reserve management to maximize risk-adjusted return and debt management to minimize cost at a certain risk level. The government’s cost and risk preference imply a currency composition for the debt portfolio. On the other side, government’s financial assets denominated with foreign currency would generate natural hedging for foreign currency debt. Furthermore, the residual risk of foreign currency debt could be transferred to the reserve management desk through an internal swap transaction between the debt management office and reserve management unit. This model enables debt management offices to minimize foreign currency risk without taking or giving collateral and having counterparty risk, furthermore without a cost. As for the reserve management, consolidated management of foreign currency risk would be consistent with its broader mandate. On the other hand, this model offers an opportunity especially to the countries with limited access to the derivatives market., At the same time, the fact that all countries in the sample maintain the largest share of their reserves in the currency in which they have the highest share of external debt is reassuring. To some extent, this demonstrates an informal implementation of a sovereign joint ALM approach even if an official framework is not in place.<sup>18</sup> However, there is still much room for improvement and potential to pursue a more formal sovereign ALM approach, enhancing coordination and information sharing to manage risks across the government balance sheet. In some countries, there are still large mismatches in the amount of external debt relative to foreign reserves and the currency composition of each.

Moreover, as the du-fold quantitative analysis conducted in Sections 4 and 5 demonstrates, the joint ALM approach has clear benefits both for central banks and ministries of finance. Central banks are benefiting from the point of view of generating greater expected returns on their excess reserves while ministries of finance are actively managing their foreign currency risk without having counterparty risk and by minimizing the operational cost and risk. In fact, the analysis indicates that the ALM approach allows sovereigns first to benefit from natural hedges without a specific need for modelling, then to optimize the reserve portfolio ensuring that higher level objectives of reserve management have been met.

It is important to note with caution that even though ALM could address several concerns and reduce FX risk, the amount of external debt is influenced by the degree of domestic debt market development. As almost all the government revenues are denominated in domestic currency, access to international markets is limited and exchange rate fluctuations have been an important source of concern, it might be a natural hedging mechanism for many developing and emerging countries to issue in local currency denominated debt. However, as indicated by the joint The World Bank and the IMF Government Bond Markets Handbook, developing a deeper and more liquid local currency capital market is a long and dynamic process which requires a stable and credible macroeconomic policy framework; sound fiscal and monetary policies; effective legal, tax, and regulatory infrastructure; smooth and secure settlement arrangements; and a liberalized financial system with competing intermediaries. Therefore, for almost all developing and

> 18 Several countries in the sample have received advisory services from the World Bank Treasury in debt and reserves management, potentially contributing to a greater awareness of asset and liability matching already.

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