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Promoting the International Promoting the International use of Emerging Country use of Emerging Country

Currencies:Currencies:debt issuance for Latin America and debt issuance for Latin America and

the Caribbean the Caribbean

Andrew PowellAndrew Powell

Research Dept., Inter American Development Research Dept., Inter American Development BankBank

BRICS Conference, Hong KongBRICS Conference, Hong Kong

Dec 10Dec 10thth and 11 and 11thth, 2012, 2012Opinions are strictly those of the author and are not necessarily those of the IDB or any other institution.

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IntroductionIntroduction Internationalization of currencies has several inter-Internationalization of currencies has several inter-

related dimensions with information and liquidity related dimensions with information and liquidity externalitiesexternalities

One extremely important dimension is being able to One extremely important dimension is being able to issue debt in one’s own currencyissue debt in one’s own currency

This paper focuses on LAC: there has been increased This paper focuses on LAC: there has been increased use of LAC currencies remains rather limiteduse of LAC currencies remains rather limited

If liquidity is self-fulfilling there is a prima facie case If liquidity is self-fulfilling there is a prima facie case for public policy actionfor public policy action

But there is a Catch 22 for MDB’sBut there is a Catch 22 for MDB’s Conclusions and recommendations for coordinated Conclusions and recommendations for coordinated

actions actions

A Word on LAC: Bad Inflation A Word on LAC: Bad Inflation Experience Has Largely been Experience Has Largely been

Conquered Conquered

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Start of Debt Crisis

Hyperinflation episodes in Argentina, Brazil

Lehman

Tequila Crisis

≈6%

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Growth Performance: not doing as well Growth Performance: not doing as well as other EM’s but better than as other EM’s but better than

Developed Countries Developed Countries

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Eight Countries in the Eight Countries in the Region are Now Inflation Region are Now Inflation

TargetersTargeters

Can see private inflation and growth Can see private inflation and growth expectations as sampled by each expectations as sampled by each country’s central bank herecountry’s central bank here

www.iadb.org/revela

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Dimensions of Currency Dimensions of Currency InternationalizationInternationalization

Trade settlement – Trade settlement – Means of ExchangeMeans of Exchange Reserve currency usage – Reserve currency usage – Store of ValueStore of Value Denomination of contracts – a Denomination of contracts – a Unit of Unit of

AccountAccount

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Dimensions of Currency Dimensions of Currency InternationalizationInternationalization

Unit of Unit of AccountAccount

Means Means of of ExchanExchangege

Store Store of of ValueValue

FunctioFunctions of ns of MoneyMoney

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This paper/presentation…This paper/presentation…

Focus on use of currencies to Focus on use of currencies to denominate debtdenominate debt (unit of account) (unit of account) and ability of countries to issue debt and ability of countries to issue debt in their own currency internationallyin their own currency internationally

I will argue this ability is important I will argue this ability is important for risk sharing and will focus on for risk sharing and will focus on Latin America and the CaribbeanLatin America and the Caribbean

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Information and Liquidity Information and Liquidity Externalities for Currency Externalities for Currency

UsageUsage If a currency is used in one dimension If a currency is used in one dimension

more likely to be used in othersmore likely to be used in others If market trading focused on the dollar, prices If market trading focused on the dollar, prices

will reflect all available informationwill reflect all available information Derivatives will give information on expected Derivatives will give information on expected

valuations and expected volatilityvaluations and expected volatility High liquidity will make it easier/cheaper for High liquidity will make it easier/cheaper for

others to trade that currency fueling yet more others to trade that currency fueling yet more liquidityliquidity

Liquidity is self-fulfillingLiquidity is self-fulfilling

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Top four currency trading Top four currency trading market shares have been market shares have been

remarkably stableremarkably stable

Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity

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More movement in next 10 More movement in next 10 currencies, but from a small currencies, but from a small

base…base…

Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity

Mexican peso, MXP

Brazilian Real, BRNL

Chilean peso, CHP Colombian

peso, COP

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Currency market shares of Currency market shares of globalglobal

derivative trading…derivative trading…

Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity

Emerging Asian and LAC currency derivatives are within others’ 9% and

residual 2%

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Global Bond IssuanceGlobal Bond Issuance

Source: Dealogic data, author’s calculations

14Source: Dealogic data, author’s calculations

Bond Bond IssuanceIssuance

Of Of US$139bn US$139bn

of 2011 LAC of 2011 LAC “deal-“deal-

nationality” nationality” issues, issues,

US$82bn US$82bn were in USDwere in USD

$22bn in BRL$18bn in MXN/MXV$5.4bn in CLP/CLF

15Source: Dealogic data, author’s calculations. Caveat: a large number of deals did not have governing law identified.

