Global Financial Stability Report: Market Developments and Issues, March 2003 (World Economic & Financial Surveys)

World Economic and Financial Sur veys

Global Financial Stability Report Market Developments and Issues

March 2003

International Monetary Fund Washington DC

© 2003 International Monetary Fund Production: IMF Multimedia Services Division Cover: Phil Torsani Photo: Padraic Hughes Figures: Theodore F. Peters, Jr. Typesetting: Choon Lee ISBN 1-58906-210-8 ISSN 0258-7440

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CONTENTS

Preface Chapter I. Overview Key Developments in Major Financial Centers Emerging Market Financing Measures to Improve Market Confidence Policy Issues in Developing Local Securities Markets Chapter II. Key Developments and Sources of Financial Risk in the Major Financial Centers Major Developments in the Mature Markets Have Key Sectors Been Weakened Further or Strengthened? Withdrawal from Risk Taking and Buildup of Cash Positions: Implications and Risks References Chapter III. Emerging Market Developments and Financing Prospects Emerging Market Flows Remain Weak Emerging Bond Markets Turn in Strong Performance Emerging Equity Markets Finished Lower in 2002 Syndicated Lending Turns Up Modestly Banking Sector Performance in Emerging Markets Outlook Appendix: A “Feast or Famine” Dynamic Prevails in Emerging Primary Markets References Chapter IV. Local Securities and Derivatives Markets in Emerging Markets: Selected Policy Issues Local Markets as Self-Insurance Against Volatile Capital Flows Extent of Securities Market Development as an Alternative Source of Funding Common Practices in Emerging Local Securities Markets Selected Policy Issues Concluding Remarks References

vii 1 1 4 5 6 7 8 15 24 32 34 35 38 46 49 52 60 63 69

70 71 74 79 82 92 92

Glossary

95

Annex: Concluding Remarks by the Acting Chair

99

Statistical Appendix

103

Boxes 3.1 The Risk of War and Emerging Market Vulnerabilities 3.2 Emerging Market Contagion in 2002

41 55

iii

CONTENTS

3.3 Collective Action Clauses: Latest Developments 4.1 An International Solution for the Original Sin

58 85

Tables 1.1 2.1 2.2 2.3 3.1 3.2 3.3 3.4 3.5 3.6 4.1 4.2 4.3 4.4

Financial Market Data United States: Household Sector Balance Sheet Internationally Active Financial Institutions: Equity Prices Global Financial Institutions: Ratings and Capital Ratios Emerging Market Financing EMBI+ Performance Currency of Issuance Equity Markets Performance, 2002 Valuation and Earnings Across Equity Markets Emerging Market Countries: Financial Soundness Indicators Reserves: Level and Ratio to GDP Private Sector Public Sector Total of All Sectors

2 17 19 20 36 39 46 47 49 53 72 75 77 78

Stock Market Performance Price/Earnings Ratios Selected Spreads Short- and Long-Term Interest Rates in Government Securities United States: Thirty-Year Mortgage Rate and Government Bond Yield Selected Major Exchange Rates United States: Net Portfolio Inflows and Net Total Capital Flows United States: Household Net Worth Position United States: Non-Financial Corporate Sector—Ratio of Broad Liquid Assets to Short-Term Debt Internationally Active Financial Institutions: Relative Stock Prices U.S. Banks: Relative Stock Prices Large Insurance Companies: Relative Stock Prices United States: Household Portfolio Allocation, Total Deposits United States: Household Balance Sheets, Selected Items Europe: Houshold Portfolio Allocation Japan: Personal Sector Portfolio Allocation, Total Deposits United States: Wholesale Cash Instruments Relative to Total Financial Claims Cumulative Gross Annual Issuance of Bonds, Loans, and Equity Emerging Market Financing Sovereign Spreads Risk Appetite and Emerging Market Debt Emerging Markets and High-Yield Fund Flows Bond Issuance Share of Bond Issues Emerging Market Equities and U.S. Treasuries Emerging Market Equity Volatility

8 9 10 13 14 15 16 18

Figures 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9

iv

18 21 22 23 25 26 27 28 29 38 38 40 40 44 44 45 47 47

CONTENTS

3.10 3.11 3.12 3.13 3.14 3.15 3.16 3.17 3.18 3.19 3.20 3.21 3.22 3.23 3.24 3.25 3.26 3.27 3.28 4.1

Correlations of S&P 500 with Emerging Markets Asian Emerging Market Equities and Semiconductor Chips Returns and Total Risk, 2002:Q4 U.S.-Based Mutual Funds Flows into Emerging Market, Emerging Asian, and Latin American Equities Cumulative Gross Annual Issuance of Equity Equity Placements S&P 500 Earnings per Share Cumulative Gross Annual Loan Issuance Syndicated Loan Commitments Loan-Weighted Interest Margin Market Valuation Sovereign Spreads Versus Historical Lows Risk Versus Return, January 1998–December 2002 EMBI+ with Periods of Opening and Closure EMBI+ Volatility During Market Closures VIX Index and Primary Market Closures, 1994–96 VIX Index and Primary Market Closures, 1997–2002 BBB-BB Spread Differentials and Primary Market Closures, 1994–96 BBB-BB Spread Differentials and Primary Market Closures, 1997–2002 Chile: Amount Outstanding of Private Nonfinancial Sector Bonds

48 48 49 49 50 50 51 51 52 52 54 61 63 64 64 66 66 67 67 83

The following symbols have been used throughout this volume: . . . to indicate that data are not available; —

to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

–

between years or months (for example, 1997–99 or January–June) to indicate the years or months covered, including the beginning and ending years or months;

/

between years (for example, 1998/99) to indicate a fiscal or financial year.

“Billion” means a thousand million; “trillion” means a thousand billion. “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to !/4 of 1 percentage point). “n.a.” means not applicable. Minor discrepancies between constituent figures and totals are due to rounding. As used in this volume the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

v

PREFACE

This issue of the Global Financial Stability Report (GFSR) marks the beginning of a new semiannual frequency for the publication. First launched in March 2002, the GFSR provides a regular assessment of global financial markets and identifies potential systemic weaknesses that could lead to crises. By calling attention to potential fault lines in the global financial system, the report seeks to play a role in preventing crises before they erupt, thereby contributing to global financial stability and to the sustained economic growth of the IMF’s member countries. The report was prepared by the International Capital Markets Department, under the direction of the Counsellor and Director, Gerd Häusler. It is managed by an Editorial Committee comprising Hung Q. Tran (Chairman), Donald J. Mathieson, David J. Ordoobadi, and Garry J. Schinasi, and benefits from comments and suggestions from Axel Bertuch-Samuels, Charles R. Blitzer, and David Cheney. Other contributors to this issue are Francesc Balcells, Gianni De Nicoló (of the IMF’s Monetary and Exchange Affairs Department), Burkhard Drees, Martin Edmonds, Toni Gravelle, Janet Kong, Gabrielle Lipworth, Chris Morris, Jürgen Odenius, Li Lian Ong, Kazunari Ohashi, Lars Pedersen, Ramana Ramaswamy, Jorge Roldos, Calvin Schnure, Srikant Seshadri, Manmohan Singh, Mazen Mahmoud Soueid, and S. Kal Wajid (Monetary and Exchange Affairs Department). Silvia Iorgova, Anne Jansen, Oksana Khadarina, Yoon Sook Kim, Kalin Tintchev (Monetary and Exchange Affairs Department), and Peter Tran provided research assistance. Caroline Bagworth, Jane Harris, Vera Jasenovec, Ramanjeet Singh, and Joan Wise provided expert word processing assistance. Jeff Hayden of the External Relations Department edited the manuscript and coordinated production of the publication. This particular issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in Brazil, Chile, China, Hong Kong SAR, Hungary, Japan, Poland, Russia, Singapore, Thailand, the United Kingdom, and the United States. The report reflects mostly information available up to February 28, 2003. The report has benefited from comments and suggestions from staff in other IMF departments, as well as from Executive Directors following their discussions of the Global Financial Stability Report on March 14, 2003. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the Executive Directors, their national authorities, or the IMF.

vii

CHAPTER 1

OVERVIEW

he adjustment in financial markets and the real economy following the bursting of the asset price bubble continues to influence developments. This is reflected in the hesitant and uneven pace of global economic growth and the reluctance of corporations to boost capital expenditure. Risk appetite has also been curtailed, contributing to the unwillingness of investors to support a recovery of equities in mature markets, to continued tiering in the mature and emerging credit markets, and to uneven flows to emerging market borrowers. The negative influence, however, appears to be waning. Household balance sheets in the United States appear to have stabilized, U.S. corporate balance sheets have strengthened somewhat, and financial institutions are showing tentative signs of being less hesitant to take on risk. The supportive stance of monetary policy in the major economies, coupled with more riskaverse behavior by both institutional and retail investors, has contributed to a sizable buildup of cash positions. A partial mobilization of these cash positions in the fourth quarter of 2002 helped fuel a short-lived stock market rally, led to a narrowing of credit spreads on mature and emerging bonds, and contributed to an increase in flows to emerging market borrowers. The steep yield curves, particularly in the United States, have also allowed financial institutions to improve their earnings through traditional carry trades and maturity mismatches. The gradual improvement of financial conditions in mature markets has reduced the perception of risk and probably the risk itself to global financial stability relative to that prevailing in September 2002 when markets hit a low. Normally, this would suggest the potential for a rebound in the economy and financial

T

markets once investor sentiment turns and the large pool of risk-capital waiting on the sidelines is reallocated back to risk taking. However, this potential is currently overshadowed by the intensified uncertainty about the prospect of war in Iraq and its repercussions on growth and stability. While markets may have priced in a short and decisive war, any departure from this scenario could weaken confidence further. Moreover, markets may have not yet focused on the possibility that uncertainty could persist for some time. Indeed, uncertainty is increasing about a conflict with Iraq. Uncertainty could also persist despite a short and decisive military conflict owing to the potential for continued geopolitical instability and tangible threats of terrorism. Even those investors who take a rather optimistic view about geopolitical events prefer to see uncertainty removed first before they invest in riskier asset classes; they are unable to price uncertainty and therefore adopt a “wait-and-see” attitude. Consequently, prolonged uncertainty could keep risk aversion at a high level, depress financial markets, and reinforce the headwind against global economic recovery. The reversal of the fourth-quarter equity market rally from mid-January to early March (see Table 1.1) highlights the continued fragility of investor sentiment and the urgent need for policies to foster market confidence, and for a resolution of geopolitical tensions.

Key Developments in Major Financial Centers Major sectors in the global financial system have made some progress in correcting past excesses (see Chapter II). However, continued

1

CHAPTER I

OVERVIEW

Table 1.1. Financial Market Data (Percentage change unless otherwise noted) Change to February 28, 2003 from ____________________________________________________________________________ 2001 2002 __________________________ ___________________________ Peak (March 24, 2000)

September 11

December 31

September 30

December 31

Equity Market Major stock indexes1 S&P 500 Nasdaq FTSE Eurotop 300 Topix

–44.9 –73.1 –53.7 –50.1

–23.0 –21.1 –30.5 –22.6

–26.7 –31.4 –39.1 –20.7

3.2 14.1 –6.2 –11.1

–4.4 0.2 –10.4 –2.9

Bank indexes S&P 500 bank index FTSE Eurotop 300 bank index Topix bank index

3.3 –32.9 –64.8

–3.5 –25.0 –50.2

–5.9 –35.0 –31.5

0.5 –1.4 –34.5

–2.1 –9.3 –8.8

Bond Market U.S. corporate bonds Yields (level change; basis points) AAA BAA High-yield bonds Spreads (level change; basis points)2 AAA BAA High-yield bonds U.S. corporate bond price indexes3 AAA A BBB

–180 –141 –49

–111 –87 –112

–78 –100 –126

–26 –47 –214

–26 –39 –71

70 109 201

–3 21 –4

58 36 10

–36 –57 –224

–14 –27 –59

... ... ...

7.3 7.1 1.4

1.4 2.0 4.3

1.1 1.3 1.7

European corporate bond spreads4 AA A BBB

3 10 87

–1 –20 –19

0 –2 18

–10 –13 –62

–4 3 –2

Japanese corporate bond spreads4 AA A BBB

–10 5 –9

–2 1 17

–5 –22 –20

–1 –4 –30

0 –5 –9

Government bond yields (level change; basis points)5 United States Germany Japan

–250 –133 –108

–108 –89 –63

–136 –108 –58

10 –35 –40

–12 –29 –12

Government bond price indexes6 United States Germany Japan

17.8 12.2 14.6

8.3 11.0 10.8

11.8 9.6 9.7

0.2 2.5 6.9

1.7 1.8 2.7

Exchange rates Euro/U.S. dollar Yen/U.S. dollar Trade-weighted nominal U.S. dollar

–9.5 10.5 –0.4

–15.5 –1.1 –8.6

–17.7 –10.3 –12.2

–8.7 –3.0 –5.6

–2.9 –0.6 –2.8

Sources: Bloomberg L.P.; and Datastream. 1In local currency terms. 2Spread over a 10-year U.S. treasury bond. 3Merrill Lynch corporate bond indexes. 4Merrill Lynch corporate bond spreads; level change, in basis points. 5Ten-year government bonds. 6Merrill Lynch government bond indexes, 10+ years.

