INDIAN INSTITUTE OF MANAGEMENT, BANGALORE Monetary Policy in Advance and Emerging Countries

Project Report Submission

Debt Management Policies

Country : Sweden
Submitted to RBI Chair Professor Charan Singh
By

Aditi Garg Amrapali Bhowmik Tamoghna Sadhu

PGP 2012-14 PGP 2012-14 PGP 2012-14

Roll No- 1211322 Roll No- 1211246 Roll No- 1211231

Abstract:
The Swedish Debt Management office is one of the earliest bodies for central government debt management and to operate independently. The advantages of debt management office from the central bank have been instrumental for Sweden. Sweden has been consistently maintaining a current account surplus in the last decade which has helped to reduce its debt to GDP ratio as well as the interest costs. In order to optimize the debt management portfolio, Swedish National Debt Management Office (SNDO) has its debt comprising of Nominal Krona Debt, Inflation Linked Krona Debt and Foreign Currency Debt. The high foreign debt in banking sector and private households is a potential risk for the Swedish economy.

Introduction
A countrys debt portfolio is a large financial portfolio consisting of complex financial structures which often can generate substantial risk to its governments balance sheet and to its financial stability. Badly structured debt portfolios also can make countries susceptible to economic and financial shocks. Debt management is the process of establishing and executing a strategy for managing a countrys debt to raise the required funding or making payments while pursuing its cost/ risk objectives1. The primary objective of debt management is to minimize the cost of a countrys financing needs and its payment obligations over the long run, with a minimal degree of risk. Debt management policy has been customarily subordinated into fiscal and monetary policies, and was not considered a separate macroeconomic policy. But recently, there is a growing consensus among industrial countries to separate the objectives and accountabilities of debt management from those of monetary and fiscal policy by introducing appropriate mechanisms. The primary reasons behind this ideology are: 1. 2. 3. 4. To preserve the integrity and independence of the central bank, To shield debt management from political interference, To ensure transparency and accountability, and To improve debt management by entrusting it to portfolio managers with expertise in modern risk management techniques2.

One of the inherent advantages achieved by separating the debt management is policy decentralization. The primary objective of fiscal policy is to achieve a steady budgetary policy that would stabilize output and improve the resource allocation, whereas monetary policy focuses on achieving price stability, while maintaining output stabilization. Assignment of separate policy objectives would enhance the credibility and effectiveness of policy implementation and can help avoid conflicts, real or perceived3.
1

Guidelines for Public Debt Management: Accompanying Document and Selected Case Studies Prepared by Staffs of International Monetary Fund and The World Bank 2 A Separate Debt Management Office, Charan Singh, IIMB Working Paper Series 3 Coordinating Public Debt Management with Fiscal and Monetary Policies : An Analytical Framework, Eriko Togo

Usually, the central bank operates in the short-run and the debt management office operates in the long run but in times of crisis the line between their operations becomes blurred. The fiscal authorities due to political pressure arising from election cycles develop a myopic vision which can force them to take short-term decisions of keeping the cost of financing the borrowing low. Similarly, the monetary authority may take the same steps leading to a higher inflation in the longrun. Thus the independence of the three authorities becomes essential as their goals are contradicting each other and must be kept separate in order to improve the functioning of any economy. Hence, the world has at large recognized the need for the separation of the debt management office from the Central Banks. This came into light especially after the international debt crisis of the 1980s and the East Asian Crisis in 1997. The governments have recognized the importance of minimizing borrowing costs but not at the expense of influencing the interest rates and thus the monetary policy. The main benefit of prudent debt management is that the fiscal profligacy is managed and long term costs for the country are always in control, free from political pressures. The first step taken in this direction was by New Zealand in 1980s followed by the European countries such as Belgium, France, Ireland and Portugal. These countries realized that without proper policy framework, the new targets adopted by them with respect to the monetary and fiscal policy would not be met.4 As per our understanding, the debt management office can authorize the central government and control borrowings in the following ways: a) An overall fixed amount of debt authorization every year and government may use balances of previous years to accommodate extra expenses in a particular year thus adjusting cycles. b) Define a set of activities and cap maximum level of borrowings for each of them to reduce approval related work and thus allow government also to plan accordingly in advance. Over the years, the caps may be revised. c) Get approval for each and every financing activity and the amounts as and when a need of borrowing arises. However care should be taken that debt management is not disconnected to the monetary policy of the country.

