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External and domestic financing in Latin America: developments, sustainability and financial stabili

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External and domestic financing in Latin America: developments, sustainability ... The financing of Latin American economies has experienced a major transformation ... – PowerPoint PPT presentation

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Title: External and domestic financing in Latin America: developments, sustainability and financial stabili


1
External and domestic financing in Latin America
developments, sustainability and financial
stability implications
  • Debt finance and emerging issues in financial
    integration
  • United Nations
  • New York April 8-9 2008

The views expressed here do not necessarilly
reflect those of the BIS.
2
Background
  • The financing of Latin American economies has
    experienced a major transformation in the past 10
    to 15 years. Two remarkable developments
  • Shift from cross-border towards domestic
    financing.
  • Shift from bank to bond financing
  • As a result, capital markets have expanded,
    deepened and diversified, creating a promising
    financing alternative.
  • Such developments help mitigate risks and sources
    of vulnerability (eg currency mismatches) and
    should help provide an alternative source of
    financing when banking sectors are weakened.
  • Nonetheless, their rapid development pose risks
    that need to be taken into account.

2
3
Main issues
  • It is still an open question whether i) reduced
    reliance on external financing and ii)
    alternative financing markets in the region are
    permanent features.
  • As the pillars supporting the favourable global
    conditions began to erode, these new domestic
    markets will have to prove their resilience and
    the extent to which they offer room of manoeuvre
    for counter-cyclical policies (in particular, if
    exchange rate appreciation trends reverse).
  • Progress in reducing currency mismatches are
    positive.
  • Nonetheless, local currency debt markets still
    have a strong short-term bias and remain highly
    illiquid.
  • Furthermore, progress in developing corporate
    bond markets are an unfulfilled promise, which
    will raise new risks.

3
4
Outline
  • Macroeconomic environment
  • Shifts in financing patterns
  • Development of local currency bond markets
  • Sustainability and financial stability
    considerations

4
5
Macroeconomic environment
  • In recent years, Latin America has at last
    witnessed high growth rates (similar to those of
    the 1960s-1970s). This has been possible due to
    exceptional international conditions
  • Strong commodity prices
  • Exceptional external financing conditions
  • Large remittances by migrant workers to the
    region
  • Two features are notorious of the current
    regional situation
  • Growth while generating current account surpluses
  • Large accumulation of international reserves

5
6
Current account surpluses
  • The large CA surpluses are unprecedented in the
    regions history, and are mainly associated with
    the improvement in terms of trade.

Terms of trade effect in 2007 3.4
6
7
Reserve accumulation
  • A new development policy has been the frequency
    and scale of intervention in foreign exchange
    markets. Therefore, several LA countries are
    operating dirty floats.

7
8
Scale of international reserve accumulation
8
9
Reserve accumulation involves costs
9
10
Shifts in financing patterns
  • Against the background of rapid growth with
    current account surpluses and reserve
    accumulation, the region has experienced a shift
    in financing needs.
  • In contrast with the past, capital flows are no
    longer needed to finance current account
    deficits.
  • New elements of the dynamics of capital flows and
    international investment positions
  • Large gross FDI and portfolio inflows
  • Incipient but growing gross capital outflows
  • Reduced reliance on external financing in net
    terms
  • Reduction in external liabilities positions
  • Improved external balance sheets

10
11
Gross and net capital flows
11
12
Changes in cross-border holdings
Debt reduction
12
13
The development of local currency bond markets
  • An important counterpart of the regions shift
    improvement of its net international position is
    the development of domestic bond markets.
  • In fact, domestic financing has expanded
    significantly vis-à-vis external financing.

13
14
Main features of domestic bond markets in Latin
America
14
15
Domestic bond markets vary widely in size
15
16
Public sector issuers dominate domestic markets
USD 808 billion
16
17
Fixed rate debt now accounts for a significant
share of domestic government securities in some
countries.
  • Dollar-linked debt has been phased out in some
    countries (eg Brazil and Mexico).
  • However, short-term, floating-rate and
    inflation-indexed securities continue to be
    significant across the region.

17
18
The maturity structure of government debt in
local currency has expanded
  • Notwithstanding this progress, the amount of
    long-term fixed rate securities remains limited,
    as reflected by the weighted average maturity of
    new issues.

18
19
Nominal yield curves have began to emerge
  • The wider availability of longer-dated bonds is
    beginning to provide a useful representation of
    the term structure of interest rates.
  • However, the information content of yield curves
    remains an issue.

19
20
Only few countries enjoy reasonably strong
liquidity
20
21
Sustainability and financial stability
considerations
21
22
Is the development of domestic bond markets
temporary or permanent?
  • Some progress at the domestic level appear to be
    of a permanent nature (eg debt management, better
    macro policies).
  • But much seems to depend on the sustainability of
    the global process of portfolio diversification.
  • Interestingly, despite the financial turmoil in
    developed economies capital continues to flow to
    the region.
  • Nonetheless, the extent to which domestic bond
    market will continue to be a dependable source of
    funding remains to be truly tested.

22
23
Diversification benefits offered by LA domestic
bond markets relative to other asset classes(US
dollar-based investors)
23
24
Financial stability considerations
  • The region has seen an improvement in currency
    exposures.

24
25
Financial stability considerations
  • Indirect (and direct evidence for government
    debt) suggest an improvement in maturity
    mismatches

25
26
Risks associate to the development of domestic
bond markets
  • As any new financial development, local currency
    bond market may involve hidden risks. These can
    be associated with
  • Local currency bond markets may have swapped
    currency risk for interest refinancing risk.
  • Lack of liquidity. This is a concern because
  • Limits the capacity to manage exposures, and
  • Constrains the possibility of making rapid
    adjustments of portfolios without a significant
    disruption of the market.
  • The type of investors (eg domestic vs. foreign).
    The lack of an appropriate infrastructure to deal
    with these markets.
  • The intrinsic characteristics of the new
    instruments (ABSs, derivatives, corporate debt,
    etc)
  • The type of issuer

26
27
Challenges
  • Improve liquidity
  • Consolidate various forms of public sector debt
    under a single obligor
  • Concentrate government issuance in a limited
    number of benchmarks, reopening issues where
    necessary.
  • Central banks can use government and other
    high-grade securities as collateral for their
    lending operations (Repos).
  • Widen the investor base (eg changes in
    regulations)
  • Regional funds (ABF-2)
  • Reduce vulnerability of debt structures to
    interest rate and refinancing risk.
  • Increase the issuance by the corporate sector.
  • Spread the risk of bond investment ie expand the
    investor base.

27
28
Resiliency of local currency bond markets
28
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