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The Changing Nature of Government Debt Markets

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1994
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GOVERNMENT securities are the backbone of world securities markets. Their turnover far surpasses that in any other financial market, except the global foreign exchange market. In recent years, government securities markets have undergone great changes.

As many industrial countries ran sustained budget deficits in the 1980s and early 1990s, the size of the government securities markets mushroomed. For most major industrial countries, the ratio of government debt to GDP has expanded greatly since 1980 (see chart). Meanwhile, trading volume in government securities skyrocketed, with the average trading volume in the United States, for example, shooting up from $14 billion a day in 1980 to $120 billion a day in 1993 (Table 1). Increases of similar magnitudes occurred in other countries, although the volume traded in these countries still substantially lags that in the United States.

Table 1.Trading volume in government securities skyrocketed(daily average in billions of dollars)
19801981198219831984198519861987198819891990199119921993
United States 113.818.123.530.338.555.568.877.170.777.976.788.1105.2119.6
Japan
Over-the-counter market in Tokyo1.41.61.82.34.817.229.173.962.149.544.138.544.257.6
Transactions in stock exchanges0.00.10.10.20.50.81.51.41.21.00.90.50.20.2
Germany 2--------------2.33.73.73.94.36.29.7
France 3
Short- and medium-term securities------------0.21.22.12.52.93.77.613.7
Treasury bonds------------------------8.214.4
United Kingdom1.41.21.41.31.41.32.57.47.96.36.87.88.59.5
Source: International Capital Markets: Developments, Prospects, and Policy Issues, IMF, September 1994.--: Data not available.

Primary dealers transactions of US Treasury securities

Stock exchange turnover for bonds of the Federal Government, Federal Railways, and Federal Post Office.

Secondary market transactions in central government securities, including repurchase agreements.

Source: International Capital Markets: Developments, Prospects, and Policy Issues, IMF, September 1994.--: Data not available.

Primary dealers transactions of US Treasury securities

Stock exchange turnover for bonds of the Federal Government, Federal Railways, and Federal Post Office.

Secondary market transactions in central government securities, including repurchase agreements.

Government debt rapidly expanded

(percent of GDP)

Source: International Capital Markets Developments. Prospects, and Policy Issues, IMF, September 1994.

The increase in the ratio of government debt to GDP has challenged the governments of industrial countries to minimize the cost of financing their debt. With high debt levels, the benefits to a small reduction in the cost of financing are substantial; for example, a government with a 100 percent debt-to-GDP ratio would save a tenth of a percent of GDP each year if it reduced its interest costs by a tenth of a percentage point. As debt levels have grown, along with the pressure to reduce financing costs, one thing has become clear: governments can no longer rely exclusively on domestic investors. This has been particularly true as capital controls were dismantled in many countries, and domestic investors no longer provided a captive market. In order to reduce debt service costs, governments have had to turn to international investors—in particular institutional investors. Indeed, as shown in Table 2, the composition of holders of government debt has changed considerably in recent years. Among the large industrialized countries, international holdings of government debt have expanded in Canada, the United Kingdom, and especially in France and Germany.

To enhance the attractiveness of the debt to international institutional investors, countries have undertaken a wide range of reforms to boost the liquidity and transparency of their market. The 1994 IMF International Capital Markets report outlines the reforms implemented by various industrialized countries. While the report focused on debt management in industrialized countries, these reforms may be of interest to developing countries as well. Some of the reforms are highlighted below.

Primary dealer systems. Governments in many countries have appointed a group of dealers as “primary dealers.” The United States has long had a primary dealer system, and in the last ten years countries such as France, Italy, and the United Kingdom have adopted similar systems. Indeed, trading volume in France and the United Kingdom (Table 2) increased greatly after the introduction of primary dealer systems and other reforms in 1986 and 1987, respectively. Primary dealers in all countries are required to make active markets in government securities, in good times and bad. This requirement helps ensure a degree of liquidity in secondary markets for the debt. Other obligations—and the privileges primary dealers get in exchange—vary widely from country to country.

Position financing. Another, more controversial, reform is the institution of a market in repurchase agreements (repos). These are contracts for the sale and subsequent repurchase of a security, which allow the holder of a security to borrow cash with the security as collateral. Such contracts, along with similar facilities for securities lending, make it easier for participants in financial markets to take positions in securities and also to establish short positions. Part of the controversy behind repos is that they allow investors to take highly leveraged positions, which if investors are forced to liquidate, may contribute to bond market turbulence. However, the United States has a huge market for repos in government securities, which is widely believed to contribute to the unparalleled liquidity of the US government debt market. Repo markets have grown recently in some other countries, but restrictions remain in Germany and the United Kingdom.

Other reforms. Other reforms that industrialized countries have implemented include:

  • concentrating debt maturities in a small set of standardized “benchmark” issues;

  • moving to auctions rather than syndicated issues;

  • setting a predictable issuing calendar;

  • establishing futures contracts on government debt;

  • creating a safe and efficient clearing and settlement system with delivery versus payment and a book-entry system; and

  • eliminating withholding taxes on government debt.

The sequencing and precise nature of these reforms has inevitably differed across the industrial countries, and few countries have adopted all of these reforms. But all of these measures can help enhance the liquidity of government debt markets and contribute to an expansion of a country’s investor base. By increasing the investor base, governments can reduce their debt service costs and free resources for other uses, including reducing the size of debt outstanding.

John Montgomery

Table 2.Tapping the international market Holders of government debt(percent of total debt outstanding)
Selected countries198019861992
United States
Domestic banks18.212.310.4
Domestic individuals19.010.210.2
Other domestic holders41.861.160.1
Foreign21.016.419.4
Germany
Domestic banks69.759.554.3
Other domestic holders21.220.319.4
Foreign9.120.226.3
France
Domestic banks--19.68.2
Other domestic holders--79.649.2
Foreign--0.842.6
Italy
Domestic banks41.328.117.0
Other domestic financial institutions5.312.79.2
Private sector and foreign53.459.273.7
United Kingdom
Domestic banks4.96.73.8
Other domestic financial institutions60.063.361.3
Domestic individuals16.312.08.9
Other domestic holders9.98.28.5
Foreign8.99.817.4
Canada
Domestic banks16.48.811.5
Other domestic financial institutions23.725.629.8
Other domestic holders46.148.134.3
Foreign13.917.624.5
Source: International Capital Markets: Developments, Prospects, and Policy Issues, IMF, September 1994.--: Data not available.
Source: International Capital Markets: Developments, Prospects, and Policy Issues, IMF, September 1994.--: Data not available.

For further analysis see International Capital Markets: Developments, Prospects, and Policy Issues, IMF, September 1994.

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