# needs drive up issuance globally.

Many of the key determinants of the scale and type of foreign demand for domestic debt are beyond the control of debt managers, such as global fund flows. In other areas, debt managers do not have direct control, but may have some degree of influence; for example, debt managers do not control macroeconomic and fiscal policies, but debt management can and does influence macro and fiscal outcomes.

However, debt managers, through their issuance choices and other remits, can profoundly affect their market’s attractiveness to foreign investors in a number of ways. A recent IMF survey of major asset managers found that “market liquidity” and “range of instruments available” were amongst the top five factors considered in cross-border investment decisions by asset managers and pension funds, respectively.<sup>17</sup> Discussions in the 2008 World Bank/IMF/OECD Bond Market Forum pointed to debt managers being able to play a “significant” role in fostering liquidity, with liquidity based on: “...(i) concentrating issuance in critical tenors; (ii) well-functioning repo markets and ability to short issues; (iii) plain vanilla derivatives markets; (iv) facilitating investor demand and price discovery; and (v) supporting a network of primary dealers”.<sup>18</sup> One area that may merit special attention from EM debt managers is the possibility of benchmark index inclusion (or, where already included, the risk of exclusion). Examining the key criteria for some major indices is revealing (Table 2). Debt managers cannot control meeting criteria like country income level or overall market size, but they certainly can influence the instrument mix and maturity structure of the public debt over time. In this respect, maximizing the odds of index inclusion largely boils down to benchmark-building beyond the 1-year tenor mark, since inclusion often involves minimum specific issue sizes in addition to total market size requirements. A focus on conventional fixed-rate, bullet bonds, which constitute the bulk of bonds included in indices (in many cases exclusively so), is also desirable from an index-inclusion point of view. Such goals are likely to form part of a more general market development strategy in any case, and also need to be evaluated in the context of other factors such as the evolving cost and risk profile of the public debt.

Ongoing innovations in indexation, and the creation of new indices, pose both risks and opportunities for EM debt managers. Changes in the availability and popularity of weighting methods, for example, can have significant effects. Indices where weights are determined by GDP or measures of economic fundamentals aim to address the perverse tendency of conventional market-capitalization weighted bond indices to increase allocations to markets where debt supply (and hence credit risk) are rising. The differences can be significant; domestic bond market size and GDP, for example, are often not highly correlated. The GEMX index (part of the World Bank’s GEMLOC Initiative) weights country constituents according to a measure of “investability”.<sup>19</sup> The potential influence of new indices tracking nonconventional bonds may also need to be considered, e.g. of EM inflation-linked bonds, such as the Barclays EM Global Inflation Linked (EMGILB) Index.

Even if significant steps are taken to enhance foreign investors’ access to domestic markets, some investors will likely never be in a position to buy onshore, since they may have neither the operational capability, nor the ability to obtain a mandate to do so given the infrastructural, regulatory and legal hurdles involved. Yet it may still be possible for debt managers to tap such investors’ potential demand for EM local currency duration exposure. Offshore markets for EM local-currency denominated bonds (e.g. of “global” bonds in the U.S. and “uridashi” bonds in Japan) are well-established. EM debt managers could consider some issuance in these markets, which may also be a good way to build offshore

> 17 IMF, _Long-term Investors and their Asset Allocation: Where are they now?_ Ch. 2 in _Global Financial Stability Report_ (September 2011) Table 2.17 (p37)

> 18 OECD/World Bank/IMF, _Secondary Market Liquidity in Domestic Debt Markets_ , Tenth Annual OECD/World Bank/IMF Bond Market Forum, 29-30 April 2008 19 See http://worldbank.org/gemloc

**11**