The Trillion Dollar Question: Who Owns Emerging Market Government Debt

IMF Blog, March 5, 2014

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The Trillion Dollar Question: Who Owns Emerging Market Government Debt

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Bibliographic details

• Authors: Serkan Arslanalp, Takahiro Tsuda
• Published: March 5, 2014

Key facts and data

• Global investors poured "$1 trillion" into emerging market government bonds in recent years.
• Data compiled for 24 emerging market countries covering the period from "2004 through June 2013".
• Foreign investment of "half a trillion dollars" flowed into emerging market government bonds from "2010 until 2012" alone.
• Foreign financial institutions that aren’t banks (large institutional investors, hedge funds, sovereign wealth funds) held about "$800 billion" of the debt—"80 percent of the total"—at end-2012.
• Foreign central banks held about "$40 to $80 billion" of the debt, with holdings concentrated in seven countries: Brazil, China, Indonesia, Poland, Malaysia, Mexico and South Africa.

Investor patterns before, during and after the global financial crisis

• Foreign investors differentiated among emerging market economies in three distinct periods—before, during and after the global financial crisis.
• Before the crisis: moderate differentiation among countries (some received inflows, others faced outflows).
• During the crisis: differentiation became much sharper.
• After the crisis (2010–12): foreign flows became almost always positive and much less differentiated.
• Five emerging markets reached or regained investment grade status during "2010–12": Colombia, Indonesia, Latvia, Romania, and Uruguay.
• Even countries whose credit ratings deteriorated or did not improve during "2010–12" continued to receive inflows against the background of near-zero interest rates in advanced economies.

Policy implications and scenario findings

• Improvements in public debt management helped attract foreign demand: extending the maturity of debt, cutting issuance of floating rate debt, and reducing foreign currency debt.
• These changes made public balance sheets more resilient to exchange rate and interest rate shocks and reduced risks on the supply-side of government debt.
• Rising foreign participation creates both opportunities and risks:
  • Opportunities: can reduce borrowing costs and spread risks more broadly among investors.
  • Risks: can raise external funding risks and make countries vulnerable to sudden reversals in foreign flows.
• Illustrative scenarios were run to assess impact of a shock (designed to assess impact, not to predict likelihood).

Scenarios — characteristics associated with lower sensitivity to external funding risks

Countries with the following characteristics would be less sensitive to external funding risks (for a given level of foreign participation):

• lower debt-to-GDP ratio
• lower gross financing needs
• more developed domestic financial systems
• larger liquidity buffers to protect against external shocks

• The scenarios illustrate the importance of:
  • extending the maturity of government debt
  • developing a local investor base
  • maintaining liquidity buffers
• Example outcome: countries that had these mitigating measures, such as Mexico and Poland, faced less pressure on bond yields during the summer of 2013, despite having higher foreign ownership of government debt.

Recommendations for emerging markets

• Carefully track who owns government debt and for how long.
• Beef up communications with the investor base to understand investor needs.
• Continue reforms to debt management that extend maturity, reduce floating-rate and foreign-currency debt, and build domestic investor capacity and liquidity buffers.

Source: The Trillion Dollar Question: Who Owns Emerging Market Government Debt — Serkan Arslanalp, Takahiro Tsuda, March 5, 2014.

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References

• new analysis
• we designed last year
• data from 24 emerging market countries