Managing Emerging Market Public Debt in a Crisis:

Has this time been different? Anderson Caputo SilvaSenior Debt Specialist

World Bank / IFC Securities Markets Group

2

Agenda

1. Developing Government Bond Markets: Rationale

2. Impact of the Crisis

3. Development Agenda Going Forward

Public Sector

3

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

1. Developing Government Bond Markets: Rationale

4

Agenda

1. Developing Government Bond Markets: Rationale

2. Impact of the Crisis

3. Development Agenda Going Forward

5

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.

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Macroeconomic fundamentals were stronger this time…

Fiscal policy: healthier fiscal balances opened space for countercyclical policies

Monetary policy: increased credibility from steady inflation rates at historically low levels

Improvements in EMs external accounts provided solid foundations to reduce vulnerability to shocks and reversals in capital flows.

Buoyant growth: together with sounder fiscal policy, contributed to a downward trend in Debt/GDP ratios.

Overall Budget balance(as a % of GDP)

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

SAR ECA LAC SSA MENA EAP

CPI Inflation(Average annual % change)

-

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

SAR ECA LAC SSA MENA EAP

GDP growth(%)

3.41

GEMX 24

8.27

6.23

1.11 High income OECD

2.32

0.64

-1 2 3 4 5 6 7 8 9

2000 2001 2002 2003 2004 2005 2006 2007 2008

Note: High income OECD is based on World bank classification, excluding Czech Republic, Hungary, Korea (South) and Slovak Republic.Source: World bank-WDI .

(80)

(60)

(40)

(20)

-

20

40

60

2000 2001 2002 2003 2004 2005 2006 2007 2008

Asia without China ECA LAC SSA/MENA

Current Account Balance(US$ bn)

7

…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.

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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

Note: Based on 24 GEMLOC countries. Source: World bank-WDI (external debt); IMF-IFS (reserves).

External Debt to FX Reserves(As a %)

-

100

200

300

400

500

2000 2001 2002 2003 2004 2005 2006 2007Asia ECA LAC SSA/MENA

Ratio of external to domestic debt

Note: USD-linked domestic debt reallocated to external.Source: JP Morgan

257.77

57.5549.7778.25

19.520

50

100

150

200

250

300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Emerging Markets Emerging Europe Asia Latin America

(%)

9

…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)

-100

0

100

200

300

400

500

600

700

800

900

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Emerging Markets Emerging Europe Latin America Asia

3.985.30

6.70

9.36

2.43 3.11

1.34

4.01

0.01.02.03.04.05.06.07.08.09.0

10.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Emerging Markets Asia Emerging Europe Latin America

10

The global financial crisis had a dramatic impact on funding conditions…

Funding conditions in international capital markets deteriorated, with generalized spikes in EM Credit Default Swaps (CDS) and in Emerging Market bond Index (EMBI) spreads.

EM external debt issuance stalled for months as a consequence of increased risk aversion and higher borrowing costs.

Significant capital outflows from most EMs increased the challenge to debt managers, especially in countries still dependent on external funding.

0

100

200

300

400

500

600

700

800

5/1/08

6/1/08

7/1/08

8/1/08

9/1/08

10/1/08

11/1/08

12/1/08

1/1/09

2/1/09

3/1/09

4/1/09

Asia ECA LAC SSA

5-yr CDS spread May 08-Apr 09(Average of Gemloc* countries)

* E

xclu

des:

In

dia,

S

ri La

nka,

M

oroc

co,

Nig

eria

, C

osta

R

ica,

R

oman

ia a

nd U

rugu

ay

EMBI Global Sovereign Spread IndexMay 08-Apr 09

0

200

400

600

800

1000

1200

5/1/08

5/22/08

6/12/08

7/3/08

7/24/08

8/14/08

9/4/08

9/25/08

10/16/08

11/6/08

11/27/08

12/18/08

1/8/09

1/29/09

2/19/09

3/12/09

4/2/09

4/23/09

EMBI Asia EMBI ECA EMBI LAC EMBI MENA EMBI SSA

Bond Funds Flows(% of GDP)

-1.2%

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

1/31/08

2/29/08

3/31/08

4/30/08

5/31/08

6/30/08

7/31/08

8/31/08

9/30/08

10/31/08

11/30/08

12/31/08

1/31/09

2/28/09

3/31/09

LAC EAP SAR SSA ECA

EM Sovereign volume(USD million)

0

5

10

15

20

25

0

5,000

10,000

15,000

20,000

25,000

2006

Q1

2006

Q2

2006

Q3

2006

Q4

2007

Q1

2007

Q2

2007

Q3

2007

Q4

2008

Q1

2008

Q2

2008

Q3

2008

Q4

2009

Q1

2009

Q2

2009

Q3

2009

Q4

2010

Q1

Total EM Volume Total no. of deals

Quarterly Portfolio Flows(% of GDP)

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…although a more mixed pattern on local currency bond yields

0

20

40

60

80

100

120

140

160

180

09/01/2008 10/01/2008 11/01/2008 12/01/2008 01/01/2009 02/01/2009 03/01/2009

Generic Government Bond Yield Index(1 Sep, 2008 = 100)

Brazil Chile Mexico Peru Hungary China India Indomesia US UK

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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

13

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.

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…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.

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…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

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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.

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…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

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Agenda

1. Developing Government Bond Markets: Rationale

2. Impact of the Crisis

3. Development Agenda Going Forward

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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

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The broad agenda involves several areas

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…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

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Thank you!

asilva3@worldbank.org