Managing Emerging Market Public Debt in a Crisis: Has this time been different?

Managing Emerging Market Public Debt in a Crisis: Has this time been different? Anderson Caputo Silva Senior Debt Specialist World Bank / IFC Securities Markets Group

Agenda 1. Developing Government Bond Markets: Rationale 2. Impact of the Crisis 3. Development Agenda Going Forward

1. Developing Government Bond Markets: Rationale Public Sector Government Bond Markets: Key Impacts Broader Financial Sector • Allows smooth implementation of different fiscal cycles • Reduces macroeconomic vulnerabilities and the cost of funding • Enhances the impact of debt management policies • Key for effective monetary policy • Creates market-based pricing and pricing benchmarks for broader types of non-government instruments • Provides essential infrastructure for the development of non-government instruments • Key for financial sector development and enhancing cost-effective access to finance

2. Impact of the Crisis: Overview • EMs before the crisis: • Macroeconomic fundamentals • Debt management • Impact of the global financial crisis • Debt managers’ response to the crisis • Lessons learnt This section is based on a draft paper “Public Debt Management in Emerging Market Economies: Has This Time Been Different” by Phillip Anderson , Anderson Caputo Silva and Antonio Velandia. The usual disclaimers apply.

Macroeconomic fundamentals were stronger this time… • Fiscal policy: healthier fiscal balances opened space for countercyclical policies • Monetary policy: increased credibility fromsteady inflation rates at historically low levels CPI Inflation (Average annual % change) Overall Budget balance (as a % of GDP) • Buoyant growth:together with sounder fiscal policy, contributed to a downward trend in Debt/GDP ratios. • Improvements in EMs external accounts provided solid foundations to reduce vulnerability to shocks and reversals in capital flows. GDP growth (%) Current Account Balance (US$ bn) Note: High income OECD is based on World bank classification, excluding Czech Republic, Hungary, Korea (South) and Slovak Republic. Source: World bank-WDI .

…and facilitated the transformation of government 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 (pension funds and insurance companies) • Increased interest by foreign investors supported by ample global liquidity and significant risk appetite for local-currency long-term fixed-rate instruments. • The aim of the portfolio shifts was to reduce the exposure of EMs to exogenous shocks and changes in market sentiment.

As a result there was a significant reduction in FX risk… • Net foreign currency debt evolved positively • Currency composition of the govt debt portfolio moved dramatically in favor of local currency External Debt to FX Reserves (As a %) Ratio of external to domestic debt Note: USD-linked domestic debt reallocated to external. Source: JP Morgan Note: Based on 24 GEMLOC countries. Source: World bank-WDI (external debt); IMF-IFS (reserves).

…and also in refinancing and interest rate risks • There was a contraction in the ratio of floating rate to fixed rate bonds and also an extension in the average life Floating to fixed debt in % (excluding Brazil) Average Life (number of years)

The global financial crisis had a dramatic impact on funding conditions… • Significant capital outflows from most EMs increased the challenge to debt managers, especially in countries still dependent on external funding. • EM external debt issuance stalled for months as a consequence of increased risk aversion and higher borrowing costs. • Funding conditions in international capital markets deteriorated, with generalized spikes in EM Credit Default Swaps (CDS) and in Emerging Market bond Index (EMBI) spreads. 5-yr CDS spread May 08-Apr 09 (Average of Gemloc* countries) Bond Funds Flows (% of GDP) EM Sovereign volume (USD million) * Excludes: India, Sri Lanka, Morocco, Nigeria, Costa Rica, Romania and Uruguay EMBI Global Sovereign Spread Index May 08-Apr 09 Quarterly Portfolio Flows (% of GDP)

…although a more mixed pattern on local currency bond yields

Debt managers responded with an array of actions • Delay borrowing or use sources other than regular market instruments • Adjusting market borrowing to changed demand • Implementation of liability management operations

Most countries reduced or delayed borrowing from regular market sources… • …some used cash reserves • Central banks in some countries were permitted to buy government bonds. • EMs debt managers also stepped up borrowing from multilaterals: • Borrowing from MDBs increased significantly, where headroom was available • A number received resources from the IMF. • A number drew down or established contingent credit lines with the WB. • Some EMs started/expanded retail debt programs or issued new products: • Indonesia expanded the retail market and introduced a Sharia-compliant market instrument • Hungary introduced a new 3-year CPI linker for the retail market. • Turkey tried new revenue indexed bonds and CPI linkers for the wholesale market.

