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San Jose February 9, 2007 Eduardo Borensztein

San Jose February 9, 2007 Eduardo Borensztein. Why Now? (when we have no crises). Precisely. Crises can be prevented (at least some) Favorable Markets. Possibility of improving debt management (local currency, new instruments)

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San Jose February 9, 2007 Eduardo Borensztein

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  1. San JoseFebruary 9, 2007Eduardo Borensztein

  2. Why Now?(when we have no crises) • Precisely. Crises can be prevented (at least some) • Favorable Markets. Possibility of improving debt management (local currency, new instruments) • Role of the IFIs is being reconsidered. New ideas to make global finance safer

  3. Outline • Stylized Facts • International Borrowing • Domestic Borrowing • Towards Safer Debt

  4. Outline • Stylized Facts • International Borrowing • Domestic Borrowing • Towards Safer Debt

  5. Public debt is not going away… Public Debt in Latin America and the Caribbean 120 80 Weighted average (right axis) Average (left axis) 70 Median (right axis) 100 Weighted average excluding Argentina (right axis) 60 80 50 60 40 30 40 20 20 10 0 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source : Authors' calculations based on Cowan et al. (2006). Note : Countries included: Argentina, Bahamas, Barbados, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Guyana, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Trinidad and Tobago, Uruguay, and Venezuela.

  6. ..and domestic debt is increasing Composition of Public Debt in Emerging Latin American Countries 70 Domestic debt External due to private creditors 60 External due to official creditors 50 40 30 20 10 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source : Authors' calculations based on Cowan et al. (2006). Note : Countries included: Argentina, Brazil, Chile, Colombia, Ecuador, El Salvador, Mexico, Panama, Peru, Uruguay, and Venezuela.

  7. Domestic Debt is also growing in the smaller markets

  8. Official borrowing remains important… Composition of Public External Debt in Latin American and Caribbean Countries with Limited Market Access 90 Bank loans 80 Bonded debt Other external 70 Bilateral Multilaterals 60 IMF 50 40 30 20 10 0 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source : Authors' calculations based on Cowan et al. (2006). Note : Countries included: Belize, Bolivia, Costa Rica, Guatemala, Guyana, Honduras, Jamaica, Nicaragua, and Paraguay.

  9. LAC debt levels are not very high… Public Debt around the World (weighted averages) SAS MNA IND SSA LAC 2001–2005 1996–2000 ECA 1991–1995 EAP 0 10 20 30 40 50 60 70 80 90 Source : Authors' calculations based on Jaimovich and Panizza (2006).

  10. …but debt structure matters more than debt level Public Debt and Sovereign Rating (1995–2005) Germany United Kingdom Switzerland France Austria Norway AAA Australia Spain Denmark Finland Canada United States Ireland Belgium New Zealand Luxembourg Portugal Japan Italy Sweden Netherlands ? AA Iceland Cyprus Saudi Arabia Malta Botswana Standard & Poor's sovereign rating Slovenia Israel Chile Czech Republic Korea A ? Qatar Investment grade line Bahamas Bahrain Barbados Malaysia Estonia Latvia Thailand China Hungary Poland Tunisia Oman Trinidad and Tobago South Africa Slovak Republic Egypt Lithuania BBB El Salvador Panama Mexico Croatia Colombia Kazakhstan Peru India Morocco Uruguay Costa Rica Guatemala Philippines BB ? Bulgaria Jordan Brazil Senegal Bolivia Russian Federation Mongolia Belize Benin Ghana Ukraine Papua New Guinea Grenada Paraguay Jamaica Venezuela Indonesia Turkey Argentina Pakistan B Ecuador 0 10 20 30 40 50 60 70 80 90 100 110 Public debt (percentage of GDP) Source : Jaimovich and Panizza (2006) and Standard & Poor's.

