World Bank Technical Assistance on improving Country Policy and Institutional Assessment (CPIA) Rating – External; Debt Mission to Uzbekistan, January 19 – February 2, 2009

1.Introduction

As a follow-up to the December 2008 CPIA mission to discuss the World Bank’s technical assistance on improving the CPIA ratings, a mission led by Mr. Ian Storkey, World Bank Consultant, was undertaken to focus on external debt management. The mission was conducted during a visit to Uzbekistan by the Consultant from January 19 to February 2, 2009.

This mission report sets out the meetings that were held, activities that were completed, and outputs that were delivered during the mission. It also sets out a brief assessment of the management of government external debt and external debt systems along with recommendations on external debt management in Uzbekistan and how to improve management of external debt.

The Consultant would like to acknowledge the help and support provided by Mr.Eskender Trushin and Mrs.Alla Abalova (translator) throughout the mission. He would also like to acknowledge the cooperation and willingness to engage in productive discussions and sharing of information by the officials in the External Assets and Liabilities Department of the Ministry of Finance – Mr.Shuhrat Vafaev, Head; Ms.Nilufar Nurkuzieva, Deputy Director; and Mr.Farrukh Tulyaganov, Head of Division.

At the introductory meeting with officials in the External Assets and Liabilities Department of the Ministry of Finance, two areas were identified for the mission to focus on:

  • development of analytical approach, criteria and thresholdsfor evaluation and forecasting of external debt in Uzbekistan
  • the software for external debt reporting and service used in the External Assets and Liabilities Department and what options are available to address the deficiencies of the existing software

2.Activities Completed and Outputs Delivered

Six meetings were held with officials in the External Assets and Liabilities Department:

  • Monday, January 19: Introductory meeting that identified the areas of focus for the mission and provided background on current debt and debt management practices in Uzbekistan. The Consultant identified the debt data that would be useful to undertake a basic assessment of government external debt in Uzbekistan. [Mr.Shuhrat Vafaev, Mr.Farrukh Tulyaganov]
  • Wednesday, January 21:Presentation on what a basic debt analysis would cover, the methodologies to use, the risk indicators and other outputs produced, and what would be most appropriate for Uzbekistan. A draft Debt Management Manual (version 1) was provided along with anote setting out debt management systems used by debt units in different countries. Information provided by UNCTAD on the Debt Management Financial and Analysis System (DMFAS) that was initially installed in Uzbekistan 1998 but was never fully implemented, was also provided to officials. [Mr.Shuhrat Vafaev, Ms.Nilufar Nurkuzieva, Mr.Farrukh Tulyaganov]
  • Monday, January 26: Presentation and discussion on the preliminary results of the assessment of government external debt of Uzbekistan. [Mr.Shuhrat Valaev, Mr.Farrukh Tulyaganov]
  • Wednesday, January 28:Interactive 5-hour session to discuss the different approaches and methodologies for valuing loans in the external debt portfolio and how this could be applied in the context of Uzbekistan. [Mr.Farrukh Tulyaganov]
  • Friday, January 30:Discussion on the draft Mission Report. [Mr.Shuhrat Valaev, Mr.Farrukh Tulyaganov]
  • Monday, February 2:Wrap-up meeting and presentation of Mission Report Final and other supporting documents. [Mr.Shuhrat Valaev, Mr.Farrukh Tulyaganov]

The activities completed and reports, documents and presentations delivered during the mission were:

  • Prepareda note on debt management systems used by debt units in different countries – refer “Debt Management Systems.doc”.
  • Provided information for the External Assets and Liabilities Department obtained from UNCTAD on DMFAS version 6 – refer “DMFAS 6 Overview word document.doc”, “DMFAS _BriefDescription_5_ENG.pdf” and“DMFAS Portal at glance.pdf”.
  • Completed a basic assessment of government external debt from a list of all external loans provided by the External Assets and Liabilities Department – refer “External Debt.xls”.
  • Prepared a draft Debt Management Manual to document the methodology and calculations that the External Assets and Liabilities Department can use to measure risk and debt sustainability. These measures can be used to undertake a risk assessment of the Government’s external debt portfolio, which can be used in the formulation of an annual debt strategy and borrowing plan in line with international sound practice – refer “Debt Management Manual v3.doc”.
  • Compiled a list of documents from government debt units and other relevant organizations that can be used by the External Assets and Liabilities Department for reference and understanding international sound practices – refer folder “Documents”.
  • Provided two presentations to officials in the External Assets and Liabilities Department – refer “Example of Debt Analysis.ppt” and “External Debt.xls”.
  • Completed the Mission Report which was presented to officials in the External Assets and Liabilities Department – refer “Mission Report Final.doc”.

3.Assessment

The following summarises the assessment undertaken by the Consultant under each of the two areas of focus for the mission.

