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FYR Macedonia Policy-Based Guarantee:
Supporting the Development Agenda and
Strengthening Access to Capital Markets
Evgenij Najdov by the current turmoil originating from the Eurozone.
Output growth underperformed in response to the
Key Messages instability, affecting labor markets and business
sentiments and putting pressure on fiscal accounts.
The ongoing global economic turmoil is seriously
impeding client countries’ access to capital markets, Yet despite its small size, FYR Macedonia has
with relatively little regard for the fundamentals of
established a robust track record in prudent
the countries involved. Growing risk aversion
among investors has triggered a “flight-to-quality�? macroeconomic management and structural reforms.
that is affecting all but the safest assets (AAA-rated). As a result, FYR Macedonia appears to be one of the
few countries in the region that has some fiscal space
Small, open, and developing economies in Europe to respond to the global slowdown, and its
and Central Asia, including FYR Macedonia, are
macroeconomic policies remain supportive of medium-
being exceptionally hurt.
term fiscal and external sustainability. With fiscal
Despite its history of prudent macroeconomic deficits typically under 3 percent of GDP and a public
policies and progress on structural reforms, FYR debt of about 29 percent of GDP, FYR Macedonia has
Macedonia’s access to capital markets has been generally managed its public finances well.
virtually closed or available only on very
unfavorable terms. Nevertheless, despite sound fundamentals, the
Policy-Based Guarantees (PBG) help well- continued turmoil was constraining the ability of fiscal
performing clients with a track record of macro policy to adequately respond to the crisis. Moreover,
stability and structural reforms mitigate market the country’s access to international capital markets
access risks while advancing a country’s was severely limited, and with capital “flight to
development policy dialogue. PBGs also have the quality,�? its sovereign spreads had risen to high levels,
added benefit of catalyzing private capital flows by making the financing of the modest deficit levels very
alleviating critical risks. challenging. FYR Macedonia thus turned to the World
The PBG extended by the World Bank to FYR Bank for a Policy-Based Guarantee (PBG).
Macedonia ensured the country’s access to markets
in a virtually closed market environment and at FYR Macedonia Development Agenda
highly competitive terms.
On the economic front, FYR Macedonia has
Introduction demonstrated sound macroeconomic management and
improved structural and social policies. The country
FYR Macedonia is a small, open, and developing
restored macroeconomic stability early in the transition
economy closely integrated with the European Union
process and has maintained it for almost two decades.
(EU) through trade, capital flows, and migration.
The size of the public sector is relatively modest by
Consequently, growth performance in the country is
regional standards, and prudence in fiscal policies has
strongly affected by developments in the EU, including
ECA Knowledge Brief
resulted in low public debt levels and debt servicing functioning of the health sector’s Single Treasury
costs. At the same time, monetary policy has been Account as well as a program to improve the overall
responsive and adequately adjusted to avoid pressures efficiency and sustainability of the health sector are
over the pegged exchange rate. expected to gradually result in more effective health
sector spending.
The authorities also remain committed to reforms
toward a sustainable and robust recovery. There has In addition, social protection reforms have been
been a strong focus on improving the investment adopted to ensure that future growth is more inclusive,
climate and as a result, the country now ranks 22nd on by improving the targeting of social spending (through
the “Ease of Doing Business�? indicator of the World the roll-out of the Cash Benefits Management
Bank’s Doing Business rankings (a dramatic Information System) and increasing the spending on
improvement from 92nd in 2006). Efforts were also those targeted programs. Actions taken in the financial
undertaken to promote competition in many sectors sector contributed to a more independent and
(banking and telecommunications), strengthen accountable monetary authority through the adoption
property, creditor, and contract rights (judiciary of a new Central Bank law, and reduced risks through
reforms and cadastre), and attract foreign direct establishment of a Financial Stability Committee.
investments. Moreover, government authorities have
initiated a comprehensive reform agenda to build Access to Capital Markets
human resources, including by revamping the social
safety net, reforming the health system, and Despite the sound fundamentals and strong track
modernizing the education sector. record, FYR Macedonia faced significant market
access challenges in the aftermath of the 2008-09
Still, the 2008-09 global financial crisis and its global financial turmoil. Thus, even though Macedonia
aftermath adversely affected the economy of FYR was one of the few countries in the region with some
Macedonia. The economy weathered the crisis fiscal space to respond to the turmoil, securing
relatively well, however, and its recovery gained financing for its modest fiscal deficit at acceptable
momentum in the first half of 2011, when real GDP terms was nonetheless very difficult.
