Debt Management: Insights and Tools From Selected Nations	 
(21-NOV-01, GAO-02-14). 					 
								 
The United States had budget surpluses for four years that	 
resulted in decreasing debt levels. Although the current economic
situation and the challenges of combating terrorism will prompt  
deficits in the short term, the budget may again return to	 
surpluses. Surpluses will be needed in the future to prepare for 
long-term costs due to the baby boom generation. GAO studied five
nations--Australia, New Zealand, Norway, Sweden, and the United  
Kingdom-- whose recent experiences with debt management in times 
of surpluses might be relevant to the United States. The	 
countries GAO studied experienced both budget surpluses and	 
deficits from 1988 through 2000. Recent budget surpluses	 
contributed to falling public debt levels in absolute terms and  
as a share of the economy in these countries. Whether government 
debt is increasing or decreasing, debt managers' objectives are  
(1) to ensure that the government's financing needs are met, (2) 
to minimize the government's cost of financing, (3) to promote	 
efficient markets, and (4) to keep risk at an acceptable level.  
However, tradeoffs among these objectives are not always	 
compatible. During  budget deficits, a primary consideration is  
making government securities more attractive to potential	 
investors. On the other hand, periods of surpluses pose 	 
challenges to maintain liquid benchmark issues and reduce	 
borrowing costs. Some nations used debt reduction and investment 
in financial assets to help achieve national goals and prepare	 
for demographic changes. The Congress may want to consider	 
various debt management tools used by other countries during	 
cycles of budget surpluses and deficits.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-14						        
    ACCNO:   A02476						        
  TITLE:     Debt Management: Insights and Tools From Selected Nations
     DATE:   11/21/2001
  SUBJECT:   Debt Management 				        

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GAO-02-14
     
A

Report to Congressional Requesters

November 2001 DEBT MANAGEMENT Insights and Tools From Selected Nations

GAO- 02- 14

a

GAO United States General Accounting Office

Page 1 GAO- 02- 14 Debt Management

November 21, 2001 The Honorable Bill Thomas Chairman Committee on Ways and
Means House of Representatives

The Honorable E. Clay Shaw, Jr. Chairman, Subcommittee on Social Security
Committee on Ways and Means House of Representatives

The Honorable Pete V. Domenici Ranking Minority Member Committee on the
Budget United States Senate

For 4 years, the United States has had a budget surplus that has resulted in
decreasing debt levels. Debt held by the public fell approximately $453
billion from the end of fiscal year 1997 to the end of fiscal year 2001. 1
Although it appears now that the economy and the challenges of combating
terrorism will prompt deficits for the short term, we may again return to
surpluses. In fact, we and others have argued that surpluses will be needed
in the future to prepare for the long- term costs of the baby boom
generation.

As we have previously reported, deficits and surpluses present different
challenges for debt management. Earlier this year 2 we provided you with
information on how the U. S. Treasury has been managing debt as the budget
was in surplus. Given the possibility for budget deficits in the near term,
the Treasury is likely to face new and persistent challenges in debt
management.

1 Gross federal debt includes debt held by the public and debt held by
government accounts, such as the Social Security trust funds. Despite the
current budget surpluses, gross federal debt continues to grow because debt
held by government accounts has increased at a faster rate than debt held by
the public has declined. Because debt held by government accounts is an
intragovernmental transaction, it is not the focus of this report.

2 See Federal Debt: Debt Management Actions and Future Challenges (GAO- 01-
317, February 28, 2001). See also Federal Debt: Debt Management in a Period
of Budget Surplus (GAO/ AIMD- 99- 270, September 29, 1999).

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 02- 14 Debt Management

A number of other nations experienced a cycle of budget deficit and surplus
before the United States. You asked us to examine the experiences of some of
these nations looking for insights and lessons learned for the United
States. You asked that we pay particular attention to the various techniques
used, including the use of ?debt buybacks.? As discussed with your staff, we
selected five nations- Australia, New Zealand, Norway, Sweden, and the
United Kingdom- whose recent approaches and experiences with debt management
in times of surplus might have relevance to or provide useful information
for the United States.

To obtain information on the experiences of these other nations in managing
sovereign debt, we interviewed government officials, capital market
participants, academics, and others to discuss fiscal and debt management
goals, the relationship between budget changes and debt policies and
actions, and the nature of the capital markets in these nations. We also
gathered and analyzed documents and publications on debt management in these
five nations. With respect to United States debt policy, we interviewed
officials and gathered data from the Department of the Treasury, Federal
Reserve Board of Governors and Federal Reserve Bank of New York, and private
sector market participants in Washington, D. C., and New York City. We did
our work in accordance with generally accepted government auditing standards
from March 2000 through October 2001. The Treasury and the Congressional
Budget Office (CBO) generally agreed with this report and provided technical
comments that we have incorporated as appropriate.

The five countries in our study experienced both budget surpluses and
deficits during the period from 1988 through 2000. Recent budget surpluses
contributed to falling sovereign public debt levels in absolute terms and as
a share of the economy. Fiscal strategies, including clearly defined targets
of debt to the overall economy, helped achieve budget surpluses in several
countries. Setting targets that measure the size of gross or net debt 3 to
the economy allowed decisionmakers to track progress toward fiscal health
and provided justification for continued fiscal discipline.

Whether government debt is increasing or decreasing, debt managers?
objectives remain the same. The objectives are (1) ensuring that the

3 Net debt is defined as gross debt minus financial assets. Results in Brief

Page 3 GAO- 02- 14 Debt Management

government?s financing needs are met, (2) minimizing the government?s cost
of financing, (3) promoting efficient markets, and (4) keeping risk at an
acceptable level. However, the trade- offs among the objectives may be
different and the objectives themselves are not always compatible. During a
budget deficit, a primary consideration is making government securities more
attractive to potential investors, which includes deciding whether to
introduce new instruments. On the other hand, periods of budget surpluses
pose challenges to maintaining liquid 4 benchmark issues and reducing
borrowing costs. Declining levels of publicly held debt would present
challenges in supporting liquid markets across the yield curve of
securities. 5 Tensions between minimizing financing cost and supporting
domestic markets could be accentuated.

During periods of surplus, falling debt levels have caused debt managers in
all study countries to concentrate a large number of diverse debt issues
into fewer, but larger, benchmark issues that are also expected to lower the
governments? financing costs. These fewer, more liquid benchmark issues
generally have initial maturities ranging from 2 to 15 years. The U. S.
Treasury announced on October 31, 2001, that it was suspending issuance of
the 30- year nominal and inflation- indexed bonds. A Treasury official noted
that the market?s attention and action have shifted away from the 30- year
bond toward the 10- year note. The Treasury?s action will leave three
Treasury benchmarks ranging from 2 to 10 years- similar to most study
countries. Lower debt levels and resulting decreases in newly issued
government securities also caused central banks to modify investment
decisions. Central banks in most countries we studied generally held a
smaller share of their portfolio in government securities and generally held
an increasing share of outstanding government debt.

While we examined debt management approaches when all study countries and
the United States were in budget surplus, some of these tools could be used
during budget deficits as well. All study countries have deployed a number
of debt management tools that the United States has used. These include debt
buybacks, reopening of outstanding issues, and reducing or eliminating
certain maturities of debt. Debt managers noted

4 A liquid debt issue is one that is large enough to be traded at will and
one for which the offer and purchase prices differ only slightly. Benchmark
issues are used by other financial services to price their products.

5 A yield curve is a graphical depiction of the current relationship between
interest rates and time to maturity, holding all other factors (such as
credit risk) constant.

Page 4 GAO- 02- 14 Debt Management

that reverse auctions are a way to consolidate government debt into
benchmark maturities and allow issuance of new bonds to meet market demand.
While we examined buybacks used in the study countries and the United States
when their budgets were in surplus, buyback results also could be achieved
in times of budget deficits. Debt buybacks can have the advantage of
allowing debt managers to change the characteristics of outstanding debt as
well as to create larger benchmark issues. The experiences of other
countries suggest that it can be difficult to manage and predict the costs
of reverse auctions.

Each of the countries, except Norway, used reverse auctions 6 that bought
back debt before it matured. Unexpected changes in key information about the
amount of debt repurchases and a compressed time schedule caused Sweden?s
buyback operations in 2000 to be more costly than expected. Australian
officials said that buying back debt through means other than a reverse
auction may lower costs to the government. The Reserve Bank of Australia
(RBA), Australia?s central bank, has conducted bond repurchases on behalf of
the Australian Office of Financial Management (AOFM) for several years.
However, an RBA official said that the success of these operations is a
function in part of the liquidity of the bond and the level of information
about the operations themselves. Debt managers in the United Kingdom planned
to buy back debt using a combination of reverse auctions and open market
repurchases to guard against the risk that it might be progressively more
expensive to acquire securities as reverse auctions continued.

All study countries, as well as the United States, used other tools to
increase market efficiency and allow increased issuance of benchmark
securities. However, the other nations used a broader range of tools: open
window repurchases, debt exchanges, buybacks without canceling debt, switch
auctions, taps and reverse taps, and swaps.

The additional debt management tools used regularly in other nations may
hold promise for the United States. Australia and the United Kingdom allow
investors to offer securities to the government for repurchase at the
government?s option. Called ?open window repurchases,? these programs
provide an opportunity for the government to buy back debt at market

6 In a reverse auction, the government receives offers from market
participants to sell securities at a specific price. In the United States,
the Treasury accepts the most competitive offers.

Page 5 GAO- 02- 14 Debt Management

rates. A variation of this approach allows investors to offer only
securities nearing their maturity dates for repurchase at the government?s
option. These programs act as both debt management and cash management
tools- reducing outstanding debt and smoothing cash flows by giving debt
managers another opportunity to use excess cash flows in surplus months that
may occur even in a budget deficit year. The government can choose which
issues to repurchase in both a reverse auction and an open window
repurchase. From the investor?s perspective, open window repurchases can be
advantageous because they are an opportunity for the investor to switch its
funds to another investment before the security matures. While the amount of
debt repurchased may be lower in an open window program, these programs may
provide a lower cost buyback because the government can choose to buy when
it believes market prices are advantageous. Open window repurchases likely
can be done more frequently than reverse auctions and may have lower
administrative costs. Debt management offices in Australia and the United
Kingdom have used open window repurchases to supplement reverse auction debt
buybacks.

