Transcript Building Bond Markets in Latin America

The State of Latin American
Bond Markets
Barry Eichengreen
Rio, August 11, 2006
• Joint work with Eduardo Borensztein and Ugo
Panizza of the Interamerican Development
Bank.
• Intended as a synthetic overview of the state of
the markets.
• Also provides a review of progress on policy
reform to date and an agenda for the future.
– Methodological innovation is to provide a systematic
comparison of East Asia and Latin America, which I
don’t think has been done before. I hope you will find
this interesting.
Why it Matters
•
Bond market development is widely regarded as important for financial
development and stability alike.
– Better diversified financial systems are more efficient. Banks and bond markets
are good at different things.
– Eliminating excessive reliance on banks may also help to lengthen tenors and
promote financial stability.
•
There has been considerable progress in recent years.
– Market cap has grown. Foreign participation has grown.
– But this remains almost entirely foreign participation in government bond
markets.
•
The important question is how much of this progress is permanent?
– Institutional reform may have permanently augmented domestic and, in
particular, foreign investor appetite.
– But recent trends may also heavily reflect favorable global liquidity conditions.
• Retrenchment in the last two quarters, associated with global monetary tightening, is
consistent with this latter view.
• But the fact that some countries, including Brazil, have been heavily if not entirely
insulated from this pull-back suggests that at least some of this progress might be
properly regarded as permanent.
1
2
3
Bond markets in Latin America have grown (more
LAC countries are above the diagonal than below)
BRA
CHL
0
COL
MEX
ARG
PER
0
.5
1
TOT BOND over GDP1994
1.5
2
.2
.3
.4
.5
Same is true of corporate bonds (most countries are above
the diagonal, though disturbingly close to the origin)
.1
CHL
ARG
0
PER
MEX
BRA
COL
0
.1
.2
CORP BOND over GDP 1994
.3
While this is progress, Latin markets continue to
lag along a number of dimensions.
• They are still small by advanced-country
standards.
• With a few exceptions, turnover rates
remain low.
• Markets are disproportionately dominated
by government bonds.
• The duration of issues remains relatively
short.
– The next two figures provide views of this.
Share of Short-Term Bonds (residual
maturity < 1 year): LA is still an outlier
Share of Short Term Bonds
(Residual Maturity Less than One Year)
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
IND 1994-1999
IND 2000-2204
EAP 1994-1999
EAP 2000-2004
LAC 1994-1999
LAC 2000-2004
Share of Medium & Long-Term Bonds
(in purple): LA is still an outlier
Com position of Bonds Issued over 2000-2005
100.00%
90.00%
80.00%
70.00%
Nominal MT & LT
60.00%
Indexed to Inflation
50.00%
Floating Rate
Foreign Currency
40.00%
Short Term
30.00%
20.00%
10.00%
0.00%
LAC
EAP
ALL EM
• Interestingly, this differential in the growth of local
markets is less pronounced when capitalization is scaled
by the size of the financial sector (by M2 or, even more
clearly, by the stock of domestic credit).
• Another way of putting the fact that Latin American bond
markets are small relative to GDP but not relative to the
financial sector is that it is Latin American financial
sectors and not merely the bond market that is
underdeveloped.
• The fact that these markets seem to grow together
suggests that bond market development is a corollary of
the larger process of financial development.
– The next two slides point up the contrast.
Here: scaled by GDP
Domestic Bonds as a Share of GDP (Weighted Average)
140.00%
120.00%
100.00%
80.00%
CORP/GDP
FIN/GDP
GOV/GDP
60.00%
40.00%
20.00%
0.00%
LAC 1994
LAC 2004
EAP 1994
EAP 2004
IND 1994
IND 2004
But here: scaled by domestic credit
Bonds as a Share of Domestic Credit (Weighted Average)
80
70
60
50
CORP/CR
FIN/CR
GOV/CR
40
30
20
10
0
LAC 1994
LAC 2004
EAP 1994
EAP 2004
IND 1994
IND 2004
The role of banks
•
The fact that bond markets grow in tandem with the rest of the financial
system, which generally means in tandem with the banking system,
suggests that banks and bond markets are complements rather than
substitutes.
– Banks provide underwriting services for prospective domestic issuers, advising
the issuer on the terms and timing of the offer.
– They provide bridge finance in the period when the marketing of bonds is still
underway.
– They provide distribution channels for government bonds and form an important
part of the primary dealer network.
– Their institutional support may also be conducive to secondary-market liquidity.
– Finally, and most directly, banks owing to their relatively large size can be major
issuers of domestic bonds themselves.
•
This perspective is rather different from the “pecking order model” of
financial development, in which bank finance develops first, because the
information and contracting environments are highly imperfect, and in which
the bond market develops only later.
• But an imperfectly competitive banking system may be
an obstacle.
• Banks with market power may collude to discourage the
development of alternative channels for intermediation.
– In Chile, the Latin American country with the most active
corporate bond market, fully 26 investment banks have been
active in underwriting and helping to place domestic debt
securities.
– In Mexico three large banks dominate the underwriting and sell
side of the domestic market.
