NO.004

Debt Management

Commencing from 1988, under the then Labor Government, the Treasury instituted

cross-currency swaps to create a US$ exposure in Government borrowings. Because

the premium on Australian interest rates were high, the objective was to access

US interest rates in order to get long-run cost advantages.

The benchmark target exposure of 15 per cent was adopted in 1989 upon the recommendation

of JP Morgan.

Commencing in 1991 the Labor Government built up an additional A$80 billion

in Commonwealth debt which peaked at A$96 billion in 1996-1997. Since it was

elected in March 1996 the Coalition Government has not borrowed in net terms.

Its task has been to manage Labor’s debt down.

Commencing in 1997 the Coalition has repaid $57 billion of Labor debt to June

2001. Per head of population Labor’s Commonwealth debt of $5,240 has been reduced

to $2,023.

The build up in Government debt to $96 billion, and the operation of 15 per

cent benchmark meant a build up in cross currency swaps from zero in 1988 to

US$9 billion in 1997.

The Benchmark of 15 per cent which was first recommended by JP Morgan in 1989

was reviewed and endorsed by: –

– Union Bank of Switzerland (UBS) 1996

– BT, Carmichael Consulting, Coopers & Lybrand 1997

– UBS Warburg, Dillon Read 1998

The Benchmark was examined by the Australian National Audit Office (Report

No.14 of October 1999). ANAO did not recommend abandoning the benchmark, but

recommended re-examining it with the next management consultancy.

By late 2000 there were two factors which required reducing the size of the

foreign currency portfolio. The first was the Coalition policy of reducing Labor’s

debt. As the overall stock of debt decreased, the foreign currency exposure

needed to be reduced in order to avoid breaching the 15 per cent benchmark.

Second, the declining AUD/US exchange rate meant the $A value of the foreign

currency debt was increasing, even though there was no new foreign currency

debt being created.

Although the portfolio had not always mechanically met the benchmark target

the AOFM worked towards it until October 2000. At the request of the Governor

of the Reserve Bank, the then Treasury Secretary, Mr Ted Evans AC, on 17 October

2000 directed AOFM to maintain its foreign currency exposure on economic policy

grounds. This had the effect of breaching the benchmark.

In November 2000, while this direction was in force, the question of whether

the foreign currency exposure benchmark should be maintained was raised with

me for the first time. At the time the RBA requested a suspension of the benchmark.

The matter was also raised by the Governor with the Auditor-General. The request

was agreed by me on 6 December 2000. The AOFM was requested to review whether

there should be a benchmark or cross-currency swaps at all and report by June

2001.

The review of the benchmark was completed in June 2001 and in September 2001

I agreed to its findings. The review recommended there should be a zero exposure

to foreign currency and an orderly rundown over a medium to long-term horizon

to eliminate foreign currency exposure from the debt portfolio altogether.

A schedule was agreed between the AOFM, Treasury and the RBA and it has been

implemented since.

Let me re-iterate. The proportion of the portfolio swapped to foreign currency

rose above the 15 per cent benchmark in late 2000 not because new swaps were

undertaken, but because:

• the overall amount of debt on issue was falling as the Government repaid

  Labor’s debt; and

• the fall in the AUD/US exchange rate raised the $A value of the swaps (which

  are fixed in $US terms).

The decision to allow the proportion of the debt portfolio swapped to foreign

currency to remain above 15 per cent took into account:

• macro policy considerations – substantial repayments of swaps at that time

  would have added to the weakness of an already sharply declining Australian

  dollar because swaps repayments would have required sales of $A and purchases

  of $US, which would have been contrary to Australia’s macro-economic policy

  interests; and

• commercial considerations – unwinding a big volume of swaps at a time when

  the exchange rate was at or close to an all-time low could lead to larger

  losses.

The debt that is being managed is Labor debt and it was managed according to

a policy implemented under the Labor Government until it was suspended at the

request of the Reserve Bank in late 2000 and ended by the current Government

from September 2001.

These transactions, whether realised or unrealised, are not reflected in the

Budget bottom line which is prepared on Government Financial Statistics (GFS)

basis. The GFS standard is administered by the Australian Bureau of Statistics

and is based on International Monetary Fund standards which classify net cash

settlements associated with swaps as financing items and not revenues or expenses.

Net cash flows and unrealized gains and losses are reflected in the operating

results of agencies under the accrual budgeting framework introduced by this

Government. In the case of the AOFM, the results are included in the Annual

Report.

4 March 2002