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Developing Government Securities Market Framework and the case of Peru

Developing Government Securities Market Framework and the case of Peru. Finance Forum 2002 June 20, 2002 Clemente Del Valle FSD, World Bank Group. This Presentation will address the following questions:. The importance of the topic and recent efforts of WB/IMF to support this development

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Developing Government Securities Market Framework and the case of Peru

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  1. Developing Government Securities Market Frameworkand the case of Peru Finance Forum 2002 June 20, 2002 Clemente Del Valle FSD, World Bank Group

  2. This Presentation will address the following questions: • The importance of the topic and recent efforts of WB/IMF to support this development • A summary of the main analytical framework being used to better organize such a developmental process • How can the development of Peru’s govt bond market be better understood with this framework ? • What are the implications to policy makers for future market development ?

  3. Why is this topic important ? Capital markets • complement bank financing • contribute to the development of multi-layered financial systems. • Government bond markets • are the backbone of most fixed-income markets • provide a number of positive external effects for overall debt market development.

  4. Some external effects of government bond market development • Macro level:non-inflationary funding of budget deficit, smooth transmission of monetary policies • Micro level: stimulate development of financial infrastructure, products, and services • reduces exposure of portfolios to interest rates and exchange rates (derivatives).

  5. What is the current state of local debt markets ? % of total Composition of domestic debt, Sept. 2000 100 80 60 40 20 0 Italy China Brazil Japan France Mexico Germany Argentina Spain United States South Korea United Kingdom Public Sector Financial Institutions Corporate Source: BIS

  6. Domestic Markets in developing Countries remain substantially underdeveloped

  7. Recent Efforts to foster Government Bond Market Development The objective is to • provide a comprehensive vision. • emphasize medium- and long-term markets. • highlight linkages with other markets.

  8. Recent Efforts to foster Government Bond Market Development Disseminating activities ( with IMF and WBI) • LAC (Rio – June 2001),ECA( Istanbul March 2002), MENA(Tunisia June 2002). • Join forum with OECD (Washington March 2002) TA Programs • New TA debt management/GB markets program • Join TA missions with IMF (Egypt and Peru) • Dedicated TA work ( China, Korea, Thailand, Brazil, Peru)

  9. Macroeconomic Policy Issuer Investor Legal framework and infrastructure Intermediaries Money markets Level of financial sector development How can we understand Government Bond markets better?

  10. Level of financial sector development The Conceptual Framework Part 1: “The Necessary Environment” Macroeconomic policy

  11. PERU: Enabling environment • Macroeconomic stability indicated by low inflation and current account deficit, built by prudent monetary and fiscal policy • Yet, savings and transactions dollarized • Financial system concentrated and fragmented • Small local currency institutional assets

  12. PERU: Government Bond Market • S 500 million and S 700 million worth of government securities underwritten in 2000 and 2001 respectively • S 1.8 billion govt securities being Dutch auctioned in 2002 • Primary market: 2 fixed interest rate securities, with 2 & 3 year maturities. All dematerialized • 2 electronic transaction platforms for FX & securities trades. • RTGS being introduced, will connect to private sector depository

  13. LAC: Fairly large markets moderately liquid

  14. LAC: Varied instrument mix, sizeable medium and long-term maturities

  15. Institutional framework and infrastructure Money market Conceptual Framework Part 2:“Basic Pillars and Prerequisites”

  16. Three Pillars of the Markets: II III I • Market Infrastructure • A secure and efficient clearing and settlement system • Reduction of counterparty risk (DvP) • An efficient depository system • Money market and monetary policy • Monetary policy through Open Market Operations • Incentives for liquidity management among banks (interbank activity) • A limited central bank credit facility for banks • Sound government cash management Institutional framework • Separation of fiscal and monetary policy • Clear mandates and governance of debt management • Coordination among supervisors

  17. PERU: Institutional and Regulatory framework • Clear mandate given to the MEF on public debt management • Current arrangement of MEF/Banco Nacion lacks of transparency and real incentives for a better cash management • Conasev’s dual role of supervising and promoting market needs to be clarified • separation between banking & fund management, and proprietary and agency trading has been eroded • Improve rules to enhance independence of commissioners • Multiple regulators and limited coordination by MEF has been the source inconsistence in regulation ( e.g.mark to market)

  18. PERU: Limited development of Money Markets • Mostly unsecured overnight interbank markets • Very limited development of the term markets. BCRP does not operate beyond the overnight • MEF’s unexpected resort to inter-bank financing via Banco Nacion reduces capacity of BCRP to be flexible • Interbank rate hampered by limited availability of securities for O/N repos • Standard repo contract, trading conventions, efficient private clearing needed

  19. Issuer Conceptual Framework Part 3:The Issuer

  20. The Issuer should... • Be credible and have a medium- and long-term vision. • Have a strategy, that promotes development of the secondary market. • Be willing to operate through the markets and to accept the prices set by them. • Facilitate transparency (prompt information). • Build institutional capacity in the debt office ( market operations, risk management).

  21. PERU as issuer: Debt management strategy • There is no medium term debt management strategy • Domestic debt markets are still view as a residual source • High exposure of the portfolio to F/X and to refinancing risk . Limited diversification. • Current short term preference due to • low credibility of economic policy, recent hyperinflation, • dollarized economy, illiquid markets along the yield curve • There is limited internal capacity to interact with the market and design a medium term strategy.

  22. Investor Conceptual Framework Part 4:The Investors

  23. The Investor base should... • Be diversified to promote liquidity along the maturity structure. • Contain domestic and foreign institutional investors as well as individual investors. Investment funds and mutual funds are often the fastest-growing market segment and should therefore be a focus of reforms.

  24. Conceptual Framework Part 5:Intermediaries and Markets Primary market Issuer Investor Secondary market Intermediaries

  25. Primary market: Distribution channels • A strengthened capacity to interact with markets and market participants is necessary. • A system of primary dealers can facilitate the transition to “financing by the market.” • Direct distribution is a limited channel but has important externalities. • Auctions are often most cost-effective & transparent.

  26. Secondary market: a demanding challenge • Ensure incentives that encourage transactions. • investor diversification • a standard, fungible product • intermediaries with risk management capacity (market makers) • Disclosure of information and an efficient trading infrastructure Electronic trading platforms can be useful if the underlying incentive structures are well designed.

  27. PERU: Building primary and secondary markets • Auction preparation should be improved, considering effects on liquidity and market appetite • Small volume of fungible instruments is an impediment to build more liquidity • Increase transparency through wider dissemination of quotes, trade reporting and information standards • Need of promote further diversification of investors; strengthen credibility of mutual funds • Explore ways to encourage market making; a PD system + strong supervision to deal with concentration

  28. Lowering of risks and costs Credibility Short-term measures Medium-term measures DEVELOPED MARKET Security Liquidity How should reform plans be prioritized? Depending on each country’s circumstances - size of its economy - sophistication of its financial system - its investor profile

  29. PERU: Leadership needed for developing market • MEF needs to lead the development of • Coordination of the overall effort ( vice-minister) • Announce a clear medium term debt management strategy • Need to engage in a open dialogue with market participants( prior to any formal PD system) • BCRP needs to lead the development of money markets • Standardization of repo contract • Induce interbank activity in the term markets • Need of strengthening overall financial supervision and eliminate sources of regulatory arbitrage and inconsistence

  30. Conclusion: Important Lessons for Policy Decisions It is essential, • to assess carefully and prioritize needs at the outset of government bond market reforms, and • to develop a formal and comprehensive strategy that will accommodate multiple agents and policies. This process calls for organized, consistent management (e.g. by a high-level committee).

  31. Thank You !

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