2

6.6 6.0 –0.5

KEY DEVELOPMENTS IN MAJOR FINANCIAL CENTERS

progress is not yet assured and remains vulnerable to reversal as market sentiment is overshadowed by heightened geopolitical concerns. • Notwithstanding continued equity and corporate bond market volatility, the U.S. household sector’s balance sheet appears to have stabilized. • The balance sheets of U.S. corporations seem to be improving slowly, as reflected in the sharp increase in the ratio of broad liquid assets to short-term debt. • Large internationally active banks remain reasonably well capitalized and liquid. At this point they are not likely to pose systemic risks, despite large write-offs that have cut into earnings. But a deterioration in the global economy or further revelations of hidden corporate losses could lead to problems. The financial condition of most European banks appears to be well supported by the underlying earnings power in their home markets. Given the currently limited earnings power in a fragmented home market, however, the financial condition of German wholesale banks needs to be improved. Japan’s banking system has deteriorated in an environment of continued deflation and limited corporate restructuring, despite recent efforts by banks to raise capital. Reforms aimed at corporate and financial sector restructuring continue to be urgently needed. • Some European insurance companies have been weakened substantially as a result of equity and corporate bond price declines. Problems are particularly acute in the U.K., German, Dutch, and Swiss insurance sectors, where life insurance companies have been forced to reduce their equity holdings into declining markets. The United Kingdom initiated some regulatory adjustments in January 2003 to remove such selling pressure. Japan’s life insurance companies have been under intense pressure for some time.

• Available data indicate that corporate defined-benefit pensions in the United States, the United Kingdom, the Netherlands, and Japan are experiencing sizable funding gaps. While precise data are not widely available, such funding gaps are likely to exist elsewhere in Europe. Unless equity and corporate bond markets recover soon, these funding gaps are expected to weigh on corporate profitability and contribute to market uncertainty in estimating future earnings. • The dollar has weakened noticeably against major currencies in the period under review. However, history has demonstrated the ability of markets to absorb wide swings in the value of the dollar in response to adjustments to fundamental disequilibriums. But a precipitous fall in the dollar could also have potentially destabilizing consequences, given the buildup over time of large holdings by foreigners of U.S. financial assets. The composition of these holdings and capital flows has changed over time from equity and foreign direct investment to fixed-income securities, including in particular U.S. treasury and agency securities. When investors focused on equities, growth differentials and relative productivity improvements—which have favored the United States—were at the forefront of their concerns. Now, however, given investor disillusionment with equities and their refocus on fixed-income securities, interest rate differentials have become paramount. Consequently, the decline in U.S. yields to levels below those in Europe has reduced the attractiveness of the U.S. fixedincome market and thereby contributed to the dollar’s decline. On a more positive note, monetary easing in the major economies and the accumulation of cash balances by households and institutions have contributed to improved balance sheet strength, and to the possibility that cash holdings will be productively deployed as uncertainties abate and investor sentiment

3

CHAPTER I

OVERVIEW

improves. Yet even in this positive scenario, caution is needed. When growth prospects improve and investors shift to higher-risk assets, short- and long-term interest rates will likely rise. This interest rate risk is significant at this juncture, as financial institutions have invested substantially in long-term treasury and agency securities, funding these positions with short-term money to benefit from the steep yield curves. Market sources suggest that most of these positions are unhedged, as the cost of hedging would erode much of the interest rate differential benefit. Investors in the U.S. mortgage-backed securities market are even more vulnerable to interest rate risks, given the negative convexity of these instruments (see Chapter II for a more detailed discussion). Consequently, the potential for sizable losses could exist for some market participants, on top of losses experienced since the bursting of the equity price bubble and the ensuing flight from corporate risk.

Emerging Market Financing The “feast or famine” dynamic of emerging market financing was evident again last year (see Chapter III), as countries at the low end of the credit rating spectrum—especially in Latin America—experienced difficult access to capital markets and high funding costs. Easing global financial market conditions in the fourth quarter of last year—characterized by a stock market rally, sharply narrowing corporate bond credit spreads, and a marked decline in actual and expected volatility—led to a reopening of capital markets to many, but not all, issuers. Investors last year were keenly focused on the sustainability of policies in making investment decisions, and this focus contributed to marked tiering by credit quality. The possibility of policy discontinuity in Brazil contributed to mounting investor anxiety and rising credit spreads in the run-up to elections; these were eased by the initial cabinet

4

appointments and policy pronouncements of the new administration. While investor sentiment toward Brazil improved markedly in the fourth quarter—contributing to a large narrowing of credit spreads and a significant strengthening of the real—domestic borrowing costs remain quite high and the spreads on foreign bonds have not yet fallen to a level that would permit renewed sovereign access to the primary market. The markets continued to differentiate borrowers by perceived credit quality, with some countries in Latin America continuing to face high yield spreads, while Asian and Eastern European borrowers benefited from near record low credit spreads. Asian markets, except for the Philippines, are supported by strong growth and macroeconomic fundamentals, regional liquidity, and a solid investor base. Similarly, Eastern European countries have attracted investor interest in anticipation of further credit upgrades stemming in part from progress on their accession to the European Union. Investors’ confidence in Russia has continued to improve based on its strong fiscal position and growth performance, both of which have been supported by high oil prices. The performance of banking sectors across major emerging markets has also been mixed in recent years. Indicators of financial health show substantial improvement in the emerging market countries of Europe, facilitated by considerable bank restructuring efforts and the entry of foreign banks in several of these countries. A similar improvement is evident in Asia, although progress has been slower and weaknesses persist in some countries, mainly because of lagging bank and corporate restructuring. In contrast, banks in some Latin American countries remain in distress, as long-standing weaknesses have been aggravated by recent economic and financial turmoil. In other countries in the region, banks have realized stronger financial results, reflecting more favorable initial conditions and economic performance.

MEASURES TO IMPROVE MARKET CONFIDENCE

Measures to Improve Market Confidence As financial markets and the real economy continue to make progress in ameliorating the excesses of the bubble years, policies must continue to boost consumer, business, and investor confidence. Improved market confidence would allow the gradual strengthening of financial conditions to support investment activities, which in turn would underpin financial market and economic recoveries. Subject to geopolitical developments, the improvement of confidence could best be achieved through continued sound macroeconomic policies and a flexible response to renewed signs of an economic downturn. It will also require the consistent implementation of steps to address the deficiencies in corporate governance, financial market practices, and accounting standards, which were starkly revealed with the bursting of the asset price bubble. First, on the macroeconomic front, the current accommodative stance of monetary policy in the major economies is appropriate, notwithstanding the buildup of cash positions. The supportive stance is needed to forestall faltering consumer and business confidence and to give a respite to financial markets. More generally, the supportive monetary stance has facilitated the gradual improvement in the financial conditions of key sectors of the economy, and the sizable buildup in liquidity positions among households and financial intermediaries. Specifically in Europe, a steepening of the yield curve would contribute substantially to financial intermediaries being able to improve their earning power, in order to digest losses in various segments of their businesses. The Japanese authorities need to act decisively to reverse years of economic decline and falling prices. Second, renewed efforts to implement corporate and financial sector reforms are urgently needed in Japan. To improve their financial conditions, many Japanese financial institutions need to address their loan-loss provisions more resolutely and their high cost base more generally. They also need to strengthen their

capital bases. A corporate sector reinvigorated by successful restructuring is crucial for allowing Japanese financial institutions to improve their earnings. In Germany, a better capitalization of small and medium-sized companies would help reduce the current substantial amount of loanloss provisions on the balance sheet of financial institutions. More important, however, a number of financial institutions need to significantly improve their earning power and reduce bloated cost bases through consolidation. The general legal and regulatory framework in both Japan and, to a lesser extent, Germany needs to support the above restructuring efforts. Progress in these endeavors would help strengthen market sentiment and growth prospects in these countries. Third, the process of post-bubble asset price adjustment has revealed specific vulnerabilities that need to be addressed in the insurance industry and in the funding of corporate pensions. • Given the weakening condition of the insurance sector, insurance regulators must intensify efforts to encourage both sounder asset risk management at the micro level and a realigning of incentives—including regulatory rules for solvency and liquidity— that are consistent with fostering market stability. The recent measures taken by the U.K. authorities, such as relaxing the Regulatory Minimum Margin, are reassuring in this regard and others should consider proactive measures as well. • The weaknesses in funding corporate pensions revealed by falling equity prices underscore the need to address the long-standing mismatch between pension assets (typically tilted toward equity investments) and pension liabilities (whose behavior typically mimics that of a bond). Furthermore, for many large corporations in the United States, the ratio of pension assets to market capitalization is more than 2 to 1. This illustrates the still high degree of leveraging in the U.S. corporate sector, as companies are

5

CHAPTER I

OVERVIEW

ultimately responsible for their pension obligations. Among the issues in pension accounting that need to be revisited, realistic actuarial assumptions underlying the measurement of funding adequacy are essential. Caution is needed, however, to avoid an immediate large drain on the earnings of companies that could trigger a selfreinforcing decline in equity markets. Fourth, the process of improving corporate governance, accounting, auditing, and other investment banking practices, which is under way in the United States and other countries, must be sustained. This will reassure investors that they face a level playing field in the financial markets and that they will have access to full and accurate information on the health of publicly traded firms. Fifth, the recent building up of cash balances necessitates vigilant risk management by private sector market participants. This is important for ensuring that the mobilization of cash balances, and the unwinding of positions now encouraged by the steepness of the yield curve, occur in an orderly fashion. A speedy return of market confidence and risk appetite would expose a significant amount of unhedged long positions in the markets for long-term government securities. This creates a potential for large losses. Consequently, national supervisors should make sure that these risk positions of financial institutions in their jurisdictions and of their hedging counterparties, irrespective of location and business sector, are properly managed. Finally, the “feast and famine” dynamic in emerging market financing and the persistent credit tiering underscore the need to consistently implement sustainable policies to facilitate access to capital at reasonable cost. This is all the more compelling at present, as many sovereign borrowers continue to face unfriendly external financial conditions. In addition, continued efforts to develop local securities markets could eventually provide an alternative source of financing and help act as a buffer against changing global financial conditions.

6

Policy Issues in Developing Local Securities Markets While establishing sound and sustainable macroeconomic policies is a necessary condition for strengthening domestic economic fundamentals and perceived creditworthiness, many emerging markets have taken additional measures designed to “self-insure” against volatile capital flows and asset prices. Most prominent among these measures is the effort to develop local securities and derivatives markets (see Chapter IV). Local securities and derivatives markets have grown substantially over the last five years. Despite the rapid expansion of local markets—in particular, local bond markets— they have not yet developed enough to provide full insurance against the closure of banking or international markets. Nonetheless, continued efforts to develop these markets could eventually provide a significant cushion against future closures. In particular, these efforts should focus on continuing to adopt measures aimed at strengthening market infrastructure, developing benchmarks and local institutional investors, and improving corporate governance and transparency. Moreover, despite the existence of ambiguities concerning some policies related to the development of local securities and derivatives markets, several measures can still be undertaken while continuing to monitor and control the potentially negative side effects. For instance, well-developed derivatives markets provide efficient instruments for risk management, and experience shows that sound macroeconomic and regulatory policies can mitigate to a large extent their potentially negative effects on financial stability. Similarly, the provision of inflationindexed instruments contributes to increase duration in fixed-income markets, but excessive indexation to foreign exchange could lead to balance sheet mismatches and unstable debt dynamics and therefore should be discouraged.

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Financial conditions in mature markets stabilized somewhat since the beginning of the fourth quarter of 2002, although any improvements remain tentative. Major equity markets edged down in October before firming through December, but for the year as a whole posted the third consecutive annual decline. Trading in the first two months of 2003 gave back most of the late-year gains. Corporate bond markets came under some stress early in the fourth quarter but firmed up toward year-end, with both rates and spreads moving lower. A decreased attractiveness of U.S. fixed income securities contributed to a weakening of the dollar, particularly versus the euro. Performance in commercial banking was mixed, as retail franchises generally strengthened while wholesale business remained depressed. Insurance companies and pension funds were hurt by equity market declines. Balance sheets in some key nonfinancial sectors have stabilized and perhaps begun to improve. Monetary accommodation and caution on the part of investors have resulted in a buildup of cash positions in both retail and institutional portfolios, which has both favorable implications for financial stability as well as presenting new risks.

inancial conditions in mature financial markets have improved gradually since the end of the third quarter of 2002, and key sectors have started to rebuild their balance sheets. Boosted by the continuous rise in house prices and further reductions in the carrying cost of debt, U.S. household balance sheets improved marginally in the fourth quarter, after significant weakening in the previous two years. Nonfinancial corporations also strengthened their financial positions, mostly by refinancing short-term liabilities with longer-term bonds. By contrast, the overall financial health of financial institutions in both the United States and Europe revealed a mixed picture. While banks with strong retail franchises performed reasonably well, those that rely heavily on wholesale business saw profitability decline sharply. Notwithstanding these relatively positive developments, there are significant areas of weakness. Hardest hit have been insurance companies, particularly in Europe. They continued to be squeezed by declining equity prices, low yields on fixed-income securities,

F

and potential losses on their derivatives positions, as well as by relatively high guaranteed rates of return on some insurance policies. The drop in equity prices and higher present values of pension liabilities as a result of lower interest rates have created substantial funding gaps in many defined-benefit corporate pension funds. The accommodative monetary policy stance in the major economies, together with less risk taking in the wake of the bursting of the equity bubble, have contributed to a sizable buildup of positions of high-quality, shortdated liquid instruments in investors’ portfolios. This “risk capital” is waiting on the sidelines and could be deployed into riskier investments once geopolitical concerns are resolved and the economic recovery accelerates. The temporary rally in equity markets during the fourth quarter may have been a foretaste of this possibility. This rally was, however, reversed in January as investor sentiment became overshadowed by geopolitical concerns. The current fragile sentiment highlights the need for policies to foster market

7

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.1. Stock Market Performance (January 3, 2000 = 100) 140

United States: S&P 500 Financial sector index

120 100 80 Insurance sector index

60 Stock market index 40 20

2000

01

02

confidence, which, if effective, could trigger the redeployment of some of the considerable cash positions into riskier assets and a revival in asset markets. This chapter is organized into three main sections. The first section documents and analyses the major developments in the mature markets. The second section assesses the impact of these developments on the financial condition of key sectors. The chapter concludes by analyzing the sizable buildup of cash positions since the bursting of the equity price bubble. It compares the present buildup to previous periods during which there was a withdrawal from risk taking and then considers the positive and negative scenarios most likely to ensue.

