Derivatives in Public Debt Management

./ TA!O PI.A Director) P&0 D0 in Mone% and Finance Dipartimento di Economia e Territorio) /niversit1 di Roma Tor !ergata gustavo0piga2uniroma*0it) 3330gustavopiga0it

Prepared for COMMITTEE ON ECONOMIC AFFAIR AND DE!E"OPMENT Over#indebtedness of tates$ a danger for democrac% and &uman rig&ts Meeting to be &eld in Paris 'Council of Europe Office( Monda%) *+ November *,-,

A Premise
I have stopped working on public debt management in 2002. Since then I have been working on public procurement economics. In recent months, after 9 years of silence, I have received as many phone calls (from journalists as I have had in !ovember 200", asking for interviews on derivatives and (public debt management . #he difference$ #his time I took up the phone.
2

A Caveat$ Are Derivatives More Debt4

No. #hey are a different type of debt. %ften a better one. 5es. If derivatives are entered into to window&dress public accounts. P0 0' (ut why was there a need to window&dress$ #he fi)ation with non continuous preferences on public deficit and debt over *+,, a -. unicum.
3

M% boo6s7 conclusions) -, %ears later

/#he0success0and0the0future0of0-1.0is, however,0threatened0not0only0by0the persistence0of0high0budgetary0imbalances,0 but also0by0the0lack0of0transparency0with0which0the0 process0of0reduction0in0these0imbalances0is carried0out.20(,iga,0200"
4

More in detail 0000

/(y closely e)amining derivative transactions b% sovereign borro3ers, this report has suggested that sufficient transparency in public accounts has not been achieved. In particular, we have shown with a true e)ample in 3hapter 4 how derivatives have been used by one large sovereign borrower to window&dress its public accounts. It is li6el% t&at t&is case is not an isolated episode and t&at some ot&er sovereign borro3ers &ave made use of derivatives to implement 3indo3#dressing strategies.2
5

ome t&ings never c&ange 0 0 0

8T&e first deficienc% has to do with the fact that disclosure regarding derivative activity by sovereign borrowers is e)tremely scarce, as e)plained in 3hapter 2. In the absence of disclosure by debt offices, monitoring by 5government shareholders6 (i.e., the ta)payers can onl% be 3ea6 at best) and this lack of disclosure makes debt offices less accountable.2
6

9 And some do '*,,:(

/#he second deficiency in reporting that has made window&dressing possible has to do 3it& t&e lac6 of a proper frame3or6 to record derivative transactions in national accounting. #his led us to suggest that the 1aastricht #reaty might have an additional endogenous effect in the euro 7one besides that of putting a ceiling on the government deficit' It mig&t reduce t&e transparenc% of national statistics. /
7

;&% s&ould 3e 3orr% 'still(4

/#here are several reasons to worry about this window&dressing activity through derivatives. First, 82

;&% s&ould 3e 3orr% 'still(4

/ econd, as most of these operations are carried out to postpone e)penditure, the cash cost of these operations might fall on subse9uent governments that were not in power at the time these operations were conducted. In turn, these subse9uent governments might ask national accountants and supranational monitoring institutions to revise past national accounting figures to cancel the effects of these window&dressing operations. #herefore, these 8 operations 8 introduce political tensions.2
9

;&% s&ould 3e 3orr% 'still(4

/T&ird,

the issue of transparency in government operations is now a key part of the policies recommended by supranational institutions to governments. 8 If these policies were perceived as such :ineffective;, they would immediately lose credibility in such countries.2 <nd what about regulation of derivative use in the private sector$
10

;&% s&ould 3e 3orr% 'still(4

8Fourt&) these operations have a negative impact on the nature of the relationship between governments and their (private counterparts 8 If a market maker has provided a government with advice on windowdressing, assistance with window&dressing operations or other inappropriate transactions, it implicates itself with the sovereign borrower. <ot& 6no3 somet&ing about t&e counterpart t&at mig&t &urt t&em if t&is activit% 3ere to be made public. =hile it is obvious that it is in their mutual interest not to reveal such activities, there is also the possibility that one of the two parties might be able to e=ert undue pressure on the other in future transactions.2
11

;&% s&ould 3e 3orr% 'still(4

/Finall%, window&dressing operations themselves will obviously come at a &ig&er cost to the debt office and the ta)payer than a regular transaction. #his is because the sovereign borrower will have to compensate the counterpart for e)posing it to reputation ris6.2

12

*,,/#he issue of window&dressing through derivatives is particularly important today in the -uropean .nion and especially within the euro 7one. <s long as accounting and deficit rules are to be disregarded (in substance if not in form , and as long as governments continue to ask important private financial institutions to keep private their knowledge of improper financial engineering, Europe7s politicians 3ill find it difficult to convince t&eir electorates of t&e importance of greater European integration.2

13

Democrac% and >uman Rig&ts4

government mig&t find it more convenient to dela% t&e stabili?ation program for political purposes 3&ile retaining t&e economic assistance of supranational institutions. < government could attempt to do so by 3indo3 #dressing public accounts and presenting these accounts as genuine. If successful, a government would obtain essential resources from those supranational institutions and would benefit from the private capital inflows that usually accompany the economic assistance programs of supranational institutions. In turn, this would further postpone any real program of economic stabili7ation, providing undeserved support to an inefficient 'and disingenuous( government.2
/A

14

Needed in t&e E/4 Reform

<ccess to Statistics. =hy still not possible$
/We have not seen the real documents, Walter Radermacher, head of the European Unions statistics agency Eurostat, said in a Sept. 2 interview in his Lu em!ourg office. ((loomberg, September >, 20"0 . -urostat first re9uested the contracts in ?ebruary. "#he European $entral %an& refused to disclose internal documents showing how 'reece used derivatives to hide its government de!t !ecause of the "acute ris& of roiling (sic) mar&ets, *resident +ean,$laude #richet said.2((loomberg, !ovember @, 20"0 . /#he information contained in the two documents would undermine the pu!lic confidence as regards the effective conduct of economic policy, #richet wrote in an %ct. 2" letter in which he rejected the appeal. -isclosure "!ears, in the current very vulnera!le mar&et environment, the su!stantial and acute ris& of adding to volatility and insta!ility.2

15

Needed in t&e E/4 Reform

<ccountability of Aegulators$ %f ,ublic .sers$ ?orbidding derivatives for public local entitities. ,ublishing all transactions with slight delay (+enmark . =histleblowing legislation$

16