Government Debt Management in Europe: Recent Changes in Debt Managers' Strategies

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Abstract

This paper presents a survey of changes in the strategies of government debt managers in European countries. These changes were introduced in response to alterations in the working environment of debt managers, like the introduction of the euro, declining government debt ratios, the introduction of electronic trading systems, and the changed institutional position of debt managers. An important recent feature of debt management strategies in the euro area is the convergence of practices. There is a clear tendency to issue 'plain vanilla' bonds, while there is less emphasis on issuing foreign currency debt. Debt managers increasingly use interest rate swaps and introduce innovative instruments, such as inflation-indexed bonds.

1. Introduction

The working environment of government debt managers in Europe has changed considerably during the last decade. By far the most important factor was the introduction of the euro. After the start of monetary union in 1999, debt managers became small to medium-sized players in a European capital market, instead of the dominant party in national capital markets. Consequently, competition among debt managers increased, fostering transparency and stimulating a more efficient primary market and a deeper, more liquid secondary market.

There have been other changes as well. The fiscal consolidation in the run-up to the Economic and Monetary Union (EMU) implied that government debt-to-GDP ratios started to decline in most countries, although this trend has recently been reversed. Furthermore, the organisation of the trade in securities has altered, notably due to the introduction of electronic trading systems. In many countries the institutional position of the government debt managers has also changed. Although there are still substantial differences across countries, there is a clear tendency to grant more independence to the organisation responsible for the management of government debt.

All these changes have affected government debt management strategies in the euro area countries, aiming at the objective of cost minimisation subject to risk-limits. Interestingly, there is considerable convergence in debt management strategies. It appears that there is a clear tendency to issue 'plain vanilla' bonds, while there is less emphasis on issuing foreign currency debt. Debt managers increasingly use interest rate swaps and introduce innovative instruments, such as inflation-indexed bonds.

This paper describes developments in debt management practices since the adoption of the euro in more detail. The remainder of the paper is organised as follows. Section 2 explains the changes in the environment for government debt managers in the euro area in somewhat greater detail, while section 3 examines how debt management strategies have been altered in light of these changes. Section 4 discusses some future challenges for government debt management, while the final section offers our conclusions.

2. A changing environment for European government debt managers

Introduction of the euro

The advent of the euro in 1999 had significant effects on how debt managers in the euro area strive for cost minimisation[1]. Four years before the launch of the euro, the government debt of Italy, Spain, and Portugal yielded about 500 basis points more than German bunds, while Greece was not even able to issue domestic bonds of 10-year maturity until 1997 (Reszat, 2003). After the decision on the adoption of the single currency had been taken, a clear trend towards the geographical diversification of institutional portfolios into assets issued in prospective euro area countries was observed. As a consequence, government bond yields quickly converged (Santillán et al., 2000).

Before the start of monetary union, debt managers were to some extent "ensured" of a demand for their bonds as securities of other governments were not full substitutes. …