Asset and Liability Management Framework

Having established the significance of policy separation and coordination between debt management, fiscal policies and monetary policies, it is important to focus on ways to analyze the consistency of a particular policy mix. Asset and liability management (ALM) framework offers an articulate structure for managing the government debt portfolio risks and provides valuable
4

http://treasury.worldbank.org/bdm/pdf/3_CoordinatingPDMwithFiscalandMonetaryPolicies_Togo.pdf

insights to understand the coordination between fiscal policies, monetary policies, and debt management. The framework suggests that balance sheet risk exists when there is a mismatch between the financial characteristics of the assets and liabilities, which can be minimized when the financial characteristics of the assets match that of the liabilities.

Swedens Debt Management Office

Swedens National Debt Office came to existence in 1989 with reporting to the Ministry of Finance and the government. The overall function of the office is to ensure that the costs of central government financial management are minimized by not taking excessive risks. They have to utilize the tax payers money efficiently and ensure the financial system remains stable. The separate debt management office helps better transparency and accountability to the citizens about governments financial condition, objectives of raising debt, strategies and modalities used by debt manager. The other functions of the office include5: 1. Banking services for the central government 2. Raising loans and managing central government debt 3. Providing state guarantees and loans The Swedish National Office goes beyond the borrowing functions as explained below6: 1. Manages the state debt as cost-effectively as possible by borrowing in the money and bond market, private market and foreign markets. 2. Grants credit to state corporation 3. Coordinates state guarantee operations and loans to industry and trade and monitors the cost of these 4. Determines rates of interest for the National Savings Account and the Young People's Housing Saving System 5. Makes forecasts for payments to and from the State and ensures that these transactions are managed as cost-effectively as possible. 6. Exercises a wide range of management functions Debt management in Sweden was initiated through the Act on State Borrowing and Debt Management which set certain rules set for the central government.

Sweden National Debt Management Hierarchy

The Swedish National Debt Management office is free to choose its organizational structure in order to ensure its efficient operations. However, as a guideline, Tomas Magnusson, the renowned economist who pioneered SNDO has suggested the following hierarchical structure. The board of commissioners will consist of seven members, out of whom four will be appointed by the government while the other three will be renowned academicians, economists etc. The board will be chaired by Director General. Under the board, different departments like Debt, Treasury etc. may operate independently, each headed by the respective Head of the Departments.
5 6

http://unctad.org/en/Docs/gdsdmfas2_en.pdf https://www.riksgalden.se/en/aboutsndo/About-the-Debt-Office/

No guideline on the structure is available for the operational level in each department.

Macroeconomic Overview of Sweden

Standard & Poor in its rating report on Sweden mentions Sweden has a prosperous, competitive and resilient economy supported by a skilled workforce, high labor participation rates and predictable transparent institutions. The GDP per capita in 2012 was around $55,000, a per capita real GDP growth of 3.1%. In order to better understand the relevance of debt management policies of Sweden, we have reproduced here some key indicators of growth, inflation, debt etc.7 Sweden is one of the most well industrialized countries with extensive cross border trades. The GDP growth has been steady but slow in the last decade and the unemployment ratio also has remained low over the years, barring the recessionary period of 2008-09. Inflation however has been rather sporadic in Sweden and fluctuated over a range from (-1.5%) to 4.5% in the last decade

