## FINANCIAL MARKET UPDATE June 2006 (Content unit 0606)

## Source details

**Canonical URL:** [FINANCIAL MARKET UPDATE June 2006 (Content unit 0606)](https://www.imf.org/-/media/files/publications/fmu/0606.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/fmu/0606.pdf.md)
- [Structured JSON version](/-/media/files/publications/fmu/0606.pdf.json)

---

### Overview and recent market developments
- Data as of June 9, 2006.
- Since the April 2006 Global Financial Stability Report (GFSR), global financial markets experienced increased volatility and a sharp correction in the price of riskier assets.
- The fall in investor risk appetite is characterized as a normal cyclical adjustment to rising perceived risks and the withdrawal of liquidity as global monetary policies normalize.
- Corrections in mature markets do not appear to signal the beginning of a protracted downturn; valuation measures for equities do not suggest serious overvaluation, and corporate credit spreads have widened only very moderately.

### Inflation, monetary policy, and funding costs
- Rising inflationary pressures prompted expectations of a synchronized tightening of global monetary policies.
- The increase in the cost of funding for leveraged trades and perceived downside growth risks triggered global equities selling from multiyear highs.
- Market-derived long-run inflation expectations:
  - 5-year, 5-year forward TIPS breakeven rate increased to 2.67 percent.
- Term premiums for risks of more volatile inflation had not increased materially.
- Federal Reserve:
  - Continued gradual tightening that started in 2004.
  - Real Fed Funds rate has now approached 2.7–3.0 percent, depending on the measure of core inflation used.
- European Central Bank:
  - Hiked rates for a third time in June, bringing policy rates to 2.75 percent.
- Bank of Japan:
  - Maintained zero interest rate policy but signaled desire to raise rates; withdrew substantial liquidity support to the Japanese banking system.
- Rate increases were echoed in other central banks, including in some emerging markets, mainly in Asia.

### What triggered the market correction
- Investor concerns: rising commodity prices, growing capacity utilization, and tightening labor markets could accelerate inflation in mature markets.
- U.S. labor markets tightened: payroll growth drove unemployment rates down to five-year lows; wage growth now in line with the pace seen before the 2001 downturn.
- Prospect of further tightening led many investors to question global growth projections, raising volatility and prompting equity selling.
- G-7 and IMFC communiqués refocused market attention on global economic imbalances, contributing to currency volatility and a stronger correction in the U.S. dollar.

### Market moves and asset-class impacts
- Equity markets:
  - Topix plunged nearly 15 percent during May and early June (Japanese equities declined most).
  - Eurofirst-300 off more than 9 percent since peaking in early May.
  - S&P 500 fell by less than 6 percent over the equivalent period.
- Correlations:
  - Declines in the S&P 500 have often coincided with declines in U.S. Treasury prices; the correlation between the two prices turned positive after several years of being negative.
- U.S. dollar and currencies:
  - On a trade-weighted basis, the dollar fell nearly 7 percent against major currencies.
  - Emerging market currencies held fairly stable overall, but with considerable divergence across countries.
  - Consensus forecasts expect dollar’s real effective exchange rate to remain relatively stable across major trading partners, with Asian currencies expected to outperform over the medium-to-long term and non-Asian currencies expected to weaken.
- Volatility and liquidity:
  - Implied volatility rose across equity, fixed income, and currency markets since the beginning of May.
  - The withdrawal of liquidity reduced incentives for carry trades and other leveraged strategies, triggering rapid unwinds in higher-yielding currencies.

### Assessment for mature markets
- Global growth outlook remains robust despite recent risk aversion.
- Growth in the United States expected to moderate over next several quarters from an already-high level.
- Recovery in Japan continues; recovery in the euro area gaining traction.
- Equity valuations in mature markets close to or below 15-year average levels.
- Corporate bond spreads remained fairly stable, implying limited perceived deterioration in corporate fundamentals.
- The rise in volatility is viewed as reducing investor complacency and consistent with a maturing expansion rather than signaling an impending downturn.

### Impact on emerging markets
- Sell-off concentrated in local emerging markets, notably equities and currencies, especially where foreign investor positions were concentrated and where markets had appreciated the most.
- Foreign exchange markets experienced rapid unwinding of leveraged carry trades by speculative investors, exacerbated by stop-losses and hedging strategies.
- External debt markets showed little sign of concern about sovereign credit distress, reflecting improved fiscal and current account balances and favorable supply-demand for emerging market borrowers.
- Depreciation over the past month relieved concerns about real exchange rate appreciations in several emerging economies, particularly in Latin America.
- Some emerging market countries more vulnerable to the external environment were hit harder.

### Policy implications and recommendations
- Central banks need to communicate clearly their assessment of inflation risks and their resolve to contain inflation effectively.
- Emerging market countries with macroeconomic imbalances and heavy reliance on external financing face a narrower margin for policy slippage.
- Recommended actions for emerging markets:
  - Continue developing domestic capital markets and build a diversified local institutional investor base.
  - Ensure debt management policies are consistent with local market absorption capacity for foreign inflows.
  - Given reserve accumulation and prefinancing, further external borrowing can wait for improved market conditions.
  - In local markets, authorities can temporarily trim supply and, and if needed, conduct secondary operations to support market liquidity.

