DOMESTICALLY ISSUED PUBLIC DEBT

A research conducted by Artak Kyurumyan Within CRRC Research Fellowship Program

Methodology used

• Cross-country analysis of domestic debt developments using recent IMF and other publications.

• Analysis of Armenian debt developments.• Analysis of Armenian financial sector.

Armenian Public Debt

• Armenia started borrowing from international financial institutions immediately after independence

• Public debt is comprised of external and domestic debt

• Armenia was considered a heavily indebted nation in late 1990s and early 2000s.

• The situation improved in early 2000s but dramatically worsened in 2009.

Armenian Debt Indicators1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

AMD billions

Total 487.3 504.4 545.2 640.6 664.4 621.1 546.1 508.9 516.2 574.8 1 270.8

External 456.1 474.6 508.8 599.8 621.3 574.7 494.8 438.2 440.8 483.7 1 121.1

Domestic 32.2 29.8 36.4 40.8 43.1 46.4 51.3 70.7 75.4 100.9 149.7

Share in Total

External 93.6 94.1 93.3 93.6 93.5 92.5 90.6 86.1 85.4 82.7 88.2

Domestic 6.4 5.9 6.7 6.4 6.5 7.5 9.4 13.9 14.6 17.3 11.8

Debt to GDP

External 46.2 46.0 43.3 44.0 38.2 30.12 22.06 16.5 14.0 13.3 35.4

Domestic 3.2 2.9 3.1 3.0 2.7 2.4 2.3 2.7 2.4 2.8 4.7

AMD per USD Average and End-of-period Exchange Rates (Q1/1997-Q1 2009)

300310320330340350360370380390400410420430440450460470480490500510520530540550560570580590

0 5 10 15 20 25 30 35 40 45 50

quartere

exch

ange

rate

AVGEoP

Some Historical Data and Expected External Debt

Developments

USD millions 2007 2008 2009 2010 2011 2012 2013 2014

IMF I Review 1 591 1 818 2 962 3 493 3 697 3 628 3 508 3 394

IMF II Review 2 701 3 191 3 394 3 329 3 209 3 092

IMF III Review 3 553 3 727 3 593 3 225 2 771

Deb Service I Rev 55 74 95 106 245 387 353

Debt Service II Rev 82 110 117 252 396 366

Debt Service III Rev 95 105 248 438 402

Public Debt Developments in the Region

Source: IMF First Review Under the SBA. July 2009. Page 18.

The Research Question

Can the domestic currency denominated debt become a sustainable alternative for

debt managers to meet the needs of public sector and what Armenia needs to

do to better use domestic financial resources?

Armenian domestic debt - 1• Armenia started issuing marketable

domestic debt in 1995.• Interest rates were very high in 1990s

(between 40-50%% most of the time reaching 70% level at certain times).• Weak investor base. Government

securities are held mostly by Armenian commercial banks.• Very thin secondary market.

Armenian domestic debt - 2• No debt management strategy. Annual

debt issuance programs are driven not by strategy but by annual budget.• Weak coordination of fiscal, debt

management and monetary policies.• The CBA refrains from using outright

purchase and sale of government securities as an important monetary policy instruments.• Unexpected exchange rate fluctuations.

Armenian domestic debt - 3• Armenia issues medium & long term

notes and bonds (up to 20 years).• Armenia has standard instruments in

the medium and long term segments of the market (3, 5, 10, and 20 year).• Transparent (but frequently changing)

issuance program.• Successful retail program.

Weighted average monthly interest rates of auctions of Armenian Gov securities (09/1995 –12/2008)

Investor StructureAMD million October

2009Resident Banks 85 527

Non-bank Financial Institutions 561

Non Financial Organizations 6 618

CBA 36 709

Non residents 27

TOTAL 129 441

Armenian Financial Industry• Mostly banks• Although the banking sector is considered

advanced one, it has a small role in economy.• No long-term financial assets.• IMF country report No 10/97 from April 2010:

“By regional standards, financial intermediation in Armenia is relatively low, with bank loans-to-GDP ratio at 22 percent in 2009, up from 17 percent in 2008 largely as a result of GDP decline”.

Crowley, J. Credit Growth in the Middle East North Africa, and Central Asia Region. IMF Working Paper 184. July, 2008

Asset Structure of Armenian BanksAMD billion QI 2009 QII 2009 QIII 2009

Liquid Assets 334.5 362.7 398.0Gov securities 75.7 69.7 101.4Loans 640.8 609.0 657.7Other 76.9 76.2 73.3Total Assets 1127.9 1117.7 1230.5Liquid Assets 29.7% 32.4% 32.3%Gov securities 6.7% 6.2% 8.2%Loans 56.8% 54.5% 53.5%Other 6.8% 6.8% 6.0%Total Assets 100.0% 100.0% 100.0%

CBA transactions

2009 (9 months) 2008 2007AMD mln % AMD mln % AMD mln %

FX purchase 11 593 0.4 22 557 1.2 145 514 12.4FX sales 184 828 7.2 136 199 7.0 28 121 2.4Repo 1 215 884 47.1 1 140 139 58.5 238 532 20.3Rev Repo - - - - 6 289 0.5Deposits 1 146 248 44.4 644 090 33.1 753 250 64.2GS purchase 20 705 0.8 5 260 0.3 1 858 0.2GS sale - - - - - -Total 1 579 259 100 1 948 245 100 1 173 564 100

Domestic Debt Around the World

• Domestic debt as percent of GDP increased from 23% in 1995 to 35% in 2004

• Share of domestic debt in total debt increased from 38% in 1995 to more than 58% in 2004.

• The main reasons for increase in domestic debt– Financial crisis– Sterilization of capital inflows– Attractiveness of domestic borrowing– Increased demand for developing country debt

Debt in Other Countries of South Caucasus

• Georgia terminated its domestic debt program in mid 2000 when the interest rates reached double digit numbers and restarted the program in 2009 with issuance of short term treasury bills.

• No reliable information about domestically issued debt of Azerbaijan.

Conclusions and Recommendations• Armenian total public debt is still below the 50%

GDP threshold. However, the revenues are also at dangerously very low level.

• In the past (in 2003-2004) Armenian external debt to GDP ratio has already been at 46%. Armenia faced problems and needed debt restructuring (debt to equity swap).

• Armenia borrowed heavily from external sources in 2009. Armenia is going to have heavy external debt repayment decade (2011-2020).

Policy Options• Increase Revenues– Increase Tax Revenues– Increase Other Revenues

•Borrow– Borrow Internationally– Borrow Domestically

•Default

Untapped financial assets in Armenia

• Attractiveness of domestic borrowing (Hanson).• Increased demand for emerging/developing country public domestic currency debt (Hanson).•Under-mattress savings of about USD 1-2 billions (or about AMD 400-800 billions)See, e.g. the speech of the PM of the RA at the financial banking conference in Dilijan May 24, 2008 (http://www.banks.am/Print.aspx?news_id=2086) and the press conference of the head of the financial system policy and analysis department of the CBA on September 11, 2007 (Capital, http://www.banks.am/index.php?sub=shownews&newsid=20070912_1).

Debt Option• Develop Debt Management Strategy – where Armenia is going in terms of debt

• Implement Pension System Reforms – already postponed twice

• Broaden relations with Primary Dealers – make them intermediaries not investors

• Broaden the Role of Monetary Authority in the Secondary Market of Government securities – buy and sell more government securities as monetary

policy instrument• Standardize the Instruments and Issuance Calendar – the behavior of the issuer is transparent but the issuance

program is volatile

Thank youQuestions please.