Promoting the International use of
Emerging Country Currencies:
debt issuance for Latin America and the Caribbean
Andrew Powell
Research Dept., Inter American Development Bank
BRICS Conference, Hong Kong
Dec 10th and 11th, 2012
Opinions are strictly those of the author and are not necessarily those of the IDB or any other institution.
1
Introduction
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Internationalization of currencies has several inter-related
dimensions with information and liquidity externalities
One extremely important dimension is being able to issue
debt in one’s own currency
This paper focuses on LAC: there has been increased use
of LAC currencies remains rather limited
If liquidity is self-fulfilling there is a prima facie case for
public policy action
But there is a Catch 22 for MDB’s
Conclusions and recommendations for coordinated actions
2
A Word on LAC: Bad Inflation Experience
Has Largely been Conquered
Consumer Price Index (end of period), annual percent change
60
Start of Debt
Crisis
Hyperinflation
episodes in
Chile starts to transition to inflation
Argentina, Brazil targeting
Argentina adopts a currency board
50
Food Crisis Lehman
Brazil’s Real Plan
Tequila Crisis
Inflation
Targeters
40
30
20
10
Intermediate
≈6%
0
Fixed
Note: data corresponds to the median country for each regime.
3
Growth Performance: not doing as well as other
EM’s but better than Developed Countries
4
Eight Countries in the Region are
Now Inflation Targeters
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Can see private inflation and growth expectations as
sampled by each country’s central bank here
www.iadb.org/revela
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Dimensions of Currency
Internationalization
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Trade settlement – Means of Exchange
Reserve currency usage – Store of Value
Denomination of contracts – a Unit of Account
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Dimensions of Currency
Internationalization
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Means of
Exchange
Trade
settlement
Functions
of Money
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Denomination
of contracts
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Reserve
currency
Store of
Value
Unit of
Account
7
This paper/presentation…
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Focus on use of currencies to denominate debt
(unit of account) and ability of countries to issue
debt in their own currency internationally
I will argue this ability is important for risk
sharing and will focus on Latin America and
the Caribbean
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Information and Liquidity
Externalities for Currency Usage
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If a currency is used in one dimension more likely to
be used in others
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If market trading focused on the dollar, prices will reflect
all available information
Derivatives will give information on expected valuations
and expected volatility
High liquidity will make it easier/cheaper for others to
trade that currency fueling yet more liquidity
Liquidity is self-fulfilling
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Top four currency trading market
shares have been remarkably stable
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
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More movement in next 10 currencies,
but from a small base…
Mexican peso, MXP
Brazilian Real, BRNL
Chilean peso, CHP
Colombian
peso, COP
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
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Currency market shares of global
derivative trading…
Emerging Asian and LAC currency derivatives are
within others’ 9% and residual 2%
Source: BIS 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
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Global Bond Issuance
Source: Dealogic data, author’s calculations
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Bond
Issuance
Of US$139bn of
2011 LAC “dealnationality”
issues, US$82bn
were in USD
$22bn in BRL
$18bn in MXN/MXV
$5.4bn in CLP/CLF
Source: Dealogic data, author’s
calculations
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And some US$10bn of LAC Currency Issues
were under Developed Country Governing
Law, the majority under London Law
Source: Dealogic data, author’s calculations. Caveat: a large number of deals did not have governing law identified.
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Why do we care…?
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The 1980’s Latin American debt crisis and
subsequent lost decade had many origins
But one was surely poor risk sharing…
Commodity prices were high and plunged
 US interest rates were low and then soared
 The dollar appreciated
 And debt was in dollars
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Today looks somewhat similar with $82bn of
LAC’s $139bn of 2011 debt issuance in dollars
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To see this more scientifically…
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A country’s ability to pay in US$ is related to
US$ GDP
A country’s ability to pay in a real domestic unit
of account is related to real local currency GDP
If the former is more volatile than the latter, US$
debt has poor risk sharing
This argument follows that in Hausmann and Rigobon and
Eichengreen and Hausmann who call for local currency
inflation indexed debt contracts
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LAC: US$ Growth vs. Real Growth Volatility
Latin America & The Caribbean
Bolivia
Brazil
Chile
Colombia
Costa Rica
Dominican Rep
Guatemala
Guyana
Haiti
Honduras
Jamaica
Mexico
Nicaragua
Paraguay
Peru
Suriname
Trinidad and Tobago
Uruguay
Venezuela
Average LAC
Source: Author’s calculations, perriod 1980-2011.
USD GDP Growth
%
7.4
17.6
11.8
11.8
11.8
6.5
6.2
8.1
16.0
4.5
6.2
15.3
4.2
14.3
9.5
18.3
18.3
18.9
17.6
11.8
Real Growth Real/USD
%
%
1.4
19.0%
2.2
12.7%
2.4
20.7%
1.8
15.1%
1.8
15.1%
2.8
42.7%
1.1
18.4%
3.3
41.0%
4.8
29.7%
2.6
56.3%
1.8
29.5%
3.5
23.1%
2.3
53.6%
4.4
30.5%
3.6
37.4%
3.3
17.8%
3.3
17.8%
4.9
25.7%
6.5
36.7%
3.0
25.7%
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And the same goes for the BRICS…
Russia
India
China
Brazil
South Africa
Average BRIC
Source: Author’s calculations, perriod 1980-2011.