### Market contagion, volatility, and investor behavior
- Cross-market linkages and contagion:
  - Losses in one market induced investors to reduce positions in other emerging market assets; anecdotal evidence suggests weakness in the Mexican peso was initially due to the unwinding of short-term positions by hedge funds funded in European currencies (most notably the Swiss franc) that took profits on Mexican interest rate positions to cover losses on positions in Turkey.
  - Equity markets with the highest run-up since 2005 experienced deepest declines, including Brazil, Mexico, Russia, and Turkey.
  - Middle East equity markets experienced a sharp correction; GCC markets discussed separately below.
- Higher-yielding currencies (Brazil, Turkey, and Indonesia) sold off the most after significant nominal and real appreciation during 2005.
- CDS markets:
  - CDS spreads generally widened and the curve steepened as riskier credits widened the most.
  - Growing liquidity and size of the CDS market allowed investors to hedge local currency positions more easily and implement short-credit trades without repo operations in the cash market.

### Asset-class performance and market technicals
- Foreign investors concentrated positions in a few, better developed domestic interest rate and government securities markets (examples: Brazil, Colombia, Mexico, and Turkey).
- Flows into inflation-indexed local instruments in Latin America were particularly strong at the beginning of the year, bringing real yields down to record levels and compressing risk premiums relative to U.S. real yields before the correction; these instruments sold off most initially.
- Selected currency moves (performance to June 9, 2006, and peak-to-June 9, 2006) examples:
  - New Turkish lira weakened 22 percent against the U.S. dollar over the last three weeks of May.
  - South African rand weakened almost 14 percent over the same period.
  - Average move for all emerging market currencies (as measured by changes in liquidity and trade-weighted exchange rate indices against the dollar) was 3.5 percent.
- Aggregated EMBIG spreads widened only moderately; external bond spreads showed little sign of market concern about sovereign credit distress events.
- Despite the May 2006 correction, valuations remained higher than in comparable earlier corrections, and the size of the external debt market correction in 2006 was much less than in prior episodes even though spreads were narrower.

### Country-specific vulnerabilities and implications for fundamentals
- Turkey singled out: large current account deficit and rising inflation raised concerns about exchange rate depreciation and inflation pass-through.
- Countries with current account deficits and overvalued equity markets could face further outflows and financial turbulence absent policy adjustment.
- Investors likely to differentiate more finely among emerging markets based on fundamentals; countries with macroeconomic imbalances or heavier reliance on external financing will need to strengthen policies further.

### Policy responses taken during the correction
- Targeted actions to maintain orderly markets and domestic financial stability:
  - Brazil: bought back inflation-linked debt, canceled scheduled debt auctions, resumed offering floating-rate bonds, and offered exchange-rate-linked interest rate swaps to stabilize market demand.
  - Turkey: central bank raised interest rates at an extraordinary meeting to reaffirm commitment to inflation targets.
  - India and South Africa: tightened monetary conditions.
  - Colombia: removed restrictions requiring foreign investments to remain in the country for one year before repatriation of profits.
- Debt management and reserves used to reduce external financing needs and improve debt profiles:
  - Over 75 percent of sovereign external debt issuance planned for 2006 was completed by the beginning of June.
  - Brazil completed repurchase of $11.7 billion in external debt through the end of May, including all of its Brady bonds, and concluded in early June a further repurchase auction for $1.1 billion in external bonds ranging in maturity from 2007 to 2030.
  - Panama plans to exercise its option to buy back $360 million of Brady bonds in June.
  - Repurchases or exchanges were also undertaken earlier in the year by Colombia, Mexico, Russia, and Venezuela.
- Policy guidance and priorities implied:
  - Strengthen macroeconomic policies in countries with imbalances and high external financing reliance.
  - Continue developing local capital markets and build a diversified local investor base.
  - Ensure sovereign debt management policies are consistent with the capacity of local markets to absorb foreign investor inflows.

### GCC equity markets (Box 1)
- Rise and correction:
  - GCC equity markets rose rapidly since 2003 and suffered sharp price declines recently.
  - 2003–04 rise largely earnings-driven (surge in oil prices); exceptional increase from early 2005 reflected unreasonable expectations of corporate profit growth, rapid household credit growth, and structural factors encouraging risk-seeking behavior.
- Triggers and amplifiers:
  - Lower-than-expected Q4 2005 earnings released in early 2006 for Saudi Arabia and Kuwait.
  - Recognition that high profits for some listed companies were driven by equity trading rather than operations.
  - Mounting IPO issuance drained liquidity; delays in refunding oversubscriptions further reduced liquidity.
  - Regulatory measures limiting daily price fluctuations (e.g., from 10 percent to 5 percent) were interpreted as lack of confidence and exacerbated the downturn; margin calls added to selling pressure.
  - Selling contagion spread from Saudi Arabia to other regional markets where Saudi investors dominate capital supply.
- Authorities’ responses in the region:
  - Saudi Arabia: reversed limit on daily price fluctuation, allowed stock splits, permitted foreign residents to trade directly with local exchanges, licensed research institutions, and introduced tougher sanctions against insider trading.
  - UAE: required timely refunding of IPO oversubscriptions (within two weeks) and eased margin requirements from 30 percent to 20 percent.
  - Central banks expanded reporting requirements to capture indirect stock market exposures.
  - Announcements of potential share purchases by state investment funds lifted market sentiment.

