1. Croatia: Debt Management and Domestic Debt Market Development
World Bank/IMF Assessment Report Presented at CARNET Centre in Zagreb
April 19, 2006
Tomas I. Magnusson
Yibin Mu
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2. WB/IMF Projects in Debt Management and Debt Market Development
Guidelines for Public Debt Management (2001)
Accompanying Document and 18 Selected Case Studies (2003)
Handbook in Developing Government Bond Markets (2001)
Sound Practice in Government Debt Management (2004)
Pilot project on designing a reform plan in 12 selected countries: Bulgaria, Colombia, Costa Rica, Croatia, Indonesia, Kenya, Lebanon, Nicaragua, Pakistan, Sri Lanka, Tunisia and Zambia ( )

3. General Lesson Integrated approach and proper sequencing!
Debt Management: A clear organizational and legal framework, supportive debt management systems, staff capacity, proper business processes, cash management and coordination with fiscal and monetary policies must come together. There is no silver bullet!
Market Development: An efficient and liquid market requires developed money, primary and secondary markets, which in turn require broad investor base, efficient custody and settlement systems, supportive market regulations, etc.

4. Debt Management
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5. Ultimate Goal for Croatia
Croatia will have the governance arrangements, internal processes, resources and staff capacity that will allow it in a sustainable manner to (i) develop a medium-term debt management strategy with yearly updates, based on a sound analysis of cost and risk, taking account of macroeconomic and market constraints, and (ii) execute that strategy efficiently, while managing operational risk in a prudent manner

6. Starting Points (April 2004)
High debt with high currency exposure (85%), but quite reasonable risk strategy, given the constraints of the kuna market (58% euro, 60% fixed rate of total debt)
High operational risks, e.g., vulnerable system support, no clear separation of front and back office functions, lack of formalized business processes, lack of transparency, high staff turnover, ‘one-man show’

7. Recommendations for Croatia (April 2004)
Governance and Legal Framework
(H) Move liquidity management from Budget Execution to Debt Management Sector
(H) Let Budget Execution continue to prepare cash-flow forecasts, but better information sharing between the two sectors is needed
(M/L) Move borrowing activities of IFI Department to Debt Management Sector
(M) Take Debt Management Sector out of Treasury and transform it into a separate department
(H) Add debt management objectives in the Budget Act
(H) Look over the process of following up audit reports

8. Recommendations (Cont.)
Internal Organization and Processes
(H) Organize Debt Management Sector along clear functional lines, with separate front, back and middle office functions
(H) Let Internal Audit frequently monitor the internal control of Debt Management Sector
(H) Formalize the main business processes, e.g., preparation of debt management strategy and borrowing plans, and other work processes within Debt Management Sector

9. Recommendations (Cont.)
Strategy and Risk Management
(M) Develop a framework to identify and manage the trade-offs between expected cost and risk
(H) Commission the Bureau for Macroeconomics to do some basic currency risk analysis
(H) In order to reduce the currency risk - 85% of total debt - set up a project to evaluate options for development of the kuna market

10. Recommendations (Cont.)
System Support and Staff Capacity
(H) Develop or purchase a new debt management system, and integrate this system with the present public expenditure management system
(H) Assign an independent consultant to review and assess system solutions and requirements going forward
(H) Conduct a study on required skill and staffing levels
(H) Establish an institutionalized training program
(H) Strengthen the management of Debt Management Sector by appointing a deputy head in charge of the daily operations

11. Debt Market Development
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12. Why do we Need a Domestic GS Market
Fiscal perspective, provide a channel for funding fiscal needs
MP perspective, provide instruments for market-based MPO
Broad FM perspective, GS is benchmark for other debt instruments
Investor perspective, provide instruments

13. Size of Domestic Marketable Securities Matters
As of 2005
In HKK billion
(%)
As % of GDP
Marketable GS (T-bills& T-bonds) 43 32 18
Non-marketable Public Debt (incl. External) 78 68
36.6
Total Public Debt (Including guarantee)
121
100
54.6
Issues:
Size of domestic marketable debt is small relative to total public debt
Recommendations:
Revisit mix between marketable and non-marketable with a view to gradually increasing domestic marketable debt issuance

14. Standardization of Debt Instruments Matters
Issues:
Debt instruments are not standardized, which leads to a large number of small issues (many series of bills & bonds with small volume)
Domestic issues are issued randomly depending on liquidity management needs of the MoF and CB, which leads to market segmentation
Recommendations:
Develop an integrated debt issuance strategy by strengthening coordination between MoF and CB
For new issues, standardize instruments and concentrate on a few benchmark instruments by using reopening technique
Restructure the outstanding GS into the designated benchmark securities through buy-back and exchange techniques

15. Efficient & Transparent Primary Market Matters
Issuing strategy should seek as far as possible to promote benchmark issues in key maturities that facilitate the growth of secondary market
An electronic auction system can facilitate the efficiency and transparency of primary market
A PD system with well-defined privileges and obligations may be beneficial when there are a large number of investors, and provided the risk of collusion can be minimized
As follow-up to the needs assessment, WB is supporting the Croatian Government to implement two reforms under a WB loan: (i) introducing electronic auction system and (ii) introducing PD system

16. Functioning Money Market Matters
A country’s money market must normally be in good working order before a govt. bond market, including both an efficient primary market and a liquid secondary market, can be fully developed
An efficient money market stimulates the development of more active debt securities markets by lowering liquidity risk premiums and enabling investors to hold larger portfolios of longer-term instruments

17. Effective Govt Cash Management Matters
One best practice of DM and DMD is that government debt should be issued in a regular manner and the volume distributed around the time horizon as stable as possible
However, if no effective cash management is in place, the government will not be able to announce its borrowing plans to the market in advance
Effective govt. cash management promotes benchmark development by improving transparency and predictability of DM

18. Sequence of Reforms First stage: Second stage: Third stage:
Promote efficiency and transparency of primary market
Second stage:
Strengthen money market
Improve government cash management
Third stage:
Improve market infrastructure
Strengthen secondary market

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