- International Monetary Fund
- Published Date:
- August 2003
After attaining independence in 1991 and throughout the first half of the 1990s, efforts were devoted to the reestablishment of Slovenia’s access to international financial markets, which involved Slovenia’s assumption of a share in the external debt of the former Yugoslavia. It also involved a smooth execution of the process of rehabilitating the banking system and restructuring various enterprises. Given the fact that the budget remained in surplus until 1997, debt management operations focused on establishing access for borrowing in different financial markets. Borrowing operations started in the domestic market through short-term borrowing to manage liquidity, continued in 1996 with the first Eurobond issue in the euro market, and, in 1997, with issuance of inflation-indexed bonds and loans in the domestic market.
When relatively small budget deficits emerged, the main objective was to develop a domestic market for debt, primarily for bonds, to finance the budget and any debt obligations incurred before 1996 in the succession process to the former Socialist Federal Republic of Yugoslavia and cover programs of real and banking sector rehabilitation.
Developing the domestic market for debt has become a priority to ensure timely financing in domestic currency and reduce macroeconomic risk associated with financing the deficit with external debt. This task has been eased recently by the lifting of capital controls and increase of foreign direct investment. A growing market capacity for government borrowing has just recently allowed undertaking of active debt management operations to reduce the overall cost of the portfolio. Efforts have also been devoted to enhancing the transparency and tradability of instruments, with the aim of deepening and enhancing liquidity of the secondary market. Similarly, building up a yield curve to price other instruments in the market has also been a priority.
Developing a Sound Governance and Institutional Framework
The basic principle underlying debt management activities is harmonization of the goals of (a) minimizing borrowing costs over the long term with a maturity structure that ensures a sustainable level of risk in refinancing the debt and (b) a currency and interest rate structure that minimizes the exposure to exchange rate, interest rate, and other risks.
In 1998, for the first time, an annual program of financing the central government budget (financing program) was adopted, stating the main objectives—both strategic and operational—and targets for debt management. These main guidelines were supported by the Public Finance Act, which was enacted in October 1999.
Strategic objectives include, next to provision of sufficient and timely financing of the budget, cost minimization; maximum reliance on financing in the domestic market, pending the crowding out or distorted effects on the market; broadening both the domestic and the foreign investors’ base; minimizing interest rate risk; minimizing foreign currency risk through continued increase of euros in the currency structure of foreign debt; and minimizing the risk of inflation in the debt in domestic currency by pursuing interest rate nominalism.
Operational objectives include determination of the short-term versus long-term financing mix consistent with a view on the term structure of the portfolio; determination of the external/foreign currency borrowing mix in total borrowing consistent with the strategy of prioritizing the domestic market; determination of the structure of the instruments, including the shares of fixed-rate, variable-rate, and foreign currency–indexed debt consistent with the strategy toward nominalism and cost and risk considerations.
Debt management encompasses all direct financial obligations of the central government. The annual financing program includes the amount to finance, which is determined by the annual budget and is the sum of the deficit and debt repayment obligations in the given fiscal year. It sets the amounts for both domestic and foreign currency borrowings, which are coordinated within the program. The choice of market is given in the form of minimal domestic and maximum foreign borrowing amounts and as maximum short-term and minimal long-term financing.
The public debt management department (PDMD) within the ministry of finance (MoF) also exercises central administrative and control functions over debt of public sector entities, whose debt represents contingent liabilities of the central government and issuance of government guarantees.
Coordination with monetary and fiscal policies
There is a clear legal, regulatory, and actual separation of debt management and monetary policy objectives and accountabilities. The Bank of Slovenia (BOS), the central bank, is an independent institution and not a part of the executive government. The government is legally banned from borrowing from the BOS, which, however, manages the foreign currency reserves and is the government’s paying agent for foreign currency payments, the depositary for foreign currency cash deposits, and, together with commercial banks, a depositary for domestic currency deposits.
On completion of the proposal of the annual financing program, it is discussed within the scope of fiscal policy documents and also shown to the BOS for (nonbinding) commentary and suggestions. The coordination takes place within the framework of a medium-term fiscal scenario.
The MoF and the BOS also discuss general liquidity conditions in the economy at the time of preparation of the annual financing program. Debt managers share information on the government’s current and future financing requirements as well as their dynamics during the year. The MoF informs the BOS of borrowing intentions in advance, whereupon the BoS provides information on market conditions.
There are regular meetings of MoF and central bank officials to discuss, without formal arrangements, the technical scope of their respective policies’ execution.