grew by about 6 percent year-on-year. However, the
renewed turmoil in the Eurozone since the second half Global investors became increasingly risk-averse,
of 2011, this time triggered by concerns regarding the reflecting widespread uncertainty about the direction
health of sovereign balance sheets, created strong of the financial market. The 2009 Eurobond was issued
headwinds for FYR Macedonia’s economy, and at very unfavorable terms (3.5 years and 9.875 percent
growth weakened to less than 1 percent in the second interest), and the attempt to tap the bond market again
half of 2011. Export demand suffered, business in 2010 was cancelled after the investor road show, as
sentiment fell, and the labor market deteriorated. emerging market spreads spiked due to the Greek crisis
and subsequent market turbulence. Risk perceptions in
In response, the Government’s policies were adjusted, the Eurozone impaired market access in general, and
giving a stronger focus on: i) reducing future risks by the impact for smaller and less well-known borrowers
strengthening the sustainability of public finances and such as FYR Macedonia was even more pronounced.
the resilience of the financial sector; ii) supporting This reflected some conditions inherent to the country
improved protection of the most vulnerable; and iii) – such as small and infrequent issuances, its
enhancing incentives for formal labor market vulnerability to external factors, and its proximity to
participation. Fiscal policy remained supportive of the troubled Eurozone countries – that were further
macroeconomic stability and also of the nascent constraining market access. For FYR Macedonia, the
growth recovery. At the same time, the de-linking of spread likely achievable at the market conditions
the free health insurance provision from administrative prevailing in late 2011 was in the range of 650-700
unemployment registration and the introduction of an basis points (bp) over the high-grade swap rate (about
income test for the provision of free health insurance 8-9 percent in aggregate), with a number of financial
increased incentives for formal labor market institutions indicating skepticism that an unenhanced
participation. Moreover, the adoption of bylaws for the transaction in euros could even be closed.
ECA Knowledge Brief
Box 1. Main Features of Policy-Based Guarantees (PBG): a Renewed Focus on an Existing Financing Instrument
The PBG is a World Bank financing instrument that has been available to client countries for a number of years. Despite this,
there were only a few PBGs processed prior to the recent global financial turmoil. During the last few years, there has been
renewed interest in this instrument and three countries — Serbia, FYR Macedonia, and Montenegro — have used it to
enhance their access to capital markets. Eligible borrowers of PBGs are sovereign governments that have shown a strong
macroeconomic management of their development agenda, as well as adequate progress toward those development goals.
More specifically, PBGs are offered to countries with: i) a strong track record of performance with a satisfactory structural,
social, and macroeconomic package; ii) a sustainable external financing plan; and iii) a coherent borrowing strategy that
enables the client to establish itself as a borrower in its own name without a guarantee over the medium term.
A PBG can cover part of debt service payments (principal and/or interest) and its structure and coverage can be determined
flexibly on a case-by-case basis, to the extent that commercial lenders share the borrower’s credit risk in a meaningful
manner and allow the extension of debt maturity and/or lower interest rate costs. The Bank charges a front-end fee (a one-
time fee of 0.25 percent of the amount of the guarantee) and a guarantee fee (0.5 percent per annum of the guarantee
exposure). Both fees are collected up front in the amount of the present value of the fee for the life of the guarantee.
Source: Policy Based Guarantees for IBRD countries, Summary Briefing.
At the same time, the FYR Macedonia domestic capital bolster growth and poverty reduction. At the same
market was very shallow. Following a period of time, the distinguishing feature of these guarantees is
intensive development between 2004 and 2009, the that they are used to catalyze private financial flows by
government issued securities (Treasury bills and mitigating critical risk factors. In this way, by using
bonds) portfolio became largely consolidated into three PBGs, the countries benefit not only from the
and six-month Treasury bills by 2011, reflecting development program supported by the project, but
increased market uncertainty and a desire to reduce also from improved market access terms as well as the
interest expenditures as pressures on the budget establishment of relations with private investors.
emerged.
