The Debt-Management Strategy

Total government debt decreased by 2.6% in 2007, from NIS 538 billion at the end of 2006 to NIS 524 billion at the end of 2007. This was the second consecutive nominal reduction in government debt, following a continual increase in debt volumes in 2001-2005.

Domestic debt increased from NIS 401 billion in 2006 to NIS 404 billion in 2007 (an increase of 0.8%), while external debt decreased from NIS 137 billion in 2006 to NIS 120 billion at the end of 2007 (a decrease of 12%).


Structure of the Government debt at the end 2007
(in NIS billions)


The debt-to-GDP ratio fell sharply in 2007, for the third consecutive year. This ratio is 79% by the end of 2007, versus 85% in 2006 and 94% in 2005. The debt-to-GDP ratio is one of the most important variables in determining a country's financial stability and credit rating. Continued growth of the Israeli economy along with a responsible fiscal policy will ensure the continued reduction of the debt-to-GDP ratio and reinforce the economy's financial stability and consequent credit rating.

Despite the consistent decrease in the debt-to-GDP ratio, the proportion of government debt in Israel remains among the highest in the Western world; principal and interest payments for the debt are a heavy burden on the state budget and on the Israeli economy in general. Interest expenses for government debt totaled NIS 34.5 billion in 2007, versus NIS 35.0 billion in 2006, a decrease of 1.4%.


Debt-to-GDP ratio and Government debt volume, 2001-2007
(NIS billions)

Broad government debt includes the debt of additional government agencies, such as local authorities.

Source: OECD Economic Outlook No. 82, Bank of Israel.

The Debt-Management Strategy 

The Government Debt Management policy objectives are:

1. Minimizing the cost of funding
   The most important goal of government debt management is to provide the government with stable financing at minimal cost while taking risks into account.
   
   
2. Reducing refinancing risks
   Refinancing risk is the risk that the debt will need to be refinanced at a particularly high cost due to inconvenient market conditions or that refinancing will not be possible at all. The Debt Management Unit has developed advanced models of which one of the main goals is to determine the funding mix that allows the most substantial reduction of these risks.
   
   
3. Reducing the volatility of principal and interest payments
   The Debt Management Unit works to reduce volatility of principal and interest payments in the State budget over time. For this purpose, when determining funding instruments, a great deal of weight is assigned to the maturity date of each bond, with the goal of smoothing the redemptions curve - smoothing over the years as well as smoothing within each year. In addition, the amendment to the State Loan Law passed by the Knesset in January 2005 allows early redemption of government bonds. This change will also assist the Debt Management Unit in smoothing the curve more successfully. Another step towards this goal is the launch of a short-range fixed-coupon bond (two years, at this stage) which will aid in managing the policy of reducing volatility in principal and interest payments.
   
   
4. Increasing the tradability and liquidity of domestic debt
   A bond holder's ability to sell the bonds easily, at a price close to the market price, at any given moment depends on the volume of trade that generally characterizes the bond. Increasing bonds' tradability and liquidity thus raises demand for them and reduces the government's funding costs. Therefore, in recent years, the Ministry of Finance has reduced the number of series traded and expanded their volume. In addition, starting in 2006, the entry of Primary Dealers into the government bond market has greatly increased the liquidity and tradability of government bonds.
   
   
5. Optimization of the debt structure
   • Establishing the domestic debt mix and the funding mix derived from it - in the past, domestic debt was almost entirely linked to the Consumer Price Index or to the U.S. dollar. In recent years, the Ministry of Finance has made efforts to increase the share of unlinked debt out of the overall tradable domestic debt in order to attain a more balanced mix of government debt. This has been achieved through increased funding in unlinked channels, subject to funding costs. At the end of 2003, the supply of unlinked tradable domestic debt exceeded the supply of linked (dollar and CPI) tradable debt for the first time and at the end of 2005 it stood at approximately 58% of tradable domestic debt. However, it still constituted just 27% of total government debt.
     
     
   • Establishing the desired external funding mix - currently, most of the external debt is denominated in U.S. dollars. The Ministry of Finance is acting to diversify the currency mix of the debt stock through issues in other currencies (such as the euro, Japanese yen, Canadian dollar and pound sterling) and to change the interest mix (fixed/floating) through floating-rate issues based on the LIBOR interest rate, both via the Israel Bonds Organization and via other funding tools (bank syndications, private placements and swap transactions).
     
     
6. Creating points of reference in domestic and foreign markets
   Government bonds issued on the domestic market serve as points of reference for the various investors, thereby facilitating the pricing of companies' bonds and supporting the development of the corporate bond market.
   The Ministry of Finance is working to create an unlinked (nominal) yield curve based on highly tradable bonds at various terms to maturity, a common practice in developed countries. The improvement in the structure of the curve is attained via issues of bonds at fixed terms to maturity (benchmarks) and issues of bonds at terms to maturity in which there are no unlinked tradable bonds.
   The Ministry of Finance is also working to create points of reference in international markets through the issuance of government bonds in these markets. The existence of tradable Israeli government bonds in international markets assists in pricing additional government issues as well as issues by Israeli companies (issuers from the private sector). In this context, it should be emphasized that despite the inexpensive funding available to the State of Israel in the form of U.S. government loan guarantees, the Debt Management Unit intends to continue to issue tradable bonds not backed by U.S. government guarantees on the international markets.
   
   
7. The government's credit rating
   The Government Debt Management Unit maintains ongoing ties with credit rating agencies in order to improve the government's credit rating. The government's credit rating in Israel and abroad serves as a reference point in determining the credit ratings of Israeli companies. A downgrading of the government's rating, especially for geopolitical reasons, would impair the funding capability of the business sector and of the banking sector. In 2006 and 2007, Israel's credit rating improved as all three international rating agencies Fitch, S&P and Moody's upgraded their outlook on Israel from Stable to Positive.
   
   
8. Increased transparency
   Disclosure and transparency are highly important to the reduction of investors' sense of uncertainty. Increased transparency and reduced uncertainty will encourage additional investors to invest in the government bond market and will lower the government's funding costs. Therefore, the Debt Management Unit is acting to increase transparency in the bond market. This activity includes advance publication of the monthly funding plan in government bonds and quarterly volumes of funding, the publication of a comprehensive annual report in Hebrew and in English and the operation of an Internet website in Hebrew and in English.