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					Asset-Liability Management – the
        Case of Hungary
              London, March 6-7, 2007
András Réz, Head of Planning, Research and Risk Management
Asset-Liability Management (ALM) – Rationale
During portfolio management or management of the
balance sheet of a bank or a private company:
• Market risks or financial risks can be reduced by having similar
  assets and liabilities characteristics (e.g. given liability structure
  by investing in instruments with similar terms of maturity, interest
  rate and currency.
• Derivative instruments can also be used to reduce „gaps”,
• With successful cover any market risks will affect assets and
  liabilities on a similar way therefore actual net losses (or gains)
  from market risks will be minimised.
ALM – from a Debt Manager’s Point of View


         Liabilities: = debt and other obligations
         Assets: = ? (difficult to identify)

     •   Equity, State ownership – only divident revenues, very long
         durations, state ownership usually not for profit making, not the
         primary goal of the Government >> Privatisation,
     •   Other state assets (e.g. motorway, national parks, army) –
         theoretical value, good for balancing the State balance sheet,
         but no real revenue from them,
     •   Future discounted tax revenues – most accepted views, but
         difficult to use practically for ALM calculations.
ALM – a Possible Point of View of the Central Bank


     Assets – Foreign currency reserves, and other
         assets on the CB balance sheet:

     •   Rationale of ALM – Foreign currency reserves and other
         (sterilisation) assets may be costly for the CB and the
         Government,
     •   Coordinated ALM - With coordinated foreign currency
         issuance FX reserves (and other assets) can be
         reduced, potential cost savings.
ALM – from the Point of View of the Government


     Liability: debt, Assets FX reserves:

     •   FX debt is usually cheaper (lower yields, longer terms),
     •   Coordination is difficult – institutional autonomy or
         independence,
     •   Coordinational problems – different time horizon
         (monetary policy – short term, inflation target, debt
         management long term, cost saving, growth), different
         objectives (e.g. level of local yields).
ALM – Problems

                     S to ck o f F o re ig n R e se rve s (1997= 100%)

    800%
                                                                         A r g e n tin a
    700%
                                                                         Tu r ke y
    600%
                                                                         V e n e z u e la ,
    500%
                                                                         Re p . B o l.
                                                                         Hu n g a r y
    400%
                                                                         Po la n d
    300%
                                                                         Cz e c h Re p u b lic
    200%
                                                                         Th a ila n d
    100%
                                                                         Ru s s ia
     0%
           1997   1998   1999   2000    2001    2002   2003    2004




                  Rapid increase of foreign currency reserves in
                   emerging countries – need to limit the rise
ALM – Basics


    Ways of FX currency reserve reductions:

    •   Borrowed reserves – simple issue, reduce FX financing
        and reserves,
    •   Non-borrowed reserves:
           Buy-back of FX debt,
           Replace FX currency debt with domestic debt,
           Unnecessary FX currency reserves can be used to
           invest in higher yielding assets to avoid cost problems
           (advisable only if reserves are coming from good BoP
           position e.g. oil revenues).
ALM – Buy-backs

                    S to c k o f B ra d y B o n d s O u ts ta n d in g
                                      (U S D b illio n fa ce va lu e )

                    60
                    50
    P eak
                    40
                    30
    R em aining
                    20
    in A pril
    2006            10
                     0


                                                              C roatia




                                                                                               R us s ia
                                                                         M ex ic o
                                       B raz il




                                                                                     P oland
                         A rgentina




                                                  B ulgaria




                                                                                                           V enez uela
                  Foreign currency reserves are already used
                    actively to reduce outstanding foreign
                       currency debt- limited future role
ALM – Use of domestic market

           F o re ig n In v e s to rs S h a re in T o ta l D e b t Is s u a n c e
               (I M F G l o b a l F i n a n c i a l S ta b i l i ty R e p o rt A p ri l , 2 0 0 6 )

   16,0%
   14,0%
   12,0%
   10,0%
    8,0%
    6,0%
    4,0%
    2,0%
    0,0%
              2000              2001               2002              2003               2004          2005




           By replacing foreign currency debt with domestic
           debt foreign owned debt may not decrease rapidly
                – FX risk replaced with interest rate risk
ALM – Basics II.