### Emerging market financing flows and issuance statistics
- Cumulative overall gross issuance (bonds, equities, and loans) by sovereign and corporate issuers through the end of April: $126.8 million (reported) vs. $113.8 million in 2005.
  - Surge in issuance mainly due to much higher equity and loan issuance; gross bond issuance was lower, reflecting prefinancing.
  - On a net basis, overall issuance declined (large decline in net bond issuance), while net loan issuance increased substantially.
  - Gross and net bond issuance were concentrated in public sector non-sovereign issuers, reflecting a surge in bond issues by government-related corporates.

### Data highlights — Emerging Market External Financing (selected numeric series)
- Total GROSS ISSUANCE BY ASSET (series of values): 216.4 162.1 135.6 199.7 286.5 406.0 71.6 63.5 70.2 81.2 94.4 88.9 107.1 115.6 96.0 29.6 22.5 43.9 30.8 126.8
- Bonds gross (selected): 80.5 89.0 61.6 99.8 135.1 182.3 40.9 29.1 34.5 30.5 61.7 37.8 40.4 42.4 48.9 19.4 8.7 20.8 5.4 54.3
- Equities gross (selected): 41.8 11.2 16.4 27.7 45.1 78.1 13.9 10.3 5.6 15.3 10.5 17.4 22.9 27.4 22.4 6.1 7.5 8.8 7.4 29.9
- Loans gross (selected): 94.2 61.9 57.6 72.2 106.2 145.5 16.8 24.0 30.1 35.3 22.3 33.8 43.7 45.7 24.7 4.7 4.1 6.3 14.3 17.9 42.6

- GROSS ISSUANCE BY REGION (selected totals): 216.4 162.1 135.6 199.7 286.5 406.0 71.6 63.5 70.2 81.2 94.4 88.9 107.1 115.6 96.0 29.6 22.5 43.9 30.8 126.8
  - Asia: 85.9 67.5 53.9 88.8 123.3 149.6 34.1 28.5 25.8 35.0 26.6 33.5 40.8 48.8 36.9 10.6 8.3 18.0 7.9 44.8
  - Latin America: 69.1 53.9 33.4 43.3 54.3 87.5 14.4 9.7 16.2 13.9 34.5 13.8 23.0 16.3 14.9 5.3 2.7 6.9 4.6 19.5
  - Europe, Middle East, Africa: 61.4 40.8 48.3 67.7 108.9 168.9 23.1 25.3 28.3 32.3 33.3 41.7 43.3 50.6 44.3 13.7 11.6 19.0 18.2 62.5

- AMORTIZATION BY ASSET total (selected): 113.9 147.0 128.4 119.5 128.1 107.8 35.0 32.8 30.6 29.7 21.6 26.1 32.6 27.5 22.2 8.9 6.2 7.1 9.1 31.3
  - Bonds amortization (selected): 51.8 59.0 58.9 57.1 69.6 65.2 21.5 17.5 15.9 14.7 13.3 14.5 21.6 15.8 13.4 4.5 4.5 4.3 6.7 20.1
  - Loans amortization (selected): 62.1 88.0 69.5 62.4 58.5 42.6 13.5 15.3 14.7 15.0 8.3 11.6 11.0 11.7 8.8 4.3 1.7 2.8 2.4 11.3

- NET ISSUANCE BY ASSET total (selected): 102.5 15.2 7.3 80.2 158.3 298.2 36.6 30.7 39.6 51.5 72.8 62.9 74.5 88.1 73.8 20.7 16.3 36.8 21.6 95.4
  - Net Bonds (selected): 28.7 30.1 2.7 42.7 65.5 117.1 9.4 11.6 18.6 15.8 48.4 23.3 18.8 26.6 35.6 14.9 4.2 16.5 -1.3 34.3
  - Net Equities: 41.8 11.2 16.4 27.7 45.1 78.1 13.9 10.3 5.6 15.3 10.5 17.4 22.9 27.4 22.4 6.1 7.5 8.8 7.4 29.9
  - Net Loans (selected): 32.1 -26.1 -11.8 9.8 47.7 103.0 3.3 8.7 15.4 20.3 14.0 22.2 32.7 34.1 15.8 -0.3 4.6 11.5 15.5 31.3