http://blogs.yis.ac.jp/13kanagawaj/2012/04/10/macroeconomics-sweden/

Government Debt as a percentage of GDP in the last decade

As we can see from the graph, the debt to GDP changed by more than 10% between 2000 and 2010, which implies focus on debt management. Also it is important to note that Sweden now has current account surplus position, which has helped them correct debt accumulated in 1970s and 1980s and indicates healthy household savings habits. Regarding their trade balance and current account, Sweden has lost some market share in exports in the recent years due to stiff competition from emerging economies, especially China. Balance of Payments has shown steady improvement in the last decade after the revised legislation was enacted by parliament in 1998 on the Act on State Borrowing and Debt Management. In 2012, Sweden loosened its budgetary stance by relaxing corporate tax from 26.3% to 22.0%, and also offering other stimulus measures which necessitated some extra debt (approximately SEK 23billion, 0.6% of GDP). The economic growth in 2013 is expected to be around 2.6% reflecting the accommodative monetary and fiscal policies. Swedish current account surpluses have successively been more than 6% of its GDP in the last few years, driven by their strong performance in trade and service balances in addition to their surplus in income account. Net of liquid external assets, Sweden held a record external debt of almost 94% CARs widening Swedens net external creditor position in the coming years. The banking sector remains the sector with largest net external debt, with the four largest Swedish banks accounting for 75% of Swedens external assets and liabilities. Since the majority of this external debt is short term, the risk of external liquidity problems looms for the Swedish financial sector. Another advantage of Sweden is the fact that Swedish Krona is now the eighth most actively traded currency in the world providing ample liquidity. It provides an additional layer of external flexibility to the government to satisfy the borrowing needs in local currency whenever required. Table 1 in appendix summarizes some key indicators for Sweden over the years for better understanding of Swedens macroeconomic position.

Debt Management Policies in Sweden8

Swedish Debt Management office takes into consideration the following two primary factors while planning debt levels: Cost v/s risk of the debts Asset Liability maturity management

In order to optimize cost v/s risk of debts, the expected method would have been to create an ideal debt portfolio. However, due to high discrepancy of foreign currency debt and the time required to restructure the same, a target portfolio has not been defined currently by SNDO to optimize debt and corresponding risk management. Rather through the guidelines SNDO is presently trying to set a direction towards the desired portfolio. One interesting observation was that the debt management office accounts the cost of debt using the interest rates during the time of issue, though foreign currency debt is valued by current exchange rates. Though there is a covered bond market in Sweden, the debts cant be refinanced at a short notice and so short term fluctuation of market values are considered insignificant The two separate functions taken as a part of debt management by the office are: i) Separation between funding decisions & deciding the characteristics of debt portfolio to find opportunities to lower costs. An example of this activity was in 1996 when SNDO borrowed in Swedish Krona and converted the debt into foreign currency obligations using interest rate and currency swaps to save on long term borrowing cost. Taking positions on basis of views of future paths of interest rates and exchange rates within defined limits of a tactical portfolio in terms of currency and maturity composition.

ii)

To ensure efficient functioning of the Swedish fixed income market, which is the primary source of the domestic debt, the major part, SNDO issues different kinds of instruments. They are: A. Nominal Bonds Primary Markets around 10 benchmark bonds are prevalent Secondary Markets through repo facilities to authorized dealers

B. Treasury Bills Biweekly auctions of eight types of bills, upto 12 months maturity C. Inflation Linked Bonds Issued through both auctions and on-tap The Swedish central government debt can be studied as a portfolio made of three parts: a) Nominal Krona Debt (Domestic) b) Inflation Linked Krona Debt (Domestic, adjustment for real cost, marked against index) c) Foreign Currency Debt

http://www.imf.org/external/pubs/ft/pdm/eng/guide/pdf/080403.pdf

As the debt requirement doubled in the mid 90s fuelled by recession, Sweden gradually increased foreign currency borrowings diversifying the debt portfolio to ease its pressure on long term interest rates in the domestic market. This however has been criticised by some agencies as it adds currency risk without any significant savings on interest costs. Inflation linked bonds were started by SNDO in the last decade to accommodate portfolio risks against economic shocks, low growth & low inflation periods through diversification. The most recent guidelines on the composition of central government debt suggest the following: a) Nominal Krona Debt: 60 per cent b) Inflation linked Debt: 25 per cent c) Foreign Currency Debt: 15 per cent Similarly, the recent guidelines on the maturity of central government debt suggest the following: a) i. ii. b) c) Nominal Krona Debt: Instruments with a maturity of upto 12 years: Interest rate re-fixing period of 2.7 3.2 years Instruments with a maturity of more than 1 years: Benchmark value of SEK 70 billion Inflation linked Debt: Interest rate re-fixing period of 7-10 years Foreign Currency Debt: Interest rate re-fixing period of 0.125 years

The Swedish debt has maintained a duration of 2.7 years for the nominal domestic and foreign currency bonds while for the inflation linked bonds, they have maintained a much longer duration of 10 years to cover uncertainty, which is the basic purpose of such bonds. SNDO plans overall in such a way that not more than 25% of the total debt on the governments books matures over the next 12 months.

