In assessing debt management operations in Turkey since 2001, this chapter focuses on how the debt structure and the institutional framework for risk management have changed since the financial crisis and what this implies for future strategies.
Turkey’s financial crisis in 2001 led to a large increase in domestic debt with a structure that was highly sensitive to exchange rate and interest rates movements. The share of domestic government debt linked to or denominated in foreign currency rose sharply between 2000 and 2001 (Table 6.1), as banks sought foreign currency assets to close their short foreign exchange positions (required by tighter risk limits imposed after the crisis). The Treasury largely met the banks’ demand for foreign currency assets, cognizant of the potential effect on the exchange rate if that demand were not met.
Currency and Interest Composition of Domestic Central Government Debt
Cash debt refers to debt issued for budget financing purposes (public and private sales).
Noncash debt refers to debt issued for nonbudget financing purposes (public sales only), such as the recapitalization of state banks.
For 2000, the stock of domestic debt does not include nonsecuritized debt.
Currency and Interest Composition of Domestic Central Government Debt
| 2000 | 2001 | 2002 | 2003 | 2004 | |||
|---|---|---|---|---|---|---|---|
| (In billions of U.S. dollars) | |||||||
| Cash1 | 44.0 | 40.5 | 54.6 | 93.5 | 123.4 | ||
| Fixed rate | 28.9 | 12.3 | 23.0 | 49.2 | 70.7 | ||
| Floating rate | 13.4 | 7.9 | 10.6 | 20.8 | 27.1 | ||
| Foreign currency denominated | 1.8 | 5.0 | 10.1 | 12.1 | 19.8 | ||
| Foreign currency indexed | … | 15.3 | 10.9 | 11.4 | 5.8 | ||
| IMF credit | … | 9.6 | 5.9 | 6.1 | 2.8 | ||
| Swap | … | 5.4 | 4.7 | 5.4 | 3.0 | ||
| Other | … | 0.4 | 0.3 | … | … | ||
| Noncash2 | 10.2 | 44.3 | 37.1 | 45.8 | 43.9 | ||
| Fixed rate | 1.5 | … | … | … | … | ||
| Floating rate | 6.0 | 34.4 | 28.6 | 38.8 | 40.1 | ||
| Foreign currency denominated | 2.7 | 8.6 | 7.3 | 5.6 | 2.5 | ||
| Foreign currency indexed | … | 1.3 | 1.2 | 1.4 | 1.3 | ||
| Total stock3 | 54.2 | 84.9 | 91.7 | 139.3 | 167.3 | ||
| (In percent of total domestic debt) | |||||||
| Cash1 | 81.2 | 47.8 | 59.6 | 67.1 | 73.8 | ||
| Fixed rate | 53.3 | 14.5 | 25.1 | 35.3 | 42.3 | ||
| Floating rate | 24.7 | 9.3 | 11.6 | 15.0 | 16.2 | ||
| Foreign currency denominated | 3.2 | 5.9 | 11.0 | 8.7 | 11.9 | ||
| Foreign currency indexed | … | 18.1 | 11.9 | 8.2 | 3.4 | ||
| IMF credit | … | 11.3 | 6.5 | 4.4 | 1.6 | ||
| Swap | … | 6.4 | 5.1 | 3.8 | 1.8 | ||
| Other | … | 0.5 | 0.3 | … | … | ||
| Noncash2 | 18.8 | 52.2 | 40.4 | 32.9 | 26.2 | ||
| Fixed rate | 2.8 | … | … | … | … | ||
| Floating rate | 11.0 | 40.5 | 31.2 | 27.8 | 24.0 | ||
| Foreign currency denominated | 5.0 | 10.1 | 7.9 | 4.1 | 1.5 | ||
| Foreign currency indexed | … | 1.5 | 1.3 | 1.0 | 0.8 | ||
| Total stock3 | 100.0 | 100.0 | 100.0 | 100.0 | 100.0 | ||
Cash debt refers to debt issued for budget financing purposes (public and private sales).
Noncash debt refers to debt issued for nonbudget financing purposes (public sales only), such as the recapitalization of state banks.
