lunes, 21 de abril de 2014

lunes, abril 21, 2014

Last updated: April 18, 2014 2:33 pm

Emerging markets repent of ‘original sin’

Issuing bonds in local currencies has not spared countries from volatility

The Christ the Redeemer statue stands on top of Corcovado Mountain in this aerial photograph of Rio de Janeiro, Brazil©Bloomberg
Emerging markets such as Brazil offer growth potential


A decade ago, economists often fretted about the so-calledoriginal sin” that plagued emerging markets. During the 1980s and 1990s, countries such as South Korea and Argentina issued vast quantities of bonds denominated in non-domestic, “hardcurrencies such as the dollar.

But while this seemed temptingly easy at the time, since international investors gobbled up that dollar-denominated debt, it came at a price. When the financial crisis hit in 1997, foreign investors dumped those assets. And when the domestic currencies of EMs fell, the debt burdens of EM issuers also soared.

The International Monetary Fund has urged EM countries to repent of thatoriginal sin” of issuing bonds in foreign currency. In particular, since 1997 the IMF has exhorted them to issue local currency debt instead, in the hope that this would reduce their vulnerability to global market swings.

The good news is that they have heeded this advice. Last week in Washington the IMF issued a fascinating report which showed that many have steadily increased their local currency issuance in recent years.

On average, local currency debt now accounts for 90 per cent of all sovereign debt, up from 70 per cent a decade ago. Meanwhile, trading volumes of local currency bonds are now almost five times bigger than for hard currency EM bonds; this is striking, since in 2000 these were at parity.

But the bad news is that reducing original sin has not been the magic wand the IMF hoped. In recent years, countries such as Brazil, China, Turkey, India and South Africa have notably cut their reliance on “hardcurrency debt, according to IMF data. This has not spared these countries from volatility, however. On the contrary, when speculation erupted last summer about US monetary tightening, debt prices fell sharply in places such as India, Turkey and Brazil.

Why? Oddly enough, local currency bond markets have almost become victims of their own success. When the IMF first urged countries to create them, it was widely assumed that they would appeal mostly to local investors. In the past four years, however, foreigners have jumped in too, with a vengeance. Indeed, by late 2013, foreign investors held more than 50 per cent of the local bond market in Peru, and more than a third in Malaysia, Mexico, Hungary and Indonesia.

On one level, this is welcome; if nothing else, it gives these markets more credibility. But it also comes at a price: IMF research shows that international investors have a nasty habit of moving as a herd, particularly since flows are concentrated in the hands of just half-a-dozen big asset managers, such as BlackRock and Pimco.

To make matters worse, though western investment banks used to act as market makers for EM assets, they are now withdrawing from that role because recent financial reforms have made it too costly for banks to hold risky assets.

JPMorgan, for example, estimates that banks’ holdings of EM bonds are down by 80 per cent. Or to put it another way, the moves that regulators have taken to make western banks safer have made EMs potentially more volatile. It is distinctly ironic.

In theory, there is one obvious way to mitigate this problem: EM countries could develop a much bigger local investor base themselves, which could buy bonds if (or when) that international asset management herd leaves – or even act as local market makers. Last week, the IMF exhorted EM countries to do just this, by promotingfinancial deepening”, as the jargon goes.

While some countries, such as Chile, have created admirably strong local investment groups and markets, this is the exception not the rule. And it may not be easy to replicate that Chile template; or not fast. Chile has a strong domestic investor base today because it decided three long decades ago to create a pension system via financial repression (the government essentially forced people to save for pensions and to keep a large chunk of money inside the country.)

Or to put it another way, even if the EMs are cutting their original sin, there is little chance they will escape from the vagaries of global capital flows anytime soon.

Many of them quietly continue to expand their dollar reserves, as a protective hedge against future volatility. In today’s world, it seems an entirely rational thing for EM policy makers to do; or, at least, a great deal more sensible than just hoping – and praying – that the Federal Reserve will not rock global markets again anytime soon.


Copyright The Financial Times Limited 2014

0 comments:

Publicar un comentario