Debt exchanges are used in three of the five study countries to promote
liquidity of benchmark securities by exchanging outstanding debt securities
for the newly issued, more liquid benchmark securities. Exchange offers are
opportunities for investors to convert one debt security into another- for
example, an older, nonbenchmark security into a new benchmark bond- at a
ratio to be determined by the debt management office. The U. S. Treasury now
is studying the advisability and feasibility of debt exchanges.

The United Kingdom has used switch auctions- a recent innovation- to build
up liquid benchmark securities in a time of low issuance and when the Debt
Management Office wished to obtain a share of a debt issue that was too
large to have been considered for a debt exchange. In a switch auction, the
debt management office offers to buy a certain amount of a nonbenchmark bond
against the issue of a further amount of a benchmark bond, with the exchange
ratio to be determined by the accepted bids. Switch auctions also may hold
promise for the U. S. Treasury in supporting the creation of large benchmark
issues without increasing outstanding debt.

Some debt management tools used abroad hold less promise for the United
States because they may be difficult to implement in a way consistent with
the value of equal access, or may require the government to assume credit
risk. One- on- one offers to buy or sell debt securities between the debt
management office and an individual market participant

Page 6 GAO- 02- 14 Debt Management

are used in all study countries. Another tool- swaps of securities between
the government and a capital market participant- may provide the opportunity
for lower cost financing, but requires the government to assume the risk
that the swap partner may default.

When some study countries experienced budget surpluses, their governments
decided to continue to maintain their sovereign debt markets to keep a role
for the central government in debt markets and/ or to facilitate potentially
higher levels of borrowing in the future. As a consequence, these countries
have had excess cash to invest in financial assets. Particular investment
decisions have been influenced by both the size of the current surplus and
projections about its level over time. Two of the five nations in our study
have chosen to place this excess cash in short- term, liquid accounts in
either the central bank or the domestic banking system. Pending the further
development of strategies, Australia has placed surplus funds in an account
at the central bank. The United Kingdom initially invested the surplus in
money market instruments, including liabilities of banks, using the cash to
reduce net debt. Sweden and New Zealand used excess cash to offset their net
government debt denominated in foreign currencies. They bought back some of
their debt denominated in foreign currencies and increased foreign currency
assets to offset their net remaining foreign currency denominated debt.
Norway, with substantial although declining oil activity receipts projected
to continue at least through 2004, created a Petroleum Fund that holds
predominantly longer- term assets (bonds and equities) and assumes more
risk.

The budgetary surpluses of recent years that were achieved by fiscal
discipline and strong economic growth positioned us well to respond to both
the events of September 11, 2001, and to the economic slowdown. Although the
budget may dip into deficit in the short term, once the economy rebounds the
nation may again return to surplus. For example, the Senate and House
Committees on the Budget, on a bipartisan basis, endorsed a long- term
fiscal policy to maintain surpluses equal to the Social Security surplus.
For the long term, sustained budgetary surpluses bolster the nation?s
economic capacity to afford the burgeoning costs of the baby boom
retirement. Other nations have used debt reduction and investment in
financial assets as a way to achieve national goals and to prepare for
future demographic changes. Several study nations have recognized potential
governance issues associated with ownership of longer- term assets. The
United States might be faced with similar issues in the future should we
return to surpluses.

Page 7 GAO- 02- 14 Debt Management

All of the study countries and the United States had budget deficits give
way to budget surpluses in the 1990s. Debt changes closely followed the
budget changes for four of the study countries. Debt and budget surplus
targets were used as fiscal goals in some countries. Maintaining government
debt at prudent or stable levels is a fiscal goal pursued in most of the
countries we studied. While in budget surplus each of the study nations
decided, for reasons particular to its own political and economic
considerations, to maintain some level of government debt to retain a
presence in the capital market. This choice may facilitate the borrowing
increase that may be caused by the recent global economic downturn.

Table 1 below shows the pattern of surpluses and deficits from 1988 through
2000. Four of the study countries- all but New Zealand- experienced a cycle
of budget surpluses, followed by deficits and then a return to surpluses in
the last 13 years. Budget surpluses were achieved in the 1990s as a result
of budget consolidations and economic growth. 7 For the United States, there
was a gap of nearly 30 years between its 1969 and 1998 unified surpluses.
The current global economic downturn may cause some nations to return to
deficits and increase debt levels.

Table 1: Budget Deficits and Budget Surpluses as Percentages of GDP, 1988
Through 2000 Country 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
1999 2000

United States -3.1% -2.8% -3.9% -4.5% -4.7% -3.9% -2.9% -2.2% -1.4% -0.3%
0.8% 1.4% 2.4% United Kingdom 0.7% 3.0% 1.3% 0.1% -2.3% -5.9% -7.1% -5.3%
-4.4% -3.0% -0.4% 0.6% 1.0% Australia 0.6% 1.8% 1.7% 0.1% -2.9% -4.0% -3.8%
-2.8% -2.0% -1.0% 0.2% 0.7% 2.0% New Zealand -4.8% -3.7% -4.7% -3.8% -3.3%
-0.6% 3.0% 3.1% 3.6% 2.0% 2.6% 1.8% 1.4% Norway 2.7% 1.8% 2.6% 0.1% -1.7%
-1.4% 0.4% 3.5% 6.6% 7.9% 3.6% 4.9% 14.0% Sweden 0.7% 1.9% -1.0% -4.1% -9.7%
-13.6% -8.5% -8.1% -1.2% -0.3% 0.5% 4.1% 4.9%

Notes: Budget surplus/ deficit measures and source documents are listed in
the footnote. 8 Budget deficits are shaded.

7 Our report, Budget Surpluses: Experiences of Other Nations and
Implications for the United States (GAO/ AIMD- 00- 23, November 2, 1999),
describes the economic changes and fiscal efforts that resulted in budget
surpluses during the 1980s and 1990s.

8 United States - ?federal surplus or deficit,? CBO, The Budget and Economic
Outlook FY 2002- 2011; United Kingdom - ?public sector net cash
requirement,? HM Treasury, Budget 2001; Australia - ?commonwealth general
government cash surplus,? Commonwealth Budget 2001- 2002; New Zealand -
budget measure is ?financial balance? in 1988- 1995,

OECD Economic Outlook, December 2000, and ?operating balance? in 1996- 2000,
Financial Statements of the Government of New Zealand, June 30, 2000; Norway
- ?financial

balance,? OECD Economic Outlook, December 2000; and Sweden - ?central
government budget balance,? Statens Finanser, Ekonomistyrningsverket. Budget
Surpluses,

Fiscal Policies, and Debt Levels

The Pattern of Surpluses and Deficits and Related Debt Levels

Page 8 GAO- 02- 14 Debt Management

Debt changes closely followed the budget cycles for four of the study
countries. Debt reductions were achieved with the budget surpluses in the
late 1980s, but debt levels increased sharply when governments borrowed to
finance the budget deficits in the early and mid- 1990s. (See figure 1.)

Figure 1: Gross Debt as a Percentage of GDP, 1988 Through 2000

Note: Gross debt measures and source documents are listed in the footnote. 9
The gross debt trends 10 for the six countries show the response of debt
levels to budget balances and economic changes. The ratios of debt to GDP in
figure 1 closely track the cycles of budget surplus and deficit shown in
table 1. All of the study countries except Sweden and the United

9 United States - ?federal debt held by the public,? CBO, The Budget and
Economic Outlook FY 2002- 2011; United Kingdom - ?general government gross
debt,? HM Treasury, Budget 2001; Australia - ?government securities on
issue,? Australian Office of Financial Management, Annual Reports and The
Treasury: Commonwealth Debt Management; New Zealand - ?Crown gross debt? in
New Zealand?s 2001 Economic and Fiscal Update and

?gross total debt? in New Zealand?s Debt Management Office?s Web site www.
nzdmo. govt. nz; Norway - ?general government gross financial liabilities,?
OECD Economic Outlook, December 2000; and Sweden - ?central government debt?
in Swedish National Debt Office?s Web site www. rgk. se.

10 For this report, gross debt refers only to debt held by the public.

0 14

28 42

56 70

84 United States United Kingdom Australia New Zealand Norway Sweden Years
1988- 2000 Percentage

Page 9 GAO- 02- 14 Debt Management

Kingdom show debt- to- GDP ratios in 2000 lower than at any time in the
period from 1988 through 2000.

Net debt- to- GDP ratios in the period 1988 through 2000 are shown in figure
2 for the study countries and the United States. Norway?s and Sweden?s large
asset holdings make their net debt substantially lower than their gross
debt. Since Norway?s assets are larger than its debt, it had negative net
debt- to- GDP ratios in this period. After Norway, Sweden had the lowest net
debt- to- GDP ratio (2 percent in 2000), although its gross debtto- GDP
ratio (61.2 percent in 2000) was the highest among the study countries and
the United States.

Page 10 GAO- 02- 14 Debt Management

Figure 2: Net Debt- to- GDP Ratios, 1988 Through 2000

Note: Net debt measures and source documents are listed in the footnote. 11
As noted in our study of the fiscal policy experiences of study nations,
debt and budget targets were used as fiscal goals in some countries.
Maintaining government debt at prudent or stable levels is a fiscal goal
pursued in most of the countries we studied. Debt objectives can be defined
in both nominal amounts and relative terms. Gross debt as a

11 United States - ?federal debt held by the public,? CBO, The Budget and
Economic Outlook FY 2002- 2011, and ?financial assets,? U. S. Treasury,
Financial Report of the United States Government; United Kingdom - ?public
sector net debt,? HM Treasury,

Budget 2001; Australia - ?commonwealth general government net debt,?
Commonwealth Budget 2001- 2002; New Zealand - ?net Crown debt? in New
Zealand?s 2001 Economic and Fiscal Update; Norway - ?general government net
financial liabilities,? OECD Economic Outlook, December 2000; and Sweden -
?general government net financial liabilities,?