For 2000, the stock of domestic debt does not include nonsecuritized debt.
Currency and Interest Composition of Domestic Central Government Debt
| 2000 | 2001 | 2002 | 2003 | 2004 | |||
|---|---|---|---|---|---|---|---|
| (In billions of U.S. dollars) | |||||||
| Cash1 | 44.0 | 40.5 | 54.6 | 93.5 | 123.4 | ||
| Fixed rate | 28.9 | 12.3 | 23.0 | 49.2 | 70.7 | ||
| Floating rate | 13.4 | 7.9 | 10.6 | 20.8 | 27.1 | ||
| Foreign currency denominated | 1.8 | 5.0 | 10.1 | 12.1 | 19.8 | ||
| Foreign currency indexed | … | 15.3 | 10.9 | 11.4 | 5.8 | ||
| IMF credit | … | 9.6 | 5.9 | 6.1 | 2.8 | ||
| Swap | … | 5.4 | 4.7 | 5.4 | 3.0 | ||
| Other | … | 0.4 | 0.3 | … | … | ||
| Noncash2 | 10.2 | 44.3 | 37.1 | 45.8 | 43.9 | ||
| Fixed rate | 1.5 | … | … | … | … | ||
| Floating rate | 6.0 | 34.4 | 28.6 | 38.8 | 40.1 | ||
| Foreign currency denominated | 2.7 | 8.6 | 7.3 | 5.6 | 2.5 | ||
| Foreign currency indexed | … | 1.3 | 1.2 | 1.4 | 1.3 | ||
| Total stock3 | 54.2 | 84.9 | 91.7 | 139.3 | 167.3 | ||
| (In percent of total domestic debt) | |||||||
| Cash1 | 81.2 | 47.8 | 59.6 | 67.1 | 73.8 | ||
| Fixed rate | 53.3 | 14.5 | 25.1 | 35.3 | 42.3 | ||
| Floating rate | 24.7 | 9.3 | 11.6 | 15.0 | 16.2 | ||
| Foreign currency denominated | 3.2 | 5.9 | 11.0 | 8.7 | 11.9 | ||
| Foreign currency indexed | … | 18.1 | 11.9 | 8.2 | 3.4 | ||
| IMF credit | … | 11.3 | 6.5 | 4.4 | 1.6 | ||
| Swap | … | 6.4 | 5.1 | 3.8 | 1.8 | ||
| Other | … | 0.5 | 0.3 | … | … | ||
| Noncash2 | 18.8 | 52.2 | 40.4 | 32.9 | 26.2 | ||
| Fixed rate | 2.8 | … | … | … | … | ||
| Floating rate | 11.0 | 40.5 | 31.2 | 27.8 | 24.0 | ||
| Foreign currency denominated | 5.0 | 10.1 | 7.9 | 4.1 | 1.5 | ||
| Foreign currency indexed | … | 1.5 | 1.3 | 1.0 | 0.8 | ||
| Total stock3 | 100.0 | 100.0 | 100.0 | 100.0 | 100.0 | ||
Cash debt refers to debt issued for budget financing purposes (public and private sales).
Noncash debt refers to debt issued for nonbudget financing purposes (public sales only), such as the recapitalization of state banks.
For 2000, the stock of domestic debt does not include nonsecuritized debt.
The share of floating rate notes (FRNs) in domestic central government debt rose from about 36 percent in 2000 to almost 50 percent in 2001. FRNs were issued mainly as part of the bank recapitalization effort.
Faced with a high debt burden and risky composition, investors were only prepared to hold short maturities. The average maturity of newly issued treasury bills was only 4.6 months in 2001 (Table 6.2).
