Managing financial risks in Papua New Guinea : an optimal external debt portfolio

This report shows that Papua New Guinea's assets and liabilities may be poorly balanced for debt servicing. Thus, it could benefit substantially from active risk management, especially through better selection of the financial instruments in its debt portfolio. The authors present a model and estimate of an optiomal debt portfolio that allows for the use of commodity-linked bonds and conventional debt denominated in different currencies. They judge the hedging effectiveness of this portfolio by how much the variance of expected real import is reduced. The results indicate that commodity-linked bonds could play an important role in the country's risk management strategy. They also show that the country's external debt structure is not well balanced to hedge the foreign exchange risk from the existing composition of non-U.S. dollar-denominated liabilities. The debt portfolio contains an excess of Japanese yen - and Deutschemark - denominated liabilities, while liabilities denominated in British pounds are substantially underrepresented.