3.1Development of Analytical Approach

To develop an analytical approach suitable for Uzbekistan, it was deemed necessary to undertake a basic assessment of government external debt from a list of all external loans provided by the External Assets and Liabilities Department. The assessment examined the currency and interest rate structure and identified loans that were considered to have an interest cost that was deemed to be above current borrowing costs. The output from the assessment is provided as graphs in the Annex. It should be noted that the assessment was undertaken on un-validated debt data so any conclusions and recommendations should be viewed with caution until the debt data is fully verified. In some case, it would be necessary to review the loan terms and conditions in the loan agreement to ensure that the assessment is correctly recording and assessing the loan. For example, it would be important to check the terms and conditions for loans contracted from the Islamic Development Bank due to the Islamic finance structure of these loans.

Nevertheless, there are some conclusions that can be drawn from the analysis:

  • The currency structure appears to be reasonably sound with around 53% denominated in USD, 27% in JPY and 20% in EUR and other currencies. The minor currencies account for less than 6% of total external debt. The question that External Assets and Liabilities Department faces is what should be the appropriate currency structure for external debt. There is no universal methodology to determine the structure as this varies significantly by country – refer to the currency composition column in the table set out in the Annex. What was recommended to officials from the External Assets and Liabilities Department during the mission was to examine the currency structure when incorporating both assets (particularly government on-lending) and liabilities as this may provide some natural hedging of foreign currency risk and more clearly identify where the government has a net foreign currency exposure.
  • The interest rate structure of 57% fixed and 43% floating is not unusual but based on international practices is over-weighted in floating rate debt – refer to the interest rate composition column in the table set out in the Annex. This is clearly an advantage in the current environment where short-term interest rates are at unprecedented low levels. Longer term, it would be advisable for the External Assets and Liabilities Department to determine what may be a desired fixed/floating interest rate mix, which may suggest following international practices of moving to a larger proportion of fixed rate debt.
  • The loan-by-loan examination of the interest rate (either fixed rate or spread over LIBOR) identified a few loans that could be deemed to be above current borrowing costs or “expensive”. Again, it would be important to check the loan documentation to ensure that the costs have been correctly recorded. Most of the expensive loans were contracted in the late 1990s and are due to mature in the next 2-3 years. These may not be worth seeking to prepay and/or refinance. For the longer maturity loans, it would be important for the External Assets and Liabilities Department to check the prepayment terms and conditions from the loan agreement and undertake a valuation of these loans to rank them according to the most expensive. If any of these loans can be prepaid, government funds that may be made available for debt repayment could be used to prepay the loans according to their ranking.

The presentations and discussions with officials from the External Assets and Liabilities Department identified the analytical approaches that can be used to set criteria and thresholdsfor evaluation and forecasting of external debt. The metrics, ratios, and indicators along with the formulae have been provided in the draft Debt Management Manual.

The assessment also recommends that the External Assets and Liabilities Department begin to develop a Medium Term Debt Strategy (MTDS) within the framework of the Government’s medium term fiscal, expenditure and budget framework, and for the strategy to be published either as part of the budget documents or as a stand-alone document. The MTDS is essentially a decision on the government’s preferred risk tolerance that will be updated annually to reflect changed circumstances (an iterative process).

The MTDS will effectively provide the authority to the External Assets and Liabilities Department to undertake debt issuance and other activities in accordance with the Government’s medium term fiscal, expenditure and budget framework. Therefore, the main objective of the MTDS will be to provide guidelines to External Assets and Liabilities Department on the type of borrowing, currency mix, ceiling on debt and conforming to the requirement for maintaining external debt at sustainable levels. Producing the MTDS on an annual basis is a necessary condition to obtain a PEFA assessment of 5 or 6.

The draft Debt Management Manual, which has been prepared to provide the basis to establish an analytical approach, criteria and thresholdsfor evaluation and forecasting of external debt in Uzbekistan, covers:

  • Medium Term Debt Strategy: the content and procedures for preparing and updating the strategy on an annual basis.
  • All-in-Cost: the methodologies to calculate the all-in-cost of a loan as a spread to 6-month US dollar LIBOR, which can be used to identify the most cost effective borrowing options.
  • Cost and Risk Measures: the measures that the External Assets and Liabilities Department can use to measure market risks (covering currency and interest rate risk), rollover or refinancing risk, and debt sustainability.
  • Risk Management Tools: the tools that the External Assets and Liabilities Department can use to identify, measure, monitor and mitigate the risk inherent in the Government’s external debt portfolio.
  • References: the publications and documents that the External Assets and Liabilities Department can refer to obtain more information or provide justification on the methodologies and calculations set out in the draft Debt Management Manual.

Building capacity and systems within the External Assets and Liabilities Department to undertake the analysis suggested is a necessary condition to obtain a Public Expenditure Financial Accountability (PEFA) assessment of 5 or 6.