And some US$10bn of LAC And some US$10bn of LAC Currency Issues were under Currency Issues were under

Developed Country Governing Law, Developed Country Governing Law, the majority under London Law the majority under London Law

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Why do we care…?Why do we care…? The 1980’s Latin American debt crisis and The 1980’s Latin American debt crisis and

subsequent lost decade had many originssubsequent lost decade had many origins But one was surely poor risk sharing…But one was surely poor risk sharing…

Commodity prices were high and plungedCommodity prices were high and plunged US interest rates were low and then soaredUS interest rates were low and then soared The dollar appreciatedThe dollar appreciated And debt was in dollarsAnd debt was in dollars

Today looks somewhat similar with $82bn Today looks somewhat similar with $82bn of LAC’s $139bn of 2011 debt issuance in of LAC’s $139bn of 2011 debt issuance in dollarsdollars

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To see this more To see this more scientifically…scientifically…

A country’s ability to pay in US$ is A country’s ability to pay in US$ is related to US$ GDPrelated to US$ GDP

A country’s ability to pay in a real A country’s ability to pay in a real domestic unit of account is related to domestic unit of account is related to real local currency GDPreal local currency GDP

If the former is more volatile than If the former is more volatile than the latter, US$ debt has poor risk the latter, US$ debt has poor risk sharingsharingThis argument follows that in Hausmann

and Rigobon and Eichengreen and Hausmann who call for local currency

inflation indexed debt contracts

18Source: Author’s calculations, perriod 1980-2011.

LAC: US$ Growth vs. Real Growth LAC: US$ Growth vs. Real Growth VolatilityVolatilityUSD GDP Growth Real Growth Real/USD

Latin America & The Caribbean % % %Bolivia 7.4 1.4 19.0%Brazil 17.6 2.2 12.7%Chile 11.8 2.4 20.7%Colombia 11.8 1.8 15.1%Costa Rica 11.8 1.8 15.1%Dominican Rep 6.5 2.8 42.7%Guatemala 6.2 1.1 18.4%Guyana 8.1 3.3 41.0%Haiti 16.0 4.8 29.7%Honduras 4.5 2.6 56.3%Jamaica 6.2 1.8 29.5%Mexico 15.3 3.5 23.1%Nicaragua 4.2 2.3 53.6%Paraguay 14.3 4.4 30.5%Peru 9.5 3.6 37.4%Suriname 18.3 3.3 17.8%Trinidad and Tobago 18.3 3.3 17.8%Uruguay 18.9 4.9 25.7%Venezuela 17.6 6.5 36.7%Average LAC 11.8 3.0 25.7%

19Source: Author’s calculations, perriod 1980-2011.

And the same goes for the BRICS…And the same goes for the BRICS…

USD GDP Growth Real Growth Real/USDRussia 22.9 5.3 23.2%India 8.7 1.9 22.5%China 8.4 1.9 22.1%Brazil 17.6 2.2 12.7%South Africa 11.3 2.0 17.3%Average BRIC 13.8 2.7 19.3%

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Inflation-indexed versus nominal Inflation-indexed versus nominal debt debt

Ability to service debt related to nominal Ability to service debt related to nominal GDP not realGDP not real

Some LAC countries issuing in nominal Some LAC countries issuing in nominal local currencylocal currency

LAC has 8 inflation targeters with good LAC has 8 inflation targeters with good inflation performanceinflation performance

BRICS also issuing in own nominal BRICS also issuing in own nominal currencycurrency

Hausmann and Rigobon likely affected by Chile’s good example, but Chile has been

“nominalizing” too..

21Source: Author’s calculations.

Simulated Volatility of LAC Debt to Simulated Volatility of LAC Debt to GDP Ratio with Local Currency vs. GDP Ratio with Local Currency vs.

Dollar Debts Dollar Debts Local Currency US Dollars Volatility LC / US$

% %Bolivia 2.3 8.1 28.6%Brazil 3.2 7.1 45.6%Chile 0.1 0.4 34.6%Colombia 1.3 5.3 25.1%Costa Rica 0.9 3.1 27.5%Dominican Rep 1.3 4.2 29.8%Guatemala 0.6 1.4 45.1%Guyana 14.7 17.9 81.8%Haiti 1.8 6.7 26.6%Honduras 2.7 4.6 58.4%Jamaica 6.1 11.7 51.9%Mexico 0.6 1.4 43.4%Nicaragua 4.4 5.0 87.8%Paraguay 1.3 9.5 13.4%Peru 3.3 3.9 84.9%Suriname 1.6 2.8 57.3%Trinidad and Tobago 1.1 1.2 90.4%Uruguay 9.0 41.2 21.9%Venezuela 1.7 6.6 25.3%LAC Average 3.0 7.5 40.7%

22Source: Author’s calculations.