– Is Brazil an intermediate case? (Brazil has 20 different
commercial and investment banks that act as lead underwriters.
But how many are really players?)
To be sure, all of the preceding are
generalizations
• Bond markets in Brazil and Chile are an order of
magnitude larger than those of Argentina and
Peru, even scaled by GDP.
• In addition, those markets are very different in
composition: in Brazil corporate bond issuance
is very small compared to government bonds,
whereas in Chile they represent a significant
share of market capitalization.
• Variation is also evident in maturity.
• And again in terms of turnover.
– The next three slides illustrate these points.
RUS
PER
ARG
IDN
NZL
MEX
HKG
SVK
COL
CHN
PAK
IND
POL
THA
PHL
NOR
CHL
GBR
ZAF
IRL
HUN
TUR
AUS
TW
BRA
CZE
SGP
FIN
CHE
CAN
AUT
LBN
DEU
KOR
ESP
PRT
SWE
MYS
FRA
GRC
NLD
BEL
ITA
USA
DNK
JPN
ISL
IRL
Total market cap by country
200.00%
180.00%
160.00%
140.00%
120.00%
100.00%
80.00%
CORP
FIN
GOV
CORP
FIN
GOV
60.00%
40.00%
20.00%
0.00%
Maturity by country
Share of Corporate Bonds with Maturity Above 5 years
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
HKG
HUN
RUS
MEX
KOR
IDN
TWN
BRA
ARG
PHL
THA
COL
SGP
CZE
IND
ZAF
POL
CHN
MYS
PER
CHL
Turnover by country
EMTA Trading of Locally Issued Bonds as a Share of Oustanding Domestic Bonds
Mexico
Russia
Singapore
South Africa
LAC AVERAGE
Hong Kong
Brazil
Poland
Argentina
Colombia
Hungary
Chile
Turkey
EAP AVERAGE
Malaysia
Pakistan
Taiwan
India
Indonesia
South Korea
Thailand
Lebanon
Philippines
Czech Republic
Peru
Slovakia
China
0.00%
460%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
160.00%
180.00%
200.00%
What are some of the determinants
of these variations?
• In the paper you have before you, we take
market capitalization as our dependent
variable, if only because data are most
comprehensive.
• And we do not limit our cross country
comparisons to LAC.
• We present the data both visually and in
the form of multiple regressions.
– First visually…
.4
Country size (and minimum efficient scale)
plausibly matter (this figure illustrating the role of
country size is for corp bonds)
.3
MYS
.2
KOR
TWN
THA
.1
CHL
ARG
SGP
HKG
PER
0
COL
PHL
2
4
IDN
6
Ln GDP
MEX
BRA
CHN
8
10
1
In addition, countries with higher
savings rates evidently have a leg up
MYS
.8
KOR
.6
BRA
.4
CHL
PHL
COL
THA
CHN
HKG
.2
MEX
SGP
TWN
ARG
0
PER
0
.2
.4
Domestic Savings over GDP
.6
.4
Size of firms also matters for corporate
bond market capitalization
.2
.3
KOR
CHL
.1
ARG
THA
PER
0
IDN
CHN
-.05
MEX
SGP
BRA
HKG
COL
PHL
0
.05
Adjusted Firm Size
.1
Institutional investors matter
• Countries with better development of institutional investors
(privatized pension funds, insurance companies, mutual funds) also
have a leg up (although IIs buy and hold, adding little to liquidity).
• There are some data on this in the paper, but these are fragmentary.
• For example, In Mexico and Chile, institutional investors hold
upward of 90 per cent of corporate bonds; in Peru they hold more
than 70 per cent.
– Pension funds hold a very significant fraction of government bonds in
Chile, Colombia, and Mexico, where the reform of pension systems was
relatively early to get underway.
– In Brazil, the mutual fund industry is the most important holder of
government securities (along with the banking system and BNDES).
– On the other hand, the role of insurance companies is smaller in Latin
America than in Asia – with the exception of Chile, where insurance
company assets under management approach 20 per cent of GDP.
Foreign investor participation can help to
relax constraints on market size and liquidity
• This includes both:
– Issuance by nonresidents
– Investment by nonresidents
• However… …
LAC lags in nonresident issuance
Domestic Currency Corporate Bonds Issued by Residents and Non-Residents (2004)
KOR
397
CHN
196
TWN
HKG
BRA
MYS
ZAF
SGP
THA
MEX
CHL
CZE
RES
ARG
NON_RES
HUN
IDN
POL
IND
PER
SVK
COL
PHL
-10
10
30
50
Bil. USD
70
90
110
130
150
Includes bonds issued by Financila and Non-Financila Corporations, State Agencies and International Organizations. It assumes that all bonds issued domestically are issued by residents
and are in Local Currency
Depending on country, LAC compares better
on nonresident investment
Share of Domestic Bonds held by Foreign Investors
USA
Uruguay
Hungary
Poland
Mexico
Turkey
Argentina
Malaysia
Japan
Brazil
Thailand
Peru
Indonesia
Korea
Bulgaria
0
5
10
15
20
25
30
35
40
45
50
55
Policy measures
• LAC has made progress but still has a way
to go in terms of:
– Investor protection
– Creditor rights
– Compliance with international accounting
standards
Investor Protection
G3 AV
Malaysia
Korea
ASIA AV
Chile
EM AV
India
Brazil
Mexico
Thailand
LAC AV
Colombia
Argentina
0
Source: IMF
1
2
3
4
5
6
7
8
9
Effective Creditors' Rights
SGP
HKG
MYS
ASIA AV
KOR
THA
IND AV
CHL
TWN
URY
EMC AV
IDN
LAC AV
VEN
ARG
BRA
PER
ECU
PHL
MEX
COL
0
0.5
1
1.5
2
2.5
3
3.5
Effective Creditor Rights are equal to Creditor Rights*Rule of Law. Creidtor rights are from La Porta et al. (1998) Rule of Law (rescaled to the 0-1 range) is from Kaufman et al.