3.2Debt Management Systems

The External Assets and Liabilities Department operate an “in-house” developed external debt system that is Oracle based. The system is effectively an external debt recording system that can generate a number of standard reports. However, feedback provided by officials indicates that there are significant deficiencies with the system and there is an urgent need for enhancements to reduce the level of manual processing and provide additional analytical and reporting functionality. The assessment identified three possible solutions to address these shortcomings:

  1. enhance the existing external debt system
  2. reactivated DMFAS and implement version 6
  3. acquire and install a new debt management system

Enhance the Existing External Debt System

Given that the current system is a complete and up-to-date database of government external debt and is familiar to staff in the External Assets and Liabilities Department, the option to develop additional functionality should be considered. The key issue is the knowledge and understanding of the developers and their response time in terms of developing new functionality and rectifying any system errors or problems. If the developers are responsive or contractual arrangements can be formalized to ensure that the developers deliver to agreed outputs and timelines, then this is probably the most effective option for the External Assets and Liabilities Department.

If the developers do not have the knowledge of financial instruments and debt management analytical functionality, this can be addressed by employing or contracting a Business Analyst who can act as a bridge between the users and the system developers, and can work with staff in the External Assets and Liabilities Department to develop the specification of requirements and ensure that the systems deliver to those requirements. Developing a business process map can also be useful to determine the processing and flow of information and areas where manual processing can be reduced through system enhancements.

It would also be important for the External Assets and Liabilities Department to ensure that a resource(s) is allocated, preferably on a full-time basis, to project manage the documentation of user requirements, preparation of technical specifications, liaison with the developers during the design and programming phase, system acceptance testing, and migration to the existing debt system. The management team in the External Assets and Liabilities Department should act as a “project steering committee” and set priorities for the phasing of development.

Reactivate DMFAS and Implement Version 6

According to an UNCTAD Annual Report, the Ministry of Finance previously used DMFAS (version 5.1) that was initiated in 1996 under a UNDP funded project. Installation and training took place in 1998 but the system was not retained and UNCTAD discontinued with implementation around that time. DMFAS could easily be re-installed at relatively low cost (no licence fee should be required for version5.3 given the existing licence from 1996) to provide basic functionality for recording and managing external debt. UNCTAD is to release version 6 in 2009 which will be web-enabled and provide greater functionality and enhanced analytical capability. As version 6 is still undergoing beta testing, it is not clear when this will be available for public release, how stable and error-free it will be, and how quickly UNCTAD can roll-out and support this new version. UNCTAD will charge a fee of US$50,000 for installation or upgrade to version 6. Installing version 5.3 and then upgrading to version 6 would involve additional time and effort.

The drawback of this option would be the time and resources required to formalize arrangements with UNCTAD, install and configure DMFAS (version 5.3 or version 6), train staff, input all the external debt data, and customize the system including reports to meet the requirements of the External Assets and Liabilities Department. This process could be expected to take around one year with a significant commitment of resources throughout the implementation process.

Acquire and Install a New Debt Management System

The option of acquiring a new system would require an extensive selection and implementation process that from experiences in other countries could take in excess of two years and cost in excess of US$2million. It is too early to be considering such an acquisition which would require considerable effort, skills and resources to select, implement and operate such a system. The functionality provided by this system would be more extensive than is required in the short-term by the External Assets and Liabilities Department. Moreover, most of these commercial systems would not provide much of the functionality required as they are designed for debt management offices that borrow in the domestic and international markets on commercial terms and use swaps and other derivatives to manage risk.

Conclusion

Therefore, it is considered that the best solution in the short-term is to enhance the existing external debt system using a structured project approach to define requirements, assign priorities, overseesystem development, system acceptance testing, and implementationof the new system developments.

Developing efficient systems within the External Assets and Liabilities Department to provide comprehensive debt statistics and analysis is a necessary condition to obtain a PEFA assessment of 5 or 6.

4.Recommendations

It is recommended that the External Assets and Liabilities Department:

  • use the draft Debt Management Manual to develop the basis to establish an analytical approach, criteria and thresholdsfor evaluation and forecasting of external debt in Uzbekistan
  • examine the currency structure when incorporating both assets (particularly government on-lending) and liabilities as this may provide some natural hedging of foreign currency risk and more clearly identify where the government has a net foreign currency exposure
  • determine what may be a desired fixed/floating interest rate mix, which may suggest following international practice of moving to a higher proportion of fixed rate debt
  • check the prepayment terms and conditions from the loan agreement and undertake a valuation of high-cost loans to rank them according to the most expensive – if any of these loans can be prepaid, government funds that may be made available for debt repayment could be used to prepay the loans according to their ranking
  • develop a Medium Term Debt Strategy (MTDS) within the framework of the Government’s medium term fiscal, expenditure and budget framework, and for the strategy to be published either as part of the budget documents or as a stand-alone document
  • enhance the existing external debt system using a structured project approach to define requirements, assign priorities, oversee system development, system acceptance testing, and implementation of the new system developments

It is also recommended that the immediate or short-term priorities include: