1. Potential sources of funding
UNCTAD, World Bank and IMF Workshop
Geneva, February

2. Step 3: Potential instruments & characteristics
Objective
Identify potential sources of finance, their financial characteristics, availability and desirability of use
Output
An assessment of the characteristics, including the cost and risk, of all available and potential financing instruments and sources.
Identification of any constraints, particularly on issue size
Note:
Identify steps necessary to improve access to or terms of these instruments

3. Current Financing Environment
Traditional concessional resources may not available on ongoing basis
Good macroeconomic policies are essential to supporting market development and access to financing
Deepening domestic markets, including broadening the investor base, is a priority (currently banking sector is the dominant investor)
Current environment of high liquidity and banking sector’s low risk appetite favorable to commercial financing, but are only a part of the overall picture

4. Overview of Potential Sources of Financing
Non-marketable
Marketable
Concessional loans
Semi-concessional loans
Commercial loans
Other non-marketable sources
International bonds
Domestic securities
Bills
Bonds

5. non-marketable

6. 1. Concessional Lender type Cost characteristics Risk characteristics
Multilateral and bilateral official creditors
Cost characteristics
Low cost – (minimum grant element 35% for multilateral) depending on exchange rate path
Risk characteristics
Interest rate exposure limited – typically long-term, fixed rate
Exchange rate exposure – mitigated by amortizing structure
Rollover exposure – mitigated by amortizing structure

7. 1. Concessional Amount – typically linked to allocation rule
Factors that may influence the amount available
Income level, quality of institutions, access to market financing
Size of multilateral balance sheet
Economic developments
Other considerations
Use of funds may be constrained to specific purpose
Project loans may require co-financing element
Indirect costs? e.g., conditionality, volatility and delays in disbursement

8. Principal Repayments (%)
Current IDA terms
Maturity
(YRS)
Grace
Principal Repayments (%)
Service Charge
(%)
Interest Rate
7-20
21-38
Regular 38 6
3.125
0.75 NA
Blend 25 5
3.300
6.700
1.25
Hard Terms
1.13
Notes:
1) Grant is another type of product available from IDA where none of these terms apply A

9. 2. Semi-Concessional Lender type Cost characteristics
Multilateral and bilateral official creditors
Cost characteristics
Often low cost – at a discount to market financing - but be wary of indirect cost [exchange rate; purchase conditions=>quantify this]
Risk characteristics
In specific cases, there may be scope to negotiate more customized terms
Interest rate exposure – may be floating rate
Exchange rate exposure – mitigated by amortizing structure
Rollover exposure – mitigated by amortizing structure

10. 2. Semi-Concessional Amount – can depend on allocation rules
Factors influencing availability
Economic developments in bilaterals
Other considerations
Use of funds may be constrained to specific purpose: cost of tied aid
Project loans may require co-financing element
Faster disbursement?
Tied aid: It is difficult to make a correct estimate on the related costs to the recipient. OECD: Tying aid to specific commodities and services, or to procurement in a specific country or region, can increase development project costs by as much as 20 to 30 per cent. If donors claim that 40 percent of bilateral aid is untied, one can assume that the remaining 60 is tied.

11. 3. Commercial Bank Loans Lender type Cost characteristics
Domestic and international banks
Cost characteristics
At market rates (typically more expensive than bonds, but cost of carry may be lower through tailoring disbursement and repayment )
Competition amongst lenders can help contain costs
Risk characteristics
May be scope to negotiate customized terms
Interest rate exposure – typically shorter tenors, often floating rate
Note may be marketable – through syndication (in which case fees increase)

12. 3. Commercial Bank Loans Amounts depends on allocated credit line
Can be augmented through syndication
Factors influencing quantity available
General health of banking system (global and domestic)
Local and global liquidity conditions
Other considerations
Documentation can be relatively straightforward
Need to consider scope for “crowding out” private sector

13. 4. Other Non-Marketable: Retail debt
Lender type
Retail investors through savings bonds, lottery bonds, etc.
Cost characteristics
Depends on pricing framework - flexible
Administrative costs can be significant
Risk characteristics
Rollover risk mitigated by nature of investor base
Typically no exchange rate exposure
Interest rate exposure depends on instrument design
Difficult to determine extent of demand

14. 4. Other Non-Marketable: Retail debt
Amount – depends on savings in the economy
Factors influencing quantity available
Degree of financial literacy
Level of banking sector penetration
Other considerations
May be other objectives involved (e.g., provide savings vehicle accessible to all)
May be in direct competition with banking sector
May cannibalize demand for wholesale instruments
Tax incentives and distortions (political dominance)

15. 4. Other Non-Marketable: Central Bank
Borrowing from CB can lead to fiscal dominance
this undermines credibility of monetary policy and inflation objectives
results in indirect cost because of a high inflation risk premium in the domestic interest rate, and lower ratings on external debt

16. Summary of Non-Marketable Debt
Structure
Issues
Cost
Risk
Official sector loans
(Multilateral and bilateral)
Fixed or floating ; amortizing; long term
Size constraint;
Volatility and speed of disbursement; conditions attached?
Very low direct cost;
Indirect costs;
Exchange rate (RER trend)
Exchange rate risk partially mitigated by low interest rate
Commercial
Fixed or floating;
Amortizing or bullet;
Domestic
International
Short term; medium term
Liquidity conditions;
Financial health of banking sector (international and domestic)
Market based
Exchange rate (if in FX);
Roll Over, refixing;
Interest rate;
Retail debt
Need efficient sales network. Reliable source.
Competitive
Uncertainty as to the quantum of supply
Other non-marketable
Depends on the terms negotiated
Non-transparent;
Hampers market development
Direct cost depends on the terms;
Indirect
Hidden costs;
Disposed to abuse

17. marketable

18. 5. Domestic Securities: T-bills
Lender type
Domestic (banks, mutual funds, pension, and insurance) and international investors
Cost characteristics
Market rates
Risk characteristics
Interest rate risk high (given refinancing)
Rollover risk given short-term nature of instrument
Quantum and factors influencing availability
Size of banking sector
General degree of market development

19. 5. Domestic Securities: T-bills
Other considerations
Simple instruments
Significant demand from banking sector
Used to meet reserve ratios, liquidity management, etc.
Captive market?
Often tool of monetary policy
Can help avoid fragmentation of the short end of the market
Potential conflict between debt management and monetary policy objectives

20. 5. Domestic Securities: T-bonds
What?
Instruments with maturities longer than T-bills
Fixed, floating, or indexed
Cost characteristics
Typically, market rates
Longer tenors requires risk premium to be paid
Inflation, liquidity, etc.
Depends on credibility of macro-policies
Depends on depth of market

21. 5. Domestic Securities: T-bonds
Risk characteristics
Interest rate risk
Reduced relative to Tbills, but high if variable rate
If indexed, exposed to other price indicators (e.g., inflation)
Rollover risk
Aggravated given typical bullet structure of the instrument
Available tenors reflect general degree of market development and nature of investor base
Exchange rate exposure – limited unless FX-indexed bond, aggravated by bullet structure

22. 6. TAPPING THE INTERNATIONAL CAPITAL MARKET

23. 6. INTERNATIONAL SOVERIGN BONDS
FACTORS INFLUENCING QUANTITY AND COST OF FINANCING
Established track record of good economic performance over the preceding few years, with a positive medium-term outlook
Credit rating
Investors’ risk appetite
Global market conditions
Size of issue (liquidity)
Can be cheaper than domestic market
Risks
Rollover and exchanger rate exposure
amortizing structure or sinking fund?
Exposed to sudden stops of funding
Tenors can be longer than domestic market and interest rate structure can be customized (depends on nature of demand)

24. Other considerations Cost of carry
Disbursement is immediate (cost of carry)
Tailor size to needs
Minimize cost of carry and rollover risk through smaller size
Scope to re-open?
Closer credit monitoring by international market can help maintain process of economic and structural reform
High transaction cost
Establishes a pricing benchmark for private sector

25. Other considerations
First time issuers & re-access after a period of hiatus
Successful completion of IMF program (particularly for re-accessing markets)
fiscal sustainability
sound macroeconomic framework (fiscal and monetary policies)
Regular communication with investors and rating agencies (inform and manage expectation)
Strong debt management unit (sovereign’s public image)
that ensures good policy coordination within the government
Investors can depend on to provide accurate and current information
Actively manage risk
bolstering credibility by building cash buffers
diversifying the investor base
continuously improve the structure of debt portfolio (e.g., lengthening maturity)

