Annex 3: Debt Management Strategy for 2012–13

Purpose

The Debt Management Strategy sets out the Government of Canada’s objectives, strategy and plans for the management of its domestic and foreign debt, other financial liabilities and related assets. Borrowing activities support the ongoing refinancing of government debt coming to maturity, the execution of the budget plan and other financial operations of the Government, including investing in financial assets needed to establish a prudent liquidity position and borrowing on behalf of some Crown corporations.

The Financial Administration Act requires that the Government table in Parliament, prior to the start of the fiscal year, a report on the anticipated borrowing to be undertaken in the year ahead, including the purposes for which the money will be borrowed.

Highlights of the Federal Debt Management Strategy

• For 2012–13, net issuance of domestic marketable bonds is planned to be approximately $97 billion, up from $94 billion in 2011–12. At the end of 2012–13, the stock of marketable bonds is projected to be $481 billion.
• The foundation for this year’s debt program is the medium-term debt strategy announced in Budget 2011. However, with long-term interest rates at historic lows and a narrower differential between long- and short-term interest rates than in recent years, the debt strategy for 2012–13 includes a temporary increase in 10-year bond issuance.
• By the end of 2012–13, the treasury bill stock is projected to be $159 billion, about $4 billion lower than the year-end level for 2011–12. The treasury bill stock is projected to decline significantly in 2013–14 when mortgage securities purchased under the Insured Mortgage Purchase Program begin to mature.
• This year’s debt strategy, together with the changes to bond maturity dates announced as part of the medium-term debt strategy in Budget 2011 and the projected drop in the stock of treasury bills in 2013–14, will lead to a substantial decline in refinancing risk.
• The Government’s prudential liquidity management plan, presented in Budget 2011, is on track to achieve the desired $35-billion target increase in liquid holdings, comprising both domestic cash balances and foreign reserve assets, by the end of 2013–14. During the past year, foreign exchange reserves have increased by about $10 billion.
• In 2012–13, a number of changes will be made to the Retail Debt Program to improve the efficiency of the program and better align product offerings to the needs of today’s investors.

Medium-Term Debt Strategy

The modelling analysis supporting the debt management strategy for 2012–13 reflects a wide range of economic and interest rate scenarios drawn from historical experience. This analysis continues to suggest that portfolios weighted towards more short- and medium-term bonds improve the cost-risk characteristics of the debt structure.

The medium-term debt strategy includes a new prudential liquidity plan and four new bond maturity dates. Over time, the implementation of the strategy is expected to lead to a more balanced debt structure profile (Chart A3.1) and a reduced exposure to debt rollover risk. Further, the current yield curve differs substantially from past history, and long-term bond rates are at record low levels. Accordingly, some adjustments to the debt program for 2012–13, discussed in more detail below, are being implemented to reflect this interest rate environment, while maintaining a portfolio generally weighted towards more short- and medium-term bonds.

Taken together, these actions will help to insulate the Government’s financial position in case of future financial shocks. However, the transition to the new debt structure will take many years. During this transition period, the strategy will be monitored and, if necessary, adjusted to respond to changing circumstances.

Chart A3.1 Composition of Market Debt by Instrument Type By Original Term at Issuance

The share of bonds with original terms of 30 years is expected to increase from 18 per cent to 28 per cent of the stock of market debt over the next decade. At that time, the share of longer-term debt is expected to stabilize as long bonds issued in the 1990s begin to mature. Over the coming decade, the share of bonds with original terms of 10 years or more is projected to increase from about 37 per cent to around 45 per cent.

Refinancing risk is being prudently managed, as evidenced by key metrics. It is projected that the net annual refixing share of debt, which measures the proportion of all interest-bearing debt net of financial assets that matures or needs to be repriced within one year, will fluctuate between 33 and 36 per cent over the coming decade (Chart A3.2)

Chart A3.2 Projected Evolution of the Refixing Share of Interest-Bearing Debt as a Percentage of the Stock of Interest-Bearing Debt

It is also projected that the average term to maturity (ATM) of the market debt net of financial assets will gradually increase (Chart A3.3).

