La Crisis financiera en Asia en 1998 y la miopia de la agencias de clasificacion de riesgo

1
La Crisis financiera en Asia en 1998 y la miopia
de la agencias de clasificacion de riesgo

• ESAN 2006
• Michel-Henry Bouchet CERAM/Finconet
• Ephraïm Clark - Middlesex University
• Bertrand Groslambert - CERAM

2
Plano

• Introduccion
• Risk perception and rating agencies
• Financial Crisis, Herd Instinct and Spill-over
  Effect
• The actual Economic and Financial Situation
• Empirical Study
• Conclusions

3
The Asian Financial Crisis

• Two Main Features
• Abrupt Crisis end-1997
• Currency devaluations
• Stock market collapses
• IFIs and rating agencies caught off guard
• Spill-over Effect
• From Thailand to Asian countries
• From Asian to world-wide stock markets
• From Asia to other EMCs in Latin America (Brazil)
  and Eastern Europe (Russia)

4
The Macro-economic Situation - I

• The tigers seemingly sound economic
  situation
• Good macroeconomic performance until 1996

Source IMF/International Financial Statistics
1999
5
The Macro-economic Situation - II

• A seemingly sound economic situation
• A prudent fiscal policy A controlled inflation
  rate

Source IMF/ International Financial Statistics
1999
6
The Macro-economic Situation- III

• A seemingly sound economic situation
• A strong investment rate high saving rates

Source International Financial Statistics
(1999), Global Development Finance (1998)
7
Trade liberalization as dynamic growth engine
8
The Macro-economic Situation - IV

• A seemingly sound economic situation
• Current account deficit but large FDI (non
  debt-creating flows)
• Official reserve assets rising till end-1996
• Interest/Export ratios between 3 (Korea
  Malaysia) and 10 (Indonesia)

Source International Financial Statistics
(1999), Global Development Finance (1998)
9
The Perceived Situation V

• Asias most distinguishing macroeconomic feature
  over the past few decades has been a very high
  saving rate.
• With an average saving rate of 30 of GDP, Asian
  powerhouses were able to garner the resources to
  invest in growth without over-reliance on foreign
  savings, hence without resorting to debt
  financing.
• Euromoney/Deutsche Bank 2000 Guide to Asian Debt
  Markets

10
Country Risk Ratings

• Shortcomings/Cons
• reductionist
• over-simplistic
• risk of self-fulfilling prophecy
• little predictive value
• weighted average tends to bury salient trends
• gives market consensus often made of herd
  instinct

• Advantages/ Pros
• simple
• shrinks a large number of variables into one
  single grade
• cross-country comparison
• comparison across time
• reliable for smooth risk evolution

11
The Perceived Situation

• Was the crisis anticipated by rating agencies?

12
EUROMONEYs Risk Ratingthe higher the score, the
larger the risk
Agencies were blind for too long then hammered
the counties with abrupt downgrading
13
Rating poor early warning signal?

• 1997 Asia risk ? Its like growth stocks
  sovereign risk has never looked better 
• Institutional Investor (March 1997)
• South Korea wa s rated as Italy and Sweden as
  recently as October of 1997! but has been
  abruptly downgraded to junk bond status!
•  There were no early warnings about Korea from
  us or, to the best of our knowledge, from other
  market participants and our customers should
  expect a better job from us  FITCH IBCA January
  14, 1998

14

• Ex Post Analysis unsustainable economic
  growth!
• Structural Weaknesses
• Weak banking supervision and crony capitalism
• Undercapitalized banks and large non-performing
  assets
• Stable dollar-pegged exchange rates
• Highly indebted corporate sector
• External Debt Overhang for Indonesia, Thailand
  and Korea

London Club commercial bank claims in US million
15
The Conventional Wisdom VI-

• Financial markets did not anticipate
• Financial markets overreacted
• Herd instinct, spill-over effect and
  self-fulfilling prophecy
• World Bank (1998) "markets and market observers
  failed to anticipate the scope and severity of
  the crisis
• Herd Instinct
•  sheep  mentality characterized by a lack of
  individuality, causing people to think and act
  like the general population. It contributes to
  unsubstantiated rallies or sell-offs.