OECD Economic Outlook, December 2000. Some Countries Used

Fiscal Targets

-56 -42

-28 -14

0 14

28 42

56 70

United States United Kingdom Australia New Zealand Norway

Sweden Years 1988- 2000 Percentage

Page 11 GAO- 02- 14 Debt Management

percentage of GDP compares debt to the size of the economy. Governments
measure the extent to which they have accumulated financial assets by
reviewing goals they have set for ?net debt?- which is defined as gross debt
minus financial assets. (See table 2.)

Table 2: Fiscal Targets Used in Study Countries Country Fiscal targets Notes

Australia Reduce net debt, with a projected negative net debt in fiscal year
2004- 2005, while maintaining liquidity in benchmark securities. New Zealand
Maintain relatively stable long- term

targets for net and gross debt below 20 percent and 30 percent of GDP,
respectively, on average over the economic cycle.

Gross debt would increase in nominal terms from 2001 through 2005 to finance
financial and physical assets.

Norway Keep revenue and expenditure at sustainable levels consistent with
stable prices and long- term fiscal sustainability, which is the primary
fiscal objective.

Short- term fluctuations in oil prices should not affect economic policy.

Sweden Maintain 2 percent of GDP budget surplus on average over an economic
cycle.

Sweden has a nominal ceiling for central government expenditures for 3 years
ahead. United Kingdom Maintain net debt at a sustainable

level, below 40 percent of GDP. The ratio of net debt to GDP was forecasted
to fall to

about 34 percent of GDP in fiscal year 2001- 2002, and remain at about that
level for the next 4 years.

Sources: Data from study countries obtained in early September 2001.

The amount of general government net debt in Australia has fallen
consistently since the mid- 1990s, from a peak of almost 19 percent of GDP
in fiscal year 1995- 1996 to an expected 5.4 percent in fiscal year 2001-
2002. Using the policy settings in the fiscal year 2000- 2001 budget, net
debt could be eliminated in fiscal year 2004- 2005. New Zealand?s 2001
Economic and Fiscal Update projects net debt- to- GDP levels of from 15.8
percent to 18 percent from 2001 through 2005.

In Europe, the Maastricht Treaty provides for a target ratio of gross
general government debt to GDP at market prices of 60 percent and budget
deficits of not more than 3 percent of GDP at market prices. Sweden and the
United Kingdom subsequently adopted fiscal policies and debt targets that
would enable them to achieve and maintain these levels.

Page 12 GAO- 02- 14 Debt Management

Sweden?s fiscal policy anchor is a budget surplus of 2 percent of GDP on
average over an economic cycle. This fiscal policy goal was adopted to
reduce general government debt in preparation for demographic changes and to
allow Sweden to achieve and maintain Maastricht?s convergence criteria. The
United Kingdom?s fiscal targets, 12 adopted in 1998, included a sustainable
investment rule that called for holding public sector net debt as a
percentage of national income at a ?stable and prudent? level over the
economic cycle. However, the United Kingdom achieved a net debt- toGDP ratio
of 31.6 percent in 2001, below the level of 40 percent of GDP referenced in
1998. The 2001 budget projects a steady ratio around 30 percent in the next
5 years.

While in budget surplus, each of these five nations also decided, for
reasons particular to its own political and economic considerations, to
maintain some level of government debt and the ability to issue debt by
retaining a presence in the capital market. The reasons given for keeping
some government debt include

 preparing for the possibility that the government may need to borrow again
(New Zealand);

 strengthening the domestic capital market (Australia, New Zealand, and
Norway); and

 providing a secure, long- term investment vehicle for pension and
insurance funds (United Kingdom).

Both structural differences in domestic capital markets and the relative
size of government debt in the world and domestic bond markets affect
options available to government decisionmakers and debt managers. For
example, some nations where government bonds comprise a large share of bond
markets found it important to maintain some level of debt to ensure
continued viability of a market for government bonds. Table 3 shows the
relative market shares of government securities by country.

12 The United Kingdom?s fiscal targets are described in the Finance Act 1998
and the Code for Fiscal Stability 1998. Study Countries Decided

to Maintain Government Debt

Page 13 GAO- 02- 14 Debt Management

Table 3: Relative Market Share of Government Securities by Country Country

Share of each country?s government bonds in world

bond market Share of central government

bonds in each country?s bond market

United States 7.34% 15.0% Australia 0.21% 35.5% New Zealand 0.04% 61.9%
Norway 0.05% 35.0% Sweden 0.24% 49.0% United Kingdom 1.33% 39.1%

Note: World bond market includes government, corporate, foreign, and
Eurobond issuers. Source: Merrill Lynch, Size and Structure of the World
Bond Market: 2001, April 2001 (data as of December 31, 2000).

The experience of moving between budget surpluses and deficits has
influenced current debt management policy and practices in the countries we
visited. Government officials told us their current debt management is based
on the assumption that borrowing needs may increase in the future.

Although the five study countries and the United States do not have
identical objectives in managing their sovereign debt, debt management
objectives in all of these countries generally fall into four categories:

 ensuring that the government?s financing needs are met,

 minimizing the cost of financing,

 supporting domestic capital markets, and

 keeping risk at an acceptable level. Debt management objectives may remain
the same regardless of whether a government?s budget is in deficit or
surplus. However, debt managers may use different strategies to pursue these
goals when budget surpluses allow lower debt levels than when deficits cause
debt to increase. Additionally, while debt managers continually make
decisions on the composition of government debt, balancing the objectives
becomes more challenging when the amount of debt outstanding is being
reduced. This is because the objectives, while interrelated, are not always
entirely compatible.

Ensuring that the government?s financing needs are met is a critical
objective and achieving it is the result of successful debt and cash
management. The cycles for issuing bills, notes, and bonds are determined
Countries Have

Similar Debt Management Objectives

Page 14 GAO- 02- 14 Debt Management

largely by the government?s cash management needs. Short, variable term
bills can be issued as needed to cover low points in available cash.

Minimizing the cost of borrowing usually is viewed as a medium- to longterm
objective. Debt management offices use different approaches toward achieving
lowest long- term cost. For example, debt management offices like those in
our study have decided to maintain regular, predictable operations and to
maintain broad and deep markets, while others with small operations may time
their actions to take advantage of market conditions. Taking advantage of
market conditions can include issuing a particular type of security only
when conditions (such as price) are advantageous to the government.

Supporting domestic markets is important because efficient, liquid- defined
as broad and deep- markets that address investor demands also contribute to
achieving the first two objectives. The U. S. Treasury advances its goal of
efficient markets by issuing debt with various maturities and in sufficient
amounts to appeal to the broadest range of investors. One way the United
Kingdom?s Debt Management Office has supported its domestic market is by
issuing relatively more long- term debt to meet strong and increased demand
caused in part by regulatory and tax factors and because the demographic
profile is becoming older and pension funds are demanding more nominal
bonds. 13 According to the United Kingdom?s Treasury, meeting this demand
will benefit both the government and investors. Insurance companies and
pension funds acquire the relatively longer- term government securities to
meet their portfolio needs, and the government may get cheaper financing
because it is issuing where demand is high. However, this government
strategy means that there is less relatively new debt in the shorter
maturity ranges sought by other capital market participants. Sweden?s
National Debt Office also helped to strengthen the domestic capital market
by its strategy of issuing securities in kronor and executing a swap
agreement wherein the government pays interest in foreign currency, and
receives payment in kronor equal to the cash flow for a krona- denominated
bond. Thus, Sweden gets a lower borrowing cost than if it sold bonds
denominated in a foreign currency and this results in improved liquidity in
the domestic

13 Institutional and regulatory factors included the ?Minimum Funding
Requirements? that created incentives for pension funds to hold long- dated
government securities. The Government has announced that these Requirements
will be abolished. Other factors include the ?Advance Corporation Tax,?
abolished in April 1999, and the dividend tax credit, abolished in the 1997
budget.

Page 15 GAO- 02- 14 Debt Management

government securities market. Debt management offices in the countries we
studied believed it was important to consult with market participants about
such issues as market conditions and investor demand.

Keeping risks at an acceptable level is key to success in each of the other
objectives. Debt management offices encounter and manage the following types
of risk:

 Funding risk is the possibility that a debt management office would not be
able to access markets or raise funds at an acceptable cost. For example,
rates may be unacceptably high when the government needs to issue debt to
cover a budget deficit.

 Liquidity risk is the possibility that market conditions might shift in
such a way as to not allow for quick or cost- effective liquidation of
securities or positions. For example, the government may face liquidity risk
when it repurchases outstanding marketable debt prior to maturity if it
causes a substantial change in prices.

 Market risk is the possibility that, once debt has been issued, adverse
changes in interest rates or foreign currency exchange rates could cause
either debt service costs to increase directly or the opportunity to reduce
debt service costs to be missed. For example, the funding cost may be higher
on new debt than on maturing debt.

 Portfolio concentration risk is created when a portfolio is unduly
affected by one specific instrument, individual transaction, industry, or
country.

 Operational risk includes, among other things, the possibility of errors
in transactions, failures of internal controls, breaches of legal
requirements, and disruption of markets from external events such as natural
disasters.

 Debt management offices that use swaps in managing their debt also face
credit risk. Credit risk is the possible default or lowered credit rating of
a financial institution participating in a swap operation with the
government.

Debt managers? assessments of the risks inherent in each of the debt
management tools are one factor used when deciding among several tools that
could address the same objective. For example, debt managers could use debt
buybacks coupled with greater new issuance, switch auctions,

Page 16 GAO- 02- 14 Debt Management

and debt exchanges to change the average maturity/ duration 14 of
outstanding debt, as is done in the United Kingdom. These tools, explained
later in more detail, may affect market risk or liquidity risk differently.
The relative market share of a government?s securities in the world and
domestic capital markets is one factor that affects the amount of risk
associated with particular debt management tools. For example, United States
government securities represent a smaller share of the domestic capital
market than do the securities of the study nations. The relatively deep,
liquid private capital market in the United States accounts in part for the
statement of a Treasury official that the market could adjust to declines in
the supply of Treasury securities in times of budget surpluses. However, as
we noted in an earlier report, the changes may not be either seamless or
without cost.

