Download - Andrew Powell Research Dept., Inter American Development Bank BRICS Conference, Hong Kong
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Promoting the International Promoting the International use of Emerging Country use of Emerging Country
Currencies:Currencies:debt issuance for Latin America and debt issuance for Latin America and
the Caribbean the Caribbean
Andrew PowellAndrew Powell
Research Dept., Inter American Development Research Dept., Inter American Development BankBank
BRICS Conference, Hong KongBRICS Conference, Hong Kong
Dec 10Dec 10thth and 11 and 11thth, 2012, 2012Opinions are strictly those of the author and are not necessarily those of the IDB or any other institution.
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IntroductionIntroduction Internationalization of currencies has several inter-Internationalization of currencies has several inter-
related dimensions with information and liquidity related dimensions with information and liquidity externalitiesexternalities
One extremely important dimension is being able to One extremely important dimension is being able to issue debt in one’s own currencyissue debt in one’s own currency
This paper focuses on LAC: there has been increased This paper focuses on LAC: there has been increased use of LAC currencies remains rather limiteduse of LAC currencies remains rather limited
If liquidity is self-fulfilling there is a prima facie case If liquidity is self-fulfilling there is a prima facie case for public policy actionfor public policy action
But there is a Catch 22 for MDB’sBut there is a Catch 22 for MDB’s Conclusions and recommendations for coordinated Conclusions and recommendations for coordinated
actions actions
A Word on LAC: Bad Inflation A Word on LAC: Bad Inflation Experience Has Largely been Experience Has Largely been
Conquered Conquered
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Start of Debt Crisis
Hyperinflation episodes in Argentina, Brazil
Lehman
Tequila Crisis
≈6%
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Growth Performance: not doing as well Growth Performance: not doing as well as other EM’s but better than as other EM’s but better than
Developed Countries Developed Countries
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Eight Countries in the Eight Countries in the Region are Now Inflation Region are Now Inflation
TargetersTargeters
Can see private inflation and growth Can see private inflation and growth expectations as sampled by each expectations as sampled by each country’s central bank herecountry’s central bank here
www.iadb.org/revela
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Dimensions of Currency Dimensions of Currency InternationalizationInternationalization
Trade settlement – Trade settlement – Means of ExchangeMeans of Exchange Reserve currency usage – Reserve currency usage – Store of ValueStore of Value Denomination of contracts – a Denomination of contracts – a Unit of Unit of
AccountAccount
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Dimensions of Currency Dimensions of Currency InternationalizationInternationalization
Unit of Unit of AccountAccount
Means Means of of ExchanExchangege
Store Store of of ValueValue
FunctioFunctions of ns of MoneyMoney
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This paper/presentation…This paper/presentation…
Focus on use of currencies to Focus on use of currencies to denominate debtdenominate debt (unit of account) (unit of account) and ability of countries to issue debt and ability of countries to issue debt in their own currency internationallyin their own currency internationally
I will argue this ability is important I will argue this ability is important for risk sharing and will focus on for risk sharing and will focus on Latin America and the CaribbeanLatin America and the Caribbean
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Information and Liquidity Information and Liquidity Externalities for Currency Externalities for Currency
UsageUsage If a currency is used in one dimension If a currency is used in one dimension
more likely to be used in othersmore likely to be used in others If market trading focused on the dollar, prices If market trading focused on the dollar, prices
will reflect all available informationwill reflect all available information Derivatives will give information on expected Derivatives will give information on expected
valuations and expected volatilityvaluations and expected volatility High liquidity will make it easier/cheaper for High liquidity will make it easier/cheaper for
others to trade that currency fueling yet more others to trade that currency fueling yet more liquidityliquidity
Liquidity is self-fulfillingLiquidity is self-fulfilling
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Top four currency trading Top four currency trading market shares have been market shares have been
remarkably stableremarkably stable
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
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More movement in next 10 More movement in next 10 currencies, but from a small currencies, but from a small
base…base…
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
Mexican peso, MXP
Brazilian Real, BRNL
Chilean peso, CHP Colombian
peso, COP
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Currency market shares of Currency market shares of globalglobal
derivative trading…derivative trading…
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
Emerging Asian and LAC currency derivatives are within others’ 9% and
residual 2%
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Global Bond IssuanceGlobal Bond Issuance
Source: Dealogic data, author’s calculations
14Source: Dealogic data, author’s calculations
Bond Bond IssuanceIssuance
Of Of US$139bn US$139bn
of 2011 LAC of 2011 LAC “deal-“deal-
nationality” nationality” issues, issues,
US$82bn US$82bn were in USDwere in USD
$22bn in BRL$18bn in MXN/MXV$5.4bn in CLP/CLF
15Source: Dealogic data, author’s calculations. Caveat: a large number of deals did not have governing law identified.
