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Original sin

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Barry Eichengreen, Ricardo Hausmann & Ugo Panizza ... BRA. CAN. CHN. CRI. CYP. CZE. DNK. DOM. EST. FIN. DEU. GRC. HUN. ISL. IND. ISR. ITA. JPN. JOR. LVA. MEX ... – PowerPoint PPT presentation

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Title: Original sin


1
Original Sin The Pain, the Mystery And the Road
to Redemption
Barry Eichengreen, Ricardo Hausmann Ugo
Panizza
UC Berkeley, Harvard, and IDB
2
PART III REDEMPTION
3
The global portfolio is highly concentrated by
currency
4
The global portfolio
(0.9857)
1
Debt
by
0.9
Currency
(0.8859)
0.8
Debt
by Country
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
United States
EUROLAND
Japan
U
.
K
Switzerland
Canada
Australia

5
Total Debt issued by residents (99-01)
International Organizations (7)
Other Developed (8)
Developing (8)
Euroland (33)
Major Financial Centers (45 )
Total Debt issued in own currency (99-01)
Other Developed (Major Financial Centers (61 )
Euroland (37)
6
This is bad
  • Makes stabilization policy less effective
  • Makes bad shocks more destabilizing
  • Think of Brazil, Thailand, Indonesia
  • It increases volatility of output and capital
    flows
  • Lowers credit ratings controlling for other
    fundamentals

7
Table 6 Original sin and exchange rate
flexibility

(1)

(2)

(3)


LYS

RESM2

RVER





OSIN3

0.984

0.248

-
0.801


(2.98)

(3.74)

(2.02)

LGDP_PC

0.268

-
0.053

0.026


(3.61)

(1.85)

(0.61)

OPEN

0.178

-
0.014

1.017


(1.85)

(0.41)

(2.88)

SHARE2

58.719

-
35.858

-
569.562


(0.46)

(0.66)

(2.36)

Constant

-
1.389

0.531

0.104


(1.79)

(1.73)

(0.17)

Observations

75

65

65

R
-
squared

0.22

0.37

0.62


8
Table 7 Original sin and volatility

(1)

(2)


VOL_GROWTH

VOL_FLOW




OSIN3

0.011

7.103


(1.96)

(3.58)

LGDP_PC

-
0.012

-
3.214


(2.14)

(2.56)

OPEN

-
0.001

-
4.181


(0.12)

(1.20)

VOL_TOT

-
0.000

0.223


(0.86)

(1.08)

SHARE2

-
1
4.287

147.265


(1.72)

(0.04)

Constant

0.135

32.825


(2.25)

(2.39)

Observations

77

33

R
-
squared

0.40

0.64


9
The Weak Relationship Between Debt/GDP and Credit
Ratings
AUT
DEU
JPN
NOR
GBR
USA
19
BEL
CAN
DNK
SWE
AUS
ESP
FIN
ITA
PRT
CYP
ISL
SVN
rating foreign currency
CZE
ISR
EST
CHN
GRC
LVA
HUN
TUN
POL
TTO
PAN
IND
MEX
ARG
CRI
MAR
BRA
DOM
JOR
PRY
TUR
PAK
5
-.291965
1.13803
net_debt/gdp
10
Debt to tax ratios do remarkably poorly as
predictors of ratings
AUT
DEU
LUX
NOR
CHE
GBR
USA
19
SGP
SWE
BEL
CAN
DNK
AUS
ESP
ITA
FIN
CYP
ISL
MLT
SVN
CZE
KOR
CHL
ISR
THA
credit rating 1992-99 average
EST
CHN
LVA
GRC
TUN
POL
HUN
COL
SVK
PAN
ZAF
IND
MEX
SLV
IDN
ARG
CRI
MAR
PER
TUR
BOL
DOM
JOR
KAZ
BRA
PRY
MNG
5
-.579362
4.13906
DE_RE2
11
Table 8 Original sin and credit ratings

(1)

(2)

(3)

(4)


RATING1

RATING1

RATING1

RATING1

DE_GDP2

-
1.553


-
1.815



(1.91)


(2.19)


DE_RE2


-
0.599


-
0.665



(1.40)


(1.52)

LGDP_PC

3.189

3.051

2.884

2.76
4


(8.54)

(7.59)

(6.47)

(5.68)

OSIN3

-
3.429

-
3.324

-
4.883

-
4.435


(3.85)

(3.49)

(3.49)

(3.11)

Constant

-
12.369

-
11.059

-
8.751

-
7.889


(3.16)

(2.60)

(1.89)

(1.57)

Observations

56

49

51

44

R
-
squared

0.82

0.81

0.81

0.80


12
It cannot be explained by weak domestic policies
and institutions
  • Too many good guys suffer from it

13
Why Might a Few Important Currencies So Dominate
the Global Portfolio?
  • Additional currencies add decreasing
    diversification benefits but constant
    transaction costs.
  • International transaction costs and
    heterogeneity
  • Network externalities may give a small number of
    vehicle currencies special attraction.
  • Countries seeking to add their currencies to the
    global portfolio thus face an uphill battle.
  • And each that succeeds makes life tougher for the
    others.