Chart A3.3 Projected Evolution of the ATM of the Marketable Debt Portfolio

Prudential Liquidity Management

The Government holds liquid financial assets in the form of domestic cash deposits and foreign exchange reserves to safeguard its ability to meet payment obligations in situations where normal access to funding markets may be disrupted or delayed. This also supports investor confidence in Canadian government debt. In Budget 2011, the Government announced its intention to increase its liquidity position. Once fully implemented, the Government’s overall liquidity levels will cover at least one month of the net projected cash flows, including coupon payments and debt refinancing needs.

During 2011–12, the Government took steps towards implementing the new liquidity plan. Liquid foreign exchange reserves have increased by about US$10 billion and exceed the minimum target level of 3 per cent of nominal gross domestic product established under the strategy. Government deposits held with financial institutions and the Bank of Canada are scheduled to grow to about $25 billion before the end of 2013–14.

Information on cash balances and foreign exchange assets is available in The Fiscal Monitor. Information on the management of Canada’s reserves held in the Exchange Fund Account is available in the Report on the Management of Canada’s Official International Reserves.

Planned Borrowing Activities for 2012–13

Borrowing Authority

For 2012–13, the aggregate borrowing limit that is being requested from the Governor in Council to meet Budget 2012 financial requirements and provide a margin for prudence will be $315 billion.

Actual borrowing and uses of funds compared with those forecast will be reported in the 2012–13 Debt Management Report, and detailed information on outcomes will be provided in the 2013 Public Accounts of Canada. Both documents will be tabled in Parliament in Fall 2013.

Sources of Borrowing

The aggregate principal amount of money required to be borrowed by the Government from financial markets in 2012–13 to finance Budget 2012 refinancing needs and other financial requirements is projected to be $268 billion.

Uses of Borrowing

Refinancing Needs

In 2012–13, refinancing needs are projected to be approximately $234 billion. The main source of refinancing needs during the year stems from the turnover of the treasury bill stock, which has a term to maturity of one year or less, and bonds that will mature in 2012–13. Other lesser amounts include retail debt (Canada Savings Bonds and Canada Premium Bonds) and foreign-currency-denominated bonds that will mature in 2012–13.

Financial Source/Requirement

The other main determinant of borrowing needs is the Government’s financial source or requirement. If the Government has a financial source, it can use the source for some of its refinancing needs. If it has a financial requirement, then it must meet that requirement along with its refinancing needs.

The financial source/requirement measures the difference between cash coming into the Government and cash going out. This measure is affected not only by the budgetary balance but also by the Government’s non-budgetary transactions.

The budgetary balance is presented on a full accrual basis of accounting, recording government liabilities and assets when they are incurred or acquired, regardless of when the cash is paid or received.

Non-budgetary transactions include changes in federal employee pension accounts; changes in non-financial assets; investing activities through loans, investments and advances (including loans to three Crown corporations—the Business Development Bank of Canada, Farm Credit Canada and Canada Mortgage and Housing Corporation); and other transactions (e.g. changes in other financial assets and liabilities, and foreign exchange activities).

For 2012–13, a budgetary deficit of $21 billion and a financial requirement of $23 billion are projected. The liquidity plan will increase borrowing in 2012–13 by about $8 billion. As the amount the Government plans to borrow is higher than the planned uses of borrowings, the year-end cash position is projected to increase by $10 billion (Table A3.1).

Actual borrowing for the year may differ from the forecast due to uncertainty associated with economic and fiscal projections, the timing of cash transactions and other factors, such as changes in foreign reserve needs and Crown borrowings.

Debt Management Strategy for 2012–13

Objectives

The fundamental objective of debt management is to raise stable and low-cost funding to meet the financial needs of the Government of Canada. An associated objective is to maintain a well-functioning market in Government of Canada securities, which helps to keep debt costs low and stable.

Raising Stable Low-Cost Funding

Achieving stable low-cost funding involves striking a balance between the cost and the risk associated with the debt structure.

Over the medium term, debt management decisions will be taken with a view to keeping debt costs low and maintaining refinancing risks at prudent levels, while reserving sufficient flexibility to adapt to changing circumstances.

