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Bond Markets in Latin America: Comments on Recent Proposals

Bond Markets in Latin America: Comments on Recent Proposals. Alejandro Werner. April, 2003. The proposals discussed in the previous panel addressed three different problems in EM financing:. Reducing the volatility of the Debt/GDP ratio by indexing to GDP.

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Bond Markets in Latin America: Comments on Recent Proposals

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  1. Bond Markets in Latin America: Comments on Recent Proposals Alejandro Werner April, 2003

  2. The proposals discussed in the previous panel addressed three different problems in EM financing: Reducing the volatility of the Debt/GDP ratio by indexing to GDP. Smoothing capital flows through contingent contracts. Dealing with default through CAC’s, SDRM’s, etc.

  3. The recent discussion has focused too much on restructuring and too little on: • How to deal with “sudden stops.” • How to handle other shocks. The policy package to address these issues should focus on: Policy response. The response of IFI’s. Design of financial instruments.

  4. Index Bonds: sources of risk to Debt/GDP. • Interest rate risk (in domestic and foreign currency) • Exchange rate risk • Growth risk • Fiscal risk

  5. External Debt in F.C. (maturity=1 to 5 years with some sweeteners) Nominal D.D. at long maturities 3, 5, 7 and 10 years Increasing Maturity of E.D. and of D.B. by indexing D.D. indexed to C.P.I. and short-term rates In Mexico, after 1995, the currency/maturity structure of public debt was re-established according to the following strategy:

  6. Public debt/GDP has been decreasing and it’s composition has changed in favor of internal (peso, CPI) financing. Gross Public Sector Debt (% of GDP) 33.3 30.7 27.9 27.6 26.2 25.6 25.0 SOURCE: SHCP

  7. 25% 1000 900 Foreign Investors 20% 800 Domestic Investors 700 15% 600 500 400 10% 300 200 5% 100 0 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 During this period, the domestic debt market has grown consistently. This growth has been primarily based on the demand of domestic investors. Domestic Participation in Government Debt Market (Billions of Pesos Dec. 2000) Value of Outstanding Domestic Government Debt / GDP

  8. Government Debt Composition by Maturity Weighted life term of government securities (in days) 1.00 0.90 0.80 1993 1997 0.70 Sep-02 0.60 0.50 0.40 0.30 0.20 0.10 0.00 1 Year or Less 3 Years or More Fixed Yield in Floating Rate Indexed to Inflation Pesos • In recent years, macroeconomic stability and the development of institutional investors have created the conditions for the public and private sectors to issue long term debt in the Mexican market. 3 Years or More, 3 Years or More,

  9. Assets Managed by Institutional Investors Share of Public Debt Held by Institutional Investors 700 60 Mutual Funds Insurance Companies and 600 Pension Funds 50 Siefores 500 40 400 Percent 30 300 20 200 100 10 0 0 1998 1999 2000 2001 1998 1999 2000 2001 The expansion of the domestic debt market has been possible due to the growth of institutional investors.

  10. Comments on indexing to GDP • Maybe not the most important source of risk. • If the country faces a quasi-permanent shock, as the bonds are re-negotiated g* changes, so the benefits are lower than those calculated in the paper. • Due to “home bias” the risk premium might be larger. • How would the political economy of adjusting be affected? • A lot of the capital inflows of the post 95 era are GDP indexed through FDI.

  11. Insuring E.M. against sudden stops: Different from stabilization funds. Very close to contingent credit lines. However, the argument that they could be re-packaged by CDO’s is powerful. The hedging argument against private CCL is not insurmountable.

  12. Creating new markets faces several free rider problems: • Role for G-7 to set benchmarks. • For for IFI’s to “subsidize” the emergence of new markets. • However, a key question is how to strengthen governments to adjust. If not, these financial gimmicks will only help to postpone crises and make them bigger.

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