Treasury Press Release: Foreign Exchange Exposure in Commonwealth Debt Portfolio
22 February 2002
Department of The Treasury Press Release No.1 of 2002
There has been considerable coverage in today’s press concerning the foreign currency exposure within the Commonwealth’s debt portfolio. Unfortunately, much of that coverage reflects important misunderstandings of the approach taken to managing the Commonwealth’s debt portfolio.
The Commonwealth has maintained a foreign currency exposure as an element of the debt portfolio for many decades. Since the late 1980s, the foreign currency exposure has had a strategic benchmark target of around 10-15 per cent of the entire debt portfolio.
This small foreign exchange exposure was maintained as part of the integrated debt management strategy to meet long-term cost and risk objectives. The strategy was implemented after independent, specialist advice. Both JP Morgan (in 1989) and UBS (in 1996 and 1998) concluded that a small foreign currency exposure in the portfolio could assist in meeting portfolio cost and risk objectives.
In moving to the benchmark approach, the potential for a foreign exchange exposure to generate short-term volatility was accepted. However, the analysis underpinning the approach indicated that savings in debt portfolio costs would be achieved over a long-term horizon. It is, therefore, utterly misleading to examine the foreign exchange element of the portfolio in isolation and on a year-to-year basis to assess the performance of the strategy.
Moreover, the use of the benchmark was a deliberate approach that focused on long-term cost and risk performance. Short-term speculative views on the currency have never influenced the management of the debt portfolio.
Cross-currency swaps have been used to meet the foreign currency benchmark target of 10-15 per cent for US dollar exposure since the early 1990s. This approach to obtain desired foreign currency exposure has consistently offered significant cost savings over the alternative of issuing new physical foreign currency debt offshore. It should also be recognised that Australia has not issued foreign currency debt since 1987 and has been reducing Commonwealth debt outstanding over the second half of the 1990s.
The strategy of maintaining a discretionary US dollar exposure in the debt portfolio was an effective tool in meeting long term objectives:
- Realised savings have averaged over $100 million per year since 1989 despite losses of around $200m over the two years to June 2001.
- In 2001-02 to date, the exposure has generated a realised gain of $43 million.
The market value of the swap portfolio changes over time. As the Commonwealth has used fiscal surpluses to retire debt and the $A-$US exchange rate has weakened this has placed upward pressure on the foreign currency share of the portfolio. However, the unrealised losses are a function of the foreign currency exposure itself, not of the fact that the share has gone above the 15 percent target range.
The Australian Office of Financial Management (AOFM) is currently using a staged process to review all elements of the present Commonwealth debt portfolio framework, including the desirability of certain discretionary exposures. A review of benchmark foreign currency exposure was completed in June 2001, with recommendations endorsed by the AOFM Advisory Board.
The review concluded that a long-term position of zero foreign currency exposure in the portfolio was now to be preferred in light of substantial changes in a number of factors that underpinned the original analysis. These factors include the significant reduction in Government debt achieved in recent years and the narrowing of spreads between Australian and US Government debt. A phased rundown of existing exposure has now commenced. This phase down of the exposure will be achieved over the course of several years, reflecting that the accumulation of the exposure was undertaken over a long period of time. This approach has received ministerial endorsement.
AOFM has managed the Commonwealth’s portfolio consistent with the policy in place at the time – the existence of unrealised losses on the foreign exchange component in no way reflects on AOFM management. The activities of AOFM have been, and continue to be, subject to external review, including by the Australian National Audit Office. An Advisory Board that includes private sector representatives oversees AOFM’s strategic direction and management operations. The AOFM also provides detailed reviews of portfolio management activities including foreign currency exposures in its Annual Reports; the most recent of which was released in October 2001.
Contacts: Treasury – Dr. Martin Parkinson, telephone 6263-3741 AOFM – Mr. Mike Allen, telephone 6263-1100
Last updated: 5 March 2014