# **IV. Why issuing Euro-denominated bonds?**

A number of reasons may lead an EM country to issue international bonds denominated in EUR. These can range from overall policy objectives like achieving the desired composition in the FX debt-portfolio to more micro considerations such as creating benchmarks for the private sector, promoting the country among a group of investors (branding), or simply lowering periodic coupon payments. To weigh the motivation, it is worth establishing the governance environment in which the debt manager operates, in particular, whether or not there is a government debt management strategy in place that includes clear guidelines for the currency composition of the FX debt.

Clear guidelines for the currency composition of the debt portfolio are typically derived from a thorough cost-risk analysis.<sup>15</sup> The analysis should reflect the linkages of the economy to the Eurozone and the extent to which the value of the local currency correlates to the euro.<sup>16</sup> As government revenues are in the local currency, selecting the euro may provide the best proxy. While this tends to be the primary justifying factor for preferring the euro, other considerations such as the diversification of the investor base, or the diversification of FX risk, can reinforce the choice.

Without a clear target for the currency composition of FX debt, debt managers are forced to navigate in the darkness without instruments and known port of arrival. In such environment, debt managers may use the same arguments mentioned above for justifying tapping the euro market. At the same time, when issuing, e.g., EUR 1 billion, they may be unable to determine whether they are moving the portfolio closer to its desired composition, or, increasing the exposure to FX risk and endangering the sustainability of the government finances. In a nutshell, without clear strategic targets, the debt manager lacks a framework to assess both cost and risk and thus is unable to base the funding decisions on a strategy to reach the debt management objectives.

The issuance of EUR-denominated bonds can support diversifying the investor base. Many countries may endeavor to diversify the investor base as a way to mitigate refinancing risk and avoid the market becoming a one-way street with all investors wanting to buy or sell the government paper at the same time. A heterogeneous investor base offers the benefit of investors acting differently over time given their preferred habitat, investment horizons, and risk-return preferences. According to the authorities, the first EUR-denominated bond launched in 2016 by Peru brought about 75% of investors with no previous exposure to Peruvian securities.

Diversification of the investor base is more relevant for countries with high financing needs or when trying to create scarcity value for the USD bonds. Even though the USD market is large and deep, EM issuers cannot dismiss the potential for market disruptions, or, investors fatigue triggered

> 15 See MTDS Guidance Note (http://www.worldbank.org/en/topic/debt/brief/mtds). More broadly, the decision on the strategy should come from a comprehensive process encompassing the analysis of the current debt portfolio, the potential sources of financing, the macroeconomic outlook, the cost-risk assessment of alternative strategies, and the degree of domestic market development, among other factors.

> 16 For example, in the case of Turkey, its geo-economic links with the Eurozone makes the EUR a less volatile foreign currency to have exposure to, although in the recent past the volatility of the USD/TRY has reduced in comparison to the EUR/TRY.

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