…and the majority of them revised their market borrowing to reflect market demand… • ….suspension of issuance in international capital markets and/or reductions in the auctions for LX markets: • The LX market for medium and long term paper came to a virtual halt in some countries • Some postponed their auctions of LX securities and relied on cash reserves • Others reduced dramatically the issuance of fixed rate paper • The impact and consequent response was mixed across countries • Concentration of the bulk of the issuance program in the shortest tenors and floaters: • Many countries increased the volume of T-Bill issuance, some dramatically • Two severely impacted countries relied basically on short-term and floaters for 8 months.

…and buybacks and switches were used as liability management tools… • Buybacks were used to alleviate sell-off pressure, enhance liquidity and improve pricing of liquid instruments: • Hungary launched a $2.5 bn buyback program in Q2 2009 allowing to restart regular bond auctions. • Mexico implemented buyback auctions of selected medium and long-term securities, Bonos and Udibonos to enhance liquidity of these instruments. • Indonesia conducted buybacks and switches of short term instruments providing good price references when market liquidity was weak helping thus to stabilize prices. • Switches were used to stabilize the market, reduce fragmentation, consolidate large size benchmarks and to manage refinancing risk (e.g.: Brazil, Indonesia and South Africa) • Revision of formal targets: • Some reviewed their strategies including a higher share of FX debt • Brazil reviewed its quarterly targets for the portfolio composition. • Countries with broader directional targets could operate within existing mandates

Some mostly positive lessons learned… • Sound macroeconomic policy was elemental in creating a buffer to the crisis and placing EMs in a position for quicker recovery. • Prudent debt management in the years before the crisis played a role in enhancing EM resilience to the crisis. (sometimes requiring difficult cost-risk tradeoffs) • During the crisis, debt managers had room to maneuver and were able to adapt quickly – absorbed some risk from the market. • The availability and quick disbursement of multilateral funding was critical in cases where the international capital markets were closed and domestic investors flew to safer markets. • Countries with larger and more developed bond markets tended to be less affected by the crisis. • The crisis highlighted the degree to which EMs have built their capacity in public debt management over the last decade.

…but a (customary) note of caution Many uncertainties about the outlook: • Timing and management of “exit strategies” • Volume of government borrowing globally • Divergent views on the strength of the recovery Need to maintain preparedness for market dislocations and seek opportunities to contain risk in public debt portfolios

The crisis reinforced the rationale for debt market development. The crisis showed: • Government bond markets provided greater resilience to shocks (negative cycle of international crisis – currency crisis - EM debt crisis – fiscal crisis, was attenuated). • Government bond markets enhanced capacity for crisis response (e.g.: implementation of counter-cyclical policies and/or absorption of higher fiscal deficits) The crisis also enhanced the need for deeper and more liquid bond markets to: • Consolidate achievements in the extension of the yield curve and improvements in debt composition • Serve as effective references for the development of non-government local currency instruments that would reduce EMs overall vulnerability and support economic growth

The broad agenda involves several areas

…but a few priorities have emerged requiring close coordination among policy-makers Examples: • Investor Base: • Strategies for Development of the Investor Base (foreign and domestic) • Revisit investment regulations • Price dissemination and marking to market • Repo Markets (regulation, valuation and operational framework) • Issuance policy and overall government debt market reforms with a broader vision to support financial market development

Thank you! asilva3@worldbank.org

Managing Emerging Market Public Debt in a Crisis: Has this time been different?