- Secondary markets and spreads (selected):
  - EMBI Global (spread in bps): 735 728 725 403 347 179 414 482 409 347 373 297 235 237 191 210 187 191 179 179
  - Merrill Lynch High Yield (spread in bps): 890 795 871 418 310 371 438 404 384 310 352 385 354 371 313 342 337 313 304 304
  - US 10 yr. Treasury Yield (yield in %): 5.12 5.05 3.82 4.25 4.22 4.39 3.84 4.58 4.12 4.22 4.48 3.92 4.33 4.39 4.85 4.52 4.55 4.85 5.05 5.05

- Equity index returns (selected series in percent):
  - DOW: -6.2 -7.1 -16.8 25.0 3.1 -0.6 -0.9 0.8 -3.4 -1.9 -2.8 -2.6 -2.2 2.9 3.7 1.4 1.2 1.1 2.3 6.1
  - NASDAQ: -39.3 -21.1 -31.5 50.5 8.6 1.4 -0.5 2.7 -7.4 1.9 -8.4 -8.1 2.9 4.6 6.1 4.6 -1.1 2.6 -0.7 5.3
  - MSCI Emerging Market Free: -31.8 -4.9 -8.0 51.2 22.4 30.3 8.9 -10.3 7.4 -0.2 0.6 1.2 3.0 17.0 11.5 10.9 -0.2 0.7 6.8 19.1

### Sovereign External New Issuance Estimates in 2006 (selected country and regional figures)
- Country-level examples (Planned; Actual; Remaining) in millions of U.S. dollars:
  - Argentina: Planned 3,400; Actual 2,139; Remaining 1,261
  - Brazil: Planned 4,500; Actual 5,330; Remaining (830)
  - Colombia: Planned 2,000; Actual 2,237; Remaining (237)
  - Panama: Planned 640; Actual 1,613; Remaining (973)
  - Turkey: Planned 5,500; Actual 3,129; Remaining 2,372
  - Venezuela: Planned 3,000; Actual 4,215; Remaining (1,215)
  - Philippines: Planned 3,100; Actual 2,250; Remaining 850
  - Poland: Planned 5,500; Actual 3,630; Remaining 1,870
  - Lebanon: Planned 2,000; Actual 267; Remaining 1,733
  - Thailand: Planned 1,000; Actual 200; Remaining 800
- Regional aggregates (In millions of U.S. dollars):
  - Asia: Planned 8,350; Actual 5,250; Remaining 3,100
  - Emerging Europe: Planned 20,050; Actual 11,275; Remaining 8,775
  - Latin America: Planned 18,365; Actual 21,344; Remaining (2,979)
  - Middle East & Africa: Planned 6,050; Actual 1,174; Remaining 4,876
  - Total: Planned 52,815; Actual 39,043; Remaining 13,772

*International Capital Markets Department, Global Markets Analysis Division, IMF — Financial Market Update (Data as of June 9, 2006).*

### Section 1

### FINANCIAL MARKET UPDATE June 2006

### Overview and recent market developments
- Data as of June 9, 2006.
- Since the April 2006 Global Financial Stability Report (GFSR), global financial markets experienced increased volatility and a sharp correction in the price of riskier assets.
- The fall in investor risk appetite is characterized as a normal cyclical adjustment to rising perceived risks and the withdrawal of liquidity as global monetary policies normalize.
- Corrections in mature markets do not appear to signal the beginning of a protracted downturn; valuation measures for equities do not suggest serious overvaluation, and corporate credit spreads have widened only very moderately.

### Inflation, monetary policy, and funding costs
- Rising inflationary pressures prompted expectations of a synchronized tightening of global monetary policies.
- The increase in the cost of funding for leveraged trades and perceived downside growth risks triggered global equities selling from multiyear highs.
- Market-derived long-run inflation expectations: the 5-year, 5-year forward TIPS breakeven rate increased to 2.67 percent.
- Term premiums for risks of more volatile inflation had not increased materially.
- Federal Reserve:
  - Continued gradual tightening that started in 2004.
  - Real Fed Funds rate has now approached 2.7–3.0 percent, depending on the measure of core inflation used.
- European Central Bank:
  - Hiked rates for a third time in June, bringing policy rates to 2.75 percent.
- Bank of Japan:
  - Maintained zero interest rate policy but signaled desire to raise rates; withdrew substantial liquidity support to the Japanese banking system.
- These rate increases have been echoed in other central banks, including in some emerging markets, mainly in Asia.

### What triggered the market correction
- Investors grew more concerned that rising commodity prices, growing capacity utilization, and tightening labor markets could accelerate inflation in mature markets.
- U.S. labor markets tightened: payroll growth drove unemployment rates down to five-year lows; wage growth now in line with the pace seen before the 2001 downturn.
- The prospect of further tightening led many investors to question global growth projections, raising volatility and prompting equity selling.
- G-7 and IMFC communiqués refocused market attention on global economic imbalances, contributing to currency volatility and a stronger correction in the U.S. dollar.

