Developing domestic bond markets: Why do we care and the role of - PowerPoint PPT Presentation

Developing domestic bond markets: Why do we care and the role of South-South cooperation Ugo Panizza UNCTAD Conference on Deepening Financial Sector Reforms and Regional Cooperation in South Asia New Delhi, November 2008

Outline • Why do we care? • Some facts about debt composition and the development of domestic bond markets in developing countries • How do we build bigger bond markets? • Regional financial cooperation

Debt Composition Matters! • The “Economics 101” debt dynamics equation tells us that the change in the stock of debt is equal to the budget deficit − = DEBT DEBT DEFICIT − 1 t t t • This equation can be used to decompose the growth rate of the Debt-to-GDP ratio Δ = − − + π x ) x ( d i d pb g d

Debt Composition Matters! • The “Economics 101” debt dynamics equation tells us that the change in the stock of debt is equal to the budget deficit − = + DEBT DEBT DEFICIT SF − 1 t t t • This equation can be used to decompose the growth rate of the Debt-to-GDP ratio Δ = − − + π + x ) x ( d i d pb g d SF

The Unexplained Part of Debt Decomposition of Debt Growth in LAC7 24 Inflation UNEXPLAINED PART Interest expenditure Primary balance Percentage of GDP GDP growth 12 0 -12 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Campos, Jaimovich, and Panizza (2006).

The Unexplained Part of Debt 15 10 5 INFLATION GDP GROWTH 0 UNEXPLAINED PART INTEREST EXPENDITURE PRIMARY DEFICIT -5 -10 -15 IND EAP ECA MNA LAC SSA Source: Campos, Jaimovich, and Panizza (2006).

The Unexplained Part of Debt • What explains the “Unexplained part of debt” – Skeletons • Fiscal policy matters! – Banking Crises – Balance Sheet Effects due to debt composition

Debt Composition Matters! Public Debt and Sovereign Rating (1995-2005) Standard & Poor's Sovereign Rating Germany United Kingdom Switzerland France Austria Norway AAA Australia Spain Finland Denmark Canada United States Ireland Belgium Luxembourg New Zealand Portugal Japan Italy Sweden Netherlands AA- Iceland Cyprus Saudi Arabia Malta Botswana Slovenia Israel Chile Czech Republic Korea, Rep. A- Qatar Bahamas Bahrain Malaysia Barbados Estonia Latvia Investment grade Thailand China Poland Hungary Oman Tunisia Trinidad and Tobago Slovak Republic South Africa Egypt, Arab Rep. Lithuania BBB- Mexico El Salvador Panama Croatia Colombia Kazakhstan Peru India Morocco Uruguay Costa Rica Guatemala Philippines BB- Bulgaria Jordan Brazil Senegal Bolivia Russian Federation Mongolia Belize Benin Ghana Ukraine Papua New Guinea Grenada Paraguay Jamaica Venezuela, RB Indonesia Turkey Argentina Pakistan B- Ecuador 0 10 20 30 40 50 60 70 80 90 100 110 Public Debt as Percent of GDP Source : Jaimovich and Panizza (2006) and Standard and Poor's

The international market is volatile… J a n J u n r A p t O c n a J n u J r p A c t O n J a u n J p A r O t c n a J u J n A p r N o v p S e F e b c e D M a r u A g o v N p e S F e b c e D r a M g A u o v N S e p F e b D e c r M a A u g v N o S e p F e b a M y y a M y a M

The international market is volatile… 700 600 500 400 300 200 100 n a J a n J n u J n J u r p A p A r O c t O c t a n J J a n u n J J n u A p r A p r c t O c O t n J a J n a J u n n u J r p A A p r c O t O c t J a n n a J J u n n u J p r A r p A N v o v o N S p e S e p b e F e b F D e c c e D r a M M r a u g A g u A o v N o N v e p S S p e b F e F b e e c D D e c a M r M r a u A g A g u v o N v N o S p e S e p b e F F e b c D e e c D r a M M a r g u A g A u N v o o v N e p S p e S e F b F e b a y M a M y y a M M y a a y M a M y 0 12.10.07 11.11.07 11.12.07 10.01.08 09.02.08 10.03.08 09.04.08 09.05.08 08.06.08 08.07.08 07.08.08 06.09.08 06.10.08