  11. Composition of Sovereign Debt, 2000-04 (in percent of GDP) Source: Faria and Tolosa, forthcoming IMF Occasional Paper

  12. , GROUP I Total PPG debt Total PPG debt Privately-held PPG debt Concessional Bank Other Private loans Bonds Official Nonconcessional GROUP II Total PPG debt Total PPG debt Privately-held PPG debt Private Nonconcessional Other Concessional Official Bank loans Group I consists of Costa Rica, Dominican Republic, El Salvador, Guatemala, and Panama. Group II includes Honduras and Nicaragua. Structure of External Debt 2001–04 Source: Faria and Tolosa, forthcoming IMF Occasional Paper

  13. Debt and Deficits • Discussions on how to control the growth public debt focus on the fiscal deficit • This is not surprising as: DEBT GROWTH = DEFICIT + SF • We expect SF (stock-flow reconciliation) to be a small adjustment • But this is not the case

  14. SF around the world The Stock- Flow Adjustment (percentage of GDP) Sub-Saharan Africa Latin America and the Caribbean Middle East and North Africa All Countries Eastern Europe and Central Asia East Asia and Pacific All observations Excluding outliers South Asia Advanced economies 0 1 2 3 4 5 6 7 8 9 10 Source : Campos, Jaimovich, and Panizza (2006).

  15. SF around the world Decomposition of Debt Growth in Different Regions of the World 15 Inflation GDP growth Percentage of GDP 0 Primary balance Interest expenditure Stock flow adjustment -15 SAS EAP IND Caribbean ECA MNA LA SSA Source : Campos, Jaimovich, and Panizza (2006).

  16. Outline • Facts • International Borrowing • Domestic Borrowing • Towards Safer Debt

  17. The emerging bond market today • Private international lending revived in the 1970s in the form of syndicated bank loans • This new wave of sovereign lending ended with the debt crisis of the 1980s • The Brady deals restarted the market for emerging market bonds and gave birth to a new asset class

  18. The International Market: Large but Volatile… • Capital flows to emerging markets tend to be volatile and procyclical • External factors explain a large share of this volatility • External debt is almost all in foreign currency

  19. Mark Twain on procyclicality A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.

  20. Sudden Stops and Contagion • Episodes of “market closure” and jump in spreads that reverse within 2 years • Spreads closely connected with global risk appetite • Effects extend to countries with little economic link to the original event • Uninformed investors may herd and/or chase an index

  21. The international market is large but volatile Emerging Markets and Latin American Spreads

  22. Has volatility abated? • Spreads are at record low levels; investors show appetite for local currency bonds • Weak or no contagion from Brazil’s election anxiety and Argentina’s and Turkey’s crises • Less cross correlation among EMBI assets

  23. Has Contagion Disappeared? Average Correlations among Sovereign Emerging Market Bonds and Industrial Sector Indices of US High Yield Bonds

  24. A new phase? • Policies are stronger: fiscal surpluses, reserve accumulation, current account surpluses • Debt structure changing to local currency • Investor base widening; EM assets more mainstream • Or, in fact, are spreads too low?

  25. 1400 1200 1000 800 600 400 200 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Predicted Spreads Actual Spreads Will the good times last? Spreads are lower than predicted

  26. Predicted Spreads would be lower with average external conditions 1400 1200 1000 800 600 400 200 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Spread for average External Conditions Actual Spreads

  27. Possibly important changes in global markets • Impact of the growth of hedge funds • Impact of the growth of credit derivatives • Is the appetite for local currency instruments permanent?

  28. Outline • Facts • International Borrowing • Domestic Borrowing • Towards Safer Debt

  29. The Domestic Markets: More Stable but Still Small • Natural habitat of local currency instruments • “Spare tire” for the banking system • High volatility in LA makes bank finance a very short-run proposition • “Captive audience” of domestic institutional investors (pension funds, banks)

  30. Domestic bond markets in LAC are growing but are still small Percentage of GDP, simple average

  31. 80 70 60 50 40 30 20 10 0 Latin America 1994 Latin America 2004 East Asia 1994 East Asia 2004 Advanced 1994 Advanced 2004 But in fact it is the whole financial sector that is small Bond Markets relative to Domestic Bank Credit Corporate issuers Financial institutions Governments

  32. Plausible Determinants of Bond Market Development • Scale of the market, in turn related to size of the economy and saving rates • Scale of firms that are potential issuers • Market liquidity • Institutional strength: creditor rights, transparency, etc. • Market microstructure

  33. Other Important Factors with Less Definite Effect • Large domestic government debt: market development or crowding out? • Well established banking system: competitor or complement?

