MAINTAINING A PRUDENT DEBT STRUCTURE INCREASING THE SHARE OF FIXED-RATE DEBT

A priority of the debt strategy has been to insulate the debt portfolio from adverse movements in interest rates by increasing the share of fixed rate debt. At the end of FY2002/03, 48.4% of the outstanding domestic debt was issued at fixed rates. This was an improvement over the 43.2% recorded at the end of FY2001/02, and compared favourably to fixed rate shares of 32.8% and 7.0% in FY2000/01 and FY1999/2000, respectively.

EXTENDING THE MATURITY STRUCTURE

Despite the challenges, there was success in extending the maturity structure of the debt. An inaugural issue of a 15- year LRS in June 2002 met with significant success. Offers of $805 million chased the $300 million stock offered. Building on this success, the Government auctioned its first 30-year LRS in August 2002. Similarly, there was strong demand for this offer, with subscriptions of $1.04 billion in response to the $300 million LRS offered. A subsequent 30-year $300 million LRS was issued in September 2002, with subscriptions amounting to $1.4 billion.

The demand for long-term instruments continued into the third quarter of FY2002/03 in an apparent need by institutional investors to ensure an appropriate mix of maturities on their balance sheets. A significant 41.5% of the funds raised through private placements had maturities in the 15- to 30-year range. The Government modified its stance and adopted the strategy of entering the market less frequently for funds offering instruments of shorter maturities when the interest rate climate changed.

Of the total new domestic debt issued in FY2002/03, 51.9% had maturities of 5 years and over compared with 49.4% in FY2001/02. Of this amount, 33.9% had maturities of 10 to 20 years, up from 15.5% in FY2001/02; 17.0% had maturities of over 20 years and up to 30 years compared with 2.3% in FY2001/02. Issues with a maturity of 30 years accounted for 3.6% of new issuance compared with none previously.

MINIMISING CURRENCY EXPOSURE

In keeping with the strategy of offering investors a wide range of instruments, the Government continued to offer US$ indexed bonds in the domestic market. The objective of issuing US$ indexed bonds is to offer risk-averse investors protection against currency depreciation. The strategy is to offer this instrument within specific limits in order to minimise the risk to the debt portfolio. US$- indexed bonds amounted to $42.3 billion (US$752.5 million equivalent) or 11.6% of total domestic debt at the end of FY2002/03.

This compared to $20.8 billion (US$435.9 million equivalent) or 6.9% in FY2001/02. The stock of US$-denominated bonds in the domestic debt portfolio stood at US$543.8 million at the end of March 2003, an increase of 1.2% from the US$537.1 million at the end of March 2002. However, in J$ terms, the value of these bonds rose a significant 19.6% to $30.6 billion, accounting for 8.2% of outstanding domestic debt. The frequency with which US$-indexed bonds were issued in the last quarter of FY2002/03 increased in order to support efforts by the Central Bank to stabilise the foreign exchange market. These instruments were offered with relatively short maturities.

DIVERSIFICATION OF THE DEBT PORTFOLIO

During FY2002/03, the Government sought to diversify the portfolio by offering instruments of various types and maturities, taking into account the cost vis-a-vis the risk preferences of investors. On the domestic side, instruments were issued across the yield curve including long-term securities with maturities of 15, 20, 25, and 30 years. A range of instruments were issued - LRS, investment debentures, US$- indexed bonds and loans - satisfying the needs of institutional and retail investors.

On the external side, in keeping with the policy of approaching the international capital markets for funding to the extent of gross external amortisation, the Government sought US$500 million from these markets. In June 2002, Government successfully issued a 15-year 10.625% US$300 million Eurobond in the international capital markets. Long-term institutional investors such as insurance companies, mutual funds and pension funds participated actively in the issue, a number of whom had not participated in previous GOJ Eurobond issues. There was also a broad geographic distribution of the transaction.

Attempts to raise Euro-denominated funds in the European markets during the last quarter of the fiscal year were postponed despite strong demand. Sharp increases in yields on existing GOJ US$ eurobonds meant that the Government would have had to pay higher premiums for the contemplated transaction.