USD GDP Growth
22.9
8.7
8.4
17.6
11.3
13.8
Real Growth Real/USD
5.3
23.2%
1.9
22.5%
1.9
22.1%
2.2
12.7%
2.0
17.3%
2.7
19.3%
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Inflation-indexed versus nominal debt
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Ability to service debt related to nominal GDP
not real
Some LAC countries issuing in nominal local
currency
LAC has 8 inflation targeters with good inflation
performance
BRICS also issuing in own nominal currency
Hausmann and Rigobon likely affected by Chile’s good
example, but Chile has been “nominalizing” too..
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Simulated Volatility of LAC Debt to GDP Ratio
with Local Currency vs. Dollar Debts
Bolivia
Brazil
Chile
Colombia
Costa Rica
Dominican Rep
Guatemala
Guyana
Haiti
Honduras
Jamaica
Mexico
Nicaragua
Paraguay
Peru
Suriname
Trinidad and Tobago
Uruguay
Venezuela
LAC Average
Source: Author’s calculations.
Local Currency US Dollars
%
%
2.3
8.1
3.2
7.1
0.1
0.4
1.3
5.3
0.9
3.1
1.3
4.2
0.6
1.4
14.7
17.9
1.8
6.7
2.7
4.6
6.1
11.7
0.6
1.4
4.4
5.0
1.3
9.5
3.3
3.9
1.6
2.8
1.1
1.2
9.0
41.2
1.7
6.6
3.0
7.5
Volatility LC / US$
28.6%
45.6%
34.6%
25.1%
27.5%
29.8%
45.1%
81.8%
26.6%
58.4%
51.9%
43.4%
87.8%
13.4%
84.9%
57.3%
90.4%
21.9%
25.3%
40.7%
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Similar Results for the BRICS
Russia
India
China
Brazil
South Africa
Average
Source: Author’s calculations.
Local Currency US Dollars
4.0
17.7
0.6
1.8
0.5
0.7
3.2
7.1
3.9
22.2
2.5
9.9
Volatility LC / US$
22.6%
35.8%
75.1%
45.6%
17.4%
24.9%
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And poor risk sharing of US$ contracts:
Brazil simulated debt ratios and growth
Source: Author’s calculations.
Dollar strong when growth was weak
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And poor risk sharing of US$ contracts:
Peru simulated debt ratios and growth
Dollar strong when growth was weak
Source: Author’s calculations.
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What can be done?
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Latin American countries have been issuing in
local currency, selected pricing points:
Chile: 2020 pesos 4.4% yield, US$ 2022 2.4%.
 Colombia: 2032 peso 4.4% yield, US$ 2022 1.8%
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MDB’s can lend in local currency
But MDB’s subject to a Catch-22
Can lend where liquid markets allow hedging
 Cannot lend where needed or will eat into valuable
capital to back currency risks
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RDB’s can reduce capital through diversification:
volatility of currency portfolios
Source: author’s calculations
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A GDP weighted portfolio brings less benefits:
global coordination valuable
Source: author’s calculations, LAC countries with GDP weights, RICS with equal weights
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TCX – www.tcxfund.com
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TCX was an initiative of the Dutch aid agency
Financed by official sources (Bilaterals, MDB’s)
Enters into exotic currency swaps
Gives liquidity where none existed
Holds naked currency risks on its books
Benefits from global diversification
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Guarantees to Kick Start
Currency Markets
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Local currency debt contracts reflect more closely
countries’ “ability to pay” which is related to nominal GDP
To the extent a contract matches a country’s “ability to
pay” then a guarantee on that contract will act on
“willingness to pay” risks 1
Some countries can already issue in local currency on
reasonable terms, others may benefit from the presence of
an MDB guarantee
A guarantee is a flexible instrument that can be adjusted to
particular required demand
Anderson, Gilbert and Powell “Securitizing commodity contingent
debt”, American Journal of Agricultural Economics 1991
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Guarantees to Kick-Start Local
Currency Markets
Currency risks
TCX-type
institution
Investors
Partial MDB
Guarantee
Country Issues
Local Currency Debt
Reinsurance
market
Other risks
Schematic representation of one sample structure to kick start
local currency markets
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Conclusions
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Several emerging economies are now able to issue debt in
their own currencies but subject to liquidity premia
But local currency issuance remains limited and yet issuing
dollar debt has dangerous risk properties
MDB’s can help but there is something of a Catch-22
If liquidity is self-fulfilling, prices are not given
Guarantees are a flexible instrument to kick start markets
Benefits to global coordination to diversify risks to
institutions providing local currency loans or guarantees
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