Publication: Global Monetary Conditions versus Country-Specific Factors in the Determination of Emerging Market Debt Spreads
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Date
2008
ISSN
02615606
Published
2008
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US interest rate policy is shown to have a significant influence on emerging market bond spreads, but it is important to allow for non-linearities: US interest rates affect secondary market spreads differently, depending on countries' debt levels. Moderate debtors suffer little impact from an increase in US interest rates, while a country close to the borderline of solvency would face a much steeper increase in its spread. A 200 basis points increase in US short-term interest rates would increase emerging market spreads by 6-65 bps, depending on debt/GNI ratios.
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Publication Global Monetary Conditions versus Country-Specific Factors in the Determination of Emerging Market Debt Spreads(World Bank, Washington, DC, 2005-06)The authors offer evidence that U.S. interest rate policy has an important influence in the determination of credit spreads on emerging market bonds over U.S. benchmark treasuries and therefore on their cost of capital. Their analysis improves on the existing literature and understanding by addressing the dynamics of market expectations in shaping views on interest rate and monetary policy changes and by recognizing nonlinearities in the link between U.S. interest rates and emerging market bond spreads, as the level of interest rates affect the market's perceived probability of default and the solvency of emerging market borrowers. For a country with a moderate level of debt, repayment prospects would remain good in the face of an increase in U.S. interest rates, so there would be little increase in spreads. A country close to the borderline of solvency would face a steeper increase in spreads. Simulations of a 200 basis points (bps) increase in U.S. interest rates show an increase in emerging market spreads ranging from 6 bps to 65 bps, depending on debt/GDP ratios. This would be in addition to the increase in the benchmark U.S. 10 year Treasury rate.Publication The New Multi-polar International Monetary System(2009-12-01)Backed by rapid economic growth, growing financial clout, and a newfound sense of assertiveness in recent years, the BRIC countries - Brazil, Russia, India, and China - are a driving force behind an incipient transformation of the world economy away from a US-dominated system toward a multipolar one in which developing countries will have a major say. It is, however, in the international monetary arena that the notion of multipolarity - more than two dominant poles - commands renewed attention and vigorous debate. For much of its history, the quintessential structural feature of the international monetary system has been unipolarity - as American hegemony of initiatives and power as well as its capacity to promote a market-based, liberal order came to define and shape international monetary relations. As other currencies become potential substitutes for the US dollar in international reserves and in cross-border claims, exchange rate volatility may become more severe. There are also risks that the rivalry among the three economic blocs may spill over into something more if not kept in check by a strong global governance structure. While the transition will be difficult and drawn out, governments should take immediate steps to prevent financial volatility by enhancing cooperation on monetary policies, currency market intervention and financial regulation.Publication Contract Risks and Credit Spread Determinants in the International Project Bond Market(World Bank, Washington, DC, 2001-11)International bond markets have become an increasingly important source of long-term capital for infrastructure projects in emerging market economies over the past decade. The Ras Laffan Liquified Natural Gas (Ras Gas) project represents a milestone in this respect: its $1.2 billion bond offering, completed in December 1996, has been the largest for any international project. The Ras Gas project has the right to extract, process, and sell liquefied natural gas (LNG) from a field off the shore of Qatar. The principal off-taker is the Korea Gas Corporation (Kogas), which resells most of the LNG to the Korea Electric Power Corporation (Kepco) for electricity generation. In this clinical study the authors analyze the determinants of credit spreads for the Ras Gas project in terms of its contractual structure, with a view to better understanding the role of contract design in facilitating access to the global project bond market. Market risk perceptions have long been recognized to be a function of firm-specific variables, particularly asset value as embodied in contracts. The authors therefore study the impact of three interlocking contracts on the credit spreads of the project's actively traded global bonds: the 25-year output sales and purchase agreement with Kogas-Kepco, the international bond covenant, and an output price-contingent debt service guarantee by Mobil to debt holders. Using a sample of daily data from January 1997 to March 2000, the authors find that the quality of the off-taker's credit-and, more important, the market's assessment of the off-taker's economic prospects-drive project bond credit spreads and pricing. In addition, seemingly unrelated events in emerging debt markets spill over to project bond markets and affect risk perceptions and prices in this segment. Judicious use of an output price-contingent debt service guarantee by shareholders can significantly reduce project risks, and markets reward issuers through tighter credit spreads. Bondholders and shareholders share residual risks over time, despite covenants meant to preempt risk shifting. This type of risk shifting originates from incomplete contracts and the nonrecourse nature of project finance. It does not necessarily result from a deliberate attempt by management to increase shareholder value at the expense of debt holders by pursuing high-risk, low-value activities, although project managers and shareholders could still exploit their informational advantages by leaving output supply contracts incomplete in ways beneficial to their private interests. The results hold important lessons for global project finance. Projects incorporating certain design features can reap significant financial gains through lower borrowing costs and longer debt maturities: Judicious guarantees by parents that enjoy a particular hedging advantage enhance a project's appeal, as reflected in favorable pricing. Pledging receivables rather than physical assets as collateral and administering investor cash flows through an off-shore account offers additional security to debt holders. Projects should use their liability structure to create an implicit option on future private debt financing that matches the real option of a project expansion. The finding that bondholders bear residual risks means that shareholders can reduce their risks arising from bilateral monopolies and buy insurance against unforeseen and unforeseeable events.Publication The Emerging Project Bond Market : Covenant Provisions and Credit Spreads(World Bank, Washington, DC, 2003-07)The emergence in the 1990s of a nascent project bond market to fund long-term infrastructure projects in developing countries merits attention. The authors compile detailed information on a sample of 105 bonds issued between January 1993 and March 2002 for financing infrastructure projects in developing countries, document their contractual covenants, and analyze their pricing determinants. They find that on average, project bonds are issued at approximately 300 basis points above U.S. Treasury securities, have a surprisingly high issue size of US$278 million, a maturity of slightly under 12 years, and are rated slightly below investment grade. In terms of geographic origin, projects in Asia and Latin America have issued more bonds than those located in other regions. Much of the recent work relating to the role of contractual covenants to the determination of bond prices has focused on the U.S. corporate bond market with its unique bankruptcy code - Chapter 11 - and well developed legal framework, recognizing the bond contract as the sole instrument of defining the rights and duties of various parties. In circumstances in which the underpinning legal and institutional frameworks governing contract formation and enforcement are not well developed, the link between bond pricing and legal framework becomes important. This finding is confirmed by the authors' econometric analysis of project bond pricing model. So, investors take into account the quality of the host country's legal framework and reward projects located in countries that adhere to the rule of law with tighter credit spreads and lower funding costs.Publication Measures of Investor and Consumer Confidence and Policy Actions in the Current Crisis(2009-07-01)The current financial crisis has highlighted the danger that declines in confidence can have a self-fulfilling effect on economic activity. In this paper, the authors consider ways of measuring investor and consumer confidence, and try to explain the evolution of confidence using measures of financial volatility, investment performance, macroeconomic outcomes, and policy actions. They identify a link between investor and consumer confidence. Finally, they show that liquidity provision and easing of interest rates had only a limited effect on financial market spreads during the crisis, arguing for additional measures to address the loss of confidence. The paper focuses on the need for financial regulatory reform, and shows how the incentives to cooperate in this area are stimulated by a common shock to confidence.
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