Similar Results for the BRICS Similar Results for the BRICS

Local Currency US Dollars Volatility LC / US$Russia 4.0 17.7 22.6%India 0.6 1.8 35.8%China 0.5 0.7 75.1%Brazil 3.2 7.1 45.6%South Africa 3.9 22.2 17.4%Average 2.5 9.9 24.9%

23Source: Author’s calculations.

And poor risk sharing of US$ And poor risk sharing of US$ contracts:contracts:

Brazil simulated debt ratios and Brazil simulated debt ratios and growth growth

Dollar strong when growth was weak

24Source: Author’s calculations.

And poor risk sharing of US$ And poor risk sharing of US$ contracts:contracts:

Peru simulated debt ratios and Peru simulated debt ratios and growth growth

Dollar strong when growth was weak

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What can be done?What can be done? Latin American countries have been issuing Latin American countries have been issuing

in local currency, selected pricing points:in local currency, selected pricing points: Chile: 2020 pesos 4.4% yield, US$ 2022 2.4%.Chile: 2020 pesos 4.4% yield, US$ 2022 2.4%. Colombia: 2032 peso 4.4% yield, US$ 2022 1.8% Colombia: 2032 peso 4.4% yield, US$ 2022 1.8%

MDB’s can lend in local currencyMDB’s can lend in local currency But MDB’s subject to a Catch-22But MDB’s subject to a Catch-22

Can lend where liquid markets allow hedgingCan lend where liquid markets allow hedging Cannot lend where needed or will eat into Cannot lend where needed or will eat into

valuable capital to back currency risksvaluable capital to back currency risks

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RDB’s can reduce capital through RDB’s can reduce capital through diversification:diversification:

volatility of currency portfoliosvolatility of currency portfolios

Source: author’s calculations

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A GDP weighted portfolio brings less A GDP weighted portfolio brings less benefits:benefits:

global coordination valuableglobal coordination valuable

Source: author’s calculations, LAC countries with GDP weights, RICS with equal weights

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TCX – TCX – www.tcxfund.com

TCX was an initiative of the Dutch aid TCX was an initiative of the Dutch aid agencyagency

Financed by official sources (Bilaterals, Financed by official sources (Bilaterals, MDB’s)MDB’s)

Enters into exotic currency swapsEnters into exotic currency swaps Gives liquidity where none existedGives liquidity where none existed Holds naked currency risks on its booksHolds naked currency risks on its books Benefits from global diversificationBenefits from global diversification

Guarantees to Kick Start Guarantees to Kick Start Currency MarketsCurrency Markets

Local currency debt contracts reflect more Local currency debt contracts reflect more closely countries’ “ability to pay” which is closely countries’ “ability to pay” which is related to nominal GDP related to nominal GDP

To the extent a contract matches a country’s To the extent a contract matches a country’s “ability to pay” then a guarantee on that “ability to pay” then a guarantee on that contract will act on “willingness to pay” risks contract will act on “willingness to pay” risks 11

Some countries can already issue in local Some countries can already issue in local currency on reasonable terms, others may currency on reasonable terms, others may benefit from the presence of an MDB guaranteebenefit from the presence of an MDB guarantee

A guarantee is a flexible instrument that can be A guarantee is a flexible instrument that can be adjusted to particular required demandadjusted to particular required demand

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Anderson, Gilbert and Powell “Securitizing commodity contingent debt”, American Journal of

Agricultural Economics 1991

Guarantees to Kick-Start Guarantees to Kick-Start Local Currency MarketsLocal Currency Markets

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Country Issues Local Currency

Debt

Investors

Partial MDB Guarantee

TCX-type institution

Reinsurance

market

Currency risks

Other risks

Schematic representation of one sample structure to kick start local currency markets

ConclusionsConclusions Several emerging economies are now able to issue Several emerging economies are now able to issue

debt in their own currencies but subject to liquidity debt in their own currencies but subject to liquidity premiapremia

But local currency issuance remains limited and yet But local currency issuance remains limited and yet issuing dollar debt has dangerous risk propertiesissuing dollar debt has dangerous risk properties

MDB’s can help but there is something of a Catch-22MDB’s can help but there is something of a Catch-22 If liquidity is self-fulfilling, prices are not given If liquidity is self-fulfilling, prices are not given Guarantees are a flexible instrument to kick start Guarantees are a flexible instrument to kick start

markets markets Benefits to global coordination to diversify risks to Benefits to global coordination to diversify risks to

institutions providing local currency loans or institutions providing local currency loans or guaranteesguarantees

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