26. Financing Environment – Debut Spreads

27. Financing Environment

28. Summary of Marketable Debt
Structure
Issues
Cost
Risk
T-bills
Discount, bullet
Demand predominantly from domestic banking sector
Low but market conditions matter (e.g. liquidity crisis, credit risk concern)
Rollover and refinancing risk
T-bonds
Fixed, floating;
Bullet, amortizing too though rare
Degree of market development
Long-term can be expensive (inflation risk premium)
Depending on tenors rollover and refinancing.
Refixing if floating coupon rate
Inflation Indexed
Indexation structure
Requires reliable index; maturity extension; complex instrument
Depends on credibility of monetary policy
Depends on inflation, supply-side shock. Reduces roll-over risk.
International bonds
Fixed / variable,
Bullet, but amortization possible (e.g., spreading repayment of principal of 10yr bond over the last 3 years)
Large size, timing risk, excess cash at issuance
Selecting managers (Legal advisers, book runners)
Credit rating, peers’ bond performance, long-term exchange rate trend
FX, rollover risk
(interest rate for those issued with floating rate)

29. DEVELOPING THE DOMESTIC MARKET

30. Why Develop the Domestic Debt Market?
Enhances supply of financing to government
Through the use of wider range of instruments possible to attract wider investor pool
Reduces the need for direct (and potentially damaging) monetary financing
Lowers the cost of financing in the medium to long term
Avoids heavy reliance on FX denominated debt
Greater resilience at time of financial crisis
Mitigates risk of “sudden stops” (e.g. capital outflow from non-residents)
Enhances diversification of financing sources
Broader economic benefits
Provides benchmark yield curve and help establish DX credit curve
Strengthens monetary policy implementation and transmission
Encourages efficient allocation of capital through development of related financial products (promoting growth)
Deep and liquid markets reduce cost of capital more generally

31. Why Develop the Domestic Debt Market?
Financial Sector
Global Markets
Creates market-based pricing and benchmarks
Increases country resilience to external shocks
Improves liquidity management and monetary policy operations
Enhances absorption of global savings and distribution of global capital
Provides foundation for non-government instruments
Enhances mobilization of savings through NBFIs

32. Market Development: Broad Perspective
Key requirements for liquid government bond market
Well-functioning and competitive primary market
Stable macroeconomic environment
Sound fiscal and credible monetary policies
Transparent and effective legal, tax and financial regulatory framework
Effective clearing and settlement systems
Establish market credibility (e.g. MTDS, engage with key stakeholders)
Strong investor base
Distinguish between monetary policy operations and fiscal financing
Market infrastructure to facilitate secondary market
Benchmark securities
Establish mechanism to make market in government securities
Trading platforms
Real-time pricing
Market surveillance
Mix of market participants
Market development is a dynamic process

33. Developing the Domestic Debt Market
Requires development on a number of fronts:
Supply side issues
Debt manager has lead role here
Demand side issues
Intermediaries
Market infrastructure, regulatory and tax framework
Debt manager can support efforts here
In general, keep it simple
Step by step; avoid complexity
Value of transparency

34. Supply Side Issues: Instrument Design
Standard design
Enhances familiarity
Reduces costs – issuer and investor
Benchmarks?
Fungible issues/re-openings
Enhances liquidity in secondary market
But … increases roll-over risk
Can be managed by buy-backs, pre-funding and other liquidity management techniques
Market conventions (Act/Act; coupon period)

35. Supply Side Issues (cont.)
Issuance techniques
Market-based – willingness to accept market rates
Auctions most typical
Uniform price
Multiple price
Transparency
Issuance calendar
Publication of results and other key data
Price dissemination
Sharing of debt management strategy
Provide a forum to facilitate dialogue with market participants

36. Demand Side Issues: Investor Base
Diversification helps liquidity and reduces volatility
Different time horizons, risk preferences and trading motives
Commercial banks often dominant investors
Inhibits development of demand for longer term securities
Risks to banking system
High margins (compensate for maturity transformation)
Banks useful as intermediaries – brokers, market makers

37. Robust Financial Market Infrastructure
Clarity and fairness in regulatory and legal framework builds confidence in the integrity of the market
Requirements include:
Adequate and well-enforced contracts
Insolvency procedures
Accounting and disclosure standards
Appropriate market infrastructure
Efficient settlement, custody and payments systems
Efficient and well-regulated market place
Non-distortionary taxation regime 37

38. Sequencing the Development
Phase 1:
Initial priority to strengthen short-end of market
Emphasis on market related issuance techniques
Development of intermediaries, market infrastructure and secondary market
Benchmark bonds
Phase 2:
Move to longer-term instruments
Ensure interaction with development of
Money market, especially repo market (source of financing and demand)
Secondary market

39. Market Development: Broad Perspective