and MDRI debt relief and other external debt relief experienced an ‘instantaneous’ transformation of the portfolio composition towards a greater share of domestic debt in the total portfolio (see Figure 24). This has meant that foreign exchange exposure has been reduced dramatically, although in the majority of countries where the MTDS has been performed, the share of external debt in the total portfolio still exceeded 50 percent. However, as the share of domestic debt grew, refinancing risk has become more acute. As can be seen in Table 3, the contrast between the average time to maturity of domestic debt and external debt in all countries is stark. Going forward, the pace with which the domestic share in total debt can be increased will be determined by the extent to which the domestic debt market development agenda is advanced. The share of variable rate debt in the total debt portfolio tends to be low in LIC portfolios, pointing to minimal interest rate exposure. Overall, the analysis of the existing debt portfolio highlights the need to reduce exchange rate risk in the external debt portfolio as well as refinancing exposure in the domestic portfolio.

The MTDS is forward looking, and useful in evaluating the cost and risk consequence of new borrowing, particularly in the context of changing financial landscape facing LIC governments today. With the rapid increase in borrowing requirements in the aftermath of the current global crisis, and the need to finance scaled‐up development expenditures to promote desired growth, the need to broaden and diversify sources of financing has become important to the sample governments. In most of the sample countries, concessional borrowing has been maximized, and the question remains how to finance additional needs that cannot be met through concessional loans. In some countries, non‐traditional bilateral lenders are emerging as important sources of finance, although their terms vary significantly from country to country. For those in the upper end of the LIC spectrum, the possibility of becoming an IBRD blend country is being explored. In almost all of the sample MTDS countries, talks of international issuance of bonds are being discussed.

Deepening and broadening the domestic debt markets has been pursued to different degrees. In some countries the closed capital account has meant that foreign investors and foreign banks have not been competing in the domestic financial system. On the one hand, this meant that governments have been able to tap domestic savings that was captive within the borders at low or negative real interest rates. On the other hand, these markets remained shallow and the absorptive capacity for future increases in domestic debt issuance tended to be limited. Where pension reforms have not

**Figure 24: Domestic Debt as a Percent of Total Public Debt in HIPC Countries**

<!-- Start of picture text --> 30%<br>25%<br>20%<br>15%<br>10%<br>5%<br>0%<br><!-- End of picture text --> Source: Panizza 2008; sample includes data for 21 countries dealt with underfunded defined benefit schemes for public and private employees, not only was domestic absorptive capacity of long term debt limited, but it also represented a significant contingent liability for the government. Other countries with open capital accounts have been aggressively courting foreign investors given the overall financing gap that needs to be filled to achieve development goals. Pension and capital market reform have helped to deepen the domestic debt market contributing to growth of the domestic investor base. In one country, where inflation expectations were not anchored and there existed high levels of political uncertainty, issuance in domestic currency was not an option.

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