Managing Emerging Market Public Debt in a Crisis: Has this time - - PowerPoint PPT Presentation

Managing Emerging Market Public Debt in a Crisis:

Phillip Anderson Acting Director Banking and Debt Management

Has this time been different?

2

Agenda

1. EMs before the crisis:

• Macroeconomic fundamentals
• Debt management

2. Impact of the global financial crisis 3. Debt managers’ response to the crisis 4. Lessons learnt

3

Healthier fiscal balances opened space for countercyclical policies

• 8.0
• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 8.0 10.0 %

EAP ECA MNA LAC SSA

Primary Balance (% of GDP)

Source: World Bank LDB Working Database

4

…and contributed to a downward trend in debt/GDP ratios

0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 100.0 2000 2001 2002 2003 2004 2005 2006 2007

ECA EAP LAC MNA SAR SSA

Central Government Debt (% of GDP)

Source: Central Government Debt from World Bank LDB Working Database; GDP from World Bank WDI

5

Credibility of monetary policy increased…

• 5.0

10.0 15.0 20.0 25.0 30.0 2000 2001 2002 2003 2004 2005 2006 2007 2008

%

EAP ECA MNA LAC SAR SSA

Average CPI Inflation (annual % change)

Source: IMF IFS

6

…and allowed a sustained easing of policy rates

2 4 6 8 10 12 14 16 18

%

Brazil China Egypt Hungary India Indonesia Malaysia Mexico Nigeria Poland South Africa Turkey

Selected Policy Rates (%)

Source: Bloomberg LP, Datastream

Economic growth was stronger this time

• Emerging market economies grew faster than developed countries

7

• 1.0

2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 2000 2001 2002 2003 2004 2005 2006 2007 2008

Real GDP Growth (%)

GEMX 24 High Income OECD

Source: World Bank WDI Note: High Income OECD is based on World Bank classification, excluding Czech Republic, Hungary, South Korea and Slovak Republic

Healthier external accounts helped reduce vulnerability to shocks

8

0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 180.0 200.0

%

EAP ECA MNA LAC SAR SSA

External Debt (% of Exports of Goods and Services)

Source: World Bank WDI

9

Stronger fundamentals facilitated the transformation of public debt portfolios

• Increase in the share of the domestic debt
• Extension of the maturity of the domestic debt:
• Supported by increased credibility of monetary policy
• Diversification of the investor base:

– Expansion of the local investor base especially non-bank financial institutions – Increased interest by foreign investors

• The aim of the portfolio shifts was to reduce the exposure of EMs to

exogenous shocks and changes in market sentiment.

There was a significant reduction in FX risk…

• Currency composition of government debt portfolios moved dramatically

in favor of local currency

10

• 0.5

1.0 1.5 2.0 2.5 3.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Ratio of external to domestic debt

Emerging Markets ECA LAC EAP

Note: USD-linked domestic debt reallocated to external. Source: JP Morgan EM Debt and Fiscal Indicators (2009) and BIS Financial Stability and local currency bond markets (2008)

…and net foreign currency debt was significantly reduced (1)

11

Source: JP Morgan EM Debt and Fiscal Indicators (2009)

• 12
• 2

8 18 28 38 48 58

• 60
• 10

40 90 140 190 240 290 340

India Indonesia Malaysia Philippines Thailand Hungary Poland Russia South Africa Turkey Brazil Chile Colombia Mexico Peru

Gross external debt vs. Int. Reserves (no China) 2001

FX Reserves FX debt Net FX debt to GDP (right axis)

USD billion (%)

…and net foreign currency debt was significantly reduced (2)

12

Source: JP Morgan EM Debt and Fiscal Indicators (2009)

• 50
• 30
• 10

10 30 50

• 500
• 300
• 100

100 300 500

India Indonesia Malaysia Philippines Thailand Hungary Poland Russia South Africa Turkey Brazil Chile Colombia Mexico Peru

Gross external debt vs. Int. Reserves (no China) 2009

FX Reserves FX debt Net FX debt to GDP (right axis)

USD billion (%)

13

Exposure to refinancing and interest rate risks was also reduced (1)

• There was a contraction in the ratio of floating rate to fixed rate bonds

Source: JP Morgan EM Debt and Fiscal Indicators (2009) and BIS Financial Stability and local currency bond markets (2008)

• 1.00

2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Floating to fixed rate debt (excluding Brazil)

Emerging Markets ECA LAC EAP

Source: JP Morgan EM Debt and Fiscal Indicators (2009) and BIS Financial Stability and local currency bond markets (2008)

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Exposure to refinancing and interest rate risks was also reduced (2)

• There was an extension in the average life

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Average Life

Emerging Markets EAP ECA LAC

Years

15

The global financial crisis had a dramatic impact on funding conditions…

• Funding conditions in international capital markets deteriorated, with

generalized spikes in EM Credit Default Swaps (CDS) and in Emerging Market bond Index (EMBI) spreads

Source: Bloomberg LP, Datastream

• 200

400 600 800 1,000 1,200 2-Jan-08 2-Feb-08 2-Mar-08 2-Apr-08 2-May-08 2-Jun-08 2-Jul-08 2-Aug-08 2-Sep-08 2-Oct-08 2-Nov-08 2-Dec-08 2-Jan-09 2-Feb-09 2-Mar-09 2-Apr-09 2-May-09 2-Jun-09 2-Jul-09 2-Aug-09 2-Sep-09 2-Oct-09 2-Nov-09 2-Dec-09 2-Jan-10 2-Feb-10 2-Mar-10 2-Apr-10 2-May-10 2-Jun-10 2-Jul-10 2-Aug-10 2-Sep-10 2-Oct-10

EMBI Global Sovereign Spread Index

SSA ECA LAC MNA EAP

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EMs experienced significant capital

• utflows
• This increased the challenge to debt managers, especially in countries still

dependent on external funding.

• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 3.0 4.0

%

EAP ECA LAC MNA SAR SSA

Quarterly Portfolio Flows (% of GDP)

Source: Portfolio flows from IMF IFS; GDP from World Bank WDI

• 1.2
• 1.0
• 0.8
• 0.6
• 0.4
• 0.2

0.0 0.2 %

EAP ECA LAC MNA SAR SSA

Net Bond Fund Flows (% of GDP)

Source: Emerging Portfolio Funds Research Note: Flows by country; as a % of GDP SAR excludes Sri Lanka; MNA excludes Morocco; SSA excludes Kenya

17

Capital outflows were particularly strong in fixed income markets

18

EM external debt issuance stalled for months … then rebounded strongly

• This was the consequence of increased risk aversion and higher borrowing

costs.

5 10 15 20 25 5 10 15 20 25 2006 Q1 2006 Q2 2006 Q3 2006 Q4 2007 Q1 2007 Q2 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 2010 Q1 2010 Q2 2010 Q3 2010 Q4 USD billion

Issuance Volume and Number of Deals

Total EM Volume (excluding China) Total number of deals (right axis)

Source: Dealogic System Note: Global Market public issuances , Emerging Market countries, excluding China

19

The impact of the crisis on local currency bond yields was mixed

20 40 60 80 100 120 140 160 180

Selected Generic 10-Year Government Bond Yield (1 Sep, 2008 = 100)

Brazil Chile China Hungary India Indonesia Mexico Peru US UK

Source: Bloomberg LP, Datastream

Debt managers responded with a range

• f actions

1. Delay borrowing or use sources other than regular market instruments 2. Adjusting market borrowing to changed demand 3. Implementation of liability management operations

20

21

Most countries reduced or delayed borrowing from regular market sources…

• Using cash reserves
• Government bond purchases by central banks
• Stepped up borrowing from multilaterals:
• MDB financing increased significantly (w/available headroom)
• IMF resources
• WB contingent credit lines
• Start/expansion of retail debt programs. Issuance of new products:
• Indonesia: Expanded retail market; Introduced a Sharia-compliant

market instrument

• Hungary: 3-year CPI linker for retail market
• Turkey: Revenue-indexed bonds and CPI linkers for wholesale market

22

• Suspension of international issuance
• Reductions in LX bond auctions:
• Virtual halt in LX market for medium- and long-term paper
• Dramatic reduction in issuance of fixed rate paper
• Mixed impact and response across countries
• Issuance concentrated in the shortest tenors and floaters:
• Increased volume of T-Bill issuance, some dramatically
• Two of the worst hit relied on short-term and floaters for 8 months

…and the majority revised market borrowing to reflect composition of demand

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…and buybacks and switches were used as liability management tools

• Buybacks alleviated sell-off pressure, enhanced liquidity and improved

pricing of liquid instruments:

• Hungary: $2.5 bn buyback program permitted resumption of bond auctions
• Mexico: Buyback of medium-/long-term securities enhanced instrument liquidity
• Indonesia: Buybacks/switches of short-term debt provided price references
• Switches stabilized market, consolidated debt into large benchmarks and

reduced refinancing risk (e.g. Brazil, Indonesia and South Africa)

• Revision of formal targets:
• Some included a higher share for FX debt
• Brazil reviewed its quarterly targets for the portfolio composition
• Those with broader directional targets operated within existing mandates

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The response of debt managers in some advanced countries was similar

• Extreme and sudden expansion of the borrowing requirement meant

large-scale issuance of short-term paper at the peak of the crisis

• Pain exacerbated by compound effect of economic crisis and financial

instability affecting primary dealers

• Dislocation of primary market and reduced liquidity in secondary markets
• Some DMOs bypassed primary dealers to deal directly with investors
• Greater use of syndication to issue bonds

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Some mostly positive lessons learned…

• Sound macroeconomic policy was elemental for insulation and recovery.
• Prudent debt management pre-crisis played a role in enhancing EMs

resilience (sometimes requiring difficult cost-risk tradeoffs).

• Debt managers had room to maneuver, adapt, and absorb risk.
• Multilateral funding was critical where international capital markets were

closed and domestic investors flew to safer markets.

• Countries with larger, more developed bond markets fared better.
• Crisis highlighted EMs improved capacity in public debt management.

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…but no room for complacency

• Uncertain outlook:
• Global imbalances persist
• Volume of government borrowing globally
• Divergent views on strength of recovery
• Need to maintain preparedness for market dislocations and seek
• pportunities to contain risk in public debt portfolios
• Take advantage of ample liquidity to reduce currency and interest rate

risks

• Stress test scenarios and cost-risk modeling need to include potential

capital outflows

• Ensure timely and accurate communications with investors and other

stakeholders – even more critical when market participants are risk averse

Notes on Presentation

• This presentation is based on the paper:

“Public Debt Management in Emerging Market Economies: Has This Time Been Different” by Phillip Anderson , Anderson Caputo Silva and Antonio

• Velandia. Policy Research Working paper WPS5399, August 2010

http://econ.worldbank.org/docsearch

• The paper was also published in the book “Sovereign Debt and the

Financial Crisis: will this time be different?” edited by Carlos Braga and Gallina Vincellete, Chapter 16.