Processing a PBG requires closer cooperation between
PBG: Ensuring Access to Capital Markets a larger number of stakeholders than is the case with a
DPL. In addition to the regular policy-level discussion
FYR Macedonia turned to the World Bank looking for with the client, it is important to closely involve the
an instrument that would support the country’s client’s public debt management authority in the
response to the turmoil and its development agenda, design of the PBG instrument.
and also provide sufficient resources to compensate for
the severely restricted access to market sources of Given the relatively limited experience of small and
financing. The PBG extended by the World Bank in developing countries such as FYR Macedonia in
late 2011 managed to accomplish exactly that. The dealing with international money markets, the strong
World Bank responded rapidly by converting the FYR cooperation between the World Bank team and the
Macedonia Second Development Policy Loan (DPL2), Ministry of Finance was a very important factor to the
which was in preparation at the time of the request, success of the transaction. On the World Bank’s side,
into a stand-alone PBG. Within six months of the processing of the PBG required the close
receiving the request, FYR Macedonia received €130 involvement of the FYR Macedonian Treasury and the
million from private lenders at highly competitive Financial Service Unit in facilitating the dialogue with
terms and partially guaranteed by the International capital markets and designing the product.
Bank for Reconstruction and Development (IBRD).
In the end, the operation returned the following major
Similar to Development Policy Loans (DPLs), the benefits to the client government:
World Bank’s PBGs are offered for general budget Improved market access, by enabling it to tap
support and to boost government programs designed to funding from the international bank loan market,
ECA Knowledge Brief
Box 2. PBG to FYR Macedonia Resulted in Substantially Improved Commercial Borrowing Terms
Following FYR Macedonia’s recent difficulties in accessing the market, the PBG allowed the country to borrow with a five-
year maturity, or about 50 percent longer tenor than was achieved through the previous market borrowing (3.5 years). In
addition, the terms of the borrowing were significantly below the rates FYR Macedonia received in 2009, as well as the
rates available in the prevailing volatile market. Including the arrangement and IBRD guarantee fees, the loan was extended
at about 4.3 percent, well below the 8-9 percent rate that FYR Macedonia would have been expected to pay in the absence
of a guarantee and assuming that access was restored. The budgetary savings from this are estimated to be roughly €25
million, or about 0.3 percent of GDP.
which it had not done before. Compared to a traditional DPL, the PBG proved to be
Expanded the investor base, by catalyzing new a more efficient instrument in the specific
interest among large foreign banks and financial circumstances of FYR Macedonia. With the country’s
institutions that previously had little or no exposure exposure to (the amount lent by) the World Bank
to the country. close to the maximum amount, the World Bank was
Diversified the country’s sources of financing. unable to provide the amount of financing the country
Leveraged the World Bank’s capital and helped needed, and other sources of external funding
FYR Macedonia increase the amount borrowed essentially dried up. Benefiting from the 4:1 exposure
from the IBRD. The PBG guaranteed only a partial treatment temporarily granted for guarantees, the
amount of the principal (around 65 percent of all World Bank was able to convert a €25 million DPL
debt service), allowing FYR Macedonia to issue a ultimately into a €130 million loan from private
relatively sizable commercial loan of €130 million lenders for the country. Additionally, with a five-year
(out of which €100 million is guaranteed by the maturity of the loan and guarantee, the IBRD capital is
IBRD). Structured in this way, the PBG-supported being recycled more quickly than would be the case
borrowing covered almost half of the financing with the longer maturity of the DPL, making resources
needs of the budget in 2012. available sooner for other development initiatives.
Improved borrowing terms, including longer tenor
The World Bank’s operational policy of a favorable
and lower rates.
treatment of guarantees against a country’s exposure
had a critical role in ensuring the success of the PBG in
Conclusions FYR Macedonia. In the absence of the 4:1 treatment
and with the prevailing market rates at the time, it
In the case of FYR Macedonia, the PBG was would have been almost impossible for the country to
successful in both supporting a robust reform program have obtained the same financial efficiency and
as well as mitigating the substantial external risks leverage that this operation provided.
facing the country due to the Eurozone turmoil. In the
market environment prevailing in late 2011, the About the Author
savings in borrowing terms were estimated at around Evgenij Najdov is a Senior Economist in the Poverty
300-400bp. More broadly, the PBG allowed the Reduction and Economic Management Sector Unit of
country to borrow on favorable terms at a time when the Europe and Central Asia Region of the World
commercial funding was virtually closed. Bank.
“ECA Knowledge Brief�? is a regular series of notes highlighting recent analyses, good practices, and lessons
learned from the development work program of the World Bank’s Europe and Central Asia Region
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