LAC Debt Group Research

Joint management of assets and liabilities, or ALM consists in matching the financial features of assets and liabilities to reduce net risks characteristics and the effects of financial or market changes to the budget.

Most countries however have until now emphasized the liability side of the balance sheet. This choice emanates from the importance given by countries to steady debt servicing flows, as appropriate management of liabilities is most important for minimizing unexpected increases in these flows.

In fact, ALM can be difficult to apply in practice due to an underdeveloped government securities market, weak domestic investor base, lack of detailed data, and the coordination needs required by ALM.

Notwithstanding countries recognize ALM as a strategic choice in the management of public debt and are making steps towards its adoption. In order to facilitate the transition to ALM, it is necessary to understand the needs of countries to consistently implement ALM.

LAC Debt Group conducts research, and training and facilitates discussions among regional debt offices about their accomplishments, challenges, and experiences in the implementation of ALM.

In addition to conventional government debt, countries are also responsible for managing contingent debt. Contingent debt refers to debt that is conditional upon predefined events or circumstances. CLs are associated with major hidden fiscal risks. In fact, be they explicit, such as those liabilities defined by law or by contract, or implicit, because they are not officially recognized, they are not visible until they are triggered or until a problem occurs. As such CLs pose a threat to future government finances.

To ensure proper management of debt, both conventional debt and contingent debt need to be included in the risk management process, and CLs have to be managed in a more prudent and systematic fashion. Countries need to identify a set of best practices for the management of explicit contingent liabilities and implement a system of disclosure on their exposure to all types of fiscal risk.

To promote better accounting, budget transparency, and discipline, and to help countries make provisions for risk LAC Debt Group promotes research and discussion on CLs on different fronts.

In the past years, the share of domestic public debt has been growing and many countries are developing their domestic debt markets. In fact, domestic debt markets have positive effects both for the government and for the economy.

For the government, having a domestic debt market creates a more diversified base of investors, which in turn might be more stable and reliable and it may reduce currency mismatches. For the economy, it may help banks to better manage their liquidity, generate positive externalities on domestic corporate bonds, and it may provide an alternative to capital flight.

However, domestic markets can also crowd out private issuers, increase contagion from shocks between the private and public sectors and lead to pressure on banks and institutional investors to absorb ¨too much¨ government debt.

As such, to effectively minimize cost and risk over the medium to long run, and to properly benefit from the expansion of their domestic markets, countries need to be cautious in how these develop. Countries require broad market access, transparency, and effective regulatory frameworks, among others.

To ensure an effective development of domestic debt markets LAC Debt Group conducts seminars and workshops on this topic and encourages the exchange of experiences between countries in different stages of development of domestic markets.

In the context of a world increasingly concerned with the negative effects of climate change, many countries have adopted new economic and financial measures designed to help them prevent, mitigate and adapt to climate change. Many countries have included provisions to manage government institutions’ expenses for the prevention and reduction of natural disasters.

In addition, to address and reduce the public debt burden, there has also been a surge of initiatives such as debt buybacks, debt reductions, and debt-for-nature swaps, in which a portion of a nation’s foreign debt is repurchased, reduced, or forgiven in exchange for local investments in environmental conservation measures.

Many countries have already experienced the benefits of such financial transactions. Nonetheless, adoption of these measures is not without challenges: countries need to prepare budget, financial, and accounting systems to allow adequate quantification of resources; resources for mitigation, adaptation, and vulnerability reduction are a significant pressure on government debt; generation and attraction of international resources are vital to the continuity of programs on climate change; and, programs or projects that are born under the debt must become self-sustaining.

In order to address these and other challenges that occur, LAC Debt has created a network for countries interested in sharing their experiences and learning how to access and manage financial mechanisms for prevention, mitigation, and adaptation to climate change.