According to a formal agreement between the MoF and the BOS, the former provides two types of monthly forecasts. The first, for three months in advance, consists of day-by-day cash flows of all revenues and expenditures for all items to be received or paid by the government. The second forecast provides the same information one month in advance, but the information is updated and thus more accurate. The three-month forecast provides an indication of future developments in the government’s account movements, and the second forecast contains updated and reviewed information.
Within the MoF, a committee on liquidity meets weekly, monitoring monthly liquidity situations and determining necessary activity versus financing and versus budget expenditure management. Budget, tax and customs, debt management, and liquidity management departments are permanent members of the committee. The MoF notifies the central bank about budget liquidity projections and monthly changes, and the BOS provides the MoF with necessary information on market liquidity conditions.
Transparency and accountability
The financing program’s objectives and accomplishments are regularly announced. The format of reports contains a separation of objectives and, for every objective where possible, statements of development. Documents are available to the financial community, as well as to the general public. The objectives and instruments of the debt management policy are made public through the annual financing program and other policy documents, including the macroeconomic and fiscal scenarios. These documents are permanently available on the MoF’s web site (http://www.sigov.si/mf/angl/apredmf1.html) and other government web sites. The public finance bulletin is also permanently available on the MoF web site and is updated monthly. It includes data on general and central government finance accounts, government debt, and outstanding guarantees.
The annual report on debt management is made public once the government has accepted it. The report includes information pertaining to the execution of strategic objectives of debt management; a description of the debt instruments issued and costs with a cost analysis; an analysis of developments of the central government debt portfolio and dynamics; information on general government and public debt and debt with central government guarantees; data on debt stock, flows, and instruments; and a brief international comparison of debt. In the form of a public finance bulletin, the MoF also publishes monthly information on the structure of the debt portfolio.
Slovenia has a practice of enacting budgets for the current year and the following year and releasing a midterm fiscal strategy paper to parliament and the general public. The amount of debt and debt-servicing projections are regular parts of policy papers. Monthly, the BOS reports a service schedule for total external debt.
The domestic market provides transparency of operations through a choice of standardized instruments, which are offered in a calendar of issuance of bonds and bills supported by publicly accessible auction results. Auction results are displayed on the MoF web site. Issues are quoted on the Ljubljana Stock Exchange. Quotes on treasury bills that are traded over the counter (OTC) are available through market makers. Further efforts to reduce the uncertainty of players in the domestic market are being made through contacts with all the important investors in the domestic financial market. To stabilize and deepen the market for government securities, transparency in domestic issuance is a strategic objective.
The MoF is striving to maintain the awareness of the international investment community by making available the maximum rating information on bonds and through contacts with the investment community within the scope of its resources. Transparency, accountability, and reliability in debt issues, as well as market approach, have been the prime policy objectives of Slovenia since the start of the dissolution of the former Socialist Federal Republic of Yugoslavia.
The tax treatment of public securities is clearly disclosed in the prospectus of each of the securities, which, besides being available to investors, are being publicly disseminated.
Debt management activities are audited annually by the court of accounts, an independent auditing institution that audits the government and public sector entities. Audit reviews of financing are made public through parliamentary procedure as part of the regular budget audit. Audit of the budget is legally required for parliament to approve the annual government budget execution report.
The legal basis for government borrowing and issuance of guarantees is based on Article 149 of the Slovenian Constitution, which states, “The state shall only be permitted to borrow monies or to guarantee credit on such conditions as are determined by law.”
The framework for central government borrowing is determined by the Public Finance Act,2 which sets out the basis for
a definition of central government borrowing and liquidity borrowing,
the method of determining the ceilings on its borrowing,
the elements of debt management,
the documents underlying the execution of borrowing transactions or programs, and
The rules on borrowing by local governments, extrabudgetary funds, and public sector entities.
The annual Budget Execution Law displays nominal ceilings (quotas) for borrowing and issuance of guarantees by the central government and borrowing by public entities.
Once the annual Budget Execution Law is adopted, the government approves the annual financing program submitted by the MoF, in which major policy guidelines and borrowing strategy are stated. This includes objectives, operations, choice of instruments, dynamics, and market choices. If there is any serious digression from the anticipated market movements or other unexpected events, the program can be amended by the same procedure established for the financing program. In preparing the program, which includes the dynamics of borrowing, consideration is given to currency structure and domestic market capacity, where the goal is to fund the bulk of the borrowing requirement domestically and develop the domestic market to minimize macroeconomic risk and risk of funding. The financing program also aims toward monetary neutrality while optimizing currency risk.