### Market moves and asset-class impacts
- Equity markets:
  - Japanese equities declined most, with the Topix plunging nearly 15 percent during May and early June.
  - Eurofirst-300 off more than 9 percent since peaking in early May.
  - S&P 500 fell by less than 6 percent over the equivalent period.
- Correlations:
  - Declines in the S&P 500 have often coincided with declines in U.S. Treasury prices; the correlation between the two prices turned positive after several years of being negative.
- U.S. dollar and currencies:
  - On a trade-weighted basis, the dollar fell nearly 7 percent against major currencies.
  - Emerging market currencies held fairly stable overall, but with considerable divergence across countries.
  - Consensus forecasts expect dollar’s real effective exchange rate to remain relatively stable across major trading partners, with Asian currencies expected to outperform over the medium-to-long term and non-Asian currencies expected to weaken.
- Volatility and liquidity:
  - Implied volatility rose across equity, fixed income, and currency markets since the beginning of May.
  - The withdrawal of liquidity reduced incentives for carry trades and other leveraged strategies, triggering rapid unwinds in higher-yielding currencies.

### Assessment for mature markets
- Global growth outlook remains robust despite recent risk aversion.
- Growth in the United States expected to moderate over next several quarters from an already-high level.
- Recovery in Japan continues; recovery in the euro area gaining traction.
- Equity valuations in mature markets close to or below 15-year average levels.
- Corporate bond spreads remained fairly stable, implying limited perceived deterioration in corporate fundamentals.
- The rise in volatility is viewed as reducing investor complacency and consistent with a maturing expansion rather than signaling an impending downturn.

### Impact on emerging markets
- The sell-off was concentrated in local emerging markets, notably equities and currencies, especially where foreign investor positions were concentrated and where markets had appreciated the most.
- Foreign exchange markets experienced rapid unwinding of leveraged carry trades by speculative investors, exacerbated by stop-losses and hedging strategies.
- External debt markets showed little sign of concern about sovereign credit distress, reflecting improved fiscal and current account balances and favorable supply-demand for emerging market borrowers.
- Following prior significant appreciations, depreciation over the past month relieved concerns about real exchange rate appreciations in several emerging economies, particularly in Latin America.
- Some emerging market countries more vulnerable to the external environment were hit harder.

### Policy implications and recommendations
- Central banks need to communicate clearly their assessment of inflation risks and their resolve to contain inflation effectively.
- Emerging market countries with macroeconomic imbalances and heavy reliance on external financing face a narrower margin for policy slippage.
- Recommended actions for emerging markets:
  - Continue developing domestic capital markets and build a diversified local institutional investor base.
  - Ensure debt management policies are consistent with local market absorption capacity for foreign inflows.
  - Given reserve accumulation and prefinancing, further external borrowing can wait for improved market conditions.
  - In local markets, authorities can temporarily trim supply and, if needed, conduct secondary operations to support market liquidity.

*International Capital Markets Department, Global Markets Analysis Division, IMF — Financial Market Update (Data as of June 9, 2006).*

### Section 2

### 0606 - Section 2

### Market contagion, volatility, and investor behavior
- Losses in one market induced investors to reduce positions in other emerging market assets; anecdotal evidence suggests weakness in the Mexican peso was initially due to the unwinding of short-term positions by hedge funds funded in European currencies (most notably the Swiss franc) that took profits on Mexican interest rate positions to cover losses on positions in Turkey.
- Equity markets that had experienced the highest run-up in prices since 2005—generally the biggest and most liquid—experienced some of the deepest declines, including Brazil, Mexico, Russia, and Turkey.
- Less risky equity markets and some Middle East equity markets fared differently; Middle East equity markets experienced a sharp correction (see GCC discussion below).
- Higher-yielding currencies (Brazil, Turkey, and Indonesia) that were favored for carry trades sold off the most after significant nominal and real appreciation during 2005.
- Emerging market corporate and sovereign credit markets reflected increased global risk aversion: CDS spreads generally widened (the CDS curve shifted up) and the curve steepened as riskier credits widened the most.
- The growing liquidity and size of the CDS market allowed investors to hedge local currency positions more easily and implement short-credit trades without repo operations in the cash market.

### Asset-class performance and market technicals
- Foreign investors concentrated positions in a few, better developed domestic interest rate and government securities markets (examples: Brazil, Colombia, Mexico, and Turkey); foreigners maintained large positions relative to the size of the local market.
- Flows into inflation-indexed local instruments in Latin American markets were particularly strong at the beginning of the year, bringing real yields down to record levels and compressing risk premiums relative to U.S. real yields before the correction.
- These local currency instruments were among those that sold off most in the initial stages of the correction.
- Net moves in selected currencies and markets (performance to June 9, 2006, and peak-to-June 9, 2006) showed varied declines across countries; examples of extreme moves:
  - New Turkish lira weakened 22 percent against the U.S. dollar over the last three weeks of May.
  - South African rand weakened almost 14 percent over the same period.
  - Average move for all emerging market currencies (as measured by changes in liquidity and trade-weighted exchange rate indices against the dollar) was 3.5 percent.
- Aggregated EMBIG spreads widened only moderately; external bond spreads showed little sign of market concern about sovereign credit distress events.
- Despite the May 2006 correction, valuations remained higher than in comparable earlier corrections, and the size of the external debt market correction in 2006 was much less than in prior episodes even though spreads were narrower.