And some US$10bn of LAC And some US$10bn of LAC Currency Issues were under Currency Issues were under
Developed Country Governing Law, Developed Country Governing Law, the majority under London Law the majority under London Law
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Why do we care…?Why do we care…? The 1980’s Latin American debt crisis and The 1980’s Latin American debt crisis and
subsequent lost decade had many originssubsequent lost decade had many origins But one was surely poor risk sharing…But one was surely poor risk sharing…
Commodity prices were high and plungedCommodity prices were high and plunged US interest rates were low and then soaredUS interest rates were low and then soared The dollar appreciatedThe dollar appreciated And debt was in dollarsAnd debt was in dollars
Today looks somewhat similar with $82bn Today looks somewhat similar with $82bn of LAC’s $139bn of 2011 debt issuance in of LAC’s $139bn of 2011 debt issuance in dollarsdollars
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To see this more To see this more scientifically…scientifically…
A country’s ability to pay in US$ is A country’s ability to pay in US$ is related to US$ GDPrelated to US$ GDP
A country’s ability to pay in a real A country’s ability to pay in a real domestic unit of account is related to domestic unit of account is related to real local currency GDPreal local currency GDP
If the former is more volatile than If the former is more volatile than the latter, US$ debt has poor risk the latter, US$ debt has poor risk sharingsharingThis argument follows that in Hausmann
and Rigobon and Eichengreen and Hausmann who call for local currency
inflation indexed debt contracts
18Source: Author’s calculations, perriod 1980-2011.
LAC: US$ Growth vs. Real Growth LAC: US$ Growth vs. Real Growth VolatilityVolatilityUSD GDP Growth Real Growth Real/USD
Latin America & The Caribbean % % %Bolivia 7.4 1.4 19.0%Brazil 17.6 2.2 12.7%Chile 11.8 2.4 20.7%Colombia 11.8 1.8 15.1%Costa Rica 11.8 1.8 15.1%Dominican Rep 6.5 2.8 42.7%Guatemala 6.2 1.1 18.4%Guyana 8.1 3.3 41.0%Haiti 16.0 4.8 29.7%Honduras 4.5 2.6 56.3%Jamaica 6.2 1.8 29.5%Mexico 15.3 3.5 23.1%Nicaragua 4.2 2.3 53.6%Paraguay 14.3 4.4 30.5%Peru 9.5 3.6 37.4%Suriname 18.3 3.3 17.8%Trinidad and Tobago 18.3 3.3 17.8%Uruguay 18.9 4.9 25.7%Venezuela 17.6 6.5 36.7%Average LAC 11.8 3.0 25.7%
19Source: Author’s calculations, perriod 1980-2011.
And the same goes for the BRICS…And the same goes for the BRICS…
USD GDP Growth Real Growth Real/USDRussia 22.9 5.3 23.2%India 8.7 1.9 22.5%China 8.4 1.9 22.1%Brazil 17.6 2.2 12.7%South Africa 11.3 2.0 17.3%Average BRIC 13.8 2.7 19.3%
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Inflation-indexed versus nominal Inflation-indexed versus nominal debt debt
Ability to service debt related to nominal Ability to service debt related to nominal GDP not realGDP not real
Some LAC countries issuing in nominal Some LAC countries issuing in nominal local currencylocal currency
LAC has 8 inflation targeters with good LAC has 8 inflation targeters with good inflation performanceinflation performance
BRICS also issuing in own nominal BRICS also issuing in own nominal currencycurrency
Hausmann and Rigobon likely affected by Chile’s good example, but Chile has been
“nominalizing” too..
21Source: Author’s calculations.
Simulated Volatility of LAC Debt to Simulated Volatility of LAC Debt to GDP Ratio with Local Currency vs. GDP Ratio with Local Currency vs.
Dollar Debts Dollar Debts Local Currency US Dollars Volatility LC / US$
% %Bolivia 2.3 8.1 28.6%Brazil 3.2 7.1 45.6%Chile 0.1 0.4 34.6%Colombia 1.3 5.3 25.1%Costa Rica 0.9 3.1 27.5%Dominican Rep 1.3 4.2 29.8%Guatemala 0.6 1.4 45.1%Guyana 14.7 17.9 81.8%Haiti 1.8 6.7 26.6%Honduras 2.7 4.6 58.4%Jamaica 6.1 11.7 51.9%Mexico 0.6 1.4 43.4%Nicaragua 4.4 5.0 87.8%Paraguay 1.3 9.5 13.4%Peru 3.3 3.9 84.9%Suriname 1.6 2.8 57.3%Trinidad and Tobago 1.1 1.2 90.4%Uruguay 9.0 41.2 21.9%Venezuela 1.7 6.6 25.3%LAC Average 3.0 7.5 40.7%
22Source: Author’s calculations.