Maintaining a Well-Functioning Government Securities Market

Having access to a well-functioning government securities market ensures that funding can be raised efficiently to meet the Government’s needs regardless of economic conditions. To support a liquid and well-functioning Government of Canada securities market, the Government strives to maintain transparent, regular and diversified borrowing programs.

Market Consultations

As in previous years, market participants were consulted periodically in 2011–12. Consultations held in November and December were focused on obtaining feedback regarding the effectiveness of the Government’s debt distribution framework to ensure that auction and intermediation processes continue to promote the debt strategy objectives of stable, low-cost funding and a well-functioning market for government securities. Additionally, market participants’ views were sought regarding trends affecting the Government of Canada securities market, the effectiveness of communications with market participants, and the changing profile of participants at auctions.

Further details on the subjects of discussion and the views expressed during the consultations can be found on the Bank of Canada website.

Adapting to Low Historic Interest Rates

Long-term interest rates have fallen to historically low levels and the differential between long-term and short-term interest rates is narrower than in recent years. Given this environment, it is advantageous and prudent for the Government to lock in additional long-term funding at these attractive rates.

Consequently, in 2012–13, the Government plans to increase issuance of 10-year bonds, reduce the stock of treasury bills and reduce issuance of short-term bonds compared to 2011–12. An additional 10-year bond auction will be conducted in the first quarter of 2012–13. In addition, regular bond buyback operations on a cash basis for the 10-year sector will be discontinued. This will contribute to a reduction in refinancing risk at a low cost, consistent with the key objectives of the medium-term debt strategy.

Composition of Market Debt

The stock of market debt increased by $117 billion between 2008–09 and 2011–12 (Table A3.2). However, since a significant proportion of market debt issued since 2008–09 was used to acquire interest-bearing investments, such as insured mortgage-backed securities through the Insured Mortgage Purchase Program (IMPP), the increase in the federal debt (accumulated deficit) is much lower. IMPP asset maturities are projected to be $42 billion in 2013–14, with approximately another $10 billion of assets maturing in 2014–15.

Bond Program

In 2012–13, the level of net bond issuance is planned to be about $97 billion, $3 billion higher than the $94 billion issued in 2011–12 (Table A3.3).

Maturity Dates and Benchmark Bond Target Range Sizes

The addition of four new maturity dates, implemented in 2011–12, has helped smooth the cash flow profile of upcoming maturities by reducing the size of June 1 and December 1 maturities and related coupon payments. The move to eight maturity dates also gives the debt program additional capacity to absorb potential increases in funding requirements.

For 2012–13, no additional changes to the bond maturity pattern and benchmark target range sizes are planned, thus preserving the structure implemented in 2011–12. Table A3.4 shows the projected bond maturity pattern and benchmark size ranges for 2012–13. These amounts do not include coupon payments.

Bond Auction Schedule

In 2012–13, there will be quarterly auctions of 2-, 3-, 5- and 10-year bonds and Real Return Bonds (RRBs). Three 30-year bond auctions will occur—one in each of the first, third and fourth quarters of 2012–13. The order of bond auctions within each quarter may be adjusted to support the borrowing program, and there may be multiple auctions of the same benchmarks in some quarters. The dates of each auction will continue to be announced through the Quarterly Bond Schedule that is published on the Bank of Canada website prior to the start of each quarter.

Bond Buyback Programs

Two types of bond buyback operations will be conducted in 2012–13: regular bond buybacks on a cash basis and on a switch basis, and cash management bond buybacks.

Regular Bond Buyback Operations

In 2011–12, regular bond buyback operations on a switch basis were used in the 2-year sector to facilitate the transition to new benchmark dates and in the 30-year sector to support liquidity in long bonds. Having successfully made the transition to the revised maturity structure, 2-year switch buybacks will cease to be used in 2012–13. A 30-year switch buyback operation will continue to be used in each quarter when no 30-year bond auction is planned. Additional 30-year switch buyback operations may also be considered.