Debt management in some study countries is driven by policy decisions on
debt targets and portfolio benchmarks. Further, differences in the size and
depth of capital markets affect options available to debt managers.

Many of the study nations set formal debt maturity or duration targets to
assist debt managers in managing risk. For example, during periods of budget
surplus, governments generally reduce debt or issue less debt than in
deficit periods. Thus, the maturity profile or the average duration is
determined more by the character of outstanding debt than the composition of
new issues. These maturity profile issues are important because debt
maturity can have a significant influence on the government?s cost of
financing as it affects interest payments and market liquidity. While the
United States does not have formal debt targets, operationally the Treasury
considers objectives similar to those of the study countries. (See table 4.)

14 Average maturity and average duration indicate the level of market and
funding risk a government might face. Modified duration of outstanding debt
is the percentage change in the debt?s market value arising from a 1-
percent change in the nominal interest rate. Two study nations use duration
targets and two do not use any targets. A Treasury official noted that the
United States does not have a formal target. However, it monitors average
maturity rather than using duration because the United States does not match
assets and liabilities. Debt Management

Approaches Differ

Page 17 GAO- 02- 14 Debt Management

Table 4: Debt Targets of Study Countries Country Debt maturity or duration
targets-

domestic currency nominal debt Notes

United States No formal target. Operationally, the United States spreads
issuance over the yield curve and maintains a limited number of liquid
benchmarks.

The Treasury monitors the average length of marketable debt, and Treasury
officials said that buybacks have prevented its lengthening by about 2 to 3
months. The average length of marketable debt was 5. 9 years as of September
30, 2001. Australia A modified debt duration range of 3

to 3.5 years for domestic debt and 1 to 1.5 years for United States
dollardenominated debt. New Zealand Spread issuance over yield curve, up

to 12 years. Debt maturity profile is kept relatively smooth to reduce

funding and market risks. Norway Build up and maintain a limited

number of liquid benchmark bonds with maturities up to 10 to 11 years.

Borrowing is done to provide funds for net lending, equity investments, debt
amortization, and central bank monetary operations. Sweden 3.5 years +/- 0.
5 years duration.

No more than 25 percent of the central government debt will mature within 1
year.

The duration of the combined domestic and foreign currency debt is shorter-
2.7 years, +/ 0.3 years. United Kingdom No formal target. Operationally,

issuance has, in the recent past, been biased toward long maturity bonds in
response to strong demand for these bonds from investors. Issuance in fiscal
year 2000- 2001 was 65 percent long- term fixed bonds and 35 percent index-
linked bonds.

Sources: Information supplied by study countries.

A flatter debt maturity profile, with approximately equal amounts of debt in
benchmark issues across the maturity curve, helps to reduce both funding and
market rate risks. For example, as a result of concentrating debt issuance
in fewer benchmark securities, New Zealand?s debt profile in August 2001 was
approximately horizontal with eight benchmark securities (out of 10 total
debt issues) of roughly similar size.

In the United States, approximately 50 percent of total outstanding
marketable debt will mature in 2 years or less. Such a profile may present
countries with less- developed capital markets or less demand for government
securities than in the United States with significant funding

Page 18 GAO- 02- 14 Debt Management

risk. 15 The United States is less likely to incur this funding risk because
the United States? government bond market is the largest in the world and
its securities enjoy high demand.

Four of the countries we studied- Australia, New Zealand, Norway, and
Sweden- develop hypothetical ?benchmark portfolios? that target the
composition of their debt portfolios and the nature of portfolio exposures
(or market risks) that are most efficient in the long term. In Sweden, the
Ministry of Finance works with the central bank and debt management office
to develop these targets. The Australian Office of Financial Management
develops its benchmark portfolio with the assistance of external portfolio
management consultants. Once the benchmarks are set, debt managers design
strategies to achieve or maintain this portfolio structure over the long
term. Oversight and accountability for debt management offices with
portfolio benchmarks can be more direct and transparent since they may
report at year- end on their portfolios and how they differ from the
targets. Some governments publish annual reports with assessments of debt
management. For example, in Sweden the government decides on such portfolio
benchmarks as the average duration of the nominal krona- denominated debt,
and the amount of inflationindexed and foreign currency- denominated debt.
The government?s decisions and supporting analysis as well as the Swedish
National Debt Office?s proposals and central bank?s comments are published
annually. Swedish law requires the government to evaluate the management of
central government debt in a written communication to the parliament.
Evaluation is both quantitative (differences in the absolute costs compared
with the government?s guidelines) and qualitative (day- to- day management
of the debt, including market maintenance efforts).

The countries? disparate experiences significantly influence the
implementation of debt management- that is, their choices of debt management
tools. Market share, market structure, and the preferences of capital market
participants can shape the choices available to debt managers. Differences
in balancing cost and risk also shape debt management choices. Further, the
size and timing of an actual or projected budget deficit or surplus can
affect choices about whether and how to hold financial assets. Some examples
of factors shaping debt management abroad follow.

15 Funding risk presents the possibility that there may not be sufficient
market demand for government securities or the government could not sell
them at an acceptable price.

Page 19 GAO- 02- 14 Debt Management

 Australia does not need to issue debt in foreign currencies because of its
deep domestic government securities market. However, it has taken on foreign
currency exposure because this can provide long- term cost and risk
advantages.

 In contrast, in New Zealand the focus of debt management from 1994 to the
present has been to reduce its large volume of foreign- currency denominated
debt and thus eliminate net foreign currency risk.

 The Norwegian government returned to surplus in 1996 on the strength of
surging oil revenues, economic improvements, and fiscal restraint. It then
was faced with the decision whether to maintain its domestic government
securities market and, if so, how to invest these receipts in assets.

 In Sweden, debt managers had to coordinate debt issuance and asset swaps
as the government undertook concurrent reform of the national pension
system. The AP funds (national pension scheme) were restructured and SEK90
billion was transferred to the central government budget during fiscal year
1999- 2000 and SEK155 billion in 2001. The government will use these
receipts to reduce debt.

 The United Kingdom has a strong institutional demand for long- term
government securities that significantly influences debt managers? choices.

The five countries in our study generally used similar debt management tools
to reduce the level of outstanding debt during budget surpluses. Some
countries reduced issuance of new debt securities. The study countries
employed similar tools to improve liquidity and concentrate new debt into
fewer, larger benchmark issues. These include eliminating certain
maturities, changing the frequency of auctions of certain debt instruments,
and adding new debt to existing issues (called reopening) rather than
creating new issues. At the same time, some study countries also
reconsidered issuance of inflation- linked securities and increased issuance
of short- term bills with varying maturities. Further, all study countries
bought back debt before it matured. The United States also used these tools
in its debt management. (See table 5.) Some Debt

Management Tools Are Common to All Study Countries and the United States,
but Implementation Varies

Page 20 GAO- 02- 14 Debt Management

Table 5: Debt Management Tools by Country Tool United

States Australia New Zealand Norway Sweden United

Kingdom

Reduce net issuance X X X X Concentrate issuance into benchmarks X X X X X X
Eliminate certain maturities X X X X X X Reopen issues X X X X X X Buy back
outstanding debt before maturity through reverse auctions X XX XX Reduce or
eliminate issuance of inflationlinked securities X XX X Increase issuance of
short- term bills with varying maturities X X

Offer standing repurchase of debt nearing maturity offered by investors X X
X Sell or buy securities between auctions

Taps/ reverse taps X X X X Open window X X X X X Use swaps to hedge domestic
interest rate risk X X Use swaps to hedge currency risk X X X Use swaps to
increase issuance in domestic currency while creating foreign currency debt
X X X Use debt exchanges X X X Use switch auctions X

Sources: GAO interviews with government officials in study countries and
publications from study nations and the United States.

As budget surpluses resulted in lower debt levels, all five study countries
restructured their debt portfolios to better achieve debt management
objectives. All of the countries in our study- as well as the United States-
have taken steps to concentrate debt issuance into fewer, larger benchmark
issues. These larger issues allow governments to capture a liquidity premium
16 in the market that reduces their costs of financing.

When governments run budget deficits and have large borrowing needs, debt
managers may be able to issue new debt in issues large enough to be liquid
(or efficient in the market). However, when governments with budget
surpluses reduce borrowing, new issues become smaller and less

16 A liquidity premium is the incremental price market participants are
willing to pay for securities that are part of large issues that can be
easily traded. Concentration of New and

Outstanding Debt Into Fewer Issues

Page 21 GAO- 02- 14 Debt Management

liquid. Continuing with many small issues is less efficient, and the
governments? financing costs may rise as the bond markets seek to offset
this lower liquidity. Therefore, as debt levels have fallen, debt managers
have concentrated new issuance into fewer, larger, benchmark issues. The
market rewards this increased liquidity by paying premiums that reduce the
governments? costs of borrowing.

The study countries all have reduced the number of new issues and used debt
management tools to concentrate borrowing into fewer, more liquid
benchmarks. The five nations in our study- and the United States- have from
3 to 12 benchmark issues that range from 1 to 30 years in maturity.
Recently, only the United Kingdom and the United States have had benchmark
bonds that mature in 30 years. The U. S. Treasury announced on October 31,
2001, that it was suspending issuance of the 30- year nominal and inflation-
indexed bonds. The announcement acknowledged that market interest and
actions have shifted from the 30- year bond to the 10- year note. The
benchmark maturities in other countries generally range from 1 to 15 years.
(See table 6.)

Page 22 GAO- 02- 14 Debt Management

Table 6: Benchmark Securities in Selected Countries as of August 2001
Country

Number of nominal coupon benchmarks and terms to maturity Comments

United States Number: 3

Terms: 2, 5, and 10 years The U. S. Treasury announced on October 31, 2001,
that it was suspending

issuance of the 30- year nominal bond. Australia Number: 12

Term: 13 years New Zealand Number: 8

Terms: almost 5 years to almost 12 years

The 5- year bond, original issue NZD$ 150 million and February 2005 maturity
was reopened seven times and increased to NZD$ 1,272 million at end of June
2001.