The policy guidelines, included in annual financing programs, have evolved with time from being a document that identified only the type of instrument and dynamics of borrowing, to a more strategic document that states and blends policy goals and policy actions. This development is explained to a great extent by the fact that the existing legal framework governing debt management operations does not specify the debt management policy objectives. Therefore, the yearly borrowing program currently aims at filling the legal vacuum and avoiding undesirable trade-offs between cost and risks. However, given the time span of the financial program (one year), only consistent policy actions can ensure that the cost dimension gets preeminence over risk dimension and an appropriate mix is preserved.
Institutional framework and internal organization
According to the Public Finance Act, the MoF is exclusively responsible for the areas of borrowing and debt management for the central government.
For debt management, the organizational framework is determined within a government decree that states functions, responsibilities, departmental organization, and description of basic tasks for every central government employee. Within the MoF, there are three departments responsible for contracting or managing debt or both:
The international department is responsible for borrowing from international financial institutions (such as the World Bank, European Investment Bank, and the European Bank for Reconstruction and Development). The importance of this source of financing is diminishing steadily and in 2002 represent about 1.5 percent of total financing.
The liquidity management department is responsible for contracting and managing short-term domestic debt and cash management.
The PDMD is responsible for executing the annual borrowing program and managing central government debt (long-term domestic and foreign debt). The PDMD also provides back office functions with record-keeping and payment instructions. Another task is to maintain debt statistics and provide long-term and short-term projections on debt service for budgetary and liquidity management uses. The PDMD prepares regular debt reports and reports on the execution of the borrowing program (financing program). Moreover, the PDMD and liquidity management department maintain MoF Internet information on their respective portions of debt and debt instruments, and the PDMD maintains contacts and provides data in regular format to rating agencies. It also cooperates with these agencies and receives their reports. Finally, the PDMD is in charge of approving and monitoring all public sector borrowing and government guarantees entered into by the minister of finance.
The PDMD is organized into different units with distinct functions and accountabilities, as well as separate reporting lines. The front office is responsible for executing transactions in financial markets, including the management of auctions and other forms of borrowing, and all other funding operations. The back office handles the settlement of transactions and the maintenance of the financial records. A separate middle, or risk management, office has been established to undertake risk analysis and monitor and report on portfolio-related risks, as well as assess the performance of debt managers against strategic benchmarks, but it is not yet in operation. A statistics unit provides reporting service and necessary projections, including debt management–related, short-term liquidity projections and projections for budget preparation, and manages the debt database used by the back office for both settlement and maintenance of debt items records. The liquidity management department is organized into two units, the budget liquidity forecasting unit and the money market unit. The department executes issuance and repayment of treasury bills and other short-term instruments and keeps records on them.
Internally, the PDMD management is carried out along instrument lines in both the debt management (front office) and the transaction management unit (back office). The lines are domestic bonds, foreign bonds, domestic loans, foreign loans, and issuing of guarantees. Except for guarantees, where there is frequent cooperation with line ministries, cooperation operates in the department from front office to back office to statistics and analysis.
Coordination and information sharing between debt management departments and other departments within the MoF take place in various forms: in the formal and internal (committees) organization of the MoF and through common work, organized by project, on establishing and upgrading information, budget execution, debt management, and accounting software systems. Connection with budget preparation follows the budget preparation schedule. Connection to general accounting is permanent and is based on a generic software application connecting accounting with budget execution and budget users. Also, the software provides a basis for monitoring the budget execution with respect to further budget planning.
Within the ministry, the PDMD and the liquidity management, budget execution, and taxation and customs departments of the MoF survey the short-term (monthly) liquidity situation every week and decide on precise liquidity management tactics. In monthly meetings, these departments analyze the three-month projections and possible developments and propose necessary action(s).
The current division and organization of work are based on the historical development and growth of the MoF. Despite the fact that borrowing functions are located in three units of the MoF, there is a reasonable degree of coordination among them and their mandates are fairly clear. Nevertheless, a drawback of the current institutional arrangement is the absence of a centralized decision-making authority, which to some extent encumbers the process of debt planning, the process of debt management, and implementation of the operations necessary for debt management.
Establishment of a separate debt management agency to take over all central government debt management is being contemplated, and the MoF is studying the suitability of setting up an independent agency or an office within the ministry to manage public debt with the following goals:
centralization of borrowing and debt management operations;
increase in responsibility for the execution of operations;
establishment of a clear and measurable debt management goal, which would become the basis for the delegation of competencies and responsibilities;
isolation of the debt management function from political and other institutions’ interference;
simplification of procedures for the provision of modern information technologies and human resources with specific knowledge necessary for a progressive stage of debt management and minimizing the operational risk; and increased flexibility of the agency to ensure a response to changes in the market and market participants.
There is no formal coordination with the BOS. The MoF has observer status with the BOS board. On the department (technical) level, both the debt and liquidity management functions hold regular working meetings with appropriate central bank officials—ideally, meetings are held monthly.
