Analyzing Cost and Risk:

The MTDS Analytical Tool

Second Asian Regional Public Debt Management Forum
Thailand, March 16-18, 2011

Lars Jessen
Banking and Debt Management
Agenda

 Risk models for analyzing cost and risk on

government debt portfolios
 The Medium-Term Debt Management Strategy
(MTDS)
 The MTDS Analytical Tool
 Some thoughts about risk modeling
Risk Models in
Debt Management

 Models are widely used by debt managers to provide

input to decision-making, and to better understand the
cost and risk trade-offs
 Provides supplement to qualitative analysis
 Starting point is a clear definition of cost and risk
– This may seem trivial, but is at the core of risk modeling
 A model should only contain elements that are
needed to answer specific questions
– Additional details = additional complexity

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The MTDS Toolkit
 Supports a structured approach to developing a
medium-term debt management strategy
– Requires a clear description of the framework within which
the strategy is developed, including objectives for debt
management, macro-economic issues, etc.

 Available on the web-sites of the Bank and the Fund

(search for “MTDS”)
– Guidance Note
– Analytical Tool and User Guide
 MTDS is a framework to fully assess relevant costs
and risks associated with a government’s desired
composition of debt
 The Process to Develop a
Debt Management Strategy
1. Objectives and scope of the MTDS
2. Current strategy and cost and risk of existing debt
3. Potential sources of finance
4. Medium-term macro and market environment
5. Vulnerabilities, risks, and structural factors
6. Analysis of alternative debt management
strategies
7. Review with fiscal, monetary and market
authorities
8. Propose and approve MTDS
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Why a Cost-Risk
Analysis Tool?

 Supports qualitative analysis, i.e., complements

the analysis described in the Guidance Note
 Allows
– Detailed cost-risk analysis of individual strategies
– Detailed analysis of individual instruments
– Detailed comparisons of strategies
– Sensitivity of portfolios to changes in macro
assumptions
What Does the MTDS
Analytical Tool Do?

 Projects cash flows as function of

– Market scenarios, i.e., future interest rates and
exchange rates
– Debt management strategies, i.e., which borrowing
instruments
– Macro assumptions, i.e., primary balances
 Computes summary statistics based on complete
cash flows at the end of each year
 Multi-currency, multi-instrument
 Closely linked with DSA and MTEF
The Basic Structure of the
Analytical Tool (1)

INPUT
•Existing debt cash
flows

•Macro variables ENGINE OUTPUT

– Primary
Cash-flow Cost
balance
Simulation Risk
•Structure of new
debt
– Borrowing
strategy

•Financial variables
– Interest rates
–
The Basic Structure of the
Analytical Tool (2)
 Excel-based
 Developed on the basis of scenario-analysis models
used by debt management offices
– Structurally, it is similar to deterministic and stochastic
scenario models used in practice
 Four separate spreadsheets
– SDModel0XL.xls – the engine
– Strategy_Test.xls – specifies strategies to be tested
– ScenarioXLTest.xls – stress scenarios
– ScenarioAnalysis.xls – comparison of strategies
Measurement of Cost

 Nominal interest cost

 Real interest cost
 Nominal interest cost to GDP
 Nominal interest cost to government revenues
 Average interest rate
 Interest cost adjusted for gains/losses on
indexed debt
 Etc.
Measurement of Risk

Cost

Risk Scenario
1 Risk1,X

Baseline Scenario Cost1,X Costbaselin

e

Time
Time
Example of Output

Interest/GDP, end 2013 Debt/GDP, end 2013

How Can a Model Support the
Development of a Strategy?
 Gives deeper insight to the debt-process
 Forces discipline
– Clear cost and risk definition
– Clarification of macro framework
– Clarification of constraints, including regarding the domestic market
– Clear time horizon
 Ensures integrity when comparing alternative strategies
 Allows identifying strategic targets
– For example, a target range for Average Time to Maturity or
Average Time to Refixing
Common Challenges in Cost-
Risk Modeling

 Simple concepts, but need lots of details

– Model building and application is a gradual process
 Lack of integrated and high quality database
– The cash-flows of the existing debt is the starting point
 Projection of market variables
– How to model future market rates if no or limited history?
 Macroeconomic projections
 Non-standard instruments
 Availability of resources for model development
and lack of technical expertise
Some Final Thoughts …

 Scenario analysis is extremely useful when developing a

Medium-Term Debt Management Strategy
– Keep in mind that models are useful - but always wrong!
 Can a sound debt management strategy be developed
without scenario analysis?
– Yes, but a model allows digging deeper
 Model building is an iterative process
– It is better to start with modest objectives and add to it than to try to
build the ultimate model
 Is the MTDS analytical tool a black box?
– Not custom-built, rather, can accommodate many types of debt
– Requires training
– World Bank and IMF are piloting a simpler model that would be
substantially more user-friendly
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