2024 Public Sector Perspectives

Selected global 10yr DM (yellow) and EM interest rates Japan (JPY) Switzerland (CHF) Euro (EUR) 0% 5% 10% 20% 25% 30% South Korea (KRW) United States (USD) Chile (CLP) Vietnam (VND) Indonesia (IDR) India (INR) Costa Rica (CRC) Mexico (MXN) Uruguay (UYU) Dominican Republic (DOP) Brazil (BRL) Colombia (COP) Kazakhstan (KZT) Uzbekistan (UZS) Egypt (EGP) Turkey (TRY) South Africa (ZAR) 0.2% 1.1% 2.9% 3.1% 4.3% 5.5% 5.6% 6.1% 7.0% 7.2% 9.8% 9.9% 10.0% 10.1% 10.2% 10.3% 13.9% 17.0% 21.4% 29.5% Interest Rate (%) After many years of broadly benign conditions, the macro environmental has decisively shifted in the post-pandemic period. Market volatility has increased and inflation, interest rates and commodity prices are significantly higher than in past years. While hard currency interest rates remain lower than those in emerging markets, some borrowers have learned painful lessons about the potential hazards of borrowing in a hard currency without putting in place strategies to de-risk their debt. Challenges in de-risking EM hard currency debt Risk Management – Derivatives Awareness and Expertise Bank Capital Cost and Credit Availability Derivatives Infrastructure (ISDA, Margining, Mark-to- Markets Accounting…) “Political Downside” Concerns High Carry Cost Low Liquidity De-risking mechanics Many MDBs recognize the risks that US dollar borrowing presents. To address the problem they may include embedded protection in their loan agreements via an elective conversion clause. This clause allows borrowers to request the lender to convert the loan into a local currency, or alternatively into other hard currencies such as EUR, JPY or CHF. Some elective conversion clauses may alter the interest rate; in certain cases the repayment of a loan may even be indexed to a basket of currencies or the value of a commodity. MDB debt de-risking mechanics MDB EMBorrower Hedging Derivative (Interest rate, local currency, commodity…) Modified Loan Repayments (e.g. Local Currency Indexation) USD Loan (New or Outstanding) USD Funding A flexible loan agreement with a conversion clause is a powerful instrument for borrowers. It allows them to obtain currency protection without the need to execute a derivative in the market, which requires them to have ISDA or CSA agreements, infrastructure to account for daily mark-to-market of a derivative, and to set aside liquidity for margining. De-dollarizing debt via a loan conversion mechanism also often results in lower credit and liquidity charges, as the swap is ultimately executed with the MDBs, which have good credit ratings and a competitive bidding process. Citi Perspectives for the Public Sector 59 58 De-Risking Emerging Market Hard Currency Debt