UNCTAD Virtual Institute for Trade and Development
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Sovereign Asset and Liability Management: An E-Learning Training Course
I. Balance Sheet Risks
I.i. Currency Matching
I.ii. Interest Rate Matching
I.iii. Maturity Matching
II. Methodologies
II.i. Initial Methodologies
II.ii. Advanced Methodologies

Interest Rate Matching

“As borrowing decisions are often made on the liability side of the balance sheet based on lowering financing costs, risks, and mitigating the impact of debt service on the budget, the composition of the debt portfolio may be directed by this objective and not overall reduction of economic risk to the sovereign.  It has been argued that in managing debt, sovereign’s do not attempt to smooth taxes, as suggested by some economic theories, but are mostly concerned with the variability of interest expenditures.  The reason for this divergence between theory and practice is that debt managers are responsible only for achieving the debt management objectives, are not responsible for the implementation of tax plans, and view interest rate expenditures as the only relevant variable” (Das et al, 2012).

Investing in assets that pay fixed or variable rates and not accounting for this on the liability side of the balance sheet leaves the sovereign vulnerable to interest rate risk.  Variable rate debt may provide lower borrowing costs in the short-term but could increase the overall borrowing cost if interest rates rise.  Additionally, if variable rates of liabilities exceed the variable or fixed rates of assets, the carrying costs of the debt will reduce the value of the sovereign’s balance sheet.  In instances where there are not natural hedges to discrepancies between interest rate characteristics of assets and liabilities or the debt portfolio itself is not diversified, derivatives will be useful to reduce exposure to interest rate risk.

“Most measures of interest rate exposure focus on balance sheet risk.  The sensitivity of a borrower’s net worth (or net income) to changes in interest rates depends on i) the average maturity of the debt, ii) the extent to which the coupon on long term-debt is linked to interest rates, and iii) the structure of assets on the balance sheet of the borrower.  Also, when gauging risk exposures based on assessments of interest rate and currency mismatches, it is important to take into account the impact of derivative transactions on the transfer of economic risk and, hence, there is a need to account for off-balance sheet exposures” (Das et al., 2012).



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