Swedens Debt in 2013

As on 31st October 2013, Swedens unconsolidated central government debt was SEK 1201 billion, which was just 33% of their GDP. At the end of 2012, the Maastricht Debt for Sweden was 38% of their GDP. The Maastricht debt is the general government consolidated gross debt, used for comparisons of public indebtedness of European Union countries. The Swedish central government debt was at less than the half of all other European Union countries average debt, measured against GDP. The debt to GDP ratio for the European Union as a whole was 87% while it was 93% for the Euro Zone countries. Sweden expects its debt to GDP ratio to fall to as low as 25% by 2017, testifying the strength of its public finances while almost every other European country is struggling. The governments revenue and expenditure as percentage of GDP declined over the years and is expected to continue trend, backing on the tax reductions in corporate tax, property tax and abolition of wealth tax. Health care has steadily risen over the past few years for the government, though it has been compensated by the reduced interest expenses on debt.

Guidelines of Debt Management in 2014

Sweden is expected to borrow a net of 163 billion SEK ($5.39 billion) in 2014, as per their forecast in July with a further shortfall next year. The central government borrowing and debt management are evaluated every second year in a government communication to the Riksdag, the Swedish Parliament. The next evaluation is pending 7

for April 2014. Currently the interest expenses have been quite less due to lower market interest rates as well as the central governments strong finances, as acknowledged by Peter Norman, Swedens minister for financial markets. In 2012, the total interest cost for government debt was SEK 18 billion, compared to interest expenses of SEK 100 billion every year in the 1990s. Accordingly, the direction of debt policy, debt shares and interest re-fixing period for central government debt has been maintained the same for 2014. To minimize risks on the debts further, the debt office has proposed that foreign currency debt should be upto 15% of the total government debt next year onwards instead of the present policy of keeping it at 15% as a benchmark for the ideal portfolio. The government however has chosen to wait for the findings of the Review of Central Government Debt Policy and a decision on the report on the Riksbanks financial independence and balance sheet before implementing this policy change. The government believes from a cost perspective, it is optimal to retain the present currency share in the total debt for the time being. Instead, to reduce the risk of losses in position taking operations during speculative trades, they mandated positions in foreign currencies are reduced from SEK 400 million to SEK 300 million, when measured as daily Value-at-Risk with a 95% probability.

Sweden Debt Management and the Economic Crisis

The economic crisis of 2008 and its aftermath had severely impacted all countries across the world. Sweden debt management office played a crucial role during that time to mitigate the economic growth of the country. Instead of popular methods like Quantitative Easing followed in the United States, SNDO followed what can be termed as Negative QE. During the period that immediately followed the economic crisis, they over issued government debt. They were selling bonds more than the amount they needed to finance government expenses. Basically, they patronized the research findings of several economists that during a period of crisis there was a special demand of safe assets with duration. Due to severe financial stress and low risk tolerance mentality of private & individual investors in general, this policy turned out to be successful. The same proposition has been used Vissing-Jorgensen and Krishnamurthy, and also Caballero and Farhi. While most other central banks through analysis of events shows that QE reduces yield by raising prices of government bonds, their argument was the impact on yields measures not the benefits, but the costs imposed by starving the economy of safe assets and of foregoing the benefits of the better. The strong government finances and a gold plated investment rating continued to spur strong demand of Swedens debt. In the wake of the financial crisis as well, foreign investors piled into their bonds and Sweden remained a net buyer instead of signs of recovery in the subsequent periods. Thomas Olofsson, the head of the debt management at Swedens Debt Office acknowledges that Sweden together with other countries in northern Europe are seen as safe havens. Foreign investors owned 51.9 % of the outstanding Swedish government bonds this year against 35.7% at the end of 2008. Most of the foreign bond demands have come from different Central Banks who wanted to diversify their foreign currency holdings and Swedens AAA rating invariably provided the most attractive option. In 2010, Swedish National Debt Management office co-hosted 10th Annual IMF consultations on Policy and Operational Issues facing Public Debt Management which gave foundation to a host of framework and guidelines known popularly as Stockholm Principles. This is being proactively followed by most advanced and emerging countries, especially in Europe in order to minimize risks of debt and efficiency in interest costs. Sweden also runs a stabilization fund since 008 to finance 8

the future potential costs of supporting the financial system in case of another crisis. This is financed by fees imposed on banks and other credit institutions and is expected to amount for 2.5% of the GDP by 2023.