### Country-specific vulnerabilities and implications for fundamentals
- For a few countries, the sell-off highlighted lingering concerns about fundamentals—Turkey is singled out where a large current account deficit and rising inflation raised concerns about exchange rate depreciation and inflation pass-through.
- Countries with current account deficits and overvalued equity markets could face further outflows and financial turbulence absent policy adjustment.
- Investors are likely to differentiate more finely among emerging markets based on fundamentals; countries with macroeconomic imbalances or heavier reliance on external financing will need to strengthen policies further.

### Policy responses taken during the correction
- Authorities sought to maintain orderly markets and domestic financial stability through targeted actions:
  - Brazil: authorities bought back inflation-linked debt, canceled scheduled debt auctions, resumed offering floating-rate bonds, and offered exchange-rate-linked interest rate swaps to stabilize market demand.
  - Turkey: central bank raised interest rates at an extraordinary meeting to reaffirm commitment to inflation targets in response to sharp exchange rate depreciation.
  - India and South Africa: tightened monetary conditions.
  - Colombia: removed restrictions requiring foreign investments to remain in the country for one year before repatriation of profits, to increase attractiveness to investment inflows.
- Debt management and reserves were used to reduce external financing needs and improve debt profiles:
  - Over 75 percent of sovereign external debt issuance planned for 2006 was completed by the beginning of June.
  - Brazil completed repurchase of $11.7 billion in external debt through the end of May, including all of its Brady bonds, and concluded in early June a further repurchase auction for $1.1 billion in external bonds ranging in maturity from 2007 to 2030.
  - Panama plans to exercise its option to buy back $360 million of Brady bonds in June.
  - Repurchases or exchanges were also undertaken earlier in the year by Colombia, Mexico, Russia, and Venezuela.
- Policy guidance and priorities implied by the episode:
  - Strengthen macroeconomic policies in countries with imbalances and high external financing reliance.
  - Continue developing local capital markets and build a diversified local investor base to cushion domestic markets against sudden sentiment changes.
  - Ensure sovereign debt management policies are consistent with the capacity of local markets to absorb foreign investor inflows.

### GCC equity markets (Box 1)
- GCC equity markets rose rapidly since 2003 and suffered sharp price declines recently; the 2003–04 rise was largely earnings-driven (surge in oil prices), while the exceptional increase from early 2005 reflected unreasonable expectations of corporate profit growth, rapid household credit growth, and structural factors encouraging risk-seeking behavior.
- Triggers and amplifiers of the correction:
  - Lower-than-expected Q4 2005 earnings released in early 2006 for Saudi Arabia and Kuwait.
  - Recognition that high profits for some listed companies were driven by equity trading rather than operations.
  - Mounting IPO issuance drained liquidity; delays in refunding oversubscriptions further reduced liquidity.
  - Regulatory measures limiting daily price fluctuations (e.g., from 10 percent to 5 percent) were interpreted as lack of confidence and exacerbated the downturn; margin calls added to selling pressure.
  - Selling contagion spread from Saudi Arabia to other regional markets where Saudi investors dominate capital supply.
- Authorities’ responses in the region aimed to increase liquidity, broaden the investor base, and improve transparency:
  - Saudi Arabia reversed the limit on daily price fluctuation, allowed stock splits, permitted foreign residents to trade directly with local exchanges, licensed research institutions, and introduced tougher sanctions against insider trading.
  - UAE: required timely refunding of IPO oversubscriptions (within two weeks) and eased margin requirements from 30 percent to 20 percent.
  - Central banks expanded reporting requirements to capture indirect stock market exposures.
  - Announcements of potential share purchases by state investment funds lifted market sentiment.

### Emerging market financing flows (Appendix highlights)
- Cumulative overall gross issuance (of bonds, equities, and loans) by sovereign and corporate issuers through the end of April was reported as hitting $126.8 million, well above the $113.8 million of 2005.
- The surge in issuance was mainly due to much higher equity and loan issuance; gross bond issuance was lower, reflecting prefinancing.
- On a net basis, overall issuance declined (large decline in net bond issuance), while net loan issuance increased substantially.
- Gross and net bond issuance were concentrated in public sector non-sovereign issuers, reflecting a surge in bond issues by government-related corporates.