03 140

Japan: Topix

120

Major Developments in the Mature Markets

Insurance sector index 100 80 60 Financial sector index

Stock market index 40 20

2000

01

02

03 140

Europe: Bloomberg European 500 120 Financial sector index

100 80

Stock market index 60 40

Insurance sector index

20 2000 Source: Bloomberg L.P.

01

02

03

Continued Volatility in the Repricing and Reallocation of Corporate Risk Markets in which corporate financial instruments—equities, bonds, credit derivatives—are traded continued to exhibit considerable volatility in the reporting period, but mostly within the range established during the preceding 12 months. After a rally in the fourth quarter of 2002, which may have signaled improved appetite for risk taking, markets weakened in early 2003. These market dynamics reflected both the uncertainty about the economic recovery and corporate earnings, as well as geopolitical concerns. Nonetheless mature capital markets remained resilient and broadly open to funding needs in both the United States and European financial centers. Equity markets moved sideways as corporate earnings improved less than expected Equity prices in the mature markets reached multiyear lows in early October 2002 on a spate of disappointing news about the economic recovery (Figure 2.1). Most markets

8

MAJOR DEVELOPMENTS IN THE MATURE MARKETS

then staged a broad recovery through the fourth quarter, spurred by a benign corporate reporting period and hopes for a sustained recovery in 2003. But sentiment soon turned negative again, with all major indexes posting significant declines, particularly as war in Iraq appeared to become increasingly likely. Concern about the solvency of U.K. insurers and possible forced selling of equities contributed to a 10 percent slide in the FTSE in January. In Japan, equity price indexes have dropped to 20-year lows and have moved largely sideways since early October 2002. Earnings reports for the fourth quarter were mixed. S&P 500 firms posted a gain of 10 percent over the previous year, according to First Call’s estimates. This is a modest improvement from the previous year’s results, which were 21.5 percent lower than in the final quarter of 2000. Looking forward, the sluggish economic recovery is prompting analysts to mark down expectations of earnings growth during the first half of 2003 to 8 percent in the first quarter and 5 percent in the second quarter, before improving in the second half to show an increase of 9 percent for 2003. Equity market valuations, generally, have come closer in line with historical valuations (Figure 2.2). However, the price-earnings ratio based on analyst expectations for earnings over the coming year for S&P 500 stocks is 16, still above the pre-bubble average. In Germany, end-2002 prices were 15 times estimated forward earnings, 4 percent above their 1988–96 average. In Japan, prices have fallen to the point where forward earnings are now converging to historic standards abroad at around 18 times forward earnings, which is 60 percent below the high market valuations of 1988–96. Corporate bond rates moved lower and spreads narrowed

Figure 2.2. Price/Earnings Ratios 35

United States

30 25 Price/earnings ratio 20 15 10

12-month forward price/earnings ratio

5 0 1988

90

92

94

96

98

2000

02 100

Japan Price/earnings ratio

80 60 40

12-month forward price/earnings ratio

20 0

1988

90

92

94

96

98

2000

02 35

Euro Area 30 12-month forward price/earnings ratio 1

25 20 15

Price/earnings ratio

10 5 0

1988

90

92

94

96

98

2000

02

Sources: Datastream; and I/B/E/S. 1Data refer to Germany.

Conditions in corporate bond markets deteriorated at the outset of the fourth quarter, with spreads, especially on high-yield bonds, widening dramatically in early October (Figure 2.3, upper panels). The market subsequently

9

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.3. Selected Spreads (In basis points) 120

Corporate Spread (AA-rated) 1

100

United States

Corporate Spread (BBB-rated) 1

350

United States

250

80

300

200 60 150

Euro area

40

Euro area

100

Japan

20

50

Japan

0 1998 160

2000

02

Repo Spread 2

1998

2000

0

02

Commercial Paper Spread 3

160

120

120

80

80

40

40

0

0

–40

200

1998

2000

02

TED Spread 4

1998

2000

02

–40

160

Swap Spread 5 United States

160

120

120 80 80 40 40 Japan

0

0 Euro area

–40

1998

2000

02

1998

2000

02

–40

Sources: Bloomberg L.P.; and Merrill Lynch. 1Nonfinancial corporate credit spread. 2Spread between yields on three-month U.S. treasury repo and on three-month U.S. treasury bill. 3Spread between yields on 90-day investment grade commercial paper and on threemonth U.S. treasury bill. 4Spread between three-month U.S. dollar LIBOR and yield on three-month treasury bill. 5Spread over 10-year government bond.

10

improved, and spreads on both investmentgrade and high-yield debt narrowed considerably. The spread of U.S. high-yield debt to treasuries declined some 140 basis points from the end of the third quarter to year-end, while investment-grade bonds closed the year slightly tighter. The relatively wide spreads on highyield debt—by historical standards—suggest that credit tiering, though moderated, continues. In Europe, corporate spreads narrowed 60 basis points for BBB-rated issues and 16 basis points for single-A during the fourth quarter of 2002. At the same time, spreads on Japanese BBB-rated bonds narrowed 20 basis points and those for higher credit qualities were little changed, as yields on 10-year Japanese government bonds (JGBs) hit record lows. Bond spreads continued to narrow during the first few weeks of January as investors anticipated further improvements in economic growth during the new year. Growing fears of the impact of rising oil prices and the possible war in Iraq, however, weighed heavily on credit markets in mid- to late January. On balance, spreads narrowed, and in U.S. markets ended the month 20 to 55 basis points smaller, while spreads in Europe and Japan were little changed on the month. The combined impact of the global recession, further effects of the bursting of the telecom bubble, and corporate accounting irregularities pushed corporate default rates to record levels in 2002. Defaults in the United States appear to have peaked in early 2002 and then began to trend down, as a year of modest economic growth tempered credit quality problems. Twelve-month default rates on speculative U.S. bonds fell from 11.4 percent in January 2002 to 8.3 percent in October 2002. A lack of pricing power, however, is holding back the earnings growth that will be necessary for significant improvement in default rates. In Europe, where the economic cycle, and thus the credit cycle, lags that in the United States, default rates continue to rise, especially in the small and medium-size enterprise sector. Generally, corporates in the United States

MAJOR DEVELOPMENTS IN THE MATURE MARKETS

appear to have been more successful in improving their balance sheets (albeit moderately) than in Europe. The commercial paper (CP) market has largely recovered from the stresses that pushed credit spreads to well beyond their historical range during 1998–2001 (see Figure 2.3, middle panel). Credit quality has improved largely as firms suffering downgrades exited the market, turning instead to bank loans or the corporate bond market. The outstanding amount of lower-rated CP (A2P2) declined to $65 billion by the end of 2002, from a peak of over $140 billion in mid2000. In addition, borrowers responded to concerns that arose in early 2002 about liquidity exposures and the adequacy of bank backup facilities by reducing their borrowings and securing additional liquidity guarantees from banks. In January 2003, the quality spread of A2P2 paper over A1P1 paper had fallen to 20 basis points or less, roughly in line with historical norms and below the levels that persisted through the previous two years. Bond issuance picked up while bank lending stayed cautious Credit markets were relatively open to new issuance during the fourth quarter. Investment-grade issuance in the United States slowed modestly, though at least some of this decline can be attributed to diminished needs to fund capital spending and inventories. Some lower-rated borrowers were able to tap the market in the fourth quarter, but highyield issuance remained well below the pace in prior years. High-grade issuance in European markets was relatively robust. Bank lending continued to be weak through the end of the year. Commercial and industrial loans by U.S. banks continued to decline, fall-

ing $10 billion during the quarter. Responses to the U.S. Federal Reserve’s Senior Loan Officer Survey indicate that banks continue to maintain tight standards for borrowers, but also that loan demand remains soft. European banks continue to extend credit, particularly outside Germany. Structural weaknesses, labor market rigidities, poor profitability of core franchises, and a rising level of default risk in the small and medium-size enterprise sector in Germany are damping loan supply. In Japan, continuing difficulties with nonperforming loans and very weak economic conditions continue to hold down lending. Credit derivatives have facilitated repricing and transfer of corporate risk The growing market for credit default swaps (CDS) has facilitated a more consistent pricing of the various forms of corporate risk. Global financial markets continued their disintermediation: the provision of credit moved from banking systems to markets with many sources for corporate funding—distinct markets for equities, corporate bonds, commercial paper, and bank loans. In the past, pricing in these markets operated largely independently of each other, although each responded to the same broad economic forces. More recently, however, the rising use of credit derivatives (particularly credit default swaps) on corporate risks has facilitated a shift away from this “silo” approach to pricing toward a unified method of pricing bank loans, corporate bonds, and equities. The resulting stronger cross-market arbitrage should contribute to more efficient pricing of credit risk, notwithstanding the growing controversy about the potential abuse of insider knowledge and the increasing concentration among market makers in the credit derivatives market.1

1The corporate bond and loan markets are typically illiquid, making it difficult to establish a short position in corporate credits and inhibiting strategies that would link the different markets for corporate risk through arbitrage relationships. Through credit default swaps one can establish a short position, however, allowing an arbitrage strategy that links the pricing in bond, equity, syndicated loan, and CDS markets. By using credit default swaps, one can arbitrage differences in pricing of corporate risk between these markets.

11

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KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

The use of credit default swaps also facilitates management of credit risk in bank loan portfolios. The CDS market is attractive relative to selling loans in the secondary market because of the market’s growing liquidity, and because a lender can use the CDS market to reduce risks while still preserving the relationship with the borrower. Despite the growth in the market, however, it remains small relative to the overall loan market. The majority of banks that use credit default swaps do so for less than 4 percent of their loan portfolio, according to the U.S. Federal Reserve’s Senior Loan Officer Survey of January 2003. Trading activity has been concentrated in a number of well-known corporate names, particularly in telecom and high-tech sectors; the rest of the market is much less liquid. Consequently, the CDS market is relatively more significant for pricing and hedging the risk of these credits than for the market at large. Shift to Safer Fixed-Income Investments Notwithstanding recent interest in highquality corporate bonds, the flight from corporate risk that began in early 2000 has led to a sizable reallocation of capital by U.S. and international investors into three alternatives of slightly differing degrees of lower risk. These alternatives are (1) a buildup of “cash” positions by households—“risk capital” waiting on the sidelines in low-risk, low-yielding investments (see the section “Withdrawal from Risk Taking and Buildup of Cash Positions: Implications and Risks” for a broader discussion of the implications of the rise in cash positions for financial markets); (2) investments by financial institutions and other insti-

tutional investors in government and government-sponsored agency securities with some duration risk but no credit risk; and (3) an accumulation of mortgage-backed securities, mostly in the U.S. markets, that entail an additional element of convexity risk.2 The reallocation of portfolios into lower-risk positions has occurred despite the fact that nominal short-term interest rates are at 40year lows in the United States and Japan, and relatively low in Europe as well. Investors have continued to avoid positions with credit and interest rate risk, even as additional easing of monetary policy during the reporting period lowered returns on short-term investments even further. On October 30, the Bank of Japan increased its target for current account balances held at the bank from a range of ¥10–15 trillion to ¥15–20 trillion as well as its outright purchase of long-term government bonds from the current ¥1.0 trillion per month to ¥1.2 trillion per month. On November 6, the U.S. Federal Reserve cut its target for the federal funds rate by 50 basis points, and on December 5, the European Central Bank reduced the minimum rate on its main refinancing operations by 50 basis points to 2.75 percent. On February 6, the Bank of England reduced its repo rate by 25 basis points to 3.75 percent. The official rate cuts and, in Japan’s case, quantitative easing, boosted the ex post return on fixed-income investments and reduced the prospective yield on cash, prompting the continued search for higher but safe returns. Lower official rates and a related steepening of the U.S. yield curve have limited the volatility of benchmark long-term interest rates in the fourth quarter and in early 2003, in contrast to the volatility

2Duration measures how the market price of an interest-bearing bond changes with interest rates. In turn, duration changes as interest rates change—an effect that is referred to as convexity. Most bonds have positive convexity, indicating the bond’s price rises more rapidly as rates fall than the price declines as interest rates increase. The prepayment option on mortgages, however, leads to negative convexity on mortgage-backed securities. As interest rates decline beyond a certain point, the value of mortgage-backed securities stops rising as mortgages are prepaid. Conversely, as interest rates rise, the prepayment rates decline, leading to the lengthening of the duration of mortgage-backed securities, and sharper price losses. Hedging against negative convexity generally involves selling treasury securities as rates rise, and can therefore amplify swings in interest rates.

12

MAJOR DEVELOPMENTS IN THE MATURE MARKETS

in prices for credit, equity, and credit derivatives (Figure 2.4). U.S. home mortgage-related securities have increasingly become a close alternative to government debt for U.S. and global investors. U.S. mortgage and mortgage-related debt has risen rapidly since the early 1990s, both in absolute terms and relative to the size of marketable U.S. treasury securities. In 1990, tradable mortgage-related securities outstanding, including in the portfolios of mortgage agencies, were equivalent to less than 50 percent of the outstandings of marketable U.S. treasury securities. At end-September 2002, however, they equaled nearly 100 percent of marketable U.S. treasury securities. International ownership of mortgage-related (mostly agency) securities was 15 percent of total foreign claims on the United States in September 2002. The accumulation of mortgage-related claims since 2000, reflecting strong housing demand and the refinancing boom in the United States, has been facilitated by strong demand by investors seeking to allocate investments into areas with even a slim additional yield relative to cash and benchmark rates. One result is the dwindling of mortgage security premiums over benchmark rates with equivalent duration (Figure 2.5).