In Slovenia, the MoF has since 1995 been developing a custom-made database for debt. At present, the base provides for a safe and reliable debt service and is an accurate tool for registering and managing debt items and a solid basis for statistics and organization of data for analysis. The initial building-up of the database has been cosponsored by the World Bank. Plans for upgrading the base—with cash-flow generation, a projections engine, and capabilities for portfolio simulation—are progressing relatively slowly, mainly because of funding constraints. The database will be fully integrated into the government’s system of budget execution and accounting system.
Electronic data preservation is supported by storage of hard-copy legal and accounting documentation. The computer system is running a continuous backup procedure. CD storage of documents, as well as data, has been made possible and is in partial use. The system has been under scrutiny at every due diligence proceeding for issuance of international bonds. Operations of the back office are separate from those of the front office, and a fixed internal procedure is in place for document delivery on business items.
Within the framework of the general administration staff and salary policies and regulations, the MoF and the department are trying to alleviate the problem of low salary incentive mainly through the extra appeal of functional education available on-site for senior staff. In addition, there are a promotional value for a debt management professional, an active policy of and support to postgraduate education through a time-off allowance, and, in most cases, payment of tuition fees. The MoF and the department are also doing their best to provide case-specific education through domestic and international seminars, workshops, and similar events. In 2001, participation of the PDMD staff in off-site educational activities was 84 days, or about 30 percent above the average of the MoF, which is not inconsiderable when taking into account an ongoing technical training for the European Union (EU) accession process. We are also working toward development of professional responsibility in junior staff through a mentor system. Nevertheless, the turnover of trained staff, specifically the front office staff, presents a permanent operational and, above all, development deterrent.
Staff involved in debt management is subject to a general government employees’ code of conduct, which includes conflict-of-interest rules. These are further detailed for MoF employees in internal rules on specific conditions applicable to activities of MoF employees. These detail the rules for management of employees’ personal financial affairs. Within the department, an unwritten code of conduct applicable for contacts with financial organizations and media is practiced.
Assessment and Management of Cost and Risk
The bulk of central government debt in Slovenia is the result of the assumption of a share in the external debt of the former Yugoslavia, bank rehabilitation, and enterprise restructuring operations. Autonomous growth of debt as a result of indexation of the principal is the second most important factor underlying growth, followed by the exchange rate changes and the budget deficit financing, contributing the least to the growth of debt.
Concerning external debt, early recognition of sovereign succession obligations by the government allowed reestablishment of the country’s access to international capital markets and the possibility of managing and reducing the risks embedded in the external debt portfolio. Reestablishing links with international financial markets was critical in ensuring a normal functioning of the economy (i.e., trade financing and access of the private sector to international credit).
External debt operations were targeted to restructure the assumed and nonmarketable, expensive debt by issuance of long-term securities (10 years) denominated in euros, the eventual domestic currency of Slovenia after joining the European Monetary Union. These operations were aimed primarily at reducing the refinancing risk of total debt profile (public and private sector debt) and the risk of a possible balance of payments crisis. They also aimed at setting a benchmark for Slovenian borrowers in international market(s).
On the internal side, most of the initially issued debt was bond issues linked to bank rehabilitation and enterprise restructuring. The government administratively issued inflation- and foreign currency–indexed bonds with a maturity schedule ranging from 5 to 22 years. This strategy, which reduced the refinancing risk and resort to foreign borrowing, took into account the evolving conditions of the small internal financial market.
Debt management strategies
Respecting the size of financing set by the annual budget, the basic principle underlying the debt management activities is harmonization of the goals of (a) minimizing borrowing costs over the long term with a maturity structure that ensures a sustainable level of risk of refinancing the debt and (b) a currency and interest rate structure that minimizes the exposure to exchange rate, interest rate, and other risks.
In deciding on annual financing programs, the MoF takes into account minimizing the rollover risk as well as the optimization of market risk, giving consideration to the desired foreign exchange neutrality of borrowing. In foreign borrowing, the MoF is striving to establish a high degree of market presence and a broadening of investor base, primarily through the Euromarket, which has the deepest knowledge of Slovenia as issuer and socioeconomic entity. At the same time, with two-thirds of Slovenia’s foreign trade in Europe, and with the euro becoming Slovenia’s prospective currency, it is the most exchange risk–neutral market.
In deciding where to borrow, the main consideration has been to give priority to the domestic market without disrupting market conditions and crowding out the private sector. External borrowing has also been restricted, to the maximum possible degree, to the rollover of foreign debt and payments of interest in foreign currency.