*Source: IMF*

### Section 3

### 0606 - Section 3

### Emerging Market External Financing — Gross Issuance by Asset (in billions of U.S. dollars)
- Total GROSS ISSUANCE BY ASSET: 216.4 162.1 135.6 199.7 286.5 406.0 71.6 63.5 70.2 81.2 94.4 88.9 107.1 115.6 96.0 29.6 22.5 43.9 30.8 126.8
- Bonds: 80.5 89.0 61.6 99.8 135.1 182.3 40.9 29.1 34.5 30.5 61.7 37.8 40.4 42.4 48.9 19.4 8.7 20.8 5.4 54.3
- Equities: 41.8 11.2 16.4 27.7 45.1 78.1 13.9 10.3 5.6 15.3 10.5 17.4 22.9 27.4 22.4 6.1 7.5 8.8 7.4 29.9
- Loans: 94.2 61.9 57.6 72.2 106.2 145.5 16.8 24.0 30.1 35.3 22.3 33.8 43.7 45.7 24.7 4.7 4.1 6.3 14.3 17.9 42.6

### Emerging Market External Financing — Gross Issuance by Region (in billions of U.S. dollars)
- Total GROSS ISSUANCE BY REGION: 216.4 162.1 135.6 199.7 286.5 406.0 71.6 63.5 70.2 81.2 94.4 88.9 107.1 115.6 96.0 29.6 22.5 43.9 30.8 126.8
- Asia: 85.9 67.5 53.9 88.8 123.3 149.6 34.1 28.5 25.8 35.0 26.6 33.5 40.8 48.8 36.9 10.6 8.3 18.0 7.9 44.8
- Latin America: 69.1 53.9 33.4 43.3 54.3 87.5 14.4 9.7 16.2 13.9 34.5 13.8 23.0 16.3 14.9 5.3 2.7 6.9 4.6 19.5
- Europe, Middle East, Africa: 61.4 40.8 48.3 67.7 108.9 168.9 23.1 25.3 28.3 32.3 33.3 41.7 43.3 50.6 44.3 13.7 11.6 19.0 18.2 62.5

### Amortization by Asset and Region (in billions of U.S. dollars)
- AMORTIZATION BY ASSET total: 113.9 147.0 128.4 119.5 128.1 107.8 35.0 32.8 30.6 29.7 21.6 26.1 32.6 27.5 22.2 8.9 6.2 7.1 9.1 31.3
- Bonds amortization: 51.8 59.0 58.9 57.1 69.6 65.2 21.5 17.5 15.9 14.7 13.3 14.5 21.6 15.8 13.4 4.5 4.5 4.3 6.7 20.1
- Equities amortization: 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
- Loans amortization: 62.1 88.0 69.5 62.4 58.5 42.6 13.5 15.3 14.7 15.0 8.3 11.6 11.0 11.7 8.8 4.3 1.7 2.8 2.4 11.3

- AMORTIZATION BY REGION total: 113.9 147.0 128.4 119.5 128.1 107.8 35.0 32.8 30.6 29.7 21.6 26.1 32.6 27.5 22.2 8.9 6.2 7.1 9.1 31.3
- Asia amortization: 56.6 66.0 55.6 45.5 49.8 38.6 13.2 12.9 11.8 11.8 8.0 5.9 11.4 13.4 10.7 3.8 2.9 3.9 3.3 14.0
- Latin America amortization: 32.3 45.6 40.8 40.4 46.7 37.1 12.3 13.4 10.2 10.9 7.7 10.4 11.1 7.9 7.9 3.9 2.2 1.8 2.4 10.3
- Europe, Middle East, Africa amortization: 24.9 35.3 32.0 33.6 31.6 32.1 9.5 6.6 8.6 7.0 5.9 9.8 10.1 6.3 6.3 1.1 1.1 1.4 3.4 7.0

### Net Issuance by Asset and Region (in billions of U.S. dollars)
- NET ISSUANCE BY ASSET total: 102.5 15.2 7.3 80.2 158.3 298.2 36.6 30.7 39.6 51.5 72.8 62.9 74.5 88.1 73.8 20.7 16.3 36.8 21.6 95.4
- Net Bonds: 28.7 30.1 2.7 42.7 65.5 117.1 9.4 11.6 18.6 15.8 48.4 23.3 18.8 26.6 35.6 14.9 4.2 16.5 -1.3 34.3
- Net Equities (matches gross equities): 41.8 11.2 16.4 27.7 45.1 78.1 13.9 10.3 5.6 15.3 10.5 17.4 22.9 27.4 22.4 6.1 7.5 8.8 7.4 29.9
- Net Loans: 32.1 -26.1 -11.8 9.8 47.7 103.0 3.3 8.7 15.4 20.3 14.0 22.2 32.7 34.1 15.8 -0.3 4.6 11.5 15.5 31.3

- NET ISSUANCE BY REGION total: 102.5 15.2 7.3 80.2 158.3 298.2 36.6 30.7 39.6 51.5 72.8 62.9 74.5 88.1 73.8 20.7 16.3 36.8 21.6 95.4
- Asia net issuance: 29.2 1.5 -1.7 43.3 73.5 111.0 20.8 15.6 13.9 23.1 18.7 27.6 29.4 35.4 26.2 6.7 5.4 14.1 4.6 30.8
- Latin America net issuance: 36.8 8.3 -7.4 2.9 7.6 50.4 2.1 -3.6 6.0 3.1 26.8 8.3 3.4 11.8 8.4 6.9 1.4 0.5 5.1 2.9 9.2
- Europe, Middle East, Africa net issuance: 36.5 5.5 16.3 34.0 77.2 136.8 13.6 18.7 19.6 25.3 27.4 31.9 33.2 44.3 40.7 12.7 10.5 17.6 14.8 55.5