4
Ko
ng
na
Countries
ys
ia
Pa
ki
st
an
Ph
ilip
pi
ne
s
Si
ng
ap
or
e
Ta
iw
an
Th
a
ila
Av
nd
er
ag
e
As
ia
n
M
al
a
Ko
re
a
pa
n
Ja
In
di
a
In
do
ne
si
a
g
LA
hi
C
ge
la
Pe
ru
ez
ue
ra
on
H
Av
e
Ve
n
le
ex
ic
o
M
hi
C
zi
l
Br
a
in
a
en
t
Ar
g
IAS Adoption Index in 2001
Compliance of Latin America and East Asian Countries with International Accounting
Standards
35
30
25
20
15
10
5
0
Finally, we provide some statistical analysis
of the determinants of market cap
• Annual data from the BIS (through 2004)
• Estimates by GLS
• Focus here on the corporate bond market
– There are too many results to summarize.
But a sweeping overview would emphasize:
Summary of results
• A limited number of variables explain the vast
majority of differences in bond market
development, so measured, across regions.
– These include GDP per capita, country size,
development of the financial system (and efficiency of
the banking system), exchange rate stability,
openness, investor protection (cost of contract
enforcement), presence or absence of capital controls.
• Thus, more stable policies and stronger investor
protections would make a difference.
Results (continued)
• In addition, however, a quarter of the difference in bond market
capitalization between industrial countries and Latin America is due
to country size (measured by aggregate GDP) and the level of
development (measured by GDP per capita).
– Level of development can be changed, but market size? Does this
mean that attempting to develop bond markets in small countries is a
losing fight?
• In addition, about 15 percent of difference is attributable to the
development of the financial system (measured by bank credit to the
private sector). These variables are not easy to change in short
order.
• Another 15 percent is related to historical and geographical factors
(like the origin of the legal code and other measures of institutional
inheritance). Can these be changed at all?
Results (continued)
• The only policy variables easily controlled in the short
run that seem to be play an important role are
macroeconomic stability (proxied by the volatility of the
exchange rate), openness, and the only institutional
variables with a first order effect are investor protection
and the cost of enforcing a contract.
• But these can explain at most 1/4 of the difference
between the Latin America and the industrial countries.
• Policy variables like the exchange rate regime, the
presence or lack of capital controls, the level of public
debt, bank concentration, and banking spreads are all
statistically significant in the empirical analysis but play a
very small role in explaining the difference between the
development of the bond market of industrial countries
and that of Latin America.
Bottom line
• Clearly, one should not conclude that policies and
institutions do not matter.
– Still, the fact that many of the obvious policy variables have only
a modest effect on bond market development suggests that
there are unlikely to be convenient short-cuts.
• Bond market development is a long hard slog.
– By implication, the same policies that are necessary for
economic development in general are also necessary for the
development of domestic bond markets.
• But, in addition, the importance of country size and firm
size raises questions about the feasibility of “bond
market development in one country.”
– Does this mean that LAC should follow Asia in attempting to
develop bond markets at the regional level?
Extra-national initiatives
• Asia has sought to integrate national markets regionally
in order to overcome handicap of small market size.
– ABF1 &2.
– Regional indices and passively managed funds.
– Asian Bond Markets Initiative.
• Latin America has not gone down this road.
– In contrast to Asia, it has sought to enhance the access of its
corporates to international markets.
– This has included, most recently, efforts to issue government
debt in local currency in New York and other centers, in the hope
that corporates will be able to follow.
• At least, this is what is suggested by the following slide:
LA relies more on international markets
(Private Sector Bonds/GDP)
• Left panel is LA, right panel is EA
Blue is domestic, red is external
Costs and benefits of the two
strategies
• Spreads are often lower on international markets, especially for LAC
borrowers (reflecting, inter alia, weak creditor rights at home).
– Thus, in the case of Colombia’s November 2004 domestic currency
issue, where we can make a direct comparison, primary spreads were
20 to 50 basis points below those on comparable domestic bonds.
– We see the same thing when we look at large corporates, which can
often borrow more cheaply on international markets.
– Thus, the LAC strategy is the obvious short-run cost-minimizing one.
• But does encouraging corporates to borrow on foreign markets slow
the development of local market liquidity?
– We find that spreads also decline with domestic market capitalization.
– So the Asian strategy may be the long-run cost-minimizing one.