increasing in debt cost Three types of debt –Foreign currency –Local currency –Indexed to CPI Nature of shocks affecting different types of debt are analyzed –Inflation –Real depreciation –Government endogenous primary expenditure, –GDP growth –Rates of interest

Optimal currency composition of public debt Strong negative correlation between real depreciation and GDP growth Lack of correlation between inflation and GDP growth Lack of correlation between inflation or real devaluation and government endogenous primary expenditure and interest rates Real depreciation volatility greater than inflation volatility Peso debt very costly

Optimal currency composition of public debt Foreign currency denominated debt is procyclical Local currency denominated debt is costly Indexed debt stabilizes real debt service Foreign currency denominated debt is less costly than indexed debt Optimal composition –Some mix between foreign currency and indexed –There seems to be no room for peso nominal debt

SOVEREIGN DEBT CLASSIFIED BY CURRENCY FOREING CURRENCY TOTALT-BILLSBONDSPESOSINDEXED ,8%17,5%82,3% 0,0%0,2% ,9%15,7%84,1% 0,0%0,1% ,9%8,5%91,4% 0,0%0,1% ,9%4,7%90,2% 1,8%3,2% ,8%7,1%80,7% 6,0%6,2% ,3%7,4%77,9% 3,2%11,5% 2005 JUN81,4%5,8%75,6% 4,5%14,1%

Initial premium for indexed debt Not a very liquid instrument –Local pension funds main holders –Lack of depth in the market Investors use Dollar as unit of account No investor education or regulatory incentives Institutional restrictions Complicated macroeconomic context

Other considerations Expansion toward international markets would imply higher premia Tax structure highly dependent on tradable goods. Improvement in reputation makes room for non-indexed peso denominated debt

Maturity structure Missale, Giavazzi y Beningo (1997) Long term indebtness recommended if: –Interest rates volatility –Yield curve doesn`t reflect time-inconsistency Fits to Uruguay during the nineties –Ex ante volatility in capital markets –Investment grade

Maturity policy Lack of planning Short run cost considerations Opportunistic considerations Redemption concentration in crisis years

Maturity trends Before crisis: strong participation of t-bills (1 to two years maturity) During the crisis : multilaterals exchange : emergency solution Vulnerabilities are still present

Maturity trends Before crisis: strong participation of t-bills (1 to two years maturity) During the crisis : multilaterals exchange : emergency solution Vulnerabilities are still present

Maturity trends Before crisis: strong participation of t-bills (1 to two years maturity) During the crisis : multilaterals exchange : emergency solution Vulnerabilities are still present

Maturity trends Before crisis: strong participation of t-bills (1 to two years maturity) During the crisis : multilaterals exchange : emergency solution Vulnerabilities are still present

The future Up to now : lack of debt policy New government commitment: debt office Planning of maturities and currency composition

Cornerstones of a management debt policy Fiscal consolidation Strong commitment with low inflation Debt office Liability management