Trabas culturales y formativas.

It is clear from the previous discussion that government deficit/surplus (net lending/borrowing) as a result of the government operations represents a measure of the government financing needs, which in the literature are also called borrowing requirements. In the context of historical analysis, government deficit/surplus indeed depicts how much money the government can lend or must borrow to remain in fiscal equilibrium. Yet, when the debt accumulation mechanics is considered from the forward- looking point of view, two important practical issues emerged:

 How much money government really can lend or has to borrow, since a certain portion of debt falling due today needs to be refinanced tomorrow?

 If the government has to borrow, how it will fund lack of financial resources?

The corroboration of the former issue is given in Table 2.7, which shows the analytics of the gross borrowing requirements as a total of government financing needs. Gross borrowing requirements are defined as a “net lending/net borrowing during a particular reporting period plus debt maturing within that reporting period.” (GFSM, 2014, pp. 83). In the context of fiscal sustainability analysis, debt maturing in a certain period is equal to the total debt redemptions, which needs to be refinanced in the next period, as illustrated below.

36 Table 2.7: Definition of the gross borrowing requirements

Source: Blommestein et al. (2010), pp. 3

From the historical point of view, gross borrowing requirements are less relevant fiscal indicator since the term, interest and currency structure of the liabilities incurred to fund government financing needs are already familiar information. From the forward-looking point of view, the gross borrowing requirements are crucial analytical input for the DMO, since DMO is legally empowered to manage public debt actively and thus to determine term, interest and currency structure of the liabilities that will incur to fund financing needs. In other words, the DMO anticipates gross financing needs for a certain period of time and makes funding strategy, i.e. decision what combination of debt instruments will be issued to close financing gaps. As defined by the OECD staff, “The funding strategy entails decisions about how the borrowing requirements or needs are going to be financed (e.g. by using long-term bonds, short-term securities, nominal or indexed bonds, etc.). Clearly, total gross borrowing requirements should be the same as total expected or projected funding amounts.” (Blommestein et al., 2010, pp. 3)

While debt accumulation mechanics explained by the equation (2.9) provides an important theoretical insight into the mechanics of debt formation over time, its application, in reality, is limited by two important issues. First, the DAE in (2.9) operates in terms of net borrowing requirements, which is not suited for the forward-looking analysis of debt dynamics in the case of DMO, which has authority to manage debt dynamics actively, including debt refinancing. Second, theory of debt accumulation is not particularly concern

37 with “stock-flow” relationship between debt (stock variable) and interest payments/government balance (flow variables). Indeed, from the theoretical view, this is irrelevant issue, but it is clear that in practice there is a big difference in managing public debt on a short-term or long-term basis. Like any other strategic decision, debt funding strategy is planning document that covers time horizon of at least one year. In practice, the DMO staff anticipate the gross borrowing requirements for a certain period of time (one year) and then decide on type of instruments and its characteristics (maturity, interest rate, currency) aiming to optimize debt servicing costs/risks and ensure fiscal sustainability. The issues of public debt costs/risks optimization and fiscal sustainability assessment are discussed in the following chapters. In this subsection focus is on development of debt accumulation mechanics, which is more suited for practical assessment of forward-looking debt dynamics as a basis for making debt funding strategy.

Let's assume that DMO is analyzing possible debt funding strategies for the one-year period 𝑡. If the beginning of the period 𝑡 is noted with 𝑡, 𝑏 and end of the period with 𝑡, 𝑒, then mechanics of the debt accumulation imposes that anticipated closing value of the public debt at the end of the period 𝐸(𝐷_𝑡,𝑒∗ ) should equal the sum of existing debt at the beginning of the period 𝐷_𝑡,𝑏𝐸𝑋 _{and anticipated value of the overall balance for the given}

period 𝐸(𝑂𝐵_𝑡),

𝐸(𝐷_𝑡,𝑒∗ _{) = 𝐷}

𝑡,𝑏𝐸𝑋+ 𝐸(𝑂𝐵𝑡). (2.14)

The existing debt 𝐷_𝑡,𝑏𝐸𝑋 consists of two components: the fraction of liabilities that will outstand by the end of the period 𝐹_𝑡,𝑒𝐸𝑋,𝑂 and a fraction of debt that will mature by the end of given period 𝐹_𝑡,𝑒𝐸𝑋,𝑀,