The risks inherent in the government’s debt structure are always being carefully monitored and evaluated. Organizational and legal steps are being taken, in line with the development of the Slovenian legal and economic system in the transition to the EU, to eliminate or hedge different risks. The MoF is continuously moving toward a degree of standardization of domestic issues that will provide the market with necessary supply. Currently, it is running a series of 3- and 5-year variable bonds in Slovenian tolars (where the inflation is the variable part of variable interest rate) and 10-year euro-denominated bonds, as well as 3-, 6-, and 12-month nominal fixed-rate treasury bills in a proportion agreed to by the annual financing program and under a fixed auction calendar, thus adding transparency and predictability to the supply. In 2002, the MoF started issuing 15-year euro-denominated bonds and 3-year tolar-denominated bonds with a nominal fixed rate to replace the present 3-year variable issue. In both the foreign and domestic markets, the MoF is using the reopening device when appropriate for benchmark or cost purposes or both.
Domestic financial capacity has been constrained by the limited depth of the financial market and, until recently, by capital controls (gradually lifted between1999 and January 1, 2002). Portfolio inflows were subject to prohibitive costs, which applied to long- and short-term securities without exception. Thus, capital controls limited foreign investors’ participation in the government securities market. It is within these limits that operations were aimed at financing the borrowing requirement without resorting to a significant increase in external debt and monetization, which could have hampered the central bank’s meeting its monetary targets (M1 until 1997, and then from thereon, M3). In 2002, the central bank began following a “two-pillar” approach to conducting monetary policy. The first pillar still emphasizes control of broad money and its components, and the second pillar includes various real and financial indicators, both domestic and external.
Nonmarket financing channels are being used for a smaller portion of the short-term borrowing; the legal arrangement allows the MoF to request public institutions to place their cash surpluses, at market rates at a given time, at government disposal through accepting promissory notes, rather than the general market. Borrowing from the BOS is not permitted.
The MoF prepares annual, quarterly, monthly, and weekly liquidity forecasts. Liquidity managers and debt managers form, with the budget execution and taxation department representatives, a permanent working body in the ministry, a committee on liquidity that monitors the constantly adjusted forecasts and decides on appropriate actions. In constant consultation with the IMF resident adviser, the MoF is improving its liquidity and budget management technologies and its revenues and expenditure forecasting.
The MoF policy is to provide a steady supply of long-term and, in proportion, short-term paper, but there is no requirement anywhere in financial, fiscal, or other regulations for buying or holding government paper.
The main risks in the debt portfolio
In the past, the share of external debt has grown slowly but constantly. This is primarily due to the fact that in the succession process, Slovenia assumed part of the debt of the former Yugoslavia, whose structure (in terms of currency, maturity, and interest rate) had no influence over debt expansion. However, the ratio also increased because of the limited size of the domestic financial market, which until 2002 did not offer the possibility of budget deficit financing and refinancing the repayment of principal in tolars in full by borrowing in the domestic financial market.
Within the structure of instruments, there has been a steady increase in the share of securities and a drop in the share of loans. The share of debt to foreign governments and international organizations is also declining, but debt to commercial banks and other creditors is rising. Both of these steady trends derive from a change in the strategy and conditions of financing. These tend to result from the fact that, since 1996–97, Slovenia has been financing itself primarily in financial markets by use of market mechanisms and instruments.
The structure of the debt is predominantly long term. By the end of 2000, the long-term debt represented 95.5 percent (term-at-issue) and 91.7 percent (term-to-maturity) of total debt. The structure is showing a low exposure to refinancing risk, but domestic short-term debt is growing rapidly.
The main focus of attention is market risk. In particular, this means the reduction of volatility of debt service in domestic currency and reduction of the effect of indexation in debt stock dynamics. The aim and the policy have been to gradually shift the composition of the debt portfolio from inflation-indexed debt (by ceasing to issue such debt from 2000 onward) and foreign currency–indexed debt to nominal instruments. A gradual strategy involving introduction of fixed-rate debt instruments and shifting foreign currency debt to the currency with less volatility (the euro) has taken place.
Most of the risk in the internal portfolio is due to the predominance of debt instruments whose cost in domestic currency varies. The most risky instruments are those indexed to inflation. Because of the high volatility of inflation and its relatively high, single-digit level, they have substantially influenced debt increase.
In the structure of interest rates and types of instruments, there has been a clear trend, since 1997 in particular, toward a fall in the share of index-linked instruments, as well as growth in the share of instruments with a fixed interest rate. The currency structure reveals rapid growth in the share of the euro against a rapid fall in the share of the U.S. dollar. The trends revealed in movements in the structure of debt are primarily a consequence of implementation of the strategic orientations and goals in borrowing and debt management, and it is expected that they will continue in the future.