Maturity of Debt
(In months)
Maturity of Debt
(In months)
| Average Maturity of Stock | Average Maturity of New Cash Borrowing | ||
|---|---|---|---|
| 2001 Total | 38.5 | 18.0 | |
| Government bonds | 44.5 | 32.9 | |
| Treasury bills | 3.4 | 4.6 | |
| 2002 Total | 32.1 | 11.1 | |
| Government bonds | 41.2 | 19.7 | |
| Treasury bills | 4.2 | 6.7 | |
| 2003 Total | 25.1 | 14.7 | |
| Government bonds | 28.4 | 20.1 | |
| Treasury bills | 2.8 | 6.2 | |
| 2004 Total | 20.6 | 15.0 | |
| Government bonds | 23.1 | 20.6 | |
| Treasury bills | 4.5 | 6.2 | |
Maturity of Debt
(In months)
| Average Maturity of Stock | Average Maturity of New Cash Borrowing | ||
|---|---|---|---|
| 2001 Total | 38.5 | 18.0 | |
| Government bonds | 44.5 | 32.9 | |
| Treasury bills | 3.4 | 4.6 | |
| 2002 Total | 32.1 | 11.1 | |
| Government bonds | 41.2 | 19.7 | |
| Treasury bills | 4.2 | 6.7 | |
| 2003 Total | 25.1 | 14.7 | |
| Government bonds | 28.4 | 20.1 | |
| Treasury bills | 2.8 | 6.2 | |
| 2004 Total | 20.6 | 15.0 | |
| Government bonds | 23.1 | 20.6 | |
| Treasury bills | 4.5 | 6.2 | |
Against this backdrop, Turkish authorities in 2002 implemented a comprehensive debt management program. Faced with large borrowing requirements, the authorities needed to ensure a high rollover rate and longer maturities. To this end, the Treasury formulated an action plan based on four objectives:
Offering securities that cater to investors’ needs;
Widening the investor base;
Improving risk management within the Treasury; and
Deepening the liquidity of benchmark issues.
New instruments targeted the balance sheet needs of the main investors, the domestic banks, which faced tight risk constraints and had little room to take on foreign currency exposure. Thus, the size of the banks’ demand for foreign currency assets was determined by their foreign currency deposits and interbank liabilities. This meant that the Treasury had to continue to issue foreign currency securities to satisfy the large demand by banks for foreign currency assets. Although there were little or no short foreign currency positions following a debt swap in 2001, banks continued to experience a shift in their liability base away from Turkish lira and into foreign currency deposits.
However, the short-term need to issue foreign currency-indexed debt created a risk for the government. If debt rollover had not been a concern, the best approach would probably have been not to accommodate the demand for foreign currency securities and instead to allow the losses that banks incurred due to their foreign currency exposure to force them to lower the interest rates they offered on their foreign currency deposits. This could have encouraged the public to move deposits into lira. However, it was uncertain at that time how quickly the demand for foreign currency deposits could be reduced, and there was a risk that some depositors would move their deposits offshore rather than switch into lira. Therefore, the Treasury decided to issue foreign currency securities to reduce market concerns about the feasibility of achieving the domestic borrowing requirement.
The Treasury also resumed the issuance of FRNs to fulfill the demand of banks for interest rate protection. The average maturity of banks’ lira liabilities had shortened to about one month, thus holding even six-month treasury bills represented a significant interest rate risk for banks. FRNs offered the best prospect for lengthening maturities in lira while providing banks with the interest rate hedge that they needed.1 In early 2002, the Treasury issued a series of two-year FRNs indexed to the three-month interest rate.
To ensure a stable and reliable source of funding, the Treasury took measures to widen its investor base. The Treasury initiated meetings with various investor groups, with an eye toward encouraging retail and foreign participation. Investors were provided updates of recent economic developments through presentations as well as one-to-one contacts. Regular press releases were issued to provide full information to the market. To target retail investors, the authorities increased the level of interest income that was exempt from tax from TL 2 billion to TL 50 billion. By the end of 2003, retail creditors owned $23.3 billion in domestic debt instruments (Table 6.3), which amounted to 16.7 percent of the government’s domestic debt stock.