Figure 2.4. Short- and Long-Term Interest Rates in Government Securities 8 7

United States

6

Against the backdrop of geopolitical concerns, persistent uncertainty about the strength of the U.S. recovery, corporate balance sheet risks, and the financial implications of a low interest rate environment, the international value of the dollar weakened significantly during the reporting period. From the end of the third quarter of 2002 through February 28, the dollar declined about 9 percent against the euro, 3 percent against the yen, and 5!/2 percent on a nominal tradeweighted basis (see Figure 2.6 and Table 1.1). The record U.S. dependence on foreign capital has been underlying the potential for dollar weakness for some time, but the fourth

7

United States

6

5

5

4

Euro area

Euro area

4

3

3

2 Japan

1 0 400 300 200

2

Japan

2000

1 01

02

03

Term Spreads (In basis points) 3

2000

01

02

Cross-Country Long-Term Spreads (In basis points) 4

0

03

200 100 0

Japan Euro area

–100

100

–200

Euro area

0

–300 –100

Dollar Declined as U.S. Capital Inflows Slowed

8

Long-Term Interest Rates (In percent) 2

Short-Term Interest Rates (In percent) 1

–200 –300

–400 Japan

United States

2000

01

–500 02

03

2000

01

02

–600 03

Source: Bloomberg L.P. 1For United States, and Japan, three-month LIBOR; for euro area, three-month EURIBOR. 2Ten-year government bond yields. 3Spread between yield on 10-year government bonds and three-month LIBOR or EURIBOR. 4Spread between yield on 10-year government bonds and yield on 10-year U.S. government bond.

13

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.5. United States: Thirty-Year Mortgage Rate and Government Bond Yield (In percent) 10 9 8 Mortgage rate 1 7 6 5

Government bond yield

2000

01

Source: Bloomberg L.P. 1 Thirty-year mortgage commitment rate.

14

02

03

4

quarter saw an acceleration of the slowdown in foreign investment interest in all but the most liquid and safe U.S. investments—such as U.S. treasury and mortgage agencies’ securities. One distinguishing feature since September 2002 has been the heightened sensitivity of investors to war-related uncertainty and risk. According to market participants, this has increasingly been a negative influence on the dollar. This view of war-related pressure on the dollar, if true, marks an important difference with previous similar occasions when the dollar strengthened (Desert Storm in 1990–91, and post–September 11, 2001). One reason may be the significantly wider U.S. current account deficit now prevailing compared to that during the Gulf War. During that earlier period of heightened uncertainty, the U.S. current account deficit narrowed rapidly, from 3.5 percent of GDP in 1987 to near balance in 1991. In sharp contrast, the deficit in the third quarter of 2002 was 4.8 percent of GDP, an alltime record, and prospects for its widening further are likely. As investors were confronted with an unusually broad range of potential economic and business outcomes, a reluctance to make credit or other market decisions is understandable, but potentially highly negative for a nation borrowing at a record pace. The flight to lower-risk investments was also evident in the changing pattern of recorded capital flows to the United States. Net inflows during the third quarter of 2002 have moved decisively away from claims on U.S. business enterprises (Figure 2.7). Foreign direct investment into the United States fell to $4.2 billion in the second and third quarters, compared with an average pace of nearly $33 billion in 2001, and international investment in U.S. corporate and equity securities dropped to a $39 billion rate in the three months to November, down from a $85 billion quarterly pace during 2001. The shift toward safer, but lower-yielding investments in the United States was apparent in other forms as well. In

HAVE KEY SECTORS BEEN WEAKENED FURTHER OR STRENGTHENED?

the three months to November 2002, international investment in U.S. government and agency securities was running at a $119 billion annual pace. In effect, U.S. external financing during much of 2002 reflected the ongoing shift by global investors from corporate risk to less risky government-linked instruments. These flows into U.S. securities may not be sustainable at current low yields. In light of rising budget deficits, foreign investors might become reluctant to buy U.S. treasury securities. In fact, the shift of capital inflows into the United States from equity to fixed-income investments, and most recently to low-risk securities, may also imply a shift in the factors that drive these capital flows. Instead of growth potential and technological innovation—which are key driving forces for equity investments and which still may be favorable for the United States—interest rate differentials, currently tilted toward other currencies, may have become more important with the increased focus on safe fixed-income investments. By the same token, if current geopolitical uncertainties were resolved, investor risk appetite rose, and interest in equity flows revived, the relatively higher economic growth prospects in the United States may again support large capital inflows.

Figure 2.6. Selected Major Exchange Rates 1.15

U.S. Dollar/Euro

1.10 1.05 1.00 0.95 0.90 0.85 2000

01

02

03

0.80

140 Japanese Yen/U.S. Dollar 135 130 125 120 115 110 105 2000

01

02

03

100

1.9 Swiss Franc/U.S. Dollar 1.8

Have Key Sectors Been Weakened Further or Strengthened? Because of the steep drop in financial asset prices since early 2000, the financial conditions of key sectors of the global financial system were identified in previous issues of the GFSR as the main sources of risk to global financial stability—namely, that of U.S. households, of some European banking systems, and of the Japanese financial system and corporate sector. The December 2002 Global Financial Stability Report suggested that, on balance, as long as global equity markets did not deteriorate further (and in particular go below previous lows) and global economic recovery remained on track, the financial con-

1.7 1.6 1.5 1.4 1.3 2000

01

02

03

1.2

Source: Bloomberg L.P.

15

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.7. United States: Net Portfolio Inflows and Net Total Capital Flows (In percent of GDP) 1.6

Net Portfolio Inflows

1.4 1.2 1.0 0.8

dition of U.S. households would likely remain resilient and not become a source of further financial market instability. While financial institutions have been resilient despite severe asset price adjustments and corporate weakness, their remaining ability to absorb additional shocks may have been weakened. The December GFSR also noted that the future resilience of insurance and reinsurance companies and company pension funds depended critically on movements in global equity and corporate bond markets. A key question going forward is how developments since the end of the third quarter of 2002 have impinged on the financial strength of these sectors and whether other subsectors have been particularly affected.

0.6 0.4 0.2 0 2000

2001

2002 1.8

Net Total Capital Flows

1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0 2000

2001

Source: IMF, International Financial Statistics database.

16

2002

U.S. Household Balance Sheets Have Stabilized U.S. household balance sheets, which have been strong enough to sustain consumer spending, firmed modestly in the fourth quarter. Household net worth rose by about 2 percent, reversing part of the decline posted in the third quarter. For the year as a whole, however, household net worth declined by $1.75 trillion, the third consecutive annual decline (Table 2.1 and Figure 2.8). On the asset side of the household balance sheet, the value of equity and mutual fund holdings rose 4!/2 percent during the fourth quarter, and household real estate values appreciated slightly. On the liability side of the U.S. households’ balance sheet, the growth of mortgage debt surged in the fourth quarter to nearly a 14 percent annual rate, as a strong housing market and an ongoing wave of mortgage refinancing boosted borrowing. At the same time, homeowners’ equity as a percentage of household real estate was roughly flat, as new construction and the appreciation of property values kept pace with the growth of mortgage debt. Several factors, however, mitigated the impact of these increases in mortgage debt on household financial positions: (1) the debt

HAVE KEY SECTORS BEEN WEAKENED FURTHER OR STRENGTHENED?

Table 2.1. United States: Household Sector Balance Sheet1 (In percent)

Net worth/assets Equity/total assets Equity/financial assets Home mortgage debt/total assets Consumer credit/total assets Total debt/financial assets Debt-service burden2

1995

1996

1997

1998

1999

2000

2001

2002

84.4 23.3 35.1 10.3 3.4 23.5 12.9

84.7 25.8 38.1 10.1 3.4 22.6 13.3

85.3 29.7 42.9 9.6 3.2 21.2 13.4

85.5 31.5 45.0 9.5 3.1 20.7 13.4

86.0 35.0 49.2 9.2 2.9 19.6 13.7

84.9 30.9 45.0 9.9 3.2 22.0 13.9

83.6 26.5 40.2 11.0 3.5 24.8 14.4

81.9 ... ... 12.5 3.7 29.2 14.0

Sources: Board of Governors the Federal Reserve System, Flow of Funds. 1For 2002, data refer to 2002:Q3. 2Ratio of debt payments to disposable personal income.

service burden has been held down by refinancing existing mortgages at lower rates; (2) some proceeds of “cash out” refinancings, which liquefy homeowners’ equity, were used to pay down consumer loans bearing higher interest rates; and (3) proceeds of mortgage refinancings also financed residential investment spending and the purchase of consumer durables. Consumer credit was flat in the fourth quarter. The growth of nonrevolving credit slowed, as automakers began to limit the interest rate incentives offered on new vehicles. Revolving credit outstanding declined, perhaps as households became increasingly cautious about taking on more debt in the current economic environment. The U.S. Federal Reserve’s Survey of Consumer Finances also indicates that leveraging is less pervasive in the United States than generally assumed, and that leveraging as well as exposure to equities tend to be concentrated in the higher-income segments of U.S. households (see Aizcorbe, Kennickell, and Moore, 2003). Financial Positions of U.S. Corporations Have Strengthened Somewhat U.S. corporations have achieved moderate success in bolstering their financial positions, despite the recession and sluggish recovery to date. Cash flow has been steadily rising since mid-2001 and last year surpassed its previous

peak. Tight controls on spending, in particular on labor costs, have been a critical factor in this improvement. In addition, cutbacks in capital outlays have reduced funding needs, and the financing gap declined from $333 billion in 2000 to an average of $73 billion for the first three quarters of 2002. Firms have acted to shore up their balance sheets as well. Exposures to liquidity risk have been trimmed, with the ratio of liquid assets to short-term liabilities rising from 65 percent at the beginning of the recession to over 100 percent late last year (Figure 2.9). The main contributor to this improvement in working capital has been the refinancing of short-term debt that began in 2001 and continued through last year. Nonfinancial corporations paid down $136 billion of commercial paper and $129 billion in bank loans during this period, while at the same time net bond issuance rose to over $400 billion. Corporate holdings of cash and liquid securities have continued to rise as well. This improvement in corporate financial positions indicates firms will be better positioned to step up real activity once the current uncertainties about economic growth and geopolitical risks are reduced. Company Pension Plans Weakened Private companies’ defined benefit pension funds in some countries are estimated to have

17

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.8. United States: Household Net Worth Position Percent change in net worth Percent change in S&P 500 (right scale) (right scale)

50

40

40 30

Net worth (in trillions of dollars; left scale)

20 10

30

0 20

–10 –20

10 –30 0

1992

94

96

98

2000

–40

02

Sources: Board of Governors of the Federal Reserve System; and Bloomberg L.P.

Figure 2.9. United States: Non-Financial Corporate Sector—Ratio of Broad Liquid Assets to Short-Term Debt 1 110 100 90 80 70 60 50 40 1980

82

84

86

88

90

92

94

96

98

2000

02

Source: Board of Governors of the Federal Reserve System, Flow of Funds. 1Short-term debt comprises commercial paper and bank loans. Broad liquid assets comprise narrow liquid assets plus commercial paper, U.S. government securities, and municipal securities. Narrow liquid assets comprise currency, deposits, and money market mutual fund shares.

18

30

sizable funding gaps as a result of the bursting of the equity price bubble, the distress experienced in corporate sectors in the mature markets, and higher present values of their pension liabilities as a result of lower interest rates. The transparency of these private pension obligations and their funding is limited, so it is difficult to assess their financial conditions with any precision. In the United States, the funding ratio declined from 131 percent at the end of 1999 to about 80 percent at end-2002 (see Towers Perrin, 2003), and market participants are estimating that S&P 500 companies had unfunded pension liabilities of between $250 billion and $300 billion at the end of 2002.3 The underfunding of U.S. defined benefit plans has gone no further than in 1992–94, at a comparable cyclical point when these plans were a larger share of total pension funds. One study suggests that average U.S. pension investments are allocated roughly 60 percent toward equity investments and 40 percent toward fixed income investments, with a maximum of 10 percent of the portfolio in the companies’ own shares (see Towers Perrin, 2003). Because these relatively large equity investments are mostly funded with long-term liabilities, companies’ defined-benefit pension funds constitute highly leveraged equity exposures, adding to the effective leverage position of the U.S. corporate sector. In the United States, pension funding gaps, measured as the difference between the discounted value of accumulating future pension obligations and the expected value of (smoothed) investment assets, are concentrated in older industries that have had large

3The Pension Benefit Guarantee Corporation (PBGC), a federal corporation created to insure the pension benefits of workers with private defined benefit pension plans, estimates that its main insurance program went from a $7.7 billion surplus in 2001 to a $3.6 billion deficit in 2002. See the Statement of Steven Kandarian, Executive Director, Pension Benefit Guarantee Corporation, before the Committee on Finance, United States Senate, March 11, 2003.