The case for innovative debt instruments • Innovative debt instruments can increase risk- sharing and reduce vulnerabilities for the borrower – Equity-like instruments • GDP indexed bonds • CAT bonds – International bonds denominated in emerging market currencies • Single currency • In a basket of currencies – Dedollarize official lending

Why doesn’t the market develop such financial innovations? • Coordination problems linked to the need of a “critical mass” and standards for new instruments. – Simultaneous issuance by many parties makes new instruments more appealing • Establishing a new asset class generates positive externalities. – For financial instruments where payments are due contingent to certain conditions, it is crucial to have verifiable standards for whether those conditions are met. • For example, the market for credit default swaps took off as soon as the standards for a “credit event” were properly defined and became broadly accepted • The highly competitive structure of financial markets. – Private financial institutions are unable to maintain a monopoly over the provision of a new instrument • Signaling. – Individual countries may fear that issuing innovative instruments is perceived as signs of weakness • Political economy

Outline • Why do we care? • Some facts about debt composition and the development of domestic bond markets in developing countries • How do we build bigger bond markets? • Regional financial cooperation

Governments have been changing their debt structure… 0.5 0.4 Debt to GDP Domestic Public Debt Ratio 0.3 0.2 External Public Debt 0.1 0.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Panizza (2008)

…in all regions… 1.00 0.90 0.80 Share of Domestic Debt 1994 2005 (weighted average) 0.70 1999 0.60 0.50 0.40 0.30 0.20 0.10 0.00 EAP ECA LAC MNA SAS SSA All Countries Source: Panizza (2008)

…and developing domestic bond markets Size of the Domestic Bond Market (all developing countries) 60.00% 50.00% 40.00% % of GDP 30.00% GOV GOV 20.00% 10.00% PRIV 0.00% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

…and developing domestic bond markets Size of the domestic bond market (Asian countries) 60.00% 50.00% 40.00% % of GDP 30.00% Government 20.00% 10.00% Private 0.00% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

…and developing domestic bond markets Size of the domestic bond market (LAC countries) 60.00% 50.00% 40.00% % of GDP 30.00% Government 20.00% 10.00% Private 0.00% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

So, is everything well? • Not really!

Bond markets remain small and are dominated by the government Domestic bond markets in developing and advanced economies (the data are for 2007) 160.00% 140.00% GOV 120.00% 44% PRIV 100.00% % of GDP 80.00% 60.00% 40.00% 62% 68% 71% 20.00% 95% 0.00% IND ASIA DEV LAC ECA

They are also “sinful”…but less so in Asia Domestic Original Sin in Emerging Regions 1.0 0.9 Index of domestic original sin 0.8 LAC 0.7 0.6 0.5 Other EMs 0.4 0.3 0.2 Asia 0.1 0.0 1996 1997 1998 1999 2000 2001 2002 2003 Note : Original sin is measured as share of domestic debt which is short term, denominated in foreign currency, or indexed to prices or the interest rate. "Latin America" includes: Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela. "Asia" includes: China, India, Indonesia (from 1998), Korea, Malaysia, Philippines, and Thailand. "Other emerging markets" includes: Czech Republic, Israel, Hungary, Poland, Russia, and Turkey.

Maturities are lengthening… Average Original Maturity (Government Bonds) 16 14 12 10 Latin America Years Asia, larger economies 8 Other Asia Central Europe IND 6 4 2 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

…but what is the “true” maturity of government bonds held by banks? India 18 16 14 Average maturity of 12 government bonds Years 10 8 6 4 2 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

…but what is the “true” maturity of government bonds held by banks? India 18 80 Share of government bonds held by domestic banks 16 (right axis) 70 14 60 Average maturity of 12 government bonds 50 (left axis) Years (%) 10 40 8 30 6 20 4 10 2 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Outline • Why do we care? • Some facts about debt composition and the development of domestic bond markets in developing countries • How do we build bigger bond markets? • Regional financial cooperation