𝐷_𝑡,𝑏𝐸𝑋 = 𝐹_𝑡,𝑒𝐸𝑋,𝑂+ 𝐹_𝑡,𝑒𝐸𝑋,𝑀, (2.15)

so equation (2.14) can be rewritten as 𝐸(𝐷_𝑡,𝑒∗ _{) = 𝐹}

𝑡,𝑒𝐸𝑋,𝑂+ 𝐹𝑡,𝑒𝐸𝑋,𝑀+ 𝐸(𝑂𝐵𝑡). (2.16)

To formalize connection of the borrowing requirements, debt funding strategy and debt accumulation mechanics, net borrowing requirements 𝑁𝐵𝑅_𝑡 and gross borrowing requirements 𝐺𝐵𝑅𝑡 for the period 𝑡 are defined and introduced to the DAE. Following the

discussion on borrowing requirements, it is evident that 𝑁𝐵𝑅_𝑡 matches the anticipated value of overall balance at the beginning of the period, 𝑁𝐵𝑅_𝑡 = 𝐸(𝑂𝐵_𝑡), which can be further decomposed to a difference between projected interest payment on the existing debt

38 𝐼𝑁𝑇_𝑡𝐸𝑋, which are already projected by the DMO staff, and the anticipated value of primary balance 𝐸(𝑃𝐵𝑡)

𝑁𝐵𝑅_𝑡 = −𝐸(𝑃𝐵_𝑡) + 𝐼𝑁𝑇_𝑡𝐸𝑋_{. (2.17)}

On the other side, 𝐺𝐵𝑅_𝑡 matches sum of the anticipated value of overall balance/net borrowing requirements and existing debt maturing over the given period, which is also projected by the debt redemption plan,

𝐺𝐵𝑅_𝑡= 𝐹_𝑡,𝑒𝐸𝑋,𝑀+ 𝐸(𝑂𝐵_𝑡) = 𝐹_𝑡,𝑒𝐸𝑋,𝑀+ 𝑁𝐵𝑅_𝑡. (2.18)

Accordingly, the anticipated value of public debt at the end of the period equals sum of existing debt outstanding by the end of given period and gross borrowing requirements

𝐸(𝐷_𝑡,𝑒∗ ) = 𝐹_𝑡,𝑒𝐸𝑋,𝑂+ 𝐺𝐵𝑅_𝑡. (2.19)

To fund 𝐺𝐵𝑅_𝑡, the government needs to either issue new debt or sell some financial assets. If only borrowing option is considered, then previous equation can be rewritten “terminologically” so that anticipated value of the debt by the end of period is decomposed more intuitively as a sum of “old”, i.e. existing debt 𝐷_𝑡,𝑒𝐸𝑋,𝑂 =𝐹_𝑡,𝑒𝐸𝑋,𝑂and increment of “new” debt 𝐸(Δ𝐷_𝑡𝑁𝐸𝑊_{) = 𝐺𝐵𝑅}

𝑡 which will be issued to fund borrowing requirements and keep

public finance in equilibrium,

𝐸(𝐷_𝑡,𝑒∗ ) = 𝐷_𝑡,𝑒𝐸𝑋,𝑂+ 𝐸(Δ𝐷_𝑡𝑁𝐸𝑊) = 𝐹_𝑡,𝑒𝐸𝑋,𝑂 + 𝐹_𝑡,𝑒𝐸𝑋,𝑀− 𝐸(𝑃𝐵_𝑡) + 𝐼𝑁𝑇_𝑡𝐸𝑋_{. (2.20)}

What would happen if the DMO wants to forecast the dynamics of the public debt one period ahead? First, the outstanding value of existing debt at the end of period 𝑡 (or beginning of the period 𝑡 + 1) is considered. A portion of this debt will mature over 𝑡 + 1, while the rest will outstand by the end of 𝑡 + 1,

𝐷_𝑡+1,𝑏𝐸𝑋,𝑂 = 𝐹_𝑡+1,𝑒𝐸𝑋,𝑂+ 𝐹_𝑡+1,𝑒𝐸𝑋,𝑀. (2.21)