     Non-borrowed FX currency reserve levels reduction
         can be difficult:

     •   ALM management can work if good cooperation between
         fiscal and monatary policy,
     •   Replacing FX currency debt with domestic debt can work
         but depends on market conditions,
     •   Coordination should work in case of outflow, CB cannot
         leave debt management alone,
     •   Slow process.
ALM – the Hungarian Case

Several institutional changes between 1990-2006:

•   Early years of setting up new systems until 1991,
•   Intermediate system with the CB having a major role until 1997,
•   Co-ordination with a strong emphasis on FXY currency reserve
    levels until 2002,
•   Balanced co-ordination from 2003.
ALM – Early Years until 1991


     Important measures to transform economic system,
         however debt management less effected:

     •   Strengthening central bank position, limitation of monetary
         financing (no deficit problem projected),
     •   NBH maintains its role as FX debt manager on behalf of the
         government and manages FX currency reserves,
     •   Underdeveloped local debt management by the Ministry of
         Finance.

     Economic and deficit problems emerged in the mid 1990s
ALM – Intermediate system until 1997


     Economic austerity program includes development of
         domestic debt management:

     •     Rapid development of domestic government securities
           market and institutions,
     •     On the basis of local market monetary financing stopped,
           later prohibited by law,
     •     FX debt management done by the NBH according to FX
           currency reserve needs.

         Previous funding relationship creates balance sheet
             problems for the NBH (devaluation losses)
ALM – Co-ordination with a Strong Emphasis on
FX reserve levels until 2002

NBH balance sheet problems solved by transformation of
foreign currency debt and management to the government in
1997:
 • Foreign currency debt management becomes part of public debt
   management strategy,
 • NBH ensures strong coordination to reach FX currency reserve
   level targets,
 • Co-ordination also resulted in hedging FX debt and reserves
   (currency benchmarks),
 • Debt management strategy aims for renewing maturing FX debt
   (no domestic monetary effect), some ad hoc deviation from the
   rule by the initiative of the NBH.
ALM – Coordination with a Strong Empasis on FX
Reserve Levels – Role of Foreigners

                                                 R a tio s to to ta l g o ve rn m e n t d e b t


 6 0 ,0 0 %




 5 0 ,0 0 %




 4 0 ,0 0 %




                                                                                                  n o n -re s id e n t to ta l h o ld in g s in H U F
 3 0 ,0 0 %
                                                                                                  fo re ig n c u rre n c y d e n o m in a te d g o ve rn m e n t d e b t in H U F




 2 0 ,0 0 %


                                                                                                           Replacing FX
 1 0 ,0 0 %
                                                                                                            debt did not
                                                                                                           reduce role of
                                                                                                         foreign investors
  0 ,0 0 %
              1998   1999   2000   2001   2002   2003        2004         2005        2006
ALM – Balanced Co-ordination from 2003

Fiscal loosening creates fiscal problems and smaller
investors’ demand:
• New debt management strategy adopted to decreased demand
  and medium term objectives (EMU accession),

• Stable FX currency debt ratio,

• NBH also ask for higher FX currency reserves (deteriorating
  BoP balance),

• Net FX currency issuance exchanged at the NBH, avoidance of
  simultaneous activity on the FX market.
 ALM – Results in Hungary


• FX currency reserve levels are relatively low vs. peer group,
  cost reduction target reached,
• Several benchmarks (e.g. funding in domestic currency, FX
  debt composition) are set up using basic ideas of ALM,

• With relative success of coordination policy, other possible
  measures to solve present problems (monetary, sterilisation
  assets) are less taken into consideration,

• In time of economic problems, relatively small FX currency
  reserve levels is not an advantage (countries with too high
  levels are the benchmarks).
Conclusions

•   Volatile international flows, and small local market may result in
    high FX currency reserve levels, causing problems in monetary
    policy and debt management

•   Unnecessary FX currency reserves levels are costly, reduction
    can be advisable

•   ALM may be introduced/implemented but practical use is difficult
    due to lack of comprehensive data, independent actors, and
    different objectives

•   Co-ordination is needed in case of both inflows and outflows of
    capital
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