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Sovereign Asset and Liability Management: An E-Learning Training Course
I. The Accounting/Financial Balance Sheet
II. Sovereign Asset and Liability Management Framework: Approach I
III. Sovereign Asset and Liability Management Framework: Approach II
IV. Sovereign Asset and Liability Management Framework: Approach III
V. Contingent Liabilities
i. Explicit Liabilities: Guarantees
ii. Implicit Liabilities: Financial Sector Bailouts and Natural Disasters
iii. Managing and Mitigating Contingent Liabilities

Conclusion

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Sovereign Asset and Liability Management Framework: Approach I

The first and most basic SALM framework requires the creation of a simplified balance sheet.  Identifying the sovereign’s primary financial asset and liabilities, as shown below, allows the sovereign to identify and match risk characteristics between assets and liabilities.  The simplified balance sheet for this analysis would look as follows:

 

Conceptual Balance Sheet

Assets

Liabilities

 

 

Present value of stream of taxes and other revenues

Present value of government outlays, net of debt servicing

 

Market value of net government debt

Source: Wheeler, 2004

 

 

Generally, assets will be denominated in the domestic currency as taxes are collected in the local currency.  However, for commodity exporting countries, commodity revenues may be collected in foreign currencies. The sovereign can pursue a debt strategy that borrows in the currency in which taxes and revenues are collected.  If the sovereign is unable to borrow in the same currency as taxes and revenues are collected, holding debt in a currency as closely correlated to the currency in which taxes and revenues are collected should be the policy objective.  This will reduce the sovereign’s exposure to currency mismatches that could devalue assets and increase debt (liabilities) if there is a devaluation of the currency in which revenues and taxes are collected or the currency in which debt is denominated.  Many emerging nations with undeveloped capital markets are unable to borrow long term in the domestic currency and often have no choice than to undertake long-term financing in foreign currencies.  This so called “original sin” leaves sovereigns more vulnerable to debt crises and can accelerate indebtedness if the domestic currency is devalued.  For this reason, matching assets and liabilities in the same currency is an appropriate and useful strategy for reducing risk.

 

 

 

 

 

 

 

 

 

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