### Secondary Markets — Bond and Equity Indicators (spreads in bps; yields in %; equity returns in percent)
- EMBI Global (spread in bps): 735 728 725 403 347 179 414 482 409 347 373 297 235 237 191 210 187 191 179 179
- Merrill Lynch High Yield (spread in bps): 890 795 871 418 310 371 438 404 384 310 352 385 354 371 313 342 337 313 304 304
- Merrill Lynch High Grade (spread in bps): 200 162 184 93 84 392 94 97 79 18 39 39 5 89 92 90 90 89 89
- US 10 yr. Treasury Yield (yield in %): 5.12 5.05 3.82 4.25 4.22 4.39 3.84 4.58 4.12 4.22 4.48 3.92 4.33 4.39 4.85 4.52 4.55 4.85 5.05 5.05

- Equity indices (returns in percent): 
  - DOW: -6.2 -7.1 -16.8 25.0 3.1 -0.6 -0.9 0.8 -3.4 -1.9 -2.8 -2.6 -2.2 2.9 3.7 1.4 1.2 1.1 2.3 6.1
  - NASDAQ: -39.3 -21.1 -31.5 50.5 8.6 1.4 -0.5 2.7 -7.4 1.9 -8.4 -8.1 2.9 4.6 6.1 4.6 -1.1 2.6 -0.7 5.3
  - MSCI Emerging Market Free: -31.8 -4.9 -8.0 51.2 22.4 30.3 8.9 -10.3 7.4 -0.2 0.6 1.2 3.0 17.0 11.5 10.9 -0.2 0.7 6.8 19.1
  - Asia: -42.5 4.2 -6.2 46.1 12.2 23.5 7.6 -12.2 4.2 -0.5 2.8 2.1 2.8 8.5 9.0 7.5 -0.4 1.8 6.9 16.5
  - Latin America: -18.4 -4.3 -24.8 66.7 34.8 44.9 6.2 -9.2 16.6 -1.1 -0.6 1.8 7.1 29.5 14.9 17.0 0.8 -2.6 7.3 23.3
  - EMEA: -22.3 -20.9 4.7 51.9 35.8 34.9 13.2 -7.4 7.8 1.0 -3.0 -1.0 0.5 27.1 14.1 13.5 -0.7 1.3 6.3 21.3

### Sovereign External New Issuance Estimates in 2006 (In millions of U.S. dollars)
- Country-level planned, actual, and remaining amounts (selected entries):
  - Argentina: Planned 3,400; Actual 2,139; Remaining 1,261
  - Brazil: Planned 4,500; Actual 5,330; Remaining (830)
  - Bulgaria: Planned 650; Actual ...; Remaining 650
  - Colombia: Planned 2,000; Actual 2,237; Remaining (237)
  - Dominican Republic: Planned 300; Actual 300; Remaining ...
  - Ecuador: Planned 500; Actual 650; Remaining (150)
  - Egypt: Planned 1,000; Actual ...; Remaining 1,000
  - El Salvador: Planned 625; Actual 400; Remaining 225
  - Hungary: Planned 3,500; Actual 2,837; Remaining 663
  - Indonesia: Planned 2,000; Actual 2,000; Remaining ...
  - Israel: Planned 900; Actual ...; Remaining 900
  - Lebanon: Planned 2,000; Actual 267; Remaining 1,733
  - Lithuania: Planned 500; Actual 480; Remaining 20
  - Malaysia: Planned 500; Actual ...; Remaining 500
  - Mexico: Planned 2,900; Actual 2,900; Remaining 0
  - Pakistan: Planned 500; Actual 800; Remaining (300)
  - Panama: Planned 640; Actual 1,613; Remaining (973)
  - Philippines: Planned 3,100; Actual 2,250; Remaining 850
  - Poland: Planned 5,500; Actual 3,630; Remaining 1,870
  - Slovak Republic: Planned 1,200; Actual 1,200; Remaining ...
  - South Africa: Planned 1,000; Actual 907; Remaining 93
  - South Korea: Planned 1,000; Actual ...; Remaining 1,000
  - Thailand: Planned 1,000; Actual 200; Remaining 800
  - Turkey: Planned 5,500; Actual 3,129; Remaining 2,372
  - Uruguay: Planned 500; Actual 1,560; Remaining (1,060)
  - Venezuela: Planned 3,000; Actual 4,215; Remaining (1,215)
  - Vietnam: Planned 250; Actual ...; Remaining 250

- Regional aggregates (In millions of U.S. dollars):
  - Asia: Planned 8,350; Actual 5,250; Remaining 3,100
  - Emerging Europe: Planned 20,050; Actual 11,275; Remaining 8,775
  - Latin America: Planned 18,365; Actual 21,344; Remaining (2,979)
  - Middle East & Africa: Planned 6,050; Actual 1,174; Remaining 4,876
  - Total: Planned 52,815; Actual 39,043; Remaining 13,772

---


_Source: https://www.imf.org/-/media/files/publications/fmu/0606.pdf_