2022 Perspectives for the Public Sector

Citi Perspectives for the Public Sector 29 Conversely, the cost of hedging a SDR liability (e.g. SDR loan) against an emerging market currency will be the difference between the local currency interest rate and the (lower) SDR interest rate. Specifically, when hedging a longer-tenor SDR loan, the client is effectively paying the high yield of the local currency, while receiving the low yield of the SDR basket. The hedging cost resulting from this dynamic, alongside the limited liquidity of longer-tenor frontier currency swap markets, can discourage hedging of SDR liabilities. To this effect we share in continuation the summary of solutions that precisely address the issues of high carry cost and illiquidity associated with hedging emerging, especially frontier, currencies. They are applicable to hedging SDR-denominated liabilities, as for any other hard currency liability exposures. Conclusion The COVID-19 pandemic has resulted in an enormous wave of SDR- denominated support to emerging and developing countries, ranging from allocations by the IMF to grants and loans. Such transactions create different SDR exposures to the receiver’s benchmark currency (local currency or USD), which vary during different stages of an SDR support. While SDR — a basket of liquid currencies — is easily hedgeable from the markets risk perspective, the challenge may arise from the limited liquidity and/or higher yield of the other side of the hedge: the emerging (especially frontier) local currency, most notably in longer tenors. The potential solutions to these dilemmas range from partial hedges to proxy solutions. Hedging of an up-coming grant (or an upcoming SDR reserve conversion) is an easy decision on the other hand: these short-tenor hedges entail selling SDR at a higher price than its current price, while the illiquidity of the local currency is typically not an issue. Indeed, all of the recent SDR hedging transactions where we assisted our clients, involved this “side of the market”, i.e. clients hedging future SDR receipts against SDR devaluation. The COVID-19 pandemic has resulted in an enormous wave of SDR-denominated support to emerging and developing countries, ranging from allocations by the IMF to grants and loans. Such transactions create different SDR exposures to the receiver’s benchmark currency (local currency or USD), which vary during different stages of an SDR support.