Of course, 𝐹_𝑡+1,𝑒𝐸𝑋,𝑂 will continue to generate interest payments 𝐼𝑁𝑇_𝑡+1𝐸𝑋 over the period 𝑡 + 1. The same logic holds for the debt issued during the period 𝑡,

𝐸(Δ𝐷_𝑡𝑁𝐸𝑊_{) = 𝐸(𝐹}

39 under the reasonable assumption that portion of newly issued debt is short-term, i.e. maturing up to one year. Again, in the period 𝑡 + 1 government operations other than interest payments will generate primary balance 𝑃𝐵_𝑡+1, which can be only forecasted at 𝑡. The gross borrowing requirements for 𝑡 + 1 relative to the beginning of the period 𝑡 then will then count as

𝐺𝐵𝑅_𝑡+1 = 𝐼𝑁𝑇_𝑡+1𝐸𝑋 + 𝐹_𝑡+1,𝑒𝐸𝑋,𝑀− 𝐸(𝑃𝐵_𝑡+1) + 𝐸(𝐹_𝑡+1,𝑒𝑁𝐸𝑊,𝑀) + 𝐸(𝐼𝑁𝑇_𝑡+1𝑁𝐸𝑊_{), (2.23)}

and consequently forecasted value of public debt by the end of period 𝑡 + 1 equals portion of existing debt in 𝑡, 𝑏 that will outstand at 𝑡 + 1, 𝑏, a portion of newly issued debt in 𝑡 that will outstand at 𝑡 + 1, 𝑏 and gross borrowing requirements outstand at 𝑡 + 1

𝐸(𝐷_𝑡+1,𝑒∗ _{) = 𝐹}

𝑡+1,𝑒𝐸𝑋,𝑂 + 𝐸(𝐹𝑡+1,𝑒𝑁𝐸𝑊,𝑂) + 𝐺𝐵𝑅𝑡+1. (2.24)

Using this pattern of forward-looking recursion, forecasts of the public debt dynamics can be extended beyond 𝑡 + 1 period.

To explain how the debt funding strategy is developed, let's assume that DMO optimizes funding of borrowing requirements over only two parameters: first, over term structure (to minimize exposure to interest rate/refinancing risks) and then over currency structure (to minimize exposure to foreign exchange rate volatility). The result of such optimization will be weights of each debt type in borrowing requirements over both parameters, 𝜔_𝑗,𝑡𝑇𝑆 for the term structure and 𝜔_𝑘,𝑡𝐶𝑆 _{for currency structure, such that}

𝐹_{𝑘,𝑗,𝑡}𝑁𝐸𝑊 _{= 𝜔} 𝑘,𝑡 𝐶𝑆_𝜔

𝑗,𝑡𝑇𝑆 𝐺𝐵𝑅𝑡. (2.25)

Since the DMO aims to keep public finance in balance, 𝐸(Δ𝐷_𝑡𝑁𝐸𝑊) = 𝐺𝐵𝑅_𝑡, then a weighted sum of all newly issued debt instruments should equal anticipated debt increment

𝐸(Δ𝐷_𝑡𝑁𝐸𝑊) = ∑𝑁𝐾_𝑘=1∑_𝑗=1𝑁𝐽 𝐹_{𝑘,𝑗,𝑡}𝑁𝐸𝑊 = ∑_𝑘=1𝑁𝐾 ∑_𝑗=1𝑁𝐽 𝜔𝐶𝑆_𝑘,𝑡𝜔_𝑗,𝑡𝑇𝑆 𝐺𝐵𝑅_𝑡. (2.26)

where 𝑁_𝐾 counts number of available currency options, 𝑁_𝐽 counts available maturity options, and 𝜔_𝑘,𝑡𝐶𝑆_𝜔

𝑗,𝑡𝑇𝑆 is a specific weight in 𝐺𝐵𝑅𝑡 for each debt type regarding the

combination of maturity and currency structure (j,k). For example, if government can borrow in local currency, EUR and USD (𝑁_𝐾 = 3), and does not prefer maturities over 10 years (𝑁_𝐽 = 10), then there will be in total 30 options to issue debt instruments (𝑁 = 𝑁_𝐾∗ 𝑁_𝐽) with respect to currency and maturity. Decisions about weights of each debt type to

40 fund gross borrowing requirements with proper argumentations (regarding debt costs/risks optimization and fiscal sustainability) make the core of debt funding strategy.