2018 - 2019 Edition of Citi Perspectives for the Public Sector

Citi Perspectives for the Public Sector |  2018-2019 53 and increasing reliance on foreign currency borrowing. At the same time, the markets where African sovereigns operate often suffer from underdeveloped or non-existent swap markets and local debt capital markets to redenominate foreign currency loans to local currency ones. Citi can connect all key stakeholders, including borrowing sovereigns, development finance institutions, and local investors to structure derivatives solutions that mitigate the currency mismatch. Leveraging our unique footprint in emerging markets and the strong relationships with local clients and investors along with development banks, Citi has executed currency redenomination for a number of loans extended by development banks in Latin America and Central Eastern Europe. We are working to replicate these structures in Africa, enabling sovereigns to strengthen their debt sustainability, for investors such as local pension funds to diversify or extend duration of their local currency portfolio and for development banks to contribute to the development of the derivatives and capital markets in frontier jurisdictions. Mitigating rate risk — Rising interest rates represent a significant source of risk for sovereigns’ existing floating debts and future debt raising. Interest rate swaps, effectively converting floating rate payments into fixed rate payments, provide full certainty of interest costs. In addition, rate lock mechanisms can help governments secure more favorable financing terms on budgeted funding in view of expected higher future interest rates. Leveraging blended finance solutions — Through the lens of debt servicing capacity, blended finance can be an effective tool to achieve lower and more sustainable financing terms compared to non-concessional options. Blended finance uses public resources to mobilize capital from private investors, by creating bankable structures through the allocation of risks and the blending of returns. Instead of raising commercial debt for financing, governments should leverage the risk sharing and risk defeasance capacity of development finance institutions and NGOs through greater use of their guarantee and funding programs, particularly for environmental and social development projects. As a leading advocate and arranger of blended finance, Citi is perfectly placed to help mobilize institutional resources and private sector capital to deliver viable and sustainable funding structures, reducing the cost of financing for public sector clients. Clearing and avoiding debt arrears — Contractors’ and creditors’ arrears are common issues in Africa. Extinguishing these arrears is often a precondition before countries can become eligible for various financial support programs, including those of the IMF and the World Bank. The need to address these arrears becomes more pressing when contractors’ arrears lead to delays or cancellation of critical public work and soaring non-performing loans in the banking sector (as these contractors cannot secure sufficient funds to service their own debts). In the case of one African country, the government was able to clear a significant volume of FX arrears by raising long-dated local currency sovereign bonds that were delivered to the local banks in exchange for non-performing loans cancellation. The bonds were then discounted by foreign investors in foreign currency to pay the contractors and cancel the arrears. Despite such innovations, avoiding arrears in the first place is more important and should be a public finance priority. Often contingent liabilities crystalize into direct obligations that cannot be immediately met by budgetary resources. The resultant arrears represent a significant fiscal risk to the budget. IMF and rating agencies’ analysis takes into account off-balance sheet items when evaluating a country’s ability and willingness to service its debt; they often assess contingent liabilities on a conservative basis if such figures are not explicitly reported. By establishing an automated and flexible payment platform supported by appropriate liquidity facilities, governments can achieve robust levels of transparency, control and verification for progress and performance against commercial contracts and ensure timely and authenticated cash disbursements. Citi can connect all key stakeholders, including borrowing sovereigns, development finance institutions, and local investors to structure derivatives solutions that mitigate the currency mismatch.