  34. Scale of the MarketsCorporate bond market as a function of country size

  35. Scale of the Markets Market capitalization as a function of saving rates

  36. Scale of Firms Corporate Bond Market as a Function of Firm Size

  37. Investor Protection Source: IMF, Global Financial Stability Report (2005)

  38. Effects of Large Government Debt • Government bonds provide a reference yield curve • Larger markets are needed for an efficient microstructure • Crowding out?

  39. Interaction between government and private bond market Domestic Government Bonds and Corporate Bonds 0.04 Latin America 0.03 Other emerging markets Fitted values 0.02 0.01 Share of corporate bonds in total domestic credit to private sector 0 -0.01 -0.02 -0.03 -0.04 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 Share of domestic government bonds in total public debt

  40. Investor Surveys in Argentina, Brazil and Mexico Do you agree or disagree with the following statements? (1 = strongly agree,…, 5 = strongly disagree)

  41. Banks vs. Bonds • Conventional sequence: 1) Banks 2) Bond Markets 3) Equity Markets • But interest groups can affect this evolution, e.g. Banks can prevent markets from developing (Rajan-Zingales)

  42. Banks and Bonds: Substitutes or Complements? • Banks contribute to market infrastructure: bridge finance, distribution channels, primary dealer network. • Banks contribute to secondary-market liquidity • Banks often are major issuers of domestic bonds and structured securities • Rather than being a political force against markets, banks and bonds seem to be held back by the same reasons in Latin America

  43. Going Forward: New Investors, New Instruments • New investors needed. Savings are low and markets are small • Institutional investors, especially pension funds, are starting to provide volume (but not liquidity). • Foreign investors provide more liquidity (but also volatility). Less averse to long-term nominal instruments (see Mexico, Brazil). Capital account restrictions must be removed.

  44. Institutional Investors • Institutional investors have been growing and they can play a key role in developing a stable demand for local currency bonds • But they could become victim of their own success, especially at times of crisis

  45. Institutional Investors Assets of Mutual Funds and Pension Funds (percentage of GDP) 50 140 Emerging markets (left axis) 45 Latin America (left axis) 120 40 Advanced economies (right axis) 100 35 30 80 25 60 20 15 40 10 20 5 0 0 1997 1998 1999 2000 2001 2002 2003

  46. Institutional Investors Government Bonds as a Share of Pension Fund Assets Mexico Argentina Uruguay LAC Colombia Peru Chile Brazil Singapore Hungary Poland Bulgaria Other EM Czech Republic Slovenia Estonia Korea Thailand Austria Italy Netherlands IND Spain Canada United Kingdom United States Germany 0 10 20 30 40 50 60 70 80 90 100

  47. Institutional Investors Banks' Exposure to Public Sector, 2003–2005 (percentage of total domestic credit) Euro area Mature markets United States Argentina Mexico Brazil Latin American countries Colombia Peru Uruguay Chile 0 10 20 30 40 50 60

  48. International Investors • Saving is low in Latin America and this affects the size of bond markets • Institutional investors like pension funds do not provide liquidity • Foreign investors display less aversion to long-term local currency instruments. But less stability. Need to open capital accounts to some extent. • In Mexico, foreign investors hold more than 50% of the ten-year bond and more than 80% of the 20-year bond.

  49. Percent of Foreign Holdings of Domestic Bonds USA Uruguay Hungary Poland Mexico Turkey Argentina Malaysia Japan Brazil Thailand Peru Indonesia Korea Bulgaria 0 5 10 15 20 25 30 35 40 45 50 55 Sources: FMI (GFSR, 2005) y Takeuchi (“Study of Impediments…” 2005, asianbondsonline.adb.org)

  50. Going Forward: New Instruments • New Instruments: Asset Backed Securities (mortgages, receivables, consumer loans, commercial paper) • Less complicated enforcement of creditor rights (by recourse to collateral) • Can overcome firms’ small scale problem • Strong growth in Mexico, Brazil, Chile, Argentina, but from a very small base • Successful securitizations for working capital to SMEs Can structured instruments also help SMEs get long-term, investment finance?

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