Managing Domestic Debt and Sovereign Foreign Reserves: Risk, Liquidity, and Strategic Allocation
DOI:
https://doi.org/10.21590/v3i2.03Keywords:
Domestic debt; foreign reserves; liquidity risk; sovereign risk; asset–liability management; reserve adequacy; debt sustainability; strategic allocation.Abstract
This paper analyzes the co-management of domestic debt and sovereign foreign reserves based on a risk-liquidity model which highlights the dependence between the two aspects as opposed to their independent maximization. It has a structural trade-off in which accumulation of reserves improves the buffers of liquidity-at the cost of fiscal cost as it is financed by domestic borrowing and costs less efficient when compared to shock resiliency. It draws on an analysis of the contribution of allocation policies in generating refinancing risk, market exposures, and the financial stability of the entire, based on the current literature in the same area, on its adequacy of reserves, and liquidity risk. The results reveal that liquidity is the binding constraint to connect assets and liability decisions and that its impacts are conveyed via debt structure, market, and institutional capacity. It is shown that the strategies that are not interacting (not combined) in the reserves and debt case give incomplete results as it is their combination with each other that gives the effective risk profile of the sovereign balance sheet. In this paper, the conclusion has been made that financial stability depends on coordination of asset-liability management whereby reserve buffers, and debt structures are balanced under an integrated risk framework model.
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