Risk analysis undertaken to develop the strategy
The MoF relies on a comprehensive definition of cost, which is the basis upon which risk is measured. Cost is measured as the present value of debt service (principal and interest) valued in domestic currency. Risk is measured by the difference between the present value of the baseline scenario and alternate present value scenarios based on possible different behavior of underlying variables affecting debt service.
The ministry relies on periodic assessment of risk based on the impact of changes of exogenous variables on the debt portfolio’s structure and cost. The cost of instruments—with the exception of treasury bills, which are short-term fixed instruments—depends on the evolution of different price variables (inflation, interest rate, or exchange rate). Therefore, the analysis of past and future evolution of different prices and its impact on the debt portfolio structure and cost is important to assess the exposure of the portfolio. The MoF relies on its own forecast and on external forecasts of main price variables and interest rates.
Market risk and refinancing risk are periodically quantified. The elasticity of the cost of the portfolio with regard to changes in various variables is calculated and serves as an input in executing the annual borrowing strategy to reduce market risk. Similarly, various issuing strategies are evaluated against the desired maturity profile in both the domestic and international markets. Buybacks are also part of the operations executed to reduce market risk and achieve the desired maturity profile. These operations are discretional and can be executed throughout the year. Debt sustainability analysis is carried out, as well as assessment of the impact of external debt service on current account sustainability.
The evolution of the borrowing requirement and the maturity profile in a dynamic setting (taking into account redemption and new issuance strategies) is important for the assessment of medium-term cost, refinancing risk, and strategy for instrument issuance. Currently, the existing software does not allow for sophisticated statistical and simulation techniques. The analysis consists mainly of simple scenario analysis. The MoF is in the process of upgrading the database applications for assessing risk. Currently, it relies on simple models on spreadsheets.
Assessments of domestic market capacity and its evolution and of international market access are also a critical part in determining cost and risk of the financing program.
Operational risk is not assessed, but it is taken into account as part of the ongoing process of aiming to avoid errors or failures in the various stages of executing and recording transactions. Efforts to reduce operational risk are being done through legal unification of responsibilities in budget execution and regulation of procedures. Responsibility for debt management within the PDMD is separated into front and back offices, with distinct functions and accountabilities and separate reporting lines.
Benchmarks for domestic debt
Currently, there are no performance benchmarks. The MoF does not have an explicit benchmark portfolio with targets. However, long-term policy actions follow policy guidelines targeted toward achieving a portfolio composition that ensures low cost and limits risks. The annual financing program sets the actions in conformity with long-term goals, and the annual debt report discusses whether the result of policy actions was consistent.
Active debt management strategies
Buyback operations and execution of call options are part of MoF operations to reduce debt-service cost. Until 2002, buyback operations have been conducted mainly in international markets, because the relatively small actions of the MoF did not disturb market conditions there. In the domestic market, the main instrument has been the execution of call options, taking into account the overall borrowing capacity of the MoF. Buybacks were not executed in the domestic market, given its relatively modest stage of development. The law strictly regulates active debt management operations. There are criteria for their execution, which include evidencing of cost savings or improvements in the debt portfolio structure without increases in the amount of debt outstanding.
Explicit contingent liabilities are monitored in the same framework as the central debt. They can be incurred only on the basis of law; the entities that would incur them (e.g., borrowing with government guarantee) are monitored throughout the process by the MoF.
The guarantees that are forecasted to be executed (because of liquidation, bankruptcy, and so forth of beneficiaries) are a matter of definite budgetary provisioning, and a set of recovery procedures is in place. Consistent use of short-term rollover projections prevents occurrence of large unpaid liabilities at any point in the system.
Development of the market for private sector debt
The MoF is aware of the importance of the government securities and a benchmark yield curve as the basic reference for pricing private sector debt. In the international market, continued effort is placed on expanding the investor base and keeping a representative yield curve for enhancing the access of domestic investors to those markets, with a clear price reference available for pricing of their transactions. In the domestic market, to build a domestic yield curve, the target has been shifting from issuance of indexed debt to fixed-rate instruments. The process has been gradual. It consisted first of introducing variable instruments as an intermediate step toward fixed-rate instruments, standardizing maturities, and introducing short-term fixed-rate instruments. The next step consists of issuing long-term fixed-rate instruments and extending their maturities. A 10-year euro-denominated bond is issued in the domestic market and will be followed by a 15-year, euro-denominated bond, which helps to price other long-term instruments.