HAVE KEY SECTORS BEEN WEAKENED FURTHER OR STRENGTHENED?

workforces in the past when defined-benefit plans were the norm. U.S. companies are allowed to replenish funding shortfalls gradually.4 A similar concentration among affected companies is reported by commentators in the United Kingdom.5 To address part of this funding gap, several large U.S. companies have made contributions to their underfunded pension plans during the reporting period. Unless these funding gaps are reversed by appreciations in equity and corporate bond markets, companies will have to set aside additional funds to make up this gap through time. This will be a drain on these companies’ profitability, their equity and bond prices, and therefore their funding costs (even though the timing of this impact is hard to predict). In the United Kingdom, estimates of the funding gap range between £85 and £100 billion. Anecdotal evidence also suggests that the Netherlands has a sizable private pension funding gap, but no hard figures are available. In most other countries, pensions rely more heavily on government pay-as-you-go schemes either explicitly or implicitly and differences in accounting systems complicate comparisons of the financial conditions of corporate pension systems. For example, in some countries corporations are not required to pre-fund their pension liabilities but can fund them on a pay-as-you-go basis. Reacting to heightened concern about the issue, one rating agency has proposed a standard assessment of net pension liabilities across countries (see Standard and Poor’s, 2003). Japanese corporate pension funds suffer serious funding gaps due largely to the protracted difficult investing environments, including depressed equity prices. According to a survey conducted in October 2001 by the

Table 2.2. Internationally Active Financial Institutions: Equity Prices Percent Change to February 28, 2003 from ___________________________ 2002 _________________ 2000 Mar. 29

Sep. 301

Nov. 42

Citigroup J.P. Morgan Chase Bank of America

–21.5 –62.4 33.2

12.4 19.4 8.5

–11.3 3.0 –1.5

Deutsche Bank Credit Suisse UBS

–47.2 –69.2 4.4

–18.1 –12.6 1.7

–20.2 –17.2 –14.8

Morgan Stanley Dean Witter Merrill Lynch Goldman Sachs

–57.5 –36.1 –39.2

8.8 3.4 5.2

–11.3 –13.0 –8.6

ING Bank ABN AMRO

–55.9 –36.6

–10.4 33.1

–26.0 –7.5

Barclays Bank HSBC Bank Royal Bank of Scotland

–12.2 –9.0 84.0

–1.2 6.2 21.1

–21.0 –6.4 –6.4

Source: Bloomberg L.P. 1End of third quarter 2002. 2Closing date for December 2002 GFSR.

Pension Fund Association, one of the largest associations of the corporate pension funds in Japan, 44 percent of the participating corporate pension funds reported that they were underfunded. In response, the government introduced the Defined Benefit Corporate Pension Law to strengthen corporate funding requirements.6 The Japanese government has also re-established the linkage between pension benefits and inflation. This will lead to a 0.9 percent cut in benefits to recipients. Banking Systems: A Mixed Performance During the reporting period, the large internationally active financial institutions reported mixed results (Table 2.2). Institutions with well-diversified sets of businesses,

4Pension laws in the United States allow firms to delay and smooth contributions to underfunded plans. Specifically, firms are only required to contribute additional assets (not necessarily cash), if the pension plan’s funding status falls below 90 percent on average for three consecutive years or 80 percent in any one year. Firms then have three to five years to correct the funding shortfall. 5See “Pension Funds Seek An Equity Trap Exit” (2003). 6In 2002, the government also introduced a 401k-type performance-linked pension scheme in addition to the existing defined-benefit scheme.

19

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Table 2.3. Global Financial Institutions: Ratings and Capital Ratios Ratings1 _____________________________________

Capital Ratio _____________________________________

Last

Long-Term

Outlook

Last

Tier 1

Total

10/11/01 10/9/02 9/24/98

Aa1 ↑ A1 ↓ Aa2↑

Stable Stable Stable

2002: 4Q 2002: 3Q 2002: 3Q

8.5 8.69 8.13

11.2 12.43 12.38

Deutsche Bank Credit Suisse First Boston2 UBS

9/19/02 7/5/02 5/31/01

Aa3 Aa3 Aa2 ↓

Neg. ↓ Neg. ↓ Stable

2002: 3Q 2002: 3Q 2002: 3Q

8.9 9.00 11.6

12.0 15.4 14.2

Morgan Stanley Dean Witter Merrill Lynch Goldman Sachs

11/24/98 4/26/02 8/9/02

Aa3↑ Aa3 Aa3 ↑

Stable Neg. ↓ Stable

November 2002 2002: 3Q 2002: 4Q

n.a. n.a. n.a.

n.a. n.a. n.a.

ING Bank ABN AMRO

5/24/00 9/12/02

Aa2 Aa3 ↓

Stable↑ Stable

2002: 3Q 2002: 2Q

6.9 7.0

10.30 10.87

Barclays Bank HSBC Bank Royal Bank of Scotland

9/19/01 8/26/97 9/18/01

Aa1↑ Aa2 Aa1↑

Stable Stable Stable

2002: 2Q 2002: 2Q 2002: 2Q

7.9 9.7 7.4

12.9 13.5 11.8

Citigroup J.P. Morgan Chase Bank of America

Sources: Moody’s; and company quarterly reports. 1Moody’s ratings as of February 28, 2002. 2Capital ratios are for Credit Suisse Group.

including successful retail franchises, performed reasonably well, considering the still-weak global economy and the gloomy securities underwriting and merger and acquisition (M&A) environments. Other global institutions, primarily those that are active in the wholesale banking business and have retail franchises of suboptimal scale, reported losses. The institutions hardest hit were predominantly those with simultaneous losses in their investment banking, insurance, and retail businesses, many of them in Europe, predominantly in Germany and Switzerland. In general, earnings weakness was most apparent in investment banking and insurance activities, especially equity underwriting and M&A. As a result, several of these institutions are on review by credit agencies (Table 2.3), and equity prices for several have been particularly hard hit (Figure 2.10). Special one time write-offs owing to regulatory pressures to separate investment research and realizations of litigation risk variously affected the earnings performance of many of these institutions, a holdover from the corporate governance and accounting problems encountered in the post-bubble period.

20

On the whole, even for global institutions that have been hard hit, Tier 1 capital has been adequate if not strong, and in some cases banks have raised additional capital (see Table 2.2). Overall, while individual banks have difficult adjustments to make, and may even become takeover targets, systemic problems are unlikely to arise as long as the global recovery is sustained, the market environment improves, and earnest efforts at cost restructuring in these institutions take place. By and large, U.S. banks of all sizes have remained well capitalized and liquid. Banks that are primarily focused on domestic retail business have been insulated largely but not completely from losses during this credit cycle. Their underlying earnings have remained solid in part owing to wide credit card margins, strong mortgage underwriting, and a steep yield curve for balance sheet positioning (Figure 2.11). The performance of individual European banking systems has been mixed. European banks are generally well capitalized and have reasonably good earnings performance in their home markets, even though the benchmark yield curve in the euro area is less advantageously steep than in the United

HAVE KEY SECTORS BEEN WEAKENED FURTHER OR STRENGTHENED?

States. But the large German banks continued their sub-par performance, which could further impede credit creation and economic growth. In the wake of a record number of domestic insolvencies, several German banks reported unusually high fourth-quarter losses that in some cases brought operations into loss for the entire year. Reflecting that strain, German bank equity performance has been particularly weak, down 70 to 75 percent since January 2001. Credit losses are an additional burden in the face of persistent structural core-earnings weakness in the German banking system arising from the fragmentation of the sector, the need to compete with public institutions with low return on equity, substantial overcapacity, and a greater degree of market risks (because of equity holdings) introduced by bank and insurance company mergers. However, many banks have endeavored to ensure that risk is adquately priced, to concentrate on core business, and to cut costs. Japanese banks have been and remain a persistent source of uncertainty under the ongoing process of assessment and resolution of the bad loan problem in the present deflationary environment. A new round of special inspections by the Financial Services Agency to be reflected in March year-end accounting will accelerate the vigorous assessment of nonperforming loans (NPLs) and might potentially lead to an increase in loan-loss reserves. In response, the four major banks in Japan have tried to raise capital via offerings of preferred and common shares (estimated to be around ¥1.9 trillion). While some of the shares have reportedly been earmarked to foreign investors and one bank has announced a public offering, some banks have placed shares with their clients and other affiliated organizations. Capital increases through double-gearing, especially with related life insurance companies, could intensify systemic concerns. Reports of these potentially controversial steps and the fear of dilution have contributed to a further decline in bank stocks. In November 2002, with a view to alleviate fur-

Figure 2.10. Internationally Active Financial Institutions: Relative Stock Prices (January 2002 = 100) 140 U.S. Banks Bank of America

120 100 Citigroup 80 60 40

JP Morgan Chase

20 0 2002

03 140

U.S. Investment Banks 120 100

Goldman Sachs

80 60 Merrill Lynch

Morgan Stanley Dean Witter

40 20 0

2002 European Banks

03 140

ABN AMRO

120 UBS 100 80 60

Deutsche Bank 40 ING

Credit Suisse

20 0

2002

03 140

U.K. Banks 120

Royal Bank of Scotland

100 80

HSBC

60

Barclays

40 20 0 2002

03

Source: Bloomberg L.P.

21

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KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.11. U.S. Banks: Relative Stock Prices (January 2000 = 100) Bank of America Citigroup

180 160 140 120 100 80 60

JP Morgan Chase 40 2000

01

02

03

20

180

US Bancorp

160

Wells Fargo

Bank One 140 120 100 80

Wachovia

60 FleetBoston 40 2000 Source: Bloomberg L.P.

ther losses on banks’ equity holdings, the Bank of Japan started purchasing stocks held by Japanese banks. By the end of January, the Bank of Japan had spent about 20 percent of the ¥2 trillion set aside for the stock purchases in the next two years, which is equivalent to about 1 percent of the equity holdings of Japanese banks. On balance, however, aggressive liquidity support and a possible capital injection in the worst case would most likely mitigate any systemic consequences in the near term.

01

02

03

20

Insurance Sectors: Still Under Pressure On balance, the financial condition of the insurance company sector has worsened, in some countries significantly. Insurance companies have been hard hit by the decline in equity and corporate bond markets since early 2000 (Figure 2.12). In the early 1990s, many insurance companies locked into annuity products promising to pay fixed interest rates at the same time they were earning even higher returns on their asset portfolios with a high share of equities and corporate bonds in them.7 Since the bursting of the bubble, earnings on their asset portfolios have dropped below these fixed rates and in some cases turned negative. In the past three years, some insurance companies have also been substantial net sellers (protection providers) of credit default swaps, total return swaps, and equity put options.8 According to market participants, most of these instruments have terms to maturity of about five years. Given the decline in equity and lower-quality bond markets, insurance companies participating in these markets might have to recognize further substantial losses in the near term (in many jurisdictions, most of these positions do not have to be marked to market). 7See the June, September, and December 2002 issues of the Global Financial Stability Report (IMF, 2002b, 2002c, and 2002d). 8See Chapter III in the March 2002 issue of the Global Financial Stability Report (IMF, 2002a).

22

HAVE KEY SECTORS BEEN WEAKENED FURTHER OR STRENGTHENED?

Insurance companies in Germany, the Netherlands, the United Kingdom, and Switzerland have been particularly hard hit. Sales of equities by insurers have contributed to declines in equity markets in 2003, as insurers have reduced their equity holdings to preserve their capital strength. In turn, these declines led to further sales of equities by insurers. On January 31, 2003, the U.K. Financial Services Authority (FSA) announced that companies, whether or not they are pressing against their “Regulatory Minimum Margin” (RMM) requirements, could apply to have particular parts of the rules in the RMM calculation waived or modified, so long as they continued to meet the European Community minima. Granting of the waiver or modification would depend in part on the company’s strength when measured on the new more “realistic calculation” of solvency.9 Companies that are approaching their RMM would otherwise have to consider corrective action, such as raising capital, reallocating assets (in this case equities), reducing bonuses or dividends, or reducing or ceasing to write new business. In making the announcement, the FSA noted that the existing RMM might force sales when this might not be in the best long-term interests of customers, and might force losses upon insurers because their sales push markets down and might therefore create a downward spiral, as described earlier. The announcement led to a rebound in U.K. equity markets. Investors have generally responded by marking down shares of insurance companies dramatically. German insurers were marked down 30 to 35 percent during the reporting period. German deregulation since 1994 had enabled a surge in equity and other risky investments, albeit from a low level, and solvency regulations are strictly enforced. British life insurers, which likewise have high equity holdings and a highly transparent regulatory regime, were

Figure 2.12. Large Insurance Companies: Relative Stock Prices (January 2002 = 100) 120

United States Berkshire Hathaway

100 80

AIG

40 20

2002

03

0

120

Switzerland

100 80

Swiss Re

60 40 Zurich Re

2002

20 03

0 120

United Kingdom

100 Prudential

80 60 40

Aviva 20 2002

03

0

120

Germany

100 80 Munich Re 60 Allianz

40 20

2002 9The new “realistic calculation” is to be published by companies at the end of 2003 and implemented during 2004.

60

MetLife

03

0

Source: Bloomberg L.P.

23

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KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

down 30 percent in some cases during the reporting period. U.S. firms did relatively well over the period, reflecting stricter regulatory limits on equity portfolios and asset risks. Ratings agencies have responded by downgrading more than one-fourth of global non-life insurers and more than one-seventh of global life insurers in October–December 2002 (see Moody’s Investors Service, 2003). In light of weaknesses, some large European insurers continued efforts to recapitalize. On October 2, Credit Suisse put 2 billion Swiss francs into its Winterthur insurance unit. On December 4, Allianz floated a €1.5 billion subordinated bond, and on December 20, Zurich Financial passed on to its insurance arm 1.7 billion Swiss francs out of a 3.7 billion Swiss franc equity rights issue from earlier in the year. Other measures, including asset sales, were reported across the range of insurers seeking to rebuild capital lost in unusually high claims and equity market losses. Japan’s life insurance companies have been under intense financial pressure, mainly due to the negative spread between guaranteed yields to policyholders and low returns on investments, including declining stock prices. The ruling parties and the government have debated remedial measures that include allowing the life insurers to reduce their guaranteed yields to policyholders. The ongoing discussion may have increased concerns among investors and policyholders about the financial health of these institutions. Further deterioration in the financial health of the global insurance industry could have negative implications for the stability of the global financial system. The risks may be limited because insurance companies—unlike banks—do not encounter acute liquidity risks and only face slow-moving liquidity shocks. The

recent experience shows, however, that insurers faced with declining stock markets may be prompted to sell equities on a large scale—thus deepening the price declines. Financial distress in parts of the insurance industry could reduce the ability of buyers of risk protection to hedge their exposures, as some insurance companies are increasingly active in over-the-counter markets for credit derivatives.