Outstanding Total Debt of Central Government by Lender
(In billions of U.S. dollars)
Outstanding Total Debt of Central Government by Lender
(In billions of U.S. dollars)
| 2000 | 2001 | 2002 | 2003 | 2004 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Debt by lender | 94.6 | 123.6 | 148.5 | 202.7 | 235.6 | ||||||
| Domestic debt stock | 54.2 | 84.9 | 91.7 | 139.3 | 167.3 | ||||||
| Market | … | 28.8 | 43.3 | 72.9 | 105.2 | ||||||
| Banks | … | … | … | 24.4 | … | ||||||
| Retail creditors | … | … | … | 23.3 | … | ||||||
| Mutual funds and legal entities | … | … | … | 22.1 | … | ||||||
| Nonresidents | … | … | … | 3.0 | … | ||||||
| Public sector | … | 56.0 | 48.4 | 66.4 | 62.1 | ||||||
| External debt stock | 40.5 | 38.7 | 56.8 | 63.4 | 68.4 | ||||||
| Loan | 19.6 | 18.6 | 33.7 | 36.6 | 38.7 | ||||||
| Multilateral agencies | 5.6 | 6.4 | 20.6 | 23.5 | 26.2 | ||||||
| Of which: | |||||||||||
| IMF credit | 0.5 | 0.5 | 13.9 | 16.7 | 18.4 | ||||||
| Bilateral lenders | 7.1 | 6.4 | 6.8 | 6.9 | 6.5 | ||||||
| Commercial banks | 6.8 | 5.8 | 6.3 | 6.1 | 6.0 | ||||||
| Bond issues | 20.9 | 20.1 | 23.1 | 26.8 | 29.7 | ||||||
Outstanding Total Debt of Central Government by Lender
(In billions of U.S. dollars)
| 2000 | 2001 | 2002 | 2003 | 2004 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Debt by lender | 94.6 | 123.6 | 148.5 | 202.7 | 235.6 | ||||||
| Domestic debt stock | 54.2 | 84.9 | 91.7 | 139.3 | 167.3 | ||||||
| Market | … | 28.8 | 43.3 | 72.9 | 105.2 | ||||||
| Banks | … | … | … | 24.4 | … | ||||||
| Retail creditors | … | … | … | 23.3 | … | ||||||
| Mutual funds and legal entities | … | … | … | 22.1 | … | ||||||
| Nonresidents | … | … | … | 3.0 | … | ||||||
| Public sector | … | 56.0 | 48.4 | 66.4 | 62.1 | ||||||
| External debt stock | 40.5 | 38.7 | 56.8 | 63.4 | 68.4 | ||||||
| Loan | 19.6 | 18.6 | 33.7 | 36.6 | 38.7 | ||||||
| Multilateral agencies | 5.6 | 6.4 | 20.6 | 23.5 | 26.2 | ||||||
| Of which: | |||||||||||
| IMF credit | 0.5 | 0.5 | 13.9 | 16.7 | 18.4 | ||||||
| Bilateral lenders | 7.1 | 6.4 | 6.8 | 6.9 | 6.5 | ||||||
| Commercial banks | 6.8 | 5.8 | 6.3 | 6.1 | 6.0 | ||||||
| Bond issues | 20.9 | 20.1 | 23.1 | 26.8 | 29.7 | ||||||
At the same time, the Treasury introduced new regulations to increase transparency and accountability in debt management. As the level of public debt rose, it became more urgent to ensure that borrowing decisions were consistent with the overall macroeconomic program and in compliance with risk and cost limits. Toward this end, the authorities introduced a new debt management law (Law No. 4749) that allowed for two important changes.
First, a debt management committee and a technical support wing (the middle office) were established within the Treasury. The middle office enhanced coordination between the domestic and foreign debt management arms of the Treasury.2 Close cooperation between the two units was important because both forms of borrowing contributed to meeting rollover needs and because they shared overlapping investor bases.
Second, changes were made to reflect the potential debt burden created by contingent liabilities in the budget. Before this provision of the debt law went into effect, the potential burden created by contingent liabilities—in the form of government guarantees for build-operate-transfer (BOT) projects and for external debt contracted by state-owned enterprises—was not reflected in the budget. Such lack of transparency appeared to have raised the risk premium and hence the cost of borrowing. Therefore, starting in 2003, a risk account was established to cover the contingent liabilities of the government, improving the effectiveness of cash and debt management. In addition, the ceiling that had been imposed on treasury guarantees since 1998 was extended to include BOT projects.
