# Introduction

The objectives for managing sovereign<sup>2</sup> assets and sovereign liabilities are usually distinct, and rarely coordinated. The main objective of government liability management is to ensure financing of the budget at the lowest possible cost subject to an acceptable level of risk.<sup>3</sup> On the asset side, the main objective is to ensure that cash balances meet commitments and maximize the purchasing power of the long‐term capital given a moderate level of risk.<sup>4</sup> Against this backdrop, the sovereign asset and liability management (SALM) approach aims at providing a strategic framework to manage both sides of the sovereign balance sheet.

The ALM approach has been used in financial institutions for many years to reduce currency, tenor, index and other mismatches between assets and liabilities so that the balance sheet is able to withstand shocks better. The SALM approach aims to identify the various types of assets and liabilities a sovereign manages and explore whether the financial characteristics associated with those assets can provide insights for managing the cost and risk of the liabilities. The management of sovereign assets and liabilities in a holistic way allows governments to evaluate risk exposures as a whole and to assess the feasibility of reducing net interest expenditure and liquidity risk. The SALM framework also provides an opportunity to conduct sovereign portfolio stress testing, allowing countries to optimally manage their sovereign debt and asset portfolios and attain a desired level of balance sheet risk exposure in a prudent and cost‐effective manner.

The SALM approach in managing sovereign risks requires a consolidated view of the sovereign balance sheet and its risk exposures, as well as coordinated decisions on the appropriate portfolio strategies to be adopted to manage that risk effectively. It involves managing different types of financial risks, such as currency, refinancing and interest rate risk, in order to reduce foreign currency and maturity mismatches on the balance sheet. Therefore, adopting a comprehensive and integrated sovereign asset and liability management framework entails performing a joint analysis of the characteristics of financial assets and liabilities on the public sector balance sheet and possibly combining it with the balance sheet of the central bank.

Many countries face institutional challenges in the design and implementation of an effective SALM framework, but as long as the roles, objectives, and resources of institutions involved in SALM are clearly defined and consistent, a SALM approach could ensure appropriate

> 2 In this paper, the government balance sheet refers to the balance sheet of the central / general government and the public sector balance sheet to public entities (including the general government) excluding the central bank. The sovereign balance sheet has the widest scope, covering the public sector balance sheet and the central bank (official reserves), including sovereign wealth funds and contingent liabilities, where relevant.

> 3 International Monetary Fund and the World Bank, Guidelines for Public Debt Management, 2014.

> 4 Das, U. Lu, Y., Papaioannou, M., and Petrova, I., Sovereign Risk and Asset and Liability Management – Conceptual Issues, IMF, 2012.

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