Withdrawal from Risk Taking and Buildup of Cash Positions: Implications and Risks The withdrawal from risk taking since the peak of the equity markets in early 2000 has been associated with a significant buildup of cash positions in investors’ portfolios.10 This accumulation of high-quality, short-dated liquid instruments by both retail and institutional investors has been greater than in previous periods of market uncertainty for two reasons: first, the recent pull-back from risk taking has been particularly dramatic; in addition, income growth has been well-maintained despite the recession, permitting net financial investment by households to continue at a relatively high level relative to the late 1990s. The implications for financial market stability of this buildup in cash positions may turn out to be mostly favorable, as this represents “risk capital” waiting for greater returns. If and when geopolitical concerns are resolved and as the economic recovery gradually picks up momentum, investors’ withdrawal from risk taking will lessen and eventually may reverse completely. As this occurs, portfolio flows out of cash and back into riskier investments may well support a recovery in prices of financial assets, including equities and corporate bonds. An improvement in market conditions would also support an increase in overall

10A “cash position” is a portfolio allocation with the primary goal being conservation of principal. These positions are typically very liquid, short term, have minimal credit risk, and are interest bearing. Bank deposits and money market mutual fund shares are the primary cash instruments held by households. Institutional investors can choose from a broader range of wholesale cash instruments, including treasury bills, short-term debt of government mortgage agencies and municipalities, commercial paper, repurchase agreements (repos), and large time deposits.

24

WITHDRAWAL FROM RISK TAKING AND BUILDUP OF CASH POSITIONS

issuance, including improved access to capital markets by lower-rated corporate borrowers and by emerging market issuers. The high levels of cash in investors’ portfolios, while mostly beneficial, also pose new risks. Large, quick portfolio shifts away from cash positions could spark sharp movements in asset prices. Depending on the suddenness and magnitude of such a shift, should it occur, and the degree of leveraging, positions in the financial sector could unwind quickly. This would reinforce the sell-off and contribute to volatility in interest rates. Retail and Institutional Portfolios Show Strong Shift Toward Cash Investor willingness to bear financial risk began to fall sharply after the peak of the U.S. stock market in early 2000. U.S. households rebalanced their portfolios away from equities and mutual funds and back into cash to a degree without precedent in the past 50 years. The magnitude of these portfolio shifts is striking: • Net sales of equities surged to more than $500 billion in 2000, and purchases of mutual fund shares fell to roughly half their peak pace during the 1990s. • Net inflows to money market mutual funds soared from an average of less than $100 billion a year in the mid- to late 1990s to a $250 billion pace in early 2001. • Inflows to time and savings deposits more than doubled, from an average of $125 billion annually in the late 1990s to $270 billion since 2000. • The deposit share of overall portfolio flows spiked to over 100 percent in 2001.11 The share of savings going into deposits declined somewhat in 2002 but still remains at the high end of its historical range (Figure 2.13).

Figure 2.13. United States: Household Portfolio Allocation, Total Deposits1 (In percent of net acquisitions of financial assets) 120 100 80 60 40 20 0 –20 1956

60

64

68

72

76

80

84

88

92

96

2000

–40

Source: Board of Governors of the Federal Reserve System, Flow of Funds. 1 Total deposits including money market mutual funds.

11The deposit share includes all demand, time, and savings deposits at banks and thrifts, as well as money market mutual fund shares, relative to the net acquisition of financial assets of all types.

25

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.14. United States: Household Balance Sheets, Selected Items (In billions of U.S. dollars) 14000 12000 Equities and mutual funds

10000 8000 6000 4000

Total deposits

2000 0 1980

82

84

86

88

90

92

94

96

98

2000

02

Source: Board of Governors of the Federal Reserve System, Flow of Funds.

26

• The preference for safe havens can be seen in prices of other assets as well. The price of gold, the classical financial refuge for centuries, has risen 15 percent since last November. There were indications last fall that households had begun to shift investments out of cash as equity markets rallied from their October lows. For example, equity mutual funds recorded a $7 billion inflow in November, the first positive flow in six months. Total deposits and money market mutual funds continued to grow at their recent trend of above 6 percent through the fourth quarter, however, and equity mutual fund flows turned negative again in December. Taken together with the recent sell-off in equities, this suggests that there has not yet been a meaningful return to the markets. Despite this shift in portfolio allocations, new financial investment slowed only modestly since the market peak in 2000. A number of factors have contributed to stable investment flows. The most important is that gross household income has continued to grow, as the brunt of the recession has been borne by the business sector. Tax cuts have supported aftertax income growth, and households have directed some of these tax cuts into savings. As a result, total net household portfolio flows into financial assets continued their recent pace of around $500 billion annually through the third quarter of 2002. These portfolio reallocations have had a noticeable impact on household financial positions. Together with the price declines in equity markets, the portfolio adjustments have resulted in household balance sheet positions that are significantly less exposed to equity market movements than just a few years ago. In particular, household holdings of deposits and money funds are nearly equal to those of corporate equities and mutual funds for the first time since 1994 (Figure 2.14). European investors also turned markedly more conservative in 2001. The net acquisition of equities and other shares by house-

WITHDRAWAL FROM RISK TAKING AND BUILDUP OF CASH POSITIONS

holds fell to its lowest share of total portfolio flows in five years, as investors redirected financial investment toward deposits and, to a lesser extent, fixed income securities (Figure 2.15). European institutional investors, especially insurance companies and pension funds, also redirected portfolios from equities to fixed-income securities, government paper, and cash. The degree of withdrawal from risk taking appears to be somewhat less pronounced than in the United States, although the lack of timely data on European portfolio flows limits the ability to compare more recent trends. The United Kingdom has shown less of a retrenchment in risk appetites, initially perhaps because the real economy continued to expand even as the U.S. economy contracted and as the continental European economy slowed. In recent months, however, U.K. investors have also turned more cautious. Investments in mutual funds declined in 2002, for example, and portfolio allocations into cash in individual savings accounts rose from 43 percent in 1999 to over 60 percent in 2002. Financial flows by Japanese households tell a similar story. Bank deposits have traditionally occupied a more central role in Japanese household finance, with deposits averaging between 60 percent and 70 percent of total financial flows in the 1960s and 1970s. Their share declined during the buildup of the Japanese asset price bubble. Japanese households turned toward the safety of bank deposits, however, as prices of financial assets fell in the early 1990s. The deposit share of total portfolio flows rose to above 100 percent in late 1997, reflecting the very cautious stance of investors (Figure 2.16). More recently, credit concerns about the nonbank segment of the Japanese financial sector (in particular, life insurance and pension funds as well as uninsured bank investments) have prompted an even greater flight into bank deposits. In addition, deflation has made the opportunity cost of holding bank deposits negative at the same time as equity

Figure 2.15. Europe: Household Portfolio Allocation (In percent of total net acquisition of financial assets) 80 Shares and other equity 60 40 Deposits 20 0 Securities other than shares

1995

96

97

98

99

2000

01

–20 –40

Source: ECB Monthly Bulletin.

27

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

Figure 2.16. Japan: Personal Sector Portfolio Allocation, Total Deposits (In percent of total financial flows) 200 180 160 140 120 100 80 60 40 20 0 1964

68

72

76

80

Source: Bank of Japan, Flow of Funds.

28

84

88

92

96

2000

prices continue to fall. In response, the deposit share has soared to more than 200 percent of total net financial flows. Institutional investors in U.S. markets have likewise shifted their portfolios away from riskier positions and into cash over the past three years. These changes are more difficult to measure than those of retail investors, however. Whereas retail cash instruments can be clearly identified in national Flow of Funds Accounts, wholesale investors have a much broader selection of cash instruments. Many of these are not distinguishable in Flow of Funds figures, which do not distinguish claims by maturity—for example, treasury bills versus longer-term treasury notes or bonds. To quantify the portfolio shift toward cash by institutional investors, we have constructed a measure for the U.S. markets of the primary wholesale cash instruments: treasury bills, short-term debt of government mortgage agencies and municipal securities, commercial paper, repurchase agreements (repos), and large time deposits. The following analysis reports on the recent behavior of this wholesale cash measure. Wholesale cash in U.S. markets began rising relative to total financial claims following the peak of the equity markets in 2000. Although the declines in equity prices would have suggested a need for less cash in institutional portfolios, the growth of U.S. wholesale cash positions actually accelerated in 2000, rising 15 percent or more over the prior year. Since then, cash positions have continued to build, rising to their highest share relative to total claims since 1995 (Figure 2.17). Moreover, this measure likely understates the portfolio shift into safe assets because it focuses on those with very short maturities. Other portfolio changes, say, from equities and corporate bonds to two- or five-year treasury notes, have almost certainly augmented the pool of “risk capital” that has been placed in safer assets. Market surveys of institutional investors support this notion. The portion of respondents indicating that cash positions are

WITHDRAWAL FROM RISK TAKING AND BUILDUP OF CASH POSITIONS

“high” has risen considerably over the past two years, while the portion with portfolios considered “overweight” with corporate bonds has declined. Some key sectors of institutional investors appear to be driving this accumulation of wholesale cash instruments: • Insurance companies bought nearly $30 billion of commercial paper in the first three quarters of 2002 (compared to less than $1 billion per year over the prior decade) and accelerated their acquisition of treasury and agency securities, as well as corporate bonds. At the same time, they cut back their purchases of equities to roughly half the average annual rate between 1996 and 1999. • Pension funds stepped up their purchases of commercial paper, repurchase agreements, and government securities in 2002, while they sold equities and slowed the purchase of corporate bonds. • Foreign investors in the U.S. markets accumulated commercial paper and repurchase agreements at greater than a $100 billion pace through the first three quarters of 2002, compared to negligible amounts in the 1990s. Foreign purchases of treasury and agency securities nearly doubled. Purchases of equities, in contrast, fell to a $57 billion annual rate during this period, less than half the pace of the previous year, and purchases of corporate bonds slowed as well. • Liquidity positions at U.S. nonfinancial corporations have improved as well. Cash holdings held by businesses are related to funding decisions rather than portfolio decisions, however, and are more likely to influence future capital spending than prices of financial assets.

Figure 2.17. United States: Wholesale Cash Instruments Relative to Total Financial Claims (In percent) 8

7

6

5

1991

93

95

97

99

2001

4

Sources: Board of Governors of the Federal Reserve System, Flow of Funds; U.S. Treasury; Fannie Mae; Freddie Mac; and IMF staff estimates.

Recent Portfolio Adjustments Dwarf Those in Previous Periods It is not unusual, of course, for investors to shift portfolio flows toward cash and other low-risk investments during periods of economic uncertainty and back to riskier assets

29

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

during periods of economic calm. The recent changes in portfolio allocations by U.S. households, however, are far greater than in previous fluctuations. Earlier movements over much of the postwar period tended to be modest, with the deposit share generally remaining between 40 percent and 60 percent of total portfolio flows between 1952 and 1990. Net purchases of equities and mutual funds, typically among the riskiest assets in household portfolios, were relatively minor during this period. In the early 1990s, U.S. investors redirected their portfolio flows away from deposits and into riskier assets. The net acquisition of corporate equities and mutual fund shares surged, exceeding one-third of total portfolio flows.12 Households began to moderate their net purchases of equities and mutual funds toward the end of the decade. As investors scaled back the additions to their equity positions, portfolio flows into deposits rose back into their historical range.13 The pattern of household portfolio flows in Europe reveals a similar increase in the latter half of the 1990s in willingness to take on risk, followed by a sharp retrenchment. Net purchases of shares and other equity rose from essentially zero in 1995 to over 60 percent of total portfolio flows in 1998. Investments in safer assets declined over this period. Deposits fell from nearly half of total portfolio flows in 1995 to as low as 12 percent in 2000. Fixedincome securities turned from net purchases corresponding to 20 percent of total portfolio flows in 1995, to significant net selling in 1998.14 The measure of wholesale cash constructed above does not exist for previous business

cycles, but the behavior over the past decade is instructive. Wholesale cash outstandings grew at a double-digit pace during the latter half of the 1990s. There was rapid growth in the demand for wholesale cash instruments, as total portfolio growth was very rapid during this period, driven primarily by rising equity valuations and strong inflows. Portfolio managers therefore needed to build their cash holdings accordingly to maintain a stable portfolio balance. Mutual funds, for example, typically keep a portion of their assets in cash to meet sudden redemptions. Even with the rapid growth of wholesale cash instruments, the value of these claims relative to total financial market claims fell steadily through much of the 1990s, from 7 percent in 1991 to 5 percent in 1999. Concerns about financial market stability during the Long-Term Capital Management (LTCM) crisis prompted a sharp rise in cash allocations late in the summer of 1998. Fears that the crisis could cause more widespread problems in equity and bond markets—and the possible damage the disruption in financial markets could cause to the macroeconomy—led institutional investors to build cash holdings. After the passing of the crisis, the share of portfolios allocated to cash resumed its downward trend in 1999 before turning up sharply over the past three years. Cash-Rich Financial Intermediaries Are Engaged in Carry Trades Commercial banks and brokers and dealers have accommodated the preference for cash by retail and institutional investors by issuing the short-term cash instruments that investors

12Indirect holdings of equities through pension and retirement accounts are not included. These flows represent a significant portion of household portfolio flows, but have tended to be more stable over time than the direct purchases of equities and mutual funds. 13Even though the net purchases, or flows into these assets, decreased to roughly zero by the late 1990s, the value of equity holdings continued to rise rapidly because of price increases. 14The component of portfolio flows that is not shown is insurance technical reserves. These flows as a share of total portfolio flows remained relatively stable between 45 percent and 55 percent.