The 12- year bond, original issue NZD$ 175 million and November 2011
maturity was reopened 20 times and increased to NZD$ 2,871 million at end of
May 2001. Norway Number: 5

Terms: 1 to 11 years Norway normally issues a new domestic bond
approximately every 2 years that

matures after 11 years. Bonds with remaining maturity less than 1 year are
no longer regarded as benchmarks. Sweden Number: 12

Terms: 2 to 15 years These securities are offered in several tranches during
the whole term of the bonds,

until they lose their benchmark status 1 year before redemption. United
Kingdom Number: 3

Terms: 5, 10, and 30 years Nominal issuance in recent years has been solely
30- year gilts responding to strong

institutional demand. Sources: Data from study countries and the U. S.
Department of the Treasury and interviews with country officials.

In the study countries, creating new issues each time the government goes to
the debt market may result in small, less liquid issues. Consequently, some
of these countries establish new issues only when needed to provide
borrowing across the yield curve. Because these new issues generally are too
small to serve as benchmarks when they are issued, debt managers then add to
them when the government needs to borrow again in the future until they
reach benchmark status. This practice, called reopening, is used in all
study countries to increase the size of outstanding benchmark issues. By
contrast, while U. S. Treasury securities have been sufficient in size to be
considered benchmarks when issued, the U. S. Treasury has implemented a
program of regular reopenings to maintain their size.

Page 23 GAO- 02- 14 Debt Management

All study countries and the United States implemented debt management
strategies to increase concentration of new issuance into fewer, larger
issues. However, the number of outstanding issues differs markedly and
reflects historical differences. Benchmark issues represent a much larger
proportion of total outstanding issues in Australia, New Zealand, Norway,
and Sweden than they do in the United States and the United Kingdom. In New
Zealand and Norway all government borrowing is concentrated into benchmark
issues. According to an official in the United States, many of their fixed-
coupon nominal issues had benchmark size when they were issued and some
issues still retain benchmark size although they are not the most currently
traded issues. Other study countries had smaller original issues and
reopened the issues to create benchmarks. (See table 7.)

Table 7: Number of Outstanding Government Bond Issues as of August 2001
Country

Number of outstanding government fixed- coupon

nominal issues Of which: number of benchmarks

United States 148 3 Australia 19 12 New Zealand 8 8 Norway 5 5 Sweden 14 12
United Kingdom 51 3

Sources: Government publications and interviews with and data provided by
government officials.

Another reason the United States and the United Kingdom have more
outstanding issues is that they are the only two countries we studied that
have recently issued nominal debt maturing in 30 years. 17 Issuing such
long- term debt over several decades results in a large number of individual
issues outstanding at any given time. In addition, some of the study
countries began to concentrate outstanding debt into benchmark securities
earlier than the United States, and these study countries also use a wider
range of tools to accomplish this goal.

Three of the five study countries have reduced or eliminated issuance of
inflation- linked debt. These securities are a valuable tool for debt
managers because they expand the range of savings opportunities in the

17 The U. S. Treasury announced on October 31, 2001, that it was suspending
issuance of the 30- year nominal and inflation- indexed bonds.

Page 24 GAO- 02- 14 Debt Management

market, may produce cost savings for the government, and enhance the
credibility and conduct of monetary policy. Inflation- linked securities may
provide the government with lower- cost funding because investors receive
lower interest rates in return for protection against inflation. In return
for potentially lower costs, the government assumes the risk of unexpected
price increases and the government?s incentives to inflate are reduced.
Inflation- linked securities can be useful to policymakers interested in
damping inflation in the future. Inflation- linked securities have some
negative attributes as well- low participation and lower liquidity. These
qualities can decrease market efficiency and can increase the cost to the
government as the market charges an illiquidity premium. Of the five
countries we visited, Australia, Sweden, and the United Kingdom actively
issue inflation- linked securities, as does the United States. A Norwegian
official told us that, given the small size of Norway?s debt, diversifying
into inflation- linked securities would reduce the amount of nominal
benchmark bonds (which is close to the level needed to maintain acceptable
liquidity in each bond). A New Zealand official told us that New Zealand
stopped issuing inflation- linked securities because of lack of investor
interest and the cost of issuance relative to other alternatives.

Although the nations in our study were moving toward generally similar debt
portfolios, we would not expect to see convergence into identical portfolio
structures. A recent report from the World Bank stressed that there is no
single portfolio design appropriate for all countries. 18 Debt portfolios
must respond to national priorities and market conditions.

By selectively reducing the outstanding amount of particular securities,
debt buybacks are a powerful tool to manage liquidity or the average
maturity of outstanding debt. Debt buybacks can be used as an end in
themselves- to reduce outstanding debt- or as a way to allow the debt
management office to issue more new debt without increasing overall debt
levels. Thus, debt buybacks can be used in periods of budget deficits as
well as budget surpluses. Debt buybacks can be implemented in a number of
ways. They can be used alone or in tandem with new debt issuance. They also
can be completed with different degrees of transparency, regularity, and
access by investors. Every study nation has used buybacks

18 Sound Practice in Sovereign Debt Management, The World Bank, Financial
Products and Services Department, July 12, 2000. Debt Buybacks Are a

Flexible Tool

Page 25 GAO- 02- 14 Debt Management

at some point in the debt reduction process, although they have designed and
managed their programs differently from the United States.

The number of outstanding issues that are not benchmarks is one indicator of
the ?buyback potential? in each country. As shown earlier in table 7, the
United States has a larger number of nominal fixed- coupon government bond
issues than any of the five study countries, with 145 that are not benchmark
issues. The portfolio structures in the United States and the United Kingdom
show significantly more potential for buybacks than other study countries
when using this measure.

While all study nations have done debt buybacks, they generally use them
differently from the United States. The United States has used a program of
ongoing, regularly scheduled reverse auctions to buy back debt. In a reverse
auction, market participants submit offers and the government accepts the
most competitive offers. The study countries- except Norway- have done
reverse auction buybacks, but they are not a routine part of debt management
abroad. Recently some study nations used reverse auctions episodically- to
reduce debt levels using one- time large receipts from the sale of
government assets. In contrast, the United States holds reverse auctions
twice a month and uses them both to reduce debt levels and to manage average
maturity and market liquidity.

In the late 1990s, the U. S. Treasury had to devise strategies for managing
large, continuing surpluses. If U. S. debt managers had used cash surpluses
to reduce debt rollover without taking other steps, they would have faced
large changes in average maturity and liquidity that could have increased
the government?s cost of financing. Because a debt buyback program of
regular reverse auctions can operationally handle relatively large volumes
and because the U. S. Treasury values regularity and predictability, the
Treasury chose to implement a debt buyback program of regular reverse
auctions with advance announcements of the size and targeted issues.

In March 2000, the Treasury held the first in a series of reverse auctions
to repurchase outstanding debt before it matured. In May 2000, the United
States implemented a program of regularly scheduled reverse auctions. The
dates and amounts of the transactions and the maturity ranges being targeted
for repurchase are announced in advance. In calendar year 2000, the Treasury
completed 20 reverse auctions and bought back $30 billion (par value) in
bonds. The Treasury?s buybacks through the end of December 2000 targeted
bonds maturing from 2010 to 2027. In calendar year 2001, the Treasury has
announced quarterly buyback amounts for its reverse auctions. The Treasury
bought back $25 billion (par value) in The United States Buyback

Program

Page 26 GAO- 02- 14 Debt Management

bonds from January through August 2001. Because reverse auctions were
suspended for the month of September, the calendar year 2001 buyback level
is projected to be $34 billion (par value). While this is lower than the
earlier projection of $37 billion for 2001, it is still $4 billion higher
than in 2000. On October 31, 2001, the Treasury announced that regular
buybacks would continue through calendar year 2001. However, an official
noted that there will be no buybacks in January 2002 and that in February
2002 they will begin quarterly announcements as to whether the Treasury will
do buybacks over the next 3- month period and also the size of any planned
operations. Decisions will be based on three factors: (1) projections of the
federal government?s annual unified budget surplus or deficit, (2)
projections of the cash position for the 3- month period, and (3) analysis
of how best to minimize borrowing costs over time.

When the budget was in surplus, the Treasury bought back longer maturity,
off- the- run securities. As a result, the Treasury was able to avoid
lengthening the average maturity by about 2 months that would have occurred
from debt redemptions without a buyback program. The buybacks also enabled
the Treasury to issue new debt in liquid benchmarks favored by the market.

Buybacks have been a routine part of debt management in most of the study
countries. However, unlike the United States, the study nations generally
also used tools other than debt buybacks to manage liquidity and average
maturity/ duration of outstanding debt.

The study nations have used a variety of buyback tools and did not rely as
heavily on reverse auctions as has the United States. Reverse auctions were
used by some study countries in the 1980s primarily to buy back debt
denominated in foreign currencies. In recent years, reverse auctions have
been used episodically, generally in connection with large, one- time
revenues such as those from auctions of the communications spectrum or
privatization of a government enterprise. Debt buybacks abroad are not
always announced in advance, are not always open to all market participants,
or are not always reported until after they have been concluded.

Other countries? experience illustrates that buybacks are an important tool
but one that potentially can be costly. These nations have used several
strategies to mitigate this potentially increased cost. They include the
episodic rather than routine use of reverse auctions and the use of reverse
auctions in combination with other tools, such as open market repurchases,
to buy back debt. Debt Repurchases by Study

Nations

Page 27 GAO- 02- 14 Debt Management

Officials in Australia and Sweden reported that their experiences showed
that the cost of a debt buyback was related in part to how it was
implemented. Swedish officials told us that clear market communication is
essential, and Australian officials said that buying back debt through means
other than a reverse auction may lower costs to the government.

Australian officials told us they undertook reverse auctions in fiscal year
1988- 1989. However, officials told us that these were not very successful
operations. In contrast, Australian government officials and market analysts
told us that the costs of buybacks done recently in Australia were low and
explained this in part by the way the repurchases are made.

