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CEE Local Currency Bond Markets: Room for Growth Sonja Gibbs Director, Capital Markets and Emerging Markets Policy Department Institute of International Finance Annual Meeting of Central and East European Chief Executives Berlin April 2013 Post-Crisis Development Has Been Rapid… • Cross-border inflows to emerging market local currency bonds have surged over the past few years • Rapid market development underpinned by very low yields on U.S. Treasuries—can this be sustained? • LC bonds as a class have been moving more in line with safe-haven assets (performing well during “risk-off” periods • More than many other asset classes, driven by local factors—provides diversification benefits • Regulatory changes (e.g., HQLA under Basel III, CCP) also encourage bank and investor demand for higher-quality fixed-income securities (of which there is a shortage). 2 Flows to LC bond funds have grown rapidly Cumulative Net Inflows to Emerging Market Bond Funds USD billions 140 Blended 120 100 Hard currency 80 Local currency 60 40 20 0 -20 2005 2006 2007 2008 2009 2010 2011 2012 3 High-frequency data show net LC bond flows to EM Europe rising in recent months EM European Bond Flows USD million 60 40 20 0 -20 -40 -60 Blend -80 Hard Currency -100 Local Currency -120 -140 Jun 08 Mar 09 Dec 09 Sep 10 Jun 11 Mar 12 Dec 12 4 …but LCBMs are still small and illiquid • Big push by the G20 for development of LCBMs, working with international institutions and the private sector • However, EM LCBM size is just $4.7 trillion, vs. $37 trillion for mature markets. Investible assets (GBI-EM) even less: $883 billion vs. $21 trillion. • Strong interest from foreign investors has meant a sharp rise in their share of domestic debt securities • 2013 has seen issuance of LC Eurobonds (e.g. RUB, TRY) • Key driver of performance: exchange rate risk 5 Share of corporate local currency bonds is growing E m erg in g Markets D o m es tic D eb t S ec u rities O u ts tanding U S D trillions 10 8 6 Financ ial C orporates S overeign Non-fin C orporates 4 2 0 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 6 Foreign ownership in LC markets has surged… Foreign Ownership of Domestic Debt Securities % of all domestic debt securities, selected countries U.S. Hungary Poland UK Indonesi Mexico S. Africa Malaysia Turkey Thailand Korea Brazil Czech R. 2012 2005 0 10 20 30 40 50 7 …encouraged by ultra-low U.S. Treasury yields Poland: Domestic Government Bond Market percent % of all domestic gov't bonds LC gov't bond yield U.S. Treasury yield 8 35 % foreign holdings (rhs) 7 30 6 5 25 4 20 3 2 15 1 0 10 04 05 06 07 08 09 10 11 12 13 8 Yield pickup remains very attractive; relative risk premium on EM Europe has disappeared Emerging Market Local Currency Bond Yields by Region percent, GBI-EM 12 EM Asia EM Europe Latin America 11 10 9 8 7 6 5 4 3 2 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 9 Plenty of room for growth in Emerging Europe Estimated domestic debt securities outstanding USD billions, latest available data 3635 China Brazil S. Korea India Mexico Other EM Asia Malaysia Other LatAm Turkey Russia Poland Hungary Other EM Europe Czech Rep 0 500 1000 1500 2000 2500 10 Steady or higher LC bond issuance seen in much of EM Europe this year Emerging Europe Gross Local Currency Market Issuance USD billions, selected countries 90 80 70 60 50 40 30 20 10 0 2012 2013f Turkey Poland Russia Czech Rep Hungary 11 Record level of EM corporate bond issuance in 2012… Emerging Markets Syndicated Loan Market and Corporate Bond Issuance, USD billions 350 300 Syndicated loans Bonds 250 200 150 100 50 0 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 12 …with all EM regions well represented Emerging Market Corporate Bond Issuance USD billion 350 MENA 300 LatAM 250 EM Asia 200 EM Europe 150 100 50 0 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 13 Impediments to LC market development remain… 1. Lack of liquidity (investible assets, money markets); limited domestic savings; limited secondary markets; limited securitization markets and hedging tools 2. Lack of market infrastructure legal and regulatory uncertainties Taxes (withholding, cap gains), currency restrictions limited range of financial and investment products undeveloped payment and settlement systems, often very divergent across borders 3. In CEE, potential currency replacement by euro 14 …but the investor base is growing • Greater appeal of LC debt to foreign investors: yield, Sharpe ratio—U.S. holdings of GBI-EMGD at 17% of all non-U.S. gov’t bonds—up from just 1% in 2001 • While foreign investors in aggregate hold about 25% of domestic EM government debt, domestic non-bank financial institutions hold 60%--this base is growing too: Domestic EM insurance companies Domestic EM pension funds • Central banks are also diversifying more in EM local currency debt—for yield and away from EUR, but also more use of EM FX in global trade, new EM-EM trade patterns. 15 EM pension fund AUM has grown rapidly… Emerging Market Pension Fund Assets USD billions 1800 1600 EMEA 1400 EM Asia 1200 Latin America 1000 800 600 400 200 0 '95 '97 '99 '01 '03 '05 '07 '09 '11 16 …as has EM insurers’ AUM 17 CEE Local Currency Bond Markets: Where Next? Sonja Gibbs Director, Capital Markets and Emerging Markets Policy Department Institute of International Finance Annual Meeting of Central and East European Chief Executives Berlin April 2013