30

WITHDRAWAL FROM RISK TAKING AND BUILDUP OF CASH POSITIONS

desire. They have done so by building “carry trade” positions that profit from the spread between short-term and long-term interest rates, which has been especially large because of the steep yield curve. In particular, banks and dealers have purchased government securities and mortgage-backed securities. Banks have funded these positions by issuing deposits, which have been growing rapidly because of households’ preference for low-risk investments, even despite the low rates of interest being paid on these deposits. A similar buildup of carry trade positions boosted earnings and helped the recovery of U.S. commercial banks in the early 1990s, when the yield curve was also quite steep. Brokers and dealers have typically funded their securities portfolios by entering into repurchase agreements (repos). The repo transaction in turn creates a low-risk secured claim for the institutional investor that is the dealer’s counterparty. Carry trade positions are reportedly widespread in the U.S. market, and to a lesser extent, in Europe, according to comments from market participants in New York and London, although comprehensive data on positions are not available. Carry trades have been less common in the London market, as the Sterling yield curve has been flatter and therefore not conducive to such a play. Implications for Financial Stability These carry trades expose commercial banks and dealers to interest rate risk. Furthermore, the prepayment option of mortgages creates negative convexity in mortgagebacked securities, which magnifies the interest rate risk in carry positions. Anecdotes suggest that carry positions are largely unhedged, as the measures that would hedge these positions would reduce or eliminate the gains from the carry trade. Although positions at the mortgage agencies do tend to be hedged, the market risks have not disappeared; rather they have been transferred to the counterparties to the derivatives transactions that hedge

the risk. In addition, the agencies have traded to some extent market risks for counterparty risks. The rapid growth of mortgage debt over the past decade has resulted in a market for mortgage-backed securities that is far greater, both in absolute terms as well as relative to the treasury securities market, than a decade ago. A key risk to the markets, therefore, is that an unexpected rise in interest rates could spark a rapid unwinding of carry trade positions in mortgage-backed securities and treasuries, resulting in market volatility equal to or exceeding what occurred in 1994 (see IMF, 1994). Many market participants expressed concern that the risks posed by these positions are significant. In this view, an unanticipated increase in interest rates could provoke a dumping of positions with potentially destabilizing effects. A simple scenario demonstrates how such an outcome could be possible. Consider two risks that now concern financial markets: geopolitical tensions regarding the threat of conflict in Iraq, and the uncertain nature of the global recovery. Should either or both of these two threats be resolved favorably, the pool of risk capital that is waiting on the sidelines could flow back into the equity and credit markets, perhaps quickly. As investors sell off safe investments, the yield curve would shift upward. A rise in the yield curve would cause losses in carry trade positions. Depending on how quickly cash flows from safe investments back into the markets and how fast carry positions are liquidated, such a development could result in considerable volatility in interest rates. This would have potential knock-on effects on commercial banks, insurance companies, and pension funds that have extensive holdings of treasury and mortgage agency securities. The prominent role of mortgage finance in the carry trade and the rapid growth of mortgage credit in the United States since 2000 highlights another potential risk to financial markets. The government-sponsored mort-

31

CHAPTER II

KEY DEVELOPMENTS AND SOURCES OF FINANCIAL RISK IN THE MAJOR FINANCIAL CENTERS

gage agencies, Fannie Mae and Freddie Mac, have assumed a large portion of the interest rate and convexity risks in the mortgage markets through their holdings of mortgages and mortgage-backed securities. The agencies maintain that the risks are modest and well managed. There is some credibility to this claim, as they hedge their positions and monitor these risks quite closely. Furthermore, they regularly stress test their portfolios against large changes in the level or slope of the yield curve.15 The agencies have managed these exposures to date without any major troubles. The large size of the agencies’ holdings (over $1 trillion), however, suggests that an outcome not anticipated by their pricing models could have severe consequences, both for the agencies and for financial market stability. The Federal Home Loan Bank (FHLB) system raises similar concerns. While positions through the FHLB are not as large as those held by Fannie Mae and Freddie Mac, neither are the member banks viewed as possessing the same degree of sophistication in hedging interest rate and yield curve risks, in particular the risks associated with prepayments of mortgage debt. These exposures, as well as the very rapid growth of mortgage debt and its critical role in supporting the boom in U.S. housing markets, suggest these risks should continue to be monitored closely. There are reasons to be somewhat sanguine about these risks and potential outcomes, however. In contrast to 1994—when the yield curve rose sharply, sparking an unwind of carry positions in mortgage-backed securities that contributed to heightened volatility in interest rates—market participants are well

aware of the risks involved in these positions, including the risks arising from the convexity risk in mortgage-backed securities. Furthermore, while the positions may be largely unhedged at present, tools for hedging—interest rate swaps and swaptions—are widely available and can be quickly implemented. If these derivatives markets remain liquid when the interest rate environment finally changes, the adjustment to changes in the shape of the yield curve may be smoother than in the past, although the counterparties to those hedges would, of course, have to bear the risk. Another element that may limit these risks is that markets have not been behaving as if there were a high degree of leverage. Rather, there is reportedly lower leverage, including a less prominent role of highly leveraged hedge funds and less credit extended to them by banks. This has been in part due to a decline in the activity of macro hedge funds since the crisis sparked by LTCM, as well as a further unwillingness to take large positions of this sort since the September 11 attacks.

References Aizcorbe, Ana M., Arthur B. Kennickell, and Kevin B. Moore, 2003, “Recent Changes in U.S. Family Finances: Evidence from the 1998 and 2001 Survey of Consumer Finances,” Federal Reserve Bulletin (Washington, January). International Monetary Fund, 1994, International Capital Markets: Developments, Prospects, and Key Policy Issues, World Economic and Financial Surveys (Washington). ———, 2002a, Global Financial Stability Report, World Economic and Financial Surveys (Washington, March).

15The Office of Federal Housing Enterprise Oversight (OFHEO), regulator for Fannie Mae and Freddie Mac, recently analyzed the threats of systemic risk posed by the agencies (United States, OFHEO, 2003). The report concludes that the agencies are critical to the intermediation of real estate finance, and large enough to impose a widespread impact on real economic activity if one were to fail. The report does not, however, evaluate the chances of such an outcome occurring. The report presents other risk scenarios where the agencies have no systemic implications, or even have a beneficial effect by providing liquidity in the mortgage-backed securities market during times of economic stress.

32

REFERENCES

———, 2002b, Global Financial Stability Report, World Economic and Financial Surveys (Washington, June). ———, 2002c, Global Financial Stability Report, World Economic and Financial Surveys (Washington, September). ———, 2002d, Global Financial Stability Report, World Economic and Financial Surveys (Washington, December). Moody’s Investors Service, 2003, “Moody’s Rating Actions and Reviews—Quarterly Update,” January.

“Pension Funds Seek An Equity Trap Exit,” 2003, Financial Times, January 30. Standard & Poor’s, 2003, “Review of Euro Corporate Post-Retirement Liabilities Leads to 10 CreditWatch Negative Listings,” Ratings Direct, February 10. Towers Perrin, 2003, “Review of Year 2002 Results for Pension Plans,” January 21. United States, The Office of Federal Housing Enterprise Oversight (OFHEO), 2003, Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO (Washington, February).

33

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Emerging markets faced internal and external challenges throughout most of last year. Toward the end of the year, however, emerging market bonds rallied in the secondary market and access eased in the primary market as global investors reached for yield and concerns over policy continuity in key emerging markets dissipated. Banking sector financial soundness—which is reviewed for the first time in this issue of the GFSR—was mixed. Banks in some countries in Latin American remain in distress, while others in the region have achieved stronger results. In contrast, the financial health of banks in emerging Asia and Eastern Europe has generally improved.

xternal financial market developments—falling prices in the major equity markets, sharply widening credit spreads, high levels of actual and implied volatility, and a withdrawal of banks from risk taking in response to loan and trading losses and falling share prices—roiled emerging markets. These developments once again highlight the strong influence of the external financial environment on emerging financial markets. Reflecting this unsupportive external environment, financial flows to emerging markets fell for the second consecutive year, and the “feast or famine” dynamic of the emerging primary bond market was again evident. Internal challenges also arose. Market anxiety over the prospects for policy continuity intensified in the run-up to elections in Brazil, Turkey, and other key emerging market countries. This risk of policy discontinuity compounded the external challenges. Partly reflecting investor focus on the likely path of policies, a marked differentiation of borrowers by perceived credit quality persisted throughout the year. Some Latin American countries—notably Brazil and other subinvestment-grade issuers—faced high yield spreads. In contrast, Asian and Eastern European borrowers benefited from nearrecord-low spreads. Asian markets, except for

E

34

the Philippines, were supported by regional liquidity and a solid investor base. Eastern European countries attracted investor interest in anticipation of further credit upgrades associated with progress on accession to the European Union. The degree of spread compression, especially in Eastern Europe, is driven in part by a search for yield on the part of European institutional investors. Current yield spreads appear to be pricing in expectations for a problem-free path to EU accession, raising the risk of reversal if these expectations prove optimistic. Notwithstanding the turmoil that peaked in the third quarter of last year, emerging markets ended last year on a positive note. Bond markets rallied, volatility declined, and bond issuance rebounded, albeit from quite low levels. The rally of the emerging bond market in the fourth quarter was led by credits at the lower end of the rating spectrum and mirrored a similar rally in U.S. corporate bonds. Investors in both markets appeared to reach for yield in an environment of historically low interest rates on U.S. and euro-zone domestic government bonds and of investor disillusionment with equities. Accumulated cash balances were partially mobilized in the fourth quarter. Low interest rates in mature markets helped spur retail flows to high-yield corporate and emerging bond market mutual funds

EMERGING MARKET FLOWS REMAIN WEAK

and contributed to increased allocations to emerging market bonds by institutional investors. Emerging markets also benefited from a relief rally as the extreme investor anxiety that preceded elections in Brazil and Turkey eased. Notwithstanding the reopening of market access that accompanied the fourthquarter rally in secondary emerging markets, gross flows for the year as a whole were low and concentrated on issuers at the higher end of the credit rating spectrum. Looking ahead, the risk that the external environment could once again become unsupportive remains palpable. The global economic recovery remains hesitant and uneven. Equity prices in the major markets remain exposed to further correction if earnings growth falls short of expectations and a renewed bout of acute risk aversion could be triggered by geopolitical events (Box 3.1). At the same time, investor perception of risk emanating from within emerging markets has not fully dissipated. Investor concerns over the direction of policies—notably in Brazil and Turkey—have eased considerably from the pre-election heights of the second and third quarters of last year. In the case of Brazil, markets have so far welcomed the cabinet appointments and policy pronouncements of the new administration, as evidenced by a strengthening real and declining foreign sovereign bond spreads. Nevertheless, interest rates on domestic and foreign Brazilian government bonds remain quite high, and sovereign access to foreign primary markets is generally considered to be excluded without a further substantial fall in yield spreads. Whether the announced primary fiscal adjustment will be sustained by structural measures—notably in the area of tax and pension reforms—is at the center of investor concerns. In the case of Turkey, the prospects for further fiscal consolidation and banking sector reform remain key investor concerns, which are at present overshadowed by the uncertainties posed by the prospect of war on its borders and its financial implications. Whether emerging markets can

benefit from the build-up of global liquidity in mature markets continues to hinge on the policies they pursue. Notwithstanding these risks from within and without, there are grounds for optimism. An external environment in which global economic growth is positive but sub par, inflationary pressure is muted, and yields on mature government bonds are low could entice capital to the higher yields offered by emerging markets. The strong risk-adjusted returns of emerging market bonds in recent years could intensify this trend, particularly for institutional investors facing large losses on equities and low yields on U.S. and euro-zone domestic government bonds.

Emerging Market Flows Remain Weak Primary market activity for bonds, loans, and equities last year was at a low ebb, reminiscent of flows seen in the early-to-mid-1990s and below those following the Asian crisis in 1998 (Table 3.1 and Figure 3.1). For the year as a whole, emerging market fund-raising totaled just $134.8 billion, reflecting a sharp fall-off in flows to Latin America following the Argentine default and in advance of the Brazilian election. In the fourth quarter of last year, gross funding by emerging markets on international capital markets rose moderately, to $33.3 billion (Figure 3.2). Bond issuance rebounded by nearly 70 percent from the third quarter as primary markets reopened after a 20-week closure. Nonetheless, total emerging market fund-raising grew only modestly, reflecting continued moderation in syndicated loan commitments. Equity placements remained limited, and concentrated largely on Asian issuers. Sub-investment-grade borrowers, particularly in Latin America, were largely shut out of the primary bond market during much of May–November of 2002 (see the Appendix to this Chapter). As in past episodes of market closure, a sharp increase in the volatility of major markets and rising risk premiums on

35

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Table 3.1. Emerging Market Financing 2000 _________________________________________ 2000

2001

2002

Issuance Bonds Equities Loans

216.4 80.5 41.8 94.2

162.1 89.0 11.2 61.9

Issuance by region Asia Latin America Europe, Middle East, Africa

216.4 85.9 69.1 61.4

Secondary markets Bonds EMBI+ (spread in basis points)2 Merrill Lynch High Yield (spread in basis points) Salomon Broad Investment Grade (spread in basis points) U.S. 10-yr. treasury yield (yield in %)

Q2

Q3

Q4

(In billions of U.S. dollars) 134.8 60.4 61.6 33.8 16.4 8.9 56.9 17.6

55.4 16.1 11.6 27.7

50.3 21.1 8.8 20.4

50.3 9.4 12.4 28.5

162.1 67.5 53.9 40.8

134.8 54.5 32.4 48.0

55.4 26.1 13.9 15.4

50.3 18.3 18.8 13.2

50.3 22.0 12.7 15.6

756

731

765

674

712

677

756

871

734

802

584

615

664

871

89 5.12

78 5.07

62 3.83

Q1

60.4 19.5 23.7 17.1

81 6.03

87 6.03

83 5.80

95 5.12

(In percent) Equity DOW NASDAQ MSCI Emerging Markets Free Asia Latin America Europe/Middle East

–6.2 –39.3 –31.8 –42.6 –18.4 –23.4

–7.1 –21.1 –4.9 4.2 –4.3 –17.7

–16.8 –31.5 –8.0 –6.3 –24.8 –9.1

–5.0 12.4 2.0 4.0 3.2 3.0

–4.3 –13.3 –10.8 –14.0 –8.1 –9.7

1.9 –7.4 –13.4 –22.4 –6.0 –3.9

1.3 –32.7 –13.5 –17.3 –8.5 –14.3

Sources: Bloomberg L.P.; Capital Data; Merrill Lynch: Salomon Smith Barney; and IMF staff estimates. 1Issuance data are as of Jan. 22, 2003 close-of-business London and secondary markets data are as of February 28, 2003 c.o.b New York. 2On April 14, 2000 the EMBI+ was adjusted for the London Club agreement for Russia. This resulted in a one-off (131 basis points) decline in average measured spreads.