USE OF THE MARKET MECHANISM

One of the key objectives of the Government's FY2002/03 debt strategy was to increase the use of the auction for the sale of government securities in the domestic market.

While Treasury Bills have been auctioned for many decades, the auction of LRS, the Government's primary debt raising instrument, was introduced in October 1999. The sale of these securities through the auction has been widely accepted by the domestic market.

The Government continued to maintain a transparent relationship with the market.

Quality information continued to be made available with an expansion in the coverage and medium through which it is circulated. In January 2003, the Government began subscribing economic and financial data to the IMF's General Data Dissemination System (GDDS). The GDDS was established to guide participating countries in the provision of timely, comprehensive, accessible and reliable economic, financial and socio-demographic data to the public.

25. Over the course of the fiscal year, the Government maintained frequent contacts with local and international investors, financial institutions and the credit rating agencies through meetings, conference calls and investor presentations. The interaction was at the ministerial and technical levels.

DEBT STRATEGY FY2003/04

The Government's medium term strategy is to return the fiscal operations to a balanced budget by FY2005/06. The debt management strategy for FY2003/04 is developed within this context. The primary objective is to minimise debt service costs subject to the containment of risks within acceptable limits.

The core debt objectives have been established since FY1998/99 and these remain unchanged. The debt management strategy to be implemented in FY2003/04 will continue to:

• Maintain a prudent debt structure;
• Use market mechanisms for domestic debt issuance;
• Promote and build a liquid and efficient market for government securities;
• Increase the transparency and predictability of primary market debt issuance;
• Finance the fiscal deficit and debt redemption;
• Access the external markets for funds to the extent of gross external amortisation.

The emphasis in FY2003/04 will be modified in light of prevailing market developments, the fiscal performance and the size of the debt while keeping the broad objectives of the strategy unchanged.

MAINTAINING A PRUDENT DEBT STRUCTURE

Given the size of the debt stock, the Government will continue to focus on achieving a prudent debt structure in terms of composition and maturity. Government will therefore seek to borrow using a variety of instruments and a range of maturities to minimise costs and limit the risk to the debt portfolio.

INCREASING THE SHARE OF FIXED-RATE DEBT

The main risk to the debt portfolio is that of higher interest costs as a result of increases in interest rates. In FY2003/04, the policy of increasing the share of fixed rate debt in the domestic portfolio will remain foremost among the debt strategies. This should reduce refinancing risk. The fixed rate target of 60% of the domestic debt portfolio will be maintained, in keeping with international best practice. However, the target will be kept under constant review in order to ensure an optimal distribution.

EXTENDING THE MATURITY STRUCTURE OF THE DEBT

Longer-term issues will allow for the achievement of a more balanced maturity structure and therefore reduce the risk associated with shorter maturities of rolling over the debt under adverse interest rate conditions.

Building on the success over the years, extending the maturity profile of both the external and domestic debt will remain a priority for the debt strategy during FY2003/04.

Market conditions prevailing, the strategy is to increase the number of offers of LRS with maturity of 10 years and over.

33. In the domestic market, the Government will initiate a limited programme of exchange offers with the objective of smoothing the distribution of the maturities. With the exchange offers, the Government will offer investors the opportunity to exchange securities nearing maturity (of up to one year) with new securities being offered with longer maturities.

Similar types of debt buyback will be explored for the GOJ international bonds, mainly for market management reasons.

MINIMISING CURRENCY EXPOSURE

The Government is committed to providing an array of instruments to the domestic markets. Maintaining a prudent domestic debt structure requires that the foreign currency exposure of the portfolio be reduced to internationally accepted standards. Consistent with this, the Government will restrict the use of US$-denominated and US$- indexed bonds to facilitate the gradual reduction of the foreign currency exposure of the domestic debt portfolio over the medium term. Hedging mechanisms to minimise Government's exposure to adverse movements in currencies other than the US$ will be kept under constant review.

USE OF MARKET-BASED MECHANISMS