Official Loans and Sovereign Market Access: Evidence on Catalysis - PowerPoint PPT Presentation

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Loans and Sovereign Market Access: Evidence on Catalysis from the Euro Area 1 Aitor Erce June, 2019 1 Joint work with Giancarlo Corsetti and Timothy Uy.

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Key motivating facts • During the recent crisis, euro area sovereigns received support from both IMF and ESM/EFSF/EFSM • Original loans design followed the IMF blueprint (EFF, SBA) • Expected to have a catalytic effect on private financing • In reaction to set-backs, the type and terms of euro area official lending evolved significantly • Beyond balance of payments needs (see loan to Spain) • Larger loan sizes • Longer maturities and lower rates • Management of repayment flows

Motivating facts ESM debt includes EFSM loans (for Ireland, also bilateral loans from DK and UK) 100 120 140 20 40 60 80 0 Analytical and Policy Issues 12/2008 04/2009 ESM debt 08/2009 12/2009 04/2010 Debt Composition and Market Spreads 08/2010 IMF debt 12/2010 04/2011 08/2011 Portugal 12/2011 Market debt 04/2012 08/2012 12/2012 04/2013 Roadmap 08/2013 market rate (rhs) 12/2013 04/2014 08/2014 12/2014 Theory 0 5 10 15 20 25 30 100 120 140 20 40 60 80 0 12/2008 Empirics 04/2009 ESM debt 08/2009 12/2009 04/2010 08/2010 IMF debt 12/2010 04/2011 08/2011 Ireland 12/2011 Market debt 04/2012 08/2012 12/2012 04/2013 08/2013 Policy Implications market rate (rhs) 12/2013 04/2014 08/2014 12/2014 0 5 10 15 20 25 30 Conclusions

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms in the euro area Maturities and marginal lending rate Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Maturity 7.5 years 15 years 15 years 22 years 22 years EFSF/ESM Interest rate 525 bps 272 bps 255 bps 226 bps 226 bps Ireland Maturity 7 years 7 years 7 years 7 years 7 years IMF Interest rate 337 bps 321 bps 307 bps 309 bps 404 bps Maturity - 15 years 15 years 22 years 22 years EFSF/ESM Interest rate - 277 bps 233 bps 210 bps 210 bps Portugal Maturity - 7 years 7 years 7 years 7 years IMF Interest rate - 321 bps 307 bps 309 bps 404 bps Sources: International Monetary Fund, European Commission, European Financial Stability Facility, European Stability Mechanism and Bloomberg.

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms in the euro area Repayment Profiles

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Analytical Issues • Debt sustainability and market access cannot be assessed independently of the terms of official lending: • they can affect governments’ incentives to issue, repay, or default (like tax capacity, spending or inflation) • they can affect investors’ incentives to roll-over (catalysis) • What are the trade-offs in varying the terms of official loans? • How do official lending terms affect debt sustainability? • And market access? Any evidence of catalysis? • Striking absence of empirical work (compare with hundreds of papers on QE) - this paper

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Policy Issues In the euro area, official lending shifted from irregular issuers in international capital markets to: • regular issuers in deep and liquid domestic markets • heavily financialized and interconnected • with structural imbalances requiring a significant adjustment Traditional approach to official lending put to the test: • Spillover and contagion • Exceptional access policy and the “systemic exemption” • Revamp debt sustainability frameworks (DSA) • Avoid arguments like “ Greece’s debt will be sustainable if it reaches 120% of GDP by 2020” • Increased role for gross financing needs within the IMF’s DSA

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Roadmap • Summarize theoretical mechanisms by which official loans affect market acces and perceptions of sustainability in the face of fundamental and roll-over risks • Outline Corsetti et al. (2018) • Provide evidence on the link between market access conditions and the terms of official loans • Effect of official maturities and interest rates on sovereigns’ market access terms • Discuss policy implications

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Corsetti et al. (2018) - framework • Quantitative model as in Conesa-Kehoe (2014): government sets taxes, borrows from investors and chooses whether to repay or default (against an output loss) • Roll-over risk: incentive to run down debt (exit crisis) • Output risk: incentive to run debt up (smooth consumption) • Augment it with two types of official lenders • One lends using short maturities • The other offers long maturity loans

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Corsetti et al. (2018) - findings • Availability of official loans raises debt levels at which default is not optimal in a liquidity crisis, but lowers them during deep recessions • More with longer maturities • Calibration to Portugal. Counterfactuals show that sustainable debt ranges from 80% to 180% GDP: • state of the economy (output and market access) and • terms of official loans (composition of borrowing)

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Other channels discussed in the literature • Seniority (Bolton and Jeanne 2009) • Moral hazard (Uhlig and Roch 2018, Aguiar and Amador 2018) • Conditionality and structural adjustment (Muller et al. 2016, Martin et al. 2018)

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions The effect of official lending terms on market access • We use various modifications to the Portuguese and Irish loans as “experiments” • In July 2011, both loans featured a 7-year maturity extension (to 15 years) & 200+ spread reduction • In December 2013, both loans featured an additional 7-year maturity extension (to 22 years) • Plot yield curves and changes in bid-ask spreads before and after the contract amendments • Regression-based event analysis using benchmark bonds (Christensen and Gillan 2018) • Panel regressions using bond data (D’Amico and King 2013)

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms and Market Access: Yield Curves

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms and Market Access: Yield Curves

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms and Market Access: Liquidity

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Official Lending Terms and Market Access • Yield curves shifted down and flattened out • Market liquidity improved • Heterogeneous effects along the yield curve • As intended!

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Regression-based event analysis. Benchmark Instruments • Evaluate the daily dynamics of specific bonds one week around the date of the announcements • Focus on 3-year, 5-year and 10-year benchmark yields - most liquid ones • Consider potential confounding factors, including monetary policy and global factors

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Regression-based event analysis. Benchmark Instruments • As in Foley-Fisher et al. (2016) or Christensen and Gillan 2018, we estimate: i =5 i =5 � � y c β A i · D A β F i · D F t = α + t + i + t + i + (1) i = − 5 i = − 5 i =5 � β S i · D S t + i + β 4 · Controls t − 1 + δ m + ε c + t i = − 5 y c t is the yield of benchmark bond with maturity c at time t . D A c , t + i , D F c , t + i , and D S c , t + i are dummies indicating that the corresponding observation is i periods away from each event. Controls t − 1 include ECB actions dummies, Home & US stock markets, VIX, oil price, and monthly fixed-effects ( δ m ) ( β e − 5 , ..., β e 5 ) collect the dynamics of the yield of the corresponding benchmark bond one week around event e .

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Regression-based event analysis: Effect of the 2011 loan amendments Ireland. 3-year maturity 10 5 0 -5 -5 0 5 Day

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Regression-based event analysis: Effect of the 2011 loan amendments Ireland. 5-year maturity 4 2 0 -2 -4 -5 0 5 Day

Motivating facts Analytical and Policy Issues Roadmap Theory Empirics Policy Implications Conclusions Regression-based event analysis: Effect of the 2011 loan amendments Ireland. 10-year maturity 2 1 0 -1 -2 -5 0 5 Day