Similar Results for the BRICS Similar Results for the BRICS
Local Currency US Dollars Volatility LC / US$Russia 4.0 17.7 22.6%India 0.6 1.8 35.8%China 0.5 0.7 75.1%Brazil 3.2 7.1 45.6%South Africa 3.9 22.2 17.4%Average 2.5 9.9 24.9%
23Source: Author’s calculations.
And poor risk sharing of US$ And poor risk sharing of US$ contracts:contracts:
Brazil simulated debt ratios and Brazil simulated debt ratios and growth growth
Dollar strong when growth was weak
24Source: Author’s calculations.
And poor risk sharing of US$ And poor risk sharing of US$ contracts:contracts:
Peru simulated debt ratios and Peru simulated debt ratios and growth growth
Dollar strong when growth was weak
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What can be done?What can be done? Latin American countries have been issuing Latin American countries have been issuing
in local currency, selected pricing points:in local currency, selected pricing points: Chile: 2020 pesos 4.4% yield, US$ 2022 2.4%.Chile: 2020 pesos 4.4% yield, US$ 2022 2.4%. Colombia: 2032 peso 4.4% yield, US$ 2022 1.8% Colombia: 2032 peso 4.4% yield, US$ 2022 1.8%
MDB’s can lend in local currencyMDB’s can lend in local currency But MDB’s subject to a Catch-22But MDB’s subject to a Catch-22
Can lend where liquid markets allow hedgingCan lend where liquid markets allow hedging Cannot lend where needed or will eat into Cannot lend where needed or will eat into
valuable capital to back currency risksvaluable capital to back currency risks
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RDB’s can reduce capital through RDB’s can reduce capital through diversification:diversification:
volatility of currency portfoliosvolatility of currency portfolios
Source: author’s calculations
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A GDP weighted portfolio brings less A GDP weighted portfolio brings less benefits:benefits:
global coordination valuableglobal coordination valuable
Source: author’s calculations, LAC countries with GDP weights, RICS with equal weights
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TCX – TCX – www.tcxfund.com
TCX was an initiative of the Dutch aid TCX was an initiative of the Dutch aid agencyagency
Financed by official sources (Bilaterals, Financed by official sources (Bilaterals, MDB’s)MDB’s)
Enters into exotic currency swapsEnters into exotic currency swaps Gives liquidity where none existedGives liquidity where none existed Holds naked currency risks on its booksHolds naked currency risks on its books Benefits from global diversificationBenefits from global diversification
Guarantees to Kick Start Guarantees to Kick Start Currency MarketsCurrency Markets
Local currency debt contracts reflect more Local currency debt contracts reflect more closely countries’ “ability to pay” which is closely countries’ “ability to pay” which is related to nominal GDP related to nominal GDP
To the extent a contract matches a country’s To the extent a contract matches a country’s “ability to pay” then a guarantee on that “ability to pay” then a guarantee on that contract will act on “willingness to pay” risks contract will act on “willingness to pay” risks 11
Some countries can already issue in local Some countries can already issue in local currency on reasonable terms, others may currency on reasonable terms, others may benefit from the presence of an MDB guaranteebenefit from the presence of an MDB guarantee
A guarantee is a flexible instrument that can be A guarantee is a flexible instrument that can be adjusted to particular required demandadjusted to particular required demand
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Anderson, Gilbert and Powell “Securitizing commodity contingent debt”, American Journal of
Agricultural Economics 1991
Guarantees to Kick-Start Guarantees to Kick-Start Local Currency MarketsLocal Currency Markets
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Country Issues Local Currency
Debt
Investors
Partial MDB Guarantee
TCX-type institution
Reinsurance
market
Currency risks
Other risks
Schematic representation of one sample structure to kick start local currency markets
ConclusionsConclusions Several emerging economies are now able to issue Several emerging economies are now able to issue
debt in their own currencies but subject to liquidity debt in their own currencies but subject to liquidity premiapremia
But local currency issuance remains limited and yet But local currency issuance remains limited and yet issuing dollar debt has dangerous risk propertiesissuing dollar debt has dangerous risk properties
MDB’s can help but there is something of a Catch-22MDB’s can help but there is something of a Catch-22 If liquidity is self-fulfilling, prices are not given If liquidity is self-fulfilling, prices are not given Guarantees are a flexible instrument to kick start Guarantees are a flexible instrument to kick start
markets markets Benefits to global coordination to diversify risks to Benefits to global coordination to diversify risks to
institutions providing local currency loans or institutions providing local currency loans or guaranteesguarantees
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