To help increase the liquidity of government paper, the Treasury in September 2002 reinstated the primary dealer system, which had been suspended following the financial crisis in early 2001. The main purpose was to ensure a minimum demand for government securities at primary issue and to improve secondary market liquidity by making continuous quotations of buying and selling prices on the Istanbul Stock Exchange bonds and bills market. Ten banks selected as primary dealers were required to purchase at least 5 percent of securities issued in any three-month period and at least 3 percent in any one month.
Improved Debt Structure
The debt management strategy complemented sound fiscal and structural policies in 2003–04, facilitating a marked improvement in the structure of debt. The Treasury took the opportunity of an improved environment to carry out a number of debt buybacks and swaps to reduce the share of debt linked to foreign currency. It also started to issue two- to three-year fixed coupon bonds for the first time since the onset of the financial crisis. As a result of these operations and the enhanced debt management framework, the structure of domestic debt improved. The share of foreign currency-denominated debt in domestic debt declined to less than 18 percent by the end of 2004, compared with 32 percent in 2002 (the large foreign debt adds to this burden if total public debt is considered). In addition, the share of lira debt with a fixed rate rose from 25 percent to more than 42 percent.
The average maturity of new cash borrowing was lengthened from 11 months in 2002 to 15 months in 2004 (Table 6.2). This could not prevent a further shortening in the maturity of the overall debt stock, however, as noncash debt continued to be replaced with auctioned market debt, which typically has shorter maturities. The introduction of the primary dealer system helped enhance liquidity in the secondary market, and the daily average volume on the Istanbul Stock Exchange bonds and bills market more than tripled from its 2002 volume of only about $200 million.
Challenges Ahead for Debt Management
Despite the achievements cited above, major risks remain. Rollover requirements are still high, and despite recent improvements, Turkey’s debt service remains very sensitive to movements in the exchange and interest rates. The government is still dependent on the domestic banking system to roll over maturing debt, and the Treasury’s ability to lengthen maturities is therefore constrained by the liability structure of the banks. Unless the maturity of customer deposits increases—the average maturity of lira deposits stands at about three months—the demand by banks for longer-term securities may continue to be constrained.
From a debt management perspective, the authorities could take a number of measures to manage these risks. The Treasury could do more to build its cash reserves at the Central Bank to provide a larger safety cushion. Opportunistic overborrowing helps to build a useful buffer in times of need. Also, market conditions allow the Treasury to issue fixed-coupon lira debt at maturities above one year. The Treasury could use this opportunity to reduce future vulnerabilities, even if this means having to accept higher interest rates in the short term.
The authorities could also explore avenues to further diversify the investor base by:
Increasing demand from insurance and pension funds. In many countries, such institutions provide a large part of the demand for longer-term government securities. In Turkey, these institutions are not yet fully developed. Their development could also raise demand for inflation-indexed securities.3
Investigating the potential to increase corporate demand for government securities, a largely untapped source that could be useful particularly if companies have in-house pension plans for employees.
Promoting treasury bills through the state banks’ extensive retail network.
Reviewing the tax treatment of various debt instruments and removing any distortions or impediments.
Encouraging foreign investors to hold domestic debt by providing good quality data and frequent updates of changes in government strategies. The Treasury could consider setting up an independent investor relations office as a permanent structure to provide a focal point of contact between the authorities and investors.
Inflation-indexed securities would have been an alternative, except that there was no demand for them. The liabilities of banks were tied to short-term interest rates, not inflation, and the correlation between nominal interest rates and inflation was too weak for inflation-indexed securities to provide an adequate hedge for bank deposits.
The main task of the middle office is to formulate risk management strategies, monitor market and fiscal risk (arising from guarantees extended to public institutions), and produce quarterly debt management reports for the debt management committee, which takes the final decision on risk management policies.
These bonds have a number of benefits. In particular, they can (i) strengthen the credibility and commitment of authorities to monetary policy, and provide useful information to policymakers about inflation expectations; (ii) reduce rollover risk and contribute to the development of long-term benchmarks; and (iii) allow authorities to issue external debt denominated in local currency, thus protecting the sovereign from the risk of currency depreciation.