The RBA has conducted bond repurchases on behalf of the AOFM for several
years. From 1996 through 2000, the RBA repurchased A$ 21.3 billion in
outstanding bonds (total face value) prior to maturity. These repurchases
have been carried out both through the central bank?s open market operations
and through direct purchases in the secondary market. An RBA official said
that, although the RBA offsets these bond repurchases when calculating
needed monetary policy actions, the market actions are taken at different
times to emphasize their different purposes. The RBA has discretion as to
the timing and price of each bond repurchase, subject to guidance set by the
AOFM. Purchases are made without prior announcement but are reported by the
AOFM at the end of the month. 19 An RBA official said that the success of
these operations is a function in part of the liquidity of the bond and the
level of information about the operations themselves. Australian officials
regard this approach as one part of a long- term strategy to consolidate
government debt into fewer maturities and have been discussing other buyback
strategies for future implementation.

Unexpected changes in key information about the amount of debt repurchases
and a compressed time schedule marred Sweden?s buyback operations in 2000.
Sweden?s National Debt Office (SNDO) completed 14 debt repurchases of three
bond issues from May 23, 2000 through June 21, 2000. The total face value of
the repurchased bonds was SEK31.2 billion (including noncompetitive offers).
The buybacks were used to offset the revenues from the privatization of the
government- controlled

19 In contrast, the U. S. Treasury established transparent debt buybacks in
which primary bond dealers know in advance the total amount the Treasury is
committed to spend in each operation and the range of securities eligible
for repurchase.

Page 28 GAO- 02- 14 Debt Management

telecommunications group, Telia, and to allow the government to continue to
issue new securities in 2000. When the debt management office announced a
buyback of SEK55 billion, the prices of debt increased. One week later, when
revenues from the Telia sale were less than expected and the debt management
office reduced the buyback total, bond prices rose again. According to the
debt office?s annual report, these buybacks triggered a change in bond
prices that implied that the government paid from SEK250 million to SEK400
million more for the securities. Swedish government and market
representatives stated that clear communication with the market was
essential to a good outcome. The only choices available to SNDO officials at
the time were to use the receipts to buy back debt or to place the receipts
in the domestic banking system. In hindsight, SNDO officials said they would
have preferred to have authority to place the receipts in other government
securities for 2 to 3 months, but to do this would have required a change in
the law.

In fiscal year 2000- 2001, the United Kingdom?s Debt Management Office
planned to buy back debt worth ï¿½5.7 billion from the market using reverse
auctions supplemented by ?open window? purchases from investors with primary
dealers acting as intermediaries. Initial plans were to buy back a total of
ï¿½3.5 billion of which at least ï¿½2.5 billion was to be done using reverse
auctions. They devised this strategy to guard against the risk that buybacks
might become progressively more expensive as reverse auctions continued.

The Debt Management Office conducted six reverse auctions during fiscal year
2000- 2001, buying back ï¿½4.1 billion (cash) from six of seven offered bond
issues- three bond issues in the 2003 through 2005 maturity range and three
issues in the 2006 through 2008 maturity range. This was an increase from
the originally planned level because the financial surplus increased through
the year. Although they were concerned that the buybacks would get
expensive, officials reported that this did not happen. In June 2000, debt
managers added a small number of additional bonds to those for which it was
prepared to bid at market prices and bought back ï¿½1.6 billion in outstanding
debt using an ?open window.? There are no initial plans to continue the
reverse auction program in fiscal year 20012002, although it remains a
possibility if the financing requirement falls. The arrangements for open
window repurchases remain in force.

Some analysts in the United States and abroad believe that buybacks could
become more costly as the volume of debt securities dwindles, and
governments may have to pay higher prices to entice ?buy and hold? investors
to sell. If true, this would reduce the long- term potential of using

Page 29 GAO- 02- 14 Debt Management

debt buybacks for debt reduction. So far, according to Goldman Sachs, 20 the
Treasury has repurchased debt at near the market prices at the time the
offers were submitted.

Some debt management tools used regularly in other nations may hold promise
for the United States in times of budget surpluses or deficits. Other tools
may be difficult to implement in ways that are compatible with the U. S.
Treasury?s position of providing equal access for transactions.

All of the study countries have at some time provided an opportunity for
investors to offer government securities- regardless of time to maturity- to
the government that then has the option to repurchase them at prevailing
market prices. When this type of debt buyback is done, the government is
said to have an open window. Bondholders would be interested in this offer
if, because of market conditions or other reasons, they wanted to use their
funds differently. New Zealand used this approach in the early 1990s to
consolidate tranches of outstanding bond issues into benchmarks. A variation
of this approach is found in Australia, New Zealand, the United Kingdom, and
Sweden where investors may offer the government the opportunity to
repurchase any securities at market prices when they near maturity. These
programs act as both debt management and cash management tools- reducing
outstanding debt and refinancing risk and smoothing cash flows. As with a
reverse auction program, the government could choose which issues to
repurchase. While the amount of debt repurchased may be lower in an open
window program, these programs may provide a lower cost buyback because the
government can choose to buy when it believes market prices are
advantageous. Open window repurchases likely can be done more frequently
than reverse auctions and may have lower administrative costs. Open window
programs are used to complement reverse auction buybacks in Australia, New
Zealand, Sweden, and the United Kingdom.

Debt exchanges are used in three of the five study countries to promote
liquidity of benchmark securities by exchanging outstanding nonbenchmark
securities for newly issued, more liquid benchmark bonds. Exchange offers
are opportunities provided to bondholders to convert one debt security into
another at a ratio set by the debt management office.

20 Goldman Sachs? Fixed Income Weekly Market Outlook: United States, August
17, 2001, p. 5. Other Countries Have

Used Debt Management Tools Not Currently Used by the United States

Page 30 GAO- 02- 14 Debt Management

Exchange offers can be used in conjunction with an open window or be made
available periodically. Some have been kept open for 3 weeks from the date
of the initial announcement of the ratio to try to attract a wide pool of
participants. Exchange offers are voluntary and bondholders are free to
retain their existing debt security, although this issue is likely to become
less liquid and lose some of its value if the majority of other bondholders
choose to convert their holdings. For example, to enhance the liquidity of
its 5- year benchmark, the United Kingdom?s Debt Management Office in July
1998 exchanged ï¿½2.9 billion of the 11 ï¿½ percent Treasury bond of 2003- 07
into ï¿½3.4 billion of the 6 ï¿½ percent Treasury bond of 2003. Swedish debt
managers have regularly exchanged outstanding bonds within 1 year of
maturity for Treasury bills to maintain liquidity at the short end of the
yield curve. The U. S. Treasury now is studying the advisability and
feasibility of debt exchanges. 21

Switch auctions are used in the United Kingdom to build liquidity in
benchmark issues when debt managers want to obtain an amount of a debt issue
that is too large to be considered for a bond exchange offer. Switch
auctions are those in which the debt management office offers to buy a
certain amount of outstanding nonbenchmark securities in exchange for the
further issue of an amount of benchmark securities, with the exchange ratio
to be determined by the accepted offers. Switch auctions are similar to debt
exchanges in that older, nonbenchmark bonds are converted into benchmark
securities. Other than volume, the key difference is that in a debt exchange
the government directly sets the exchange ratio and in a switch auction it
does so indirectly by accepting or rejecting market offers. The United
Kingdom debt managers use switch auctions to accelerate the creation of new,
liquid benchmark securities. Investors choose to sell their securities to
the government because they have alternate uses for their capital. In three
operations in fiscal year 20002001, the Debt Management Office offered to
allow market makers to switch some existing off- the- run issues into new
benchmark issues. In these operations, the Debt Management Office purchased
older 8- percent Treasury securities maturing in 2015 and reopened a newer
4.25- percent Treasury security maturing in 2032. The three switch auctions
added ï¿½6.8 billion to the original issue, more than doubling its size in 1
year. An AOFM official told us that Australia may use switch auctions to

21 The U. S. Treasury used ?advance refundings? in the 1960s to exchange new
issues for outstanding debt.

Page 31 GAO- 02- 14 Debt Management

consolidate debt into fewer benchmarks. Switch auctions may provide another
tool for the U. S. Treasury to use in managing liquidity.

Some countries continue to hold debt they have bought back without canceling
it. For example, the AOFM does not always immediately cancel the securities
it repurchases. According to AOFM officials, they have not canceled long-
term debt bought back from the RBA. Rather, it is held until the securities
mature.

Other tools employed at times by some other nations may be difficult to use
in ways that are compatible with the values of transparency, predictability,
and equal access. For example, one- on- one offers to sell or buy debt
securities at market prices between the debt management office and
individual capital market participants (called ?taps? or ?reverse taps?) are
used in the United Kingdom and other study nations. Taps (or sales) have
been initiated by the Debt Management Office in the United Kingdom when
there is temporary excess demand in a particular security that does not
require a large auction. For example, in August 1998, the Debt Management
Office tapped ï¿½150 million of 4 3/ 8 percent inflation- linked debt maturing
in 2004. The United Kingdom has only tapped nominal bonds once, when in
August 1999 the Russian default saw a huge flight to quality. Norway used a
reverse tap in 1997 to buy back three bond issues. A Swedish debt manager
told us Sweden taps older issues to build liquidity. The United States sells
all marketable coupon securities only at regularly scheduled auctions. While
taps and reverse taps may be reported after the fact, the operations are
less transparent than open market operations, may not provide equal access,
and may not represent lowest cost to the government.

The U. S. Treasury does not currently use tools that expose the government
to credit risk- for example, debt swaps. While swaps may take a number of
forms, they generally involve the government taking a position on future
changes in interest rates or the prices of government securities. For
example, a government may swap fixed interest rate securities with another
party for variable interest rate securities. Debt swaps are used in
Australia, New Zealand, Sweden, and the United Kingdom. One outcome of using
swaps is that the government assumes additional risk not found with other
debt management tools. This credit risk comes from the possibility that the
other party may default. The Australian government uses interest rate and
foreign currency swaps to achieve desired portfolio exposures. Australia
does not borrow in overseas markets, but conducts exchange rate swaps to
hedge against the possibility of changes in the value of the Australian
dollar against foreign currencies. The Australian

Page 32 GAO- 02- 14 Debt Management

government also swaps out of fixed rate bonds into variable rate bonds on a
portfolio basis to hedge against changes in interest rates. Sweden also used
swaps as an alternative to direct borrowing in foreign currency. Sweden
issues bonds in krona and makes a swap agreement in which the government
pays foreign interest and receives payment in krona equal to the payment
requirement for krona bonds. This lowers the cost of borrowing and improves
liquidity in the domestic government securities market. In fiscal year 1999-
2000, the United Kingdom planned to issue ï¿½2.5 billion in domestic currency
government bonds, investing the proceeds in high- grade foreign currency
assets using cross- currency swaps to hedge the currency risk.