14
Bottom Line
  • Original sin is not merely a problem of country
    policies (one need not deny the relevance of
    these, of course).
  • It is also a problem with the operation of the
    international system (given transactions costs, a
    world of heterogeneous countries, and network
    effects that lock in the status quo).
  • Redemption therefore requires international
    action to overcome the inertia in the system.

15
Lessons from outliers
  • Countries that have recently escaped original sin
    seem to have done so through non-nationals
    issuing debt in domestic currency
  • IFIs have played a major role in this process
  • Borrowers swap their obligations with residents

16
Foreigners issue most of the debt in exotic
currencies
1
Foreign
OSIN 3
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Czech Republic
South Africa
New Zealand
Poland
Hong Kong
Denmark
Canada
Singapore
Australia
Countries with OSIN 3 below 0.8, excluding
Financial Centers
17
IFIs are very important in the new OS outliers
1993-98
1999-01
18
Our proposal
  • We propose an index based on an
    inflation-adjusted basket of EM currencies
  • Historically it shows trend appreciation, low
    volatility and negative correlation with
    industrial country consumption
  • We propose that the WB, other IFIs and C-5
    governments issue debt in this index and swap
    obligations with EMs

19
Why is this so?
  • Not because of a developmental goal
  • IDB issued in non-member currencies
  • Only because it is cheaper
  • Swap back into US
  • What makes it more efficient?
  • Correlation between currency risk and default
    risk makes local instruments inefficient
  • IFIs have no correlation between currency and
    default risk
  • Local borrowers on the other end pay to get rid
    of the mismatch enough to encourage IFIs to issue

20
An ideal world without OS
IFI
iD
Dollar bond
The Belgian dentist would hold both the
riskless
IFI bond plus the currency,
Belgian
the credit risk and the covariance
dentist
term between the two.
i D
Peso bond
EM government
21
An alternative route to
redemption
IFI
EM has to pay when
the real exchange rate is
i D
strong, which is often
Peso bond
when the economy is OK.
Performance risk is
diminished.
Belgian
iD
i D
dentist
Dollar bond
iD
EM government
The Belgian dentist now holds the currency risk
in the IFI bond and the credit risk,
in the EM bond, but these are not correlated
anymore.
22
Our proposal
  • Develop an index
  • based on a basket of currencies
  • Indexed to inflation
  • GDP PPP weighted
  • We show that it has three characteristics
  • Trend appreciation
  • Low volatility very diversified
  • Negative correlation with consumption in
    industrial countries
  • Excellent for a developed country portfolio

23
The EM is a stable index
1.7
20 in the 80's
1.5
22 from 93-02
DM Index
1.3
Yen Index
1.1
0.9
0.7
0.5
0.3
1980Q1
1981Q1
1982Q1
1983Q1
1984Q1
1985Q1
1986Q1
1987Q1
1988Q1
1989Q1
1990Q1
1991Q1
1992Q1
1993Q1
1994Q1
1995Q1
1996Q1
1997Q1
1998Q1
1999Q1
2000Q1
2001Q1
24
Appreciation, stability, risk diversification
1
Note
Correlations with Real Consumption for
France, Germany, Italy and Spain it covers
1980-1998.
For Canada, UK, US and Japan it covers 1980-01. A
negative number indicates that the returns tend
to be high when real
private consumption is low.
25
Step 2. Have the World Bank and other IFIs issue
debt in EMs
  • IFIs are AAA, so they have access to a broad
    asset class
  • They can hedge their currency exposure by
    converting loans to EM-index members into indexed
    local currency loans
  • They become a solution, not a cause of OS
  • Regional IFIs can swap with the WB or the
    governments themselves for non-regional index
    members
  • WB would calculate index lowering manipulation
    risk

26
Step 3. Have C-5 countries issue debt denominated
in index
  • Also high-grade non-residents with an interest in
    lowering global risks
  • Swap currency exposure with EM-member countries
  • This gets read of the mismatch
  • Need not cost them anything
  • Make sure by providing put-option on the price of
    the swap
  • The swap is much safer than sovereign risk and
    can be made safer

27
Expected further developments
  • If the EM-index market develops, mutual funds and
    institutional investors will try to add a by
    buying local currency instruments issued by
    residents
  • Evidence from exotic currencies is that IFI role
    dwindles in time as market develops

28
In conclusion
  • We base our solution on the experience of
    outliers
  • Role of foreign issuers, IFIs, swaps
  • We address the cause of OS by offering a well
    diversified synthetic currency
  • We address the credibility problem of EMs by
    indexing to inflation
  • Very limited downside risk if attempt to develop
    EM market fails

29
Original Sin The Pain, the Mystery And the Road
to Redemption
Barry Eichengreen, Ricardo Hausmann Ugo
Panizza
UC Berkeley, Harvard, and IDB
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