16
Markets and Rating Agencies shortsightedness

• Observed Risk Premium subtracting the US T-bond
  yield from the average yield to maturity (nearest
  maturity to the countrys debt duration)

17
After Asia some lessons of the crisis

• Any agency which rated the Republic of Korea at
  the high investment grade rating of AA- (in the
  case of Fitch IBCA and SPs) or A1 (in the case
  of Moodys) before the crisis and which now rates
  Korea at a speculative grade B- was clearly
  either wrong initially or subsequently. Clients
  are entitled to expect us to perform better in
  the future.
• Fitch IBCA January 13, 1998
• When the facts change, I change my mind
• J.M Keynes

18
The Clark (1991) Method

• Clark's approach to cross-border risk analysis
• A country's economy a financial asset
• Adopting the perspective of an international
  economic agent (investor, exporter or creditor)
• Is the economy able to generate enough hard
  currency cash to meet foreign obligations?
• (similar method to that of California-based
  KMV-Moodys to assess an enterprises credit risk
  as reflecting uncertain future economic
  performance. Risk is considered as volatility in
  market values! Credit risk is viewed as a
  portfolio management problem, requiring timely
  measurement of default probabilities)

19
The Method

• This approach allows to compute
• The foreign economy' s market value
• The macroeconomic market rate of return
• Therefore, it generates the inputs required to
  apply the Modern Financial Theory
• Option Pricing Model

20
The Option Pricing Tool (Black/Scholes 1973)

• Pricing of Options and Corporate Liabilities
• Corporate debt considered as sale of companys
  assets to creditors with shareholders owning an
  option to buy the assets back.
• On the exercise date, if value of assets gt
  nominal value of debt, the shareholders will
  exercise their option and buy back the assets (by
  paying the debt). Otherwise, the company defaults
  and creditors take possession of the assets.
• gt When firm borrows, it boils down to
• lenders effectively acquire company
• companys shareholders are given call options to
  buy the company back (underlying asset) by
  repaying debt (strike price)

21
The Option Pricing Tool

• Option applied to cross-border risk analysis
• Computation of the implied volatility
• Based on market data
• Market value of the call
• Market value of the economy
• - Market value of the debt (? Face Value x e-YTM
  x Duration)

Macroeconomic Balance Sheet

• Market Value of
• the Economy

• Market Value of the Debt
• Market Value of the Call Option

22
The Option Pricing Tool

• Option applied to cross border risk analysis
• We are given
• Underlying asset market value of the economy
  (expected value of future cash-flows of the
  stream of hard currency export income of Goods
  Services)
• Strike price present value of projected debt
  service
• Risk free rate US T-bonds
• Time to maturity duration of the external debt
• Market value of the call
• gt Implied volatility ?

23
The Data

• Marked to market data are required
• Difficult because no Brady Bonds (except
  Philippines)
• London-based ISMA Database
• Eurobond market
• Issued amount weighted average YTM
• Brady bonds Philippines

24
The Empirical Study

• Volatility implied by the observed risk premium

25
The Empirical Study

• What does the implied volatility suggest?
• Market clearly perceived the risky nature of
  Asian countries
• Implied volatility between 40 and 90
• As of the end of 1996
• Philippines was the less risky
• Malaysia was the second less risky immediately
  followed by Thailand
• Korea and Indonesia very risky

26
Protracted Impact of the crisis

• What was the extent of the crisis?
• Philippines and Malaysia less affected
• Korea and Thailand severely affected
• Indonesia the most badly hit

27
Net Short-term bank debt
US billion
Source BIS
28
(No Transcript)
29
Ratio of Net short-term debt/Official reserve
assets
Source BIS
30
Capital fligth as early warning signal
Currency overvaluation
K flight repatriation
31
Conclusions

• Rational portfolio rebalancing
• Not a mindless, indiscriminate panic

32
Country Risk Analysis

• Further readings
• Risk Magazines (Euromoney, Institutional
  Investor, RISK)
• Bouchet The political Economy of International
  Debt, Greenwood/Praeger
• Bouchet alii The Market-Based Menu Approach
  (World Bank-DMFAS)
• International Debt and the Developing Countries,
  WB Symposium, edited by Smith and Cuddington
• Bouchet, Clark, Groslambert, Wiley, 2003