# **I. Introduction**

Since the global financial crisis, government debt has increased by $19 trillion in advanced economies and $9.6 trillion in emerging markets.<sup>2</sup> At the same time, <mark>the value of assets held in central banks, sovereign funds and public pension funds hit $36 trillion in 2017, which is equal to 45% of global GDP.</mark><sup>3</sup> Fiscal Transparency Evaluations conducted by the International Monetary Fund (IMF) suggest that many countries may not be using these assets to efficiently manage their foreign currency obligations because they do not manage their assets and liabilities in an integrated fashion (Sayegh 2017). World Bank–IMF Guidelines for Public Debt Management suggest countries to adopt a “holistic” risk management framework based on a government’s overall balance sheet. The outcome is a cost and risk analysis of sovereign debt based on a government’s net revenues. This full picture enables governments to design a comprehensive strategy to reduce balance sheet risk and lower hedging costs, thereby efficiently improving a country’s ability to absorb exogenous shocks.<sup>4</sup> Multiple resources address sovereign asset and liability management (ALM) at the conceptual level (Cassard and Folkerts-Landau 1997, Velandia 2002, Wheeler 2004, Das et al 2012). Although there are significant challenges to its implementation, such as lacking legal framework, difficulties in valuation of the assets, diverse and sometimes conflicting objectives across entities, and different accounting systems, the benefits of ALM are widely accepted both by practitioners and academicians.

Sovereign assets and liabilities have different objectives and are traditionally managed separately. Foreign exchange (FX) reserve portfolio is likely the largest asset on a sovereign’s balance sheet and is managed to meet balance of payment requirements and provide macroeconomic stability in the medium and long term (see Das et al, 2012). On the liability side, similar to the FX reserves, government debt is often the largest and the most complex component of a country’s liability portfolio. The main objective of public debt management is to raise the required amount of funds with the lowest possible cost and at an acceptable risk level.

Governments often issue sizable amounts of debt in foreign currencies and their fiscal positions are frequently subject to foreign exchange volatility. An ALM framework for managing risks arising from sovereign FX obligations requires joint analysis of (i) the financial liabilities resulting from sovereign debt and (ii) the FX reserve assets of its central bank.<sup>5</sup> This study recommends a practical approach based on the challenges associated with the implementation of an ALM framework. It suggests optimizing a country’s net FX position based on an analysis of its central bank’s FX reserve positions and central government debt portfolios.

> 2 Institute of International Finance, Global Debt Monitor October 2017.

> 3 Real Momentum: Global Public Investors and the Real Assets Market, OMFIF, 2018.

> 4 Society of Actuaries (2003) defines ALM as “the ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities to achieve an organization's financial objectives, given the organization's risk tolerances and other constraints.”

> 5 Sovereign liabilities could also include government contingent liabilities and local government as well as debt of state-owned enterprises (SOEs). Sovereign assets may include any holdings of sovereign wealth funds or public pension funds. In this study, we limit the analysis to central government debt and central banks’ FX reserves.

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