Developing the Markets for Government Securities
Slovenia’s government securities market is framed on the background of a hyperinflationary environment inherited from the former Yugoslavia and a strong policy stance until 1997, where the budget was either balanced or in surplus. As a consequence of the hyperinflation scenario inherited from the former Yugoslavia, all financial contracts in the economy were indexed to inflation, the index expressed as the basic interest rate (the average of the last three months of inflation and, later, the last 12 months) calculated by the BOS. Only in 1998 did treasury bills with maturities of 6 and 12 months appear as the first nominal instruments denominated in domestic currency. Issuance of treasury bills before 1997 was only sporadic because of the relatively comfortable fiscal position. The bulk of domestic debt corresponds to the bank rehabilitation and enterprise restructuring that followed independence in 1991. The instruments issued for these purposes were inflation-indexed bonds or foreign currency–indexed bonds with different maturities. These instruments were issued administratively (not in the market) and were the only long-term instruments available until 1997.
In 1997, as the budget deficit emerged, inflation-indexed bonds started to be issued sporadically without a preannounced calendar. Sporadic issuance of indexed bonds continued in 1998 and 1999 without standardized maturities. Since 2000, bonds have been regularly issued according to a preannounced calendar. Maturities were standardized as 3- and 5-year variable-rate bonds (where indexation is the variable part of variable interest rate) as part of the strategy to move toward introduction of fixed-rate instruments denominated in domestic currency, and a 10-year fixed-rate foreign currency–denominated bond. The bonds aimed at spreading the stock of debt across the yield curve to minimize rollover risk. Different interest calculation formulas used earlier were unified to enhance secondary trading and transparency. Enhancement of the market structure—including improvements in the auction mechanism, standardization and issuance of simple instruments, and announcement and calendar of funding needs—contributes to developing the market and helps to broaden the investor base.
The 10- and 15-year bonds were introduced to satisfy the demand of institutional investors. They are denominated in foreign currency and payable in domestic currency as an intermediate step toward nominal rates. In the event Slovenia becomes an EU country, the euro-denominated bonds will be repaid in euros.
In 2002, the MoF issued, for the first time, a three-year fixed-rate bond denominated in domestic currency, and the ministry will gradually shift other maturities to fixed-rate instruments. The shift to fixed-rate instruments not only aims at reducing market risk, but also at developing an identifiable yield curve and enhancement of trading. The MoF also believes that a liquid secondary market in government securities can be built only by means of fixed-rate instruments. When investors buy variable or inflation-indexed instruments, they are hedged against inflation risk, which deters trading of inflationary expectations. Inflation-indexed bonds are the least traded instrument in the secondary market.
The MoF reopens on-the-run issues several times during the year, according to a preannounced calendar, until it reaches a desired level (benchmark). The MoF has resorted to such a technique because of limited subscription in a single auction.
The issuance of treasury bills also became systematic in 1998. First, a three-month bill was introduced in May 1998, then a 6-month bill in October 1999, and a one-year bill in May 2000. These bills aim at establishing a flexible and cost-effective source of short-term borrowing to finance liquidity shortages, and they have contributed decisively to the move toward nominal rates in the economy and creation of a money market yield curve.
The MoF and the BOS issue their respective instruments. The MoF issues treasury bills and bonds, and the central bank issues its central bank bills. The MoF issues securities through an auction mechanism and accepts the market price, and the BOS, by means of a tap and recently through the use of auctions. There is no conflict in issuing different instruments and pricing them differently. However, there might be competition of securities in the secondary market.
Securities are issued through auctions. Bonds are issued by means of a multiple-price auction, and treasury bills, through a fixed-price auction. Auctions are, in legal form, public auctions. The MoF executes the auctions.
For short-term paper, all sectors except the BOS can participate. All participants bid through primary dealers, the commercial banks that are registered security dealers.
In auctions of long-term paper, banks, securities dealers and other firms, and funds, including public and government agencies—all sectors except the central bank—can participate; interested entities that possess adequate technical and other means can participate in the auctions directly by agreement with the MoF (the PDMD). Other market participants, including households, participate through those commercial banks that are registered securities dealers.
To develop an efficient secondary market of government securities, the first task has been to provide instruments that can be easily marketable and will have simple features and clearly identifiable cash flow. To achieve this goal, the MoF is implementing a strategy toward nominalization of the main borrowing instruments. This includes the introduction of treasury bills with different maturities and a shift from inflation-indexed instruments, first, toward variable-rate instruments and, then, to fixed-rate instruments. Changing to variable-rate bonds also involved a gradual simplification of bond formulas in an effort to avoid disrupting the market. This development has also fostered similar development in the products offered by the domestic banking system.