Each of the five study countries acquired financial assets during times of
budget surpluses. No single model of asset accumulation is followed in all
countries. Each country holding assets selected methods and asset types to
respond to its need at the time.

The sustainability of budget surpluses is one factor that influences
governments? choices to invest in longer- term, perhaps riskier, financial
assets. Norway?s main goal was to accumulate financial assets to address
long- term fiscal and economic concerns resulting primarily from an aging
population and declining petroleum revenues. Norway, with its projections of
substantial receipts from oil activities in the medium term, has chosen to
build an investment portfolio of foreign currency assets, sovereign and
international institution debt, and foreign equities. Norway decided to
continue to issue debt to maintain a government debt market that would
facilitate future borrowing when needed and to strengthen its domestic
capital market.

Short- term investments appealed to nations like Australia, Sweden, New
Zealand, and the United Kingdom, which have not had large, sustained
surpluses. Australia would not expect large, persistent surpluses because
its fiscal goal is to balance the budget on average over the economic cycle.
Australia has invested its surplus in interest- bearing deposits at the
central bank. Short- term increases in cash deposits provide flexibility to
policymakers. Australia also has adopted guidelines for longer- term
investments. The United Kingdom initially invested the surplus in deposits
in the banking system and used the cash to reduce outstanding debt. New
Zealand and Sweden have chosen to use surpluses to reduce their borrowing
risks by reducing foreign currency- denominated debt. While New Zealand used
early budget surpluses to reduce foreign debt, it plans to use the 2001
surplus to invest in physical assets, increase student loans, Financial
Assets

Address Different National Needs

Page 33 GAO- 02- 14 Debt Management

and pre- fund for the first time its pay- as- you- go pension fund. Sweden
has used budget surpluses to reduce both foreign currency- denominated debt
and nominal domestic debt but not inflation- linked bonds. Nations may
accumulate financial assets in times of budget deficits as well. These could
include foreign currency reserves, pension fund assets, and student loans.

Addressing long- term national needs has been one of the principal drivers
behind Norway?s investment decisions on how to use its surpluses. The rapid
aging of the population in the 2000 through 2020 period will substantially
increase demand for services for the elderly. This fiscal pressure is
expected to coincide with a decline in petroleum revenues, as shown in
figure 3. In order to ensure that future fiscal resources would be available
when oil revenues decline, Norway?s central government has saved its budget
surplus since 1996 by building a substantial portfolio of foreign financial
securities.

Figure 3: Net Cash Flow From Petroleum Activities and Old Age and Disability
Expenditures, 1988 Through 2020

Sources: Statistics Norway and the Ministry of Finance.

Norway

0 2

4 6

8 10

12 14

16 18

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
13 14 15 16 17 18 19 20 Year Percentage of GDP

Net cash from petroleum Old age and disability pensions

Page 34 GAO- 02- 14 Debt Management

At the end of 2000, the Norwegian Government Petroleum Fund had about 60
percent of its investments in fixed income securities (including bank
deposits) and 40 percent of its investments in equities. The Fund?s
investments were distributed geographically as follows: Europe (52.5
percent), North America (29.2 percent), and Asia and Oceania (18.4 percent),
as shown in figure 4.

Figure 4: Norway?s Government Petroleum Fund Investments as of December 31,
2000, $386.5 Billion Norwegian Kroner

Note: Percentages add to 101 percent because of rounding. Source: Norwegian
Ministry of Finance.

Norway?s strategy of investing in foreign financial assets is designed to
help the Fund achieve four objectives. These are (1) serve as a budget
buffer on which the government can rely if there is a deficit, (2) avoid
pressures in the domestic economy if funds need to be withdrawn because of a
substantial budget deficit, (3) spread the Fund?s risk over different
countries and regions, and (4) help the Fund achieve a higher rate of return
than if the money were invested in Norway. Because of substantial oil
receipts and specific medium- term goals, Norway chose a more longterm
investment strategy than other nations and also accepted more risk in hopes
of higher returns. Through the program, an important part of the

Fixed income Europe Equities Europe Equities Asia

and Oceania Equities North America

Fixed income North America Fixed income -

Asia and Oceania 7%

11% 12% 18% 21% 32%

Page 35 GAO- 02- 14 Debt Management

petroleum wealth in the North Sea will have been converted to financial
assets.

One- time revenues from the sale of government assets contributed heavily to
budget surpluses. As an interim arrangement, the Commonwealth Government in
Australia invested these budget surpluses in term deposits at the RBA.
Unlike the U. S. Treasury?s deposits in Federal Reserve Banks, 22 the AOFM?s
accounts at the RBA earn interest. The interest rate on the RBA term
deposits averaged 5.48 percent during fiscal year 1999- 2000, which is paid
on maturity. 23 These term deposits have helped the government manage its
cash balances, as some deposits have matured at times when the government
otherwise would have needed to borrow from the market. In effect, these
assets reduce gross debt levels without repurchasing outstanding debt. The
AOFM manages the risk created by short- term debt and assets in accordance
with benchmarks for the portfolio as a whole.

The Australian government has adopted guidelines for long- term financial
investments that the Treasurer is authorized to make on behalf of the
Commonwealth. The AOFM has the Treasurer?s delegation under Section 39( 2)
of the Financial Management and Accountability Act to make investments,
which may include the following financial assets:

 high- quality credit assets of other governments,

 debt securities of Australian state governments,

 certificates of deposit of highly rated banks, and

 debt of international organizations of which Australia is a member. The
government of the United Kingdom accumulated short- term financial assets
with its recent budget surpluses and the one- time revenues from the auction
of mobile telephone licenses in April 2000. The cash was temporarily placed
in government accounts in the domestic banking system before being invested
in money market instruments. The United

22 Although balances in the Federal Reserve Account do not earn an explicit
rate of interest, most of the Federal Reserve?s earnings are transferred to
the Treasury. 23 The AOFM also maintained an operational bank account with
the RBA, which paid a money market call rate on the account?s daily balance.
This account paid 5.12 percent in fiscal year 1999- 2000. Australia

United Kingdom

Page 36 GAO- 02- 14 Debt Management

Kingdom?s National Audit Office reported that the ï¿½19.5 billion in spectrum
auction receipts was eventually used to reduce outstanding short- term debt
(ï¿½ 11.4 billion), reduce sales of government bonds (ï¿½ 2.2 billion), and
increase foreign currency reserves to offset some government debt
denominated in foreign currencies (ï¿½ 5.9 billion). In effect, the United
Kingdom is smoothing the issuance of government debt by continuing to issue
in times of surplus and running down its short- term investments as issuance
needs increase.

Within New Zealand?s overall debt reduction efforts, the government gave
priority in 1994 to reducing its foreign currency debt. This objective was
achieved in late 1996 by a combination of cash obtained from budget
surpluses, sale of government assets, and higher domestic borrowing.

Since 1997 New Zealand has continued to largely eliminate its foreign
currency exchange risk by holding foreign currency assets equal to a
substantial portion of its foreign currency debt. The Government maintained
the liquidity in New Zealand?s domestic Government bond market by investing
the surplus in financial assets- predominantly student loans- and physical
assets. New Zealand?s 2001 budget projects surpluses to continue over its
forecast period that ends in fiscal year 2004- 2005. The New Zealand
government has decided to use the surplus to invest in physical assets,
refinance private sector housing and health debt, increase student loans,
and pre- fund for the first time its pay- as- you- go Superannuation (or
pension) Fund.

Sweden has chosen to use budget surpluses to reduce its borrowing risks by
reducing foreign currency- denominated debt. Sweden has paid down foreign
currency debt and nominal domestic debt, but not inflation- linked bonds.

While it is not directly related to a discussion of using budget surpluses
to acquire financial assets, the Swedish National Pension Insurance Fund, or
AP funds, provides an interesting model for how a government may choose to
hold assets. Recent reforms in Sweden?s pension system, and resulting asset
shifts between the AP funds and the government, have affected debt
management. Like the Social Security trust funds in the United States, the
AP funds are part of the unified budget total but are considered outside the
portion of the budget subject to budget controls. The AP funds hold most of
Sweden?s financial assets, as shown in table 8. New Zealand

Sweden

Page 37 GAO- 02- 14 Debt Management

These assets include cash, government bonds, mortgage bonds, and domestic
and international equities.

Table 8: Sweden?s Financial Net Position (SEK billion) 1999 2000

Central government Assets 414 439 Liabilities (1,374) (1,279)

Net financial wealth (960) (840)

National pension system Assets 752 801 Liabilities (8) (2)

Net financial wealth 744 799

Source: Swedish Ministry of Finance.

As part of a reform of the pension system, the AP funds transferred to the
government SEK245 billion of its cash, government bonds, and mortgage bonds
during the period from 1999 through 2001. The largest transfer, in January
2001, had a market value of SEK155 billion, and consisted of government
bonds for SEK85 billion and mortgage bonds for SEK70 billion. The transfer
of government bonds amounted to 10 percent of the outstanding debt of kronor
bonds at the end of December 2000, and approximately 5 percent of the total
government debt. The transfer of assets from the AP funds was done to
compensate the central government budget for some extra costs. Also, with
the new, more sustainable pension system the AP funds were considered to be
too large.

As government debt levels have fallen, four of the five central banks have
reduced their holdings of government bonds; however, most have held an
increasing percentage of total outstanding government debt. (See table 9.)

The U. S. Federal Reserve?s holdings of U. S. Treasury securities in its
portfolio in 2000 ranked higher than central banks in any of the study
nations. Sovereign debt represented 85 percent of the U. S. Federal
Reserve?s portfolio while it equaled only 5.8 percent of the Bank of
England?s portfolio. Central banks in all study countries except New Zealand
reduced the percentage of government securities in their portfolios. While
the U. S. Federal Reserve decreased the percentage of government bonds in
its portfolio in 1999, this percentage increased in 2000. Central bank
officials in the study countries told us they have expanded their
investments in other asset classes, such as state debt and Central Banks
Have

Responded to Lower Debt Levels

Page 38 GAO- 02- 14 Debt Management

government enterprises, at the same time. Central banks in some study
countries increased holdings of U. S. government corporation and federal
agency bonds, such as securities issued by the U. S. Government National
Mortgage Association (Ginnie Mae) and Fannie Mae.