Sweden Debt Management and the Housing Market:

An in depth review presented by the European Commission in its first Alert Mechanism Report (AMR) on February 2012 suggested that Sweden is experiencing minor macroeconomic imbalances, primarily regarding private sector debt and housing market. The next external debt for banking sector is relatively high (58% of current account receipts). The household debts in Sweden are also among the highest in Europe. Also, it is imperative that a house price crash can trigger deep economic recession in Sweden leading to big losses for Swedens lenders and a liquidity problem in the economy. To ease the pressure in the housing market, Swedish government has introduced a number of measures. If borrowing rates do not slow, the government plans to look at revising the capital requirement of banks upward to cover banks mortgage lending. The debt office is also looking at the option of issuing a new 30 year bond, though they are not sure about the demand of such a long maturity debt instrument. However, with recent revision in regulations for insurance companies, a considerable increase in demand for debt instruments with 10-20 year maturity range is expected.

Conclusion:

We can easily conclude that Swedens separate debt management office has been a success till now and we hope the same would continue if the minor issues with household debt and banking system are managed. As per the analysis in the report by IMF and World Bank members, Sweden would look to increase its investor base and try attracting new international institutional investors in order to further diversify and get better opportunities of borrowings. They are also looking at improving distribution channels of the bonds, using technological advancements to help participation of retail investors in the debt market as well. It will be interesting to see how technology can improve the debt portfolio further optimizing the ratio of currency debts from time to time. Detailed data availability regarding the past and projected balance sheets would have helped us in also quantitatively analysing the efficacy of Swedish Debt Management Office and comparing it with other advanced economies. From the various research reports and papers we have gone through it is clear that Swedens National Debt management Office remains a role model for most other countries. They have maintained strong investment rating, current account surplus and reduced their debt expenses over the years, managing the maturities of their various assets and liabilities prudently.

Annexure - Table 1 Selected Indicators Kingdom of Sweden9

2006 (% of GDP) GDP per capita ($) Real GDP (% change) Real GDP per capita (% change) General Government balance General Government debt Net General Government debt General Government Interest Expense (% of revenues) Domestic claim on Private Sector & NFPEs Consumer Price Index (average, % change) Gross ext financing needs (% of CARs & usable reserves) Current Account Balance Narrow Net external debt (% of CARs) 44,108 4.3 3.9 2.2 45.0 8.0 3.1 113.2 1.5 182.0 8.6 98.6 50,751 3.3 2.6 3.6 40.2 3.3 3.2 122.1 1.7 188.7 9.4 90.5 52,942 (0.6) (1.4) 2.2 38.8 8.8 3.1 128.1 3.3 205.0 9.2 89.6 43,838 (5.0) (5.8) (1.0) 42.6 5.5 2.3 136.2 1.9 238.1 7.4 126.6 49,575 6.6 5.6 (0.1) 39.3 4.1 2.1 135.4 1.9 208.7 6.6 110.4 57,287 3.9 3.1 0.1 38.3 7.5 2.3 135.8 1.4 194.3 6.9 94.6 55,525 1.4 0.8 (0.3) 37.5 7.6 1.9 138.1 1.4 204.5 6.6 94.0 59,512 2.6 2.0 (0.6) 36.5 7.9 1.9 138.9 2.0 197.1 6.6 86.4 63,808 3.0 2.4 0.3 34.6 7.3 1.9 138.8 2.0 191.1 6.7 79.4 66,341 3.0 2.4 1.7 31.4 5.2 2.0 138.8 2.0 186.0 7.1 73.6 2007 2008 2009 2010 2011 2012 2013f 2014f 2015f

Source: Standard and Poors Rating Report Sweden, 12th November 2012