In Slovenia, the central bank conducts open market operations exclusively with central bank bills, which can deter secondary trading of government securities. However, the BOS had a catalytic role in contributing to establishment of OTC trading in short-term government securities in November 2001. In particular, the BOS designed its regulatory framework. OTC transactions in government bonds also started recently, in August 2001, and activity has increased steadily in both types of instruments. The BOS is also contributing to the design of the regulatory framework for repo operations with short-term government securities in the OTC market. The rapid increase in OTC transactions is due to lower costs resulting from the absence of brokerage fees and low commissions charged by the Depository and Settlement Company.
Keeping access to domestic and international financial markets
To keep access to domestic and international financial markets, the MoF maintains frequent contact with investors and monitors financial markets’ developments and investors’ preferences. There has also been a strategy to issue debt instruments with standard maturities and, within the limits of borrowing needs, a size that enhances investors’ appetite. In the international market, the PDMD has aimed at establishing a yield curve, which helps to price transactions. The PDMD strives to establish a size that ensures a certain degree of liquidity for investors but at the same time does not represent a refinancing risk for the portfolio. In the domestic market, investors are informed in advance about the issuing plans, to avoid any surprises or advantage. The PDMD aims at being reliable in its strategy and pricing of transactions. The investors’ preference for particular instruments is also taken into account in preparation of the annual financing program.
Clearing and settlement
Slovenia uses an electronic system to settle and clear all security transactions occurring on the Ljubljana Stock Exchange. All trades conducted on that exchange are automatically transmitted to the Depository and Settlement Company, a clearing and settlement corporation. Settlement is T+2 on a delivery-versus-payment basis. Depository and Settlement Company rules comply with the Group of 30 international standards and all nine recommended actions in 1989 for clearing houses. Compliance with the CPSS-IOSCO recommendations adopted in November 2001 is under assessment.
Interest income and capital gains from government securities is at present taxed under the broad category of corporate income tax. Interest income from government securities is tax exempt for personal income tax purposes. Any profit arising from appreciation in the price of the security, when a security is sold within three years of the date of its acquisition, is treated as a capital gain for personal income tax purposes. There are no differences between financial and nonfinancial corporations in the treatment of government securities for taxation purposes. There is also no distinction between current income and capital gains for corporate income tax purposes. No withholding tax is applied on income derived from government securities for residents and nonresidents. Primary and secondary transactions with securities and shares are exempt from value-added tax.
The outlines of the legal framework, given in Articles 81 through 84 of the Public Finance Act, are as follows:
The central government may incur debt both locally and abroad and up to the level stipulated by law (i.e., to the sum necessary for financing the deficit and for repayments of debt in the current year). During a period of temporary financing, the central government may incur debt up to the amount necessary for current debt repayments.
If, because of mismatches in flows, budget expenditures cannot be covered with current budget receipts, the central government may borrow for liquidity purposes, however not in excess of 5 percent of the last regular budget.
By drawing loans and issuing securities, the central government may raise funds necessary either to repay the public debt before falling due or to purchase its own securities, provided that:
Measures to establish economic stability are supported;
Cost of central government debt is reduced; or
The quality of debt portfolio is improved without increasing the central government debt.
The central or local government may also enter into other debt transactions in order to manage exchange and interest risks related to the central and/or local government debt (transactions with derivatives). The central government may buy and sell its own securities either on or outside the organized securities market. The funds for the purchase of securities shall be included in the central government budget.
Decisions regarding transactions in relation to central government borrowing, central government debt management, and interventions in securities markets are made by the minister responsible for finance on the basis of the annual Financing Program adopted by the Government.
The debt operations are concluded by the minister responsible for finance or another person authorized by the minister in writing.
Decisions regarding liquidity borrowing are made and executed by the minister responsible for finance or another person authorized in writing by the minister.
Article 85 specifies financing rules for local governments:
Local governments may borrow and manage debt on the basis of prior approval of the minister responsible for finance and under the terms and conditions laid down by the act regulating the financing of local governments. Borrowing transactions for which no prior approval has been given by the ministry responsible for finance shall be deemed null and void. Should it be impossible to balance the implementation of the budget due to uneven inflow of receipts, local governments may borrow for liquidity, however no more than 5 percent of the last regular budget. Unless otherwise stipulated in a special law, incomes from cash management are budget revenues, whereas the expenses of liquidity borrowing of the budget are budget expenditures. Local governments are obliged to report to the ministry responsible for finance on the borrowing and repayments of debt in a manner determined by the minister responsible for finance.
The case study was prepared by Stanislava Zadravec C., Gonzalo Caprirolo, and Andrej Klemenčič from the Public Debt Management Department of the Ministry of Finance.
A more detailed outline of the framework is described in the Appendix to this report.