Table 9: Central Banks? Ownership of Domestic Central Government Securities
Country (amounts)

Government securities as a percentage of central bank?s assets

Government securities owned by central bank, as percentage of total
government securities

United States (US$ billion) 1998 : 456.3 1999 : 483.7 2000 : 518.4

83.8 % 71.7 % 85.0 %

12.5 % 12.9 % 15.8 % Australia (AU$ billion) 1998 : 11.4 1999 : 9.3 2000 :
6.9

24.2 % 18.9 % 12.4 %

10.7 % 8.7 % 8.8 % New Zealand (NZ$ billion) 1998 : 2.1 1999 : 2.2 2000 :
2.4

19.4 % 18.6 % 24.6 %

5.4 % 5.9 % 6.5 % Norway (NOKbillion) 1998 : 9.8 1999 : 10.8 2000 : 13.5

5.1 % 4.4 % 4.5 %

3.8 % 4.2 % 4.7 % Sweden (SEKbillion) 1998 : 32.8 1999 : 28.9 2000 : 20.7

15.3 % 12.7 % 8.9 %

2.3 % 2.1 % 1.6 % United Kingdom (ï¿½ billion) 1998 : ï¿½1.4 1999 : ï¿½1.3 2000 :
ï¿½1.4

10.0 % 6.6 % 5.8 %

0.46 % 0.46 % 0.48 %

Notes: Data as of end of fiscal year for each country. The 1999 figures
include the effects of preparations for the year 2000.

Sources: Central banks? annual reports and U. S. Treasury Bulletins.

During the recent budget surpluses in the United States, the U. S. Federal
Reserve has made several adjustments to its operations and has studied the
question of what alternative assets might replace some U. S. Treasury
securities in its portfolio. In July 2001, the Federal Reserve reported
that, for the near term, it was considering purchasing and holding
mortgagebacked securities from Ginnie Mae, 24 and engaging in repurchase

24 Mortgage- backed securities of Ginnie Mae are explicitly backed by the
full faith and credit of the U. S. government.

Page 39 GAO- 02- 14 Debt Management

agreements backed with foreign sovereign debt. The Federal Reserve is
studying other steps for possible implementation later. For many years,
Treasury securities have been used by the Federal Reserve both to add to its
permanent asset portfolio and for the conduct of monetary policy. The high
liquidity of Treasury securities allowed the New York Federal Reserve Bank
to conduct large buy- sell operations quickly and with little disruption to
capital markets. Treasury securities also allowed the Federal Reserve to
avoid credit risk in its portfolio and the potential for distorting the
allocation of credit to private entities.

The U. S. Federal Reserve made several adjustments to its operations in
response to actual and prospective reduction in Treasury securities. In 2000
the Federal Reserve started to limit its holdings of individual Treasury
bills to 35 percent of the total amount of each issue outstanding and of
longer- term securities declining to 15 percent. If the Federal Reserve had
not adopted these limits, its holdings of Treasury securities would have
been significantly higher than the increase of $34.7 billion that occurred
in 2000. The Federal Reserve satisfied its demand for longer- term reserves
by increasing its holdings of longer- term repurchase agreements. 25 The
Federal Reserve held an average of more than $15 billion of about 1month
repurchase agreements in 2000. The reappearance of deficits may prompt
reconsiderations of these actions in the near future.

The debt management policies and experiences of all five of the selected
industrial nations have followed generally similar paths to each other as
they moved from deficits to a period of surpluses. The experiences and
approaches of the five nations we studied have relevance to or provide
useful insights for debt management in the United States both in times of
budget deficits and surpluses.

Because of the current global economic slowdown, the United States and the
study countries face the prospect of budget deficits and increased borrowing
and debt levels. Several study countries experienced a similar fiscal
deterioration in the late 1980s and early 1990s.

25 In a repurchase agreement an entity, like a central bank, purchases
securities from a counterparty, like a bank, and simultaneously agrees to
sell them back on a specified future date. Implications and

Future Issues for the United States

All Study Countries and the United States Have Experienced Budget Deficits
and Surpluses

Page 40 GAO- 02- 14 Debt Management

The timing and size of the budget surpluses in the other nations we studied
have been different from projected surpluses in the United States. Four of
the study countries- Australia, Norway, Sweden, and the United Kingdom-
experienced a cycle of surplus to deficit then surplus again in 12 years
(1988 through 1999). For the United States there was a gap of nearly 30
years between its 1969 and 1998 unified budget surpluses.

Budget surpluses in the other nations, except Norway, had been possible
because of strong economic conditions and targets that focused on budget
balance (or small surplus). 26 All of the study countries, except Sweden,
reported lower gross debt- to- GDP and net debt- to- GDP ratios in 2000 than
in 1988. While Norway?s surpluses are large and projected to continue in the
medium term, the sources of the revenues are quite different. In Norway,
large revenues from oil activities are the main source of budget surpluses
that began in 1994. Although each of the study countries had a budget
surplus in 2000, shifts to deficits would influence debt management.

Managing declining debt as the budget is in surplus presents different
challenges than managing growing debt in a budget deficit. Maintaining
liquidity and market efficiency are more difficult in a period of budget
surpluses. The United States faces challenges similar in part to those faced
by study countries. However, the timing and size of its budget surplus may
be different and pose additional challenges for the United States. Managing
debt if the surplus is projected to be large and sustained would be
different from managing debt when budget projections are uncertain or fiscal
targets focus on budget balance (or a small surplus) over the economic
cycle.

In the late 1990s, the U. S. Treasury had to devise strategies to manage
large, continuing surpluses. If U. S. debt managers had used cash surpluses
to reduce debt rollover without taking other steps, they would have faced
large changes in average maturity and liquidity that could have increased
the government?s cost of financing. Because a debt buyback program of
regular reverse auctions can operationally handle relatively large volumes
and because the U. S. Treasury values regularity and predictability, the
Treasury chose to implement a debt buyback program of regular reverse

26 Targets in New Zealand, Sweden, and the United Kingdom focus on balance
(or a small surplus) across the economic cycle. Debt Management Choices

Page 41 GAO- 02- 14 Debt Management

auctions with advance announcements of the size and targeted issues. Other
nations? experiences suggest that less transparent buybacks may achieve
savings in the short term, but, over the long term, market prices may
incorporate a premium to compensate sellers for the lack of transparency.
The nations? experiences also suggest that, over time, buybacks may become
more costly as a government seeks to purchase more debt from the markets.
This suggests that the Treasury may consider supplementing buybacks with
other tools consistent with our values and debt management goals.

Some other debt management tools used regularly in other nations may hold
promise for the United States and be compatible with the values of
transparency, predictability, and equal access. Repurchasing debt within a
short time before it matures and open window repurchases are used abroad to
allow investors to offer securities to the government, which then has the
option to repurchase them at market rates. These programs act as both debt
management and cash management tools- reducing outstanding debt and
smoothing cash flows. As with a buyback program, the government could choose
which issues to repurchase. However, with these programs, both the cost of
the repurchases and the amount of debt repurchased may be lower than with
reverse auctions. Debt exchanges are used in three of the five study
countries to promote liquidity of benchmark securities by exchanging
outstanding debt securities for newly issued, more liquid benchmark
securities. The U. S. Treasury now is studying the advisability and
feasibility of debt exchanges. Switch auctions are used in the United
Kingdom when the amount of debt to be converted into newly issued securities
is too large to be appropriate for a debt exchange. Switch auctions also may
hold promise for the U. S. Treasury in supporting the creation of large
benchmark issues without increasing outstanding debt.

While the United States may experience budget deficits in the near term, the
U. S. Treasury still has the challenge of managing debt to achieve its goals
of ensuring that the government?s financing needs are met, minimizing long-
term cost, and promoting efficient capital markets. A number of the
techniques described above could be used to manage debt in times of deficits
as well as surpluses. Open windows are useful for both cash and debt
management purposes. Debt exchanges and switch auctions are used abroad to
promote liquidity of benchmark securities. However, they also could be used
to manage the maturity of outstanding debt and, indirectly, to minimize
long- term costs.

The budgetary surpluses of recent years that were achieved by fiscal
discipline and strong economic growth positioned us well to respond to

Page 42 GAO- 02- 14 Debt Management

both the events of September 11, 2001, and to the economic slowdown. While
some acknowledge that the budget may dip into deficit in the short term,
once the economy rebounds the budget is poised to return to surplus. For
example, the Senate and House Committees on the Budget, on a bipartisan
basis, endorsed a long- term fiscal policy to maintain surpluses equal to
the Social Security surplus. For the long- term, sustained budgetary
surpluses bolster the nation?s economic capacity to afford the burgeoning
costs of the baby boom retirement. Other nations have used debt reduction
and investment in financial assets as a way to achieve national goals and to
prepare for future demographic changes. Several study nations have
recognized potential governance issues associated with ownership of longer-
term assets. The United States might be faced with similar issues in the
future should we return to surpluses.

We are sending copies of this report to the Ranking Minority Member, House
Committee on Ways and Means; the Ranking Minority Member, Subcommittee on
Social Security, House Committee on Ways and Means; the Chairman, Senate
Committee on the Budget; the Chairmen and Ranking Minority Members, House
Committee on the Budget, Senate Committee on Finance, and House Committee on
Financial Services. We also are sending copies to the Chairman of the
Federal Reserve Board, the Secretary of the Treasury, Director of the
Congressional Budget Office, Director of the Office of Management and
Budget, and other interested parties. We also will make copies available to
others upon request.

If you or your staffs have any questions concerning this report, please
contact me at (202) 512- 9573. Key contributors to this assignment were
Thomas James, Jose Oyola, Carolyn Litsinger, Melinda Bowman, and Quan Thai.

Paul L. Posner Managing Director Federal Budget Issues, Strategic Issues

(935351)

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