Regular bond buyback operations on a cash basis, introduced as a temporary measure in 2011–12 to support gross long bond issuance in the 10- and 30-year sectors, will be discontinued for the 10-year sector in 2012–13. Cash bond buybacks will continue in the 30-year sector, subject to market conditions.

Cash Management Bond Buyback Operations

The cash management bond buyback program helps manage government cash requirements by reducing the high levels of cash balances needed ahead of large bond maturities. In light of the success of these operations in 2011–12 and taking into account feedback received during market consultations, weekly cash management bond buyback operations will be continued in 2012–13.

Treasury Bill Program

Bi-weekly issuance of 3-, 6- and 12-month maturities will be continued. By the end of 2012–13, the treasury bill stock is projected to be $159 billion, approximately $4 billion lower than the end-of-year level for 2011–12. The treasury bill stock is being held at this level so that it can be managed lower in order to absorb large cash inflows in 2013–14 related to asset maturities from the IMPP. This action is being taken in an effort to ensure that the treasury bill market continues to function well while keeping the size of the bond program roughly stable in 2013–14.

Cash management bills (i.e. short-dated treasury bills) help manage government cash requirements in an efficient manner. These instruments will also continue to be used in 2012–13.

Retail Debt Program

Almost 3 million Canadians hold Canada Savings Bonds (CSBs) or Canada Premium Bonds (CPBs). This past year, around 750,000 Canadians purchased bonds through the payroll savings option offered by more than 11,000 employers across Canada, while over 50,000 Canadians purchased bonds directly with cash. Investors repeatedly cite the safety and security of CSBs and CPBs as key attributes, with payroll deduction providing a convenient automatic savings option.

In 2012–13, a number of changes will be made to the Retail Debt Program to improve the efficiency of the program and better align product offerings to the needs of today’s investors.

Beginning with the Fall 2012 campaign, the Retail Debt Program will offer one product per sales channel (i.e. cash purchases and payroll deductions).

The CPB will continue to be sold through the cash channel by financial institutions, investment dealers and direct phone sales. CPBs will be enhanced with a cashability feature—they will be redeemable throughout the year with interest earned up to the last anniversary date of purchase. All outstanding CPBs will also benefit from this feature. The term to maturity of all new CPBs will be shortened to three years from ten years to align with their three-year step-up coupon pricing. This will also make the CPB’s term to maturity comparable with other retail products.

CSBs will be offered exclusively through the Payroll Savings Program, which is how the vast majority of CSBs are currently sold. The term to maturity of all new CSBs will also be shortened to three years to match the term of CPBs.

Further information on the Retail Debt Program is available on the Canada Savings Bonds website.

Foreign Currency Funding

The purpose of the Exchange Fund Account (EFA) is to aid in the control and protection of the external value of the Canadian dollar. Assets held in the EFA are managed to provide foreign currency liquidity, support market confidence, and promote orderly conditions for the Canadian dollar in the foreign exchange markets, if required. The prudential liquidity plan instituted in Budget 2011 calls for liquid foreign exchange reserves to be maintained at a level at or above 3 per cent of nominal gross domestic product.

The Government has access to a range of direct sources of funding for its foreign currency assets. These include a short-term US-dollar paper program, medium-term note issuance in various markets, international bond issues, purchases and sales of Canadian dollars in foreign exchange markets, and cross-currency swaps involving the exchange of domestic liabilities for foreign-currency-denominated liabilities. In February 2012, the Government issued a US$3-billion global bond to help meet the requirements of the prudential liquidity plan. This was Canada’s first US-dollar global bond issuance since September 2009.

The debt management strategy for 2012–13 assumes that all foreign liabilities maturing during the year will be refinanced. The actual amount of gross foreign currency funding may vary from this assumption, depending on market conditions and the Government’s foreign currency needs. The mix of funding sources used to finance the reserves in 2012–13 will depend on a number of considerations, including relative cost, market conditions, and the objective of maintaining a prudent foreign-currency-denominated debt maturity structure.

Further information on managing foreign currency reserves and funding objectives is provided in the Report on the Management of Canada’s Official International Reserves, which is available on the Department of Finance website.