Emerging Market Sovereign Debt Research Articles

Emerging Market Sovereign Debt in the Aftermath of the Pandemic

For emerging markets, fiscal space is a very real constraint that can surface under a variety of circumstances, including rising world interest rates, falling commodity prices, or a global recession. Some emerging markets, and the majority of low-income developing economies, are already in debt distress or default. Near-term, making sure that troubled debtor countries are aware of the full menu of options, including heterodox strategies such as default, is important. Longer-term, a rethink of the Bretton Woods financial institutions to incorporate a greater emphasis on outright grants instead of loans, makes more sense than ever.

Avoiding a Lost Decade -- Sovereign Debt Workouts in the Post-COVID Era

All sovereign debt restructurings risk undershooting (providing less debt relief than is needed to restore the country to long-term sustainability) or overshooting (extracting more debt relief from creditors than turns out to have actually been necessary). Of these, undershooting will be the greater risk in sovereign debt workouts in the post-COVID era. Bondholders can be expected to prefer short and shallow debt restructurings that provide near-term debt relief (time enough to sell out of sticky positions). As for the future, creditors will endorse Doris Day’s assessment — que será será. For their part, politicians in the debtor country may also prefer a quick restructuring that provides abundant short-term debt relief even if it complicates the life of the next administration. The last time a systemic emerging market sovereign debt crisis was handled through a series of short and shallow debt restructurings was in the 1980s. It bequeathed to the debtor countries what is still called the Lost Decade. Can a similar fate be avoided in the decade that has just begun?

Covered Interest Rate Parity Deviations in External Emerging Market Sovereign Debt

Non-US dollar denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead issuing external sovereign debt in dollars more cheaply (versus non-dollar developed world currencies like euro, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually. TOPICS:Fixed income and structured finance, exchanges/markets/clearinghouses, emerging markets Key Findings • This article is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. • Such mispricing creates investment opportunities and suggests that by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euro, yen, and sterling) and swapping the proceeds to non-dollar currencies, emerging market country policymakers could create substantial fiscal savings from switching to dollar funding.

Covered Interest Rate Parity Deviations In External Emerging Market Sovereign Debt

Non-U.S. dollar denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This paper is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euro, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually.

Rethinking economic capital management through the integrated derivative-based treatment of interest rate and credit risk

This research revisits the economic capital management regarding banking books of financial institutions exposed to the emerging market sovereign debt. We develop a derivative-based integrated approach to quantify economic capital requirements for considered jointly interest rate and credit risk. Our framework represents a major contribution to the empirical aspects of capital management. The proposed innovative modeling allows applying standard historic value-at-risk techniques developed for stand-alone risk factors to evaluate aggregate impacts of several risks. We use the time-series of credit default swap spreads and interest rate swap rates as proxy measures for credit risk and interest rate risk, respectively. An elasticity of interest rate risk and credit risk, considered a function of the business cycle phases, maturity of instruments, creditworthiness, and other macroeconomic parameters, is gauged by means of numerical modeling. Our contribution to the new economic thinking regarding the interest rate risk and credit rate risk management consists in their integrated treatment as the dynamics of interest rate and credit spreads is found to demonstrate the features of automatic stabilizers of each other. This research sheds light on how financial institutions may address hedge strategies against downside risks. It is of special importance for emerging markets heavily dependent on foreign capital as it potentially allows emerging market banks to improve risk management practices in terms of capital adequacy and Basel III rules. From the regulatory perspective, by taking into account inter-risk diversification effects it allows enhancing financial stability through jointly optimizing Pillar 1 and Pillar 2 economic capital.

A Survey of Experiences with Emerging Market Sovereign Debt Restructurings

This paper takes stock of past episodes of debt restructuring and reviews the relevant literature. Based on cross-country experience from the late 1990s through 2010 of emerging markets it offers some stylized facts.

Limited Liability Government Debt for the Eurozone

The Maastricht treaty, notably the article 103 prohibition on 'bail-outs', gave a prominent role to market disciplines on fiscal policy. These were not effective, failing to prevent the Euro area government debt crisis. This article suggests that these market disciplines can be made effective through issue of 'limited liability' debt (debt with a maximum debt service obligation as a proportion of GDP), together with rules constraining bank holdings of government debt and maturity structure, and a senior liquidity facility. This proposal is supported by analysis of fiscal arrangements within single currency areas and of emerging market sovereign debt restructuring. (JEL codes: E42, E62, H6 and H87) Copyright The Author 2011. Published by Oxford University Press on behalf of Ifo Institute for Economic Research, Munich. All rights reserved. For permissions, please email: journals.permissions@oup.com, Oxford University Press.

COLLECTIVE ACTION CLAUSES IN INTERNATIONAL SOVEREIGN BOND CONTRACTS - WHENCE THE OPPOSITION?

In the debate on strengthening the international financial architecture, which peaked in 2002 after a series of emerging market sovereign debt crises, the universal adoption of collective action clauses (CACs) was the most promising reform proposal. Academics and the official sector had been promoting CACs at least since 1995, yet market practice did not begin to change until 2003. This delay is often attributed to the opposition of investors and sovereign borrower to CACs. This paper evaluates the publicly stated as well as the suspected private motives of the two sides to block the spread of CACs. It draws on a wide range of existing evidence and adds some new theoretical considerations to show that there is no reason to be sceptical of CACs unless bailouts exist as an alternative crisis resolution mechanism. This conclusion may be of interest purely for the sake of historical accuracy. But more importantly, it may help to better understand any potential future resistance by market participants, e.g. in the process of introducing CACs in bonds governed by German law.

Sound Policies or Good Fortune: What Drives Emerging Market Spreads?

Since 2002, spreads on emerging market sovereign debt have fallen to historical lows. Given the close links between sovereign spreads, capital flows to emerging markets, and economic growth, understanding the factors driving sovereign spreads is very important. This paper uses factor analysis to study the extent to which emerging market bond spreads ‐ measured by JP Morgan’s EMBI Global index ‐ are driven by global factors, such as global liquidity or commodity prices, as opposed to country-specific macroeconomic fundamentals. Our results show that a common factor explains a substantial portion of the co-movements in emerging market spreads in the last decade. This factor is closely linked to global financial conditions, as well as to energy- and non-energy commodity prices. This factor, however, is not responsible for the reduction in EMBI spreads. Instead, emerging markets have benefited considerably from better macroeconomic policies. Therefore, a reversal of the benign global economic environment need not have a substantial negative impact on financing conditions for emerging markets. Bank index: Development economics, financial stability, international topics

International Financial Transmission: Emerging and Mature Markets

With an increasingly integrated global …nancial system, we frequently observe that shocks to individual asset markets aect …nancial markets worldwide. The aim of this paper is to quantify the comovements between bond markets in the US and emerging market economies. Following Rigobon (2003) we exploit the changing volatility of the data to fully identify a structural VAR, without imposing ad-hoc restrictions. Our results indicate that shocks that widen emerging market sovereign debt (EMBIG) spreads tend to have a negative eect on US interest rates (consis- tent with ‡ight quality episodes), while the eect of US interest rates on EMBIG spreads is mixed. We also …nd that shocks that raise EMBIG spreads tend to raise US high yield spreads and vice versa, constituting an important channel through which crises in EMEs can aect mature markets. Forecast error variance decompo- sitions show that the variance of both EMBIG and US high yields spreads is mainly explained by shocks to US long rates. JEL classi…cation: C32, F30, G15