U.S. high-yield corporate bonds were the main external contributors to last year’s emerging market issuance famine. The issuance famine ended in the fourth quarter, as improvements in market sentiment—notably the decline in volatility, rally in major bond and equity markets, and narrowing spreads in the secondary market for emerging market bonds—facilitated a rebound. The rush to issuance since November is also typical of past episodes of market reopenings. This time, however, the risk that war might result in renewed access difficulties has provided a further spur to tap primary markets quickly. It remains to be seen whether the spurt in issuance, which continued throughout January, will, as in past reopenings, again lead to an issuance glut and contribute to indigestion on the secondary markets.

36

In the primary bond markets, issuance recovered from the famine that began in the second week of May, totaling a healthy $14.6 billion in the fourth quarter. In contrast to previous reopenings, however, tiering remained prevalent. Investment-grade issuers were the first to regain market access, accounting for roughly 45 percent of quarterly issuance. The dollar market saw the bulk of new issues (around 80 percent). Euro-denominated issuance remained negligible in the wake of the losses sustained by the European retail investor base after the Argentine default. The Samurai market staged a weak comeback in the fourth quarter but its share in the total remained low by historical standards. January 2003 saw a continuation of the buoyant fourth quarter conditions for emerging bond issuance,

EMERGING MARKET FLOWS REMAIN WEAK

2001 ____________________________________

2002 ___________________________________

Q1

Q2

Q3

Q4

Q1

42.2 26.8 2.3 13.1

50.5 28.8 5.3 16.4

29.2 11.7 1.0 16.4

40.2 21.7 2.6 15.9

37.0 22.2 4.1 10.7

42.2 19.6 15.2 7.4

50.5 22.8 15.4 12.4

29.2 7.5 11.4 10.4

40.2 17.6 11.9 10.7

37.0 13.3 11.9 11.9

Q2

Q3

(In billions of U.S. dollars) 32.9 31.7 15.9 8.8 4.3 3.8 12.6 19.0 32.9 11.9 8.3 12.7

31.7 14.1 5.6 12.0

2002 _______________________

2003 Year to Date1

Q4

Oct.

Nov.

Dec.

33.3 14.6 4.1 14.5

7.5 3.5 0.3 3.7

13.3 7.2 2.6 3.5

12.4 3.9 1.2 7.3

7.7 7.6 0.0 0.2

33.3 15.2 6.6 11.5

7.5 2.4 1.8 3.3

13.3 8.5 1.4 3.4

12.4 4.4 3.3 4.7

7.7 1.8 4.2 1.8

784

766

1005

731

598

799

903

765

862

778

765

707

757

736

915

734

623

809

890

802

974

799

802

757

89 4.93

80 4.93

77 4.60

78 5.07

69 5.42

73 4.86

75 3.98

62 3.83

82 3.99

69 4.22

62 3.83

52 3.69

9.9 14.0 9.8 4.9 19.6 9.1

10.6 13.5 6.4 4.8 13.8 7.3

5.9 11.2 6.8 6.8 3.2 9.2

–6.2 –9.7 –3.4 –6.3 1.9 –6.9

–5.4 –4.4 –3.7 –4.4 –6.1 –0.7

(In percent) –8.4 –25.5 –6.2 –0.1 –3.5 –22.0

6.3 17.4 3.1 –1.6 7.1 4.5

–17.5 –30.5 –23.4 –22.1 –24.7 –26.1

15.7 29.9 28.4 36.1 23.0 36.8

3.8 –5.4 10.7 14.9 7.1 0.2

–11.2 –20.7 –9.0 –6.3 –22.0 –11.0

reflecting seasonal factors and an acceleration of issuance plans in anticipation of military conflict in Iraq. Notwithstanding the reopening of access in the fourth quarter, bond issuance in 2002 amounted to only $61.6 billion, the lowest level since the mid-1990s. The main reasons for low levels of primary market activity in 2002 were Argentina’s absence from the primary market throughout the year, Brazil’s limited issuance from the first quarter onward, Turkey’s difficulties in coming to market in the run-up to the November elections, and an unsupportive external environment throughout the second and third quarters of the year. Equity issuance remained subdued in the fourth quarter of 2002, with placements totaling $4.1 billion. While cumulative issuance for the year as a whole was 45 percent higher

–17.9 –19.9 –16.8 –17.0 –24.7 –6.5

than in 2001, it represented a precipitous decline from the heady days of 2000. Syndicated lending to emerging markets declined in the fourth quarter to $14.5 billion, bringing cumulative issuance in 2002 to $56.9 billion. This level was similar to that in 1998, the year of the Asian crisis, and well below 2000, which featured the syndication of jumbo loans to finance mergers and acquisitions in the technology, media, and telecom (TMT) sector. In 2002, the malaise in crossborder syndications stemmed from a further reduction in demand for credit by corporates, particularly in Asia and the EMEA (Europe, and the Middle East and Africa) regions, as firms appeared hesitant to invest in the wake of the slowdown in economic activity in the industrialized countries and uncertainty over recovery prospects. Ample liquidity in the

37

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.1. Cumulative Gross Annual Issuance of Bonds, Loans, and Equity (In billions of U.S. dollars) 300 1997 250 2000

200 150

1999

100

1998 2002 2001

Jan. Feb. Mar. Apr. May Jun.

50

Jul. Aug. Sep. Oct. Nov. Dec.

0

Source: Capital Data.

Figure 3.2. Emerging Market Financing

local markets further constrained lending opportunities for the international banks. On the supply side, lending conditions tightened further as international banks sought to rebuild their balance sheets, having sustained sizable losses on their exposures following several high-profile corporate bankruptcies in the United States and Europe. The upshot for the emerging markets was increased discrimination according to credit quality. In Latin America, this led to a broad-based retrenchment from the riskier bank loan markets, following the default in Argentina and in the context of the pre-election uncertainty surrounding Brazil. Flows of foreign direct investment (FDI) were also weak last year and remained heavily concentrated in a few host countries. According to World Bank data, FDI flows to emerging markets in 2002 declined to $143 billion compared with $171 billion in 2001. The decline was part of a global decline in direct investment that reflected unsettled investor sentiment throughout much of the year and a falloff in privatizations and transactions involving mergers and acquisitions.

(In billions of U.S. dollars) 90

Equities Loans Bonds

80 70 60 50 40 30 20 10

1993

94

95

Source: Capital Data.

38

96

97

98

99

2000

01

02

0

Emerging Bond Markets Turn in Strong Performance Last year, the return on the EMBI+ (Emerging Market Bond Index) was 14.2 percent, as the decline in U.S. treasury yields to near historic lows contributed about 8 percentage points of return. This, together with high coupon payments, more than offset the drag on returns posed by the modest widening of spreads (Table 3.2). The strong overall returns of last year mask important differences across regions and credit segments, however, with bonds at the lower end of the credit rating spectrum performing considerably less well than their higher-grade counterparts. Non-Latin American sovereigns, which generally benefited from narrowing spreads, posted a 26 percent return for the year, compared with 7 percent for Latin America, which saw

EMERGING BOND MARKETS TURN IN STRONG PERFORMANCE

Table 3.2. EMBI+ Performance Returns

Spreads

(in percent) (in basis points) __________________________________________________ ______________________________________________________ 2002 2002 ______________________________ __________________________________ 2003 2003 EMBI+ Latin Non-Latin Argentina Brazil Bulgaria Colombia Ecuador Egypt Malaysia Mexico Morocco Nigeria Panama Peru Philippines Poland Russia South Africa Turkey Ukraine Venezuela

Oct.

Nov.

Dec.

Q4

2002

to date1

Oct.

Nov.

Dec.

Q4

2002

to date1

7.7 9.7 5.0

3.2 3.6 2.6

3.1 4.3 1.5

14.6 18.6 9.3

14.2 7.2 25.6

5.5 5.4 5.6

–179 –246 –100

–84 –99 –62

–13 –47 28

–276 –392 –134

34 174 –100

–58 –64 –54

5.4 22.9 3.7 12.2 10.0 4.4 –1.3 2.6 0.8 6.7 5.7 7.9 0.6 1.6 7.2 0.1 9.0 0.0 3.1

–1.3 5.0 1.5 5.7 7.7 2.8 –0.7 2.2 0.8 9.8 2.6 6.0 –0.3 0.8 2.5 1.9 10.2 –1.3 4.3

1.2 8.7 1.3 6.0 –2.3 5.1 2.8 3.1 3.4 0.8 1.5 4.5 1.5 1.4 1.4 2.4 –0.4 3.1 –3.3

5.3 40.2 6.6 25.8 15.7 12.8 0.7 8.1 5.1 18.1 10.0 19.5 1.8 3.8 11.4 4.4 19.7 1.8 4.0

–5.6 –3.3 10.5 12.8 –4.7 ... ... 16.4 7.2 9.9 11.7 10.7 14.4 13.3 35.9 ... 20.7 21.0 18.7

1.0 13.2 3.7 0.5 19.7 4.5 2.9 1.8 1.9 14.8 1.2 5.9 1.1 2.4 8.1 4.4 1.8 7.2 –6.1

–361 –653 –70 –243 –121 –109 6 –64 –17 –1,261 –88 –138 –28 –75 –118 –19 –190 58 –94

48 –136 –36 –147 –158 –58 –20 –61 –55 –814 –53 –106 –14 –47 –55 –65 –218 85 –125

151 –160 7 –49 105 –36 15 20 –83 419 31 –26 41 4 36 18 77 –136 184

–162 –949 –99 –439 –174 –203 1 –105 –155 –1,656 –110 –270 –1 –118 –137 –66 –331 7 –35

2,019 583 –142 131 568 ... ... 23 –128 850 35 89 64 –10 –191 ... –14 –269 –3

345 –264 –43 31 –279 –32 –29 –7 –32 –776 3 –63 10 –3 –84 –54 14 –251 279

Source: J.P. Morgan Chase. 1As of February 28, 2003.

spreads widen, especially in the third quarter (Figure 3.3). The strong performance of emerging market bonds in 2002 is particularly striking relative to the returns of other asset classes, including U.S. high-yield corporate bonds (down 1.1 percent), U.S. high-grade corporate bonds (up 10 percent), and the S&P 500 (down 23.4 percent). Moreover, as emerging bond market volatility remained well below previous crisis episodes, emerging market bonds also posted solid risk-adjusted returns, with only mature government bonds and U.S. high-grade corporate bonds generating higher risk-adjusted returns. With the strong performance of last year, emerging market bonds have provided better risk-adjusted returns over the past five years than most other asset classes. This performance could, in an environment of low interest rates on mature government bonds and disillusionment with equities, attract increased flows to the asset class.

Unlike the second and third quarters, during which high-grade emerging market bonds outperformed others, lower credit quality bonds rebounded strongly in the fourth. This largely reflected a relief rally in Brazil following the high level of investor anxiety in the run-up to the October presidential election. The rebound in emerging debt markets during the fourth quarter also resulted from an improvement in the external financing environment, including a marked reduction in global risk aversion, ample global liquidity following the 50-basis-point U.S. Federal Reserve rate cut in November, and renewed if shortlived optimism for the prospects for growth in output and earnings (Figure 3.4). The correlation between indicators of global risk appetite and emerging debt markets became particularly high in the fourth quarter. High-grade emerging market bonds appeared to have been particularly influenced by external developments. They traded more in line with U.S.

39

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.3. Sovereign Spreads (In basis points) 1200

2500

Brazil (right scale)

1000 2000 800

EMBI+ (left scale)

Non-Latin (left scale)

Russia (left scale)

1500

600 1000

400 Mexico (left scale) 200 2002

2003

500

Source: J.P. Morgan Chase.

Figure 3.4. Risk Appetite and Emerging Market Debt 0.8

500

0.6

600

0.4

700

0.2

800 900

0 –0.2 –0.4

Risk Appetite Index (left scale)

EMBI+ spreads (basis points, right scale, inverted)

1100 2002

Sources: J.P. Morgan Chase; and IMF staff estimates.

40

1000

2003

high-grade corporate bonds than their emerging debt market counterparts. Notwithstanding the spike in the cross-correlation of emerging bond market returns in the third quarter, contagion remained largely in check throughout the year. Changes in the investor base for emerging market bonds, an increase in the overall credit quality of the emerging market bond universe, and increased transparency that facilitated investor discrimination across countries on the basis of policies all helped to limit contagion. Developments in Brazil nevertheless played a prominent role, and the repercussions emanating from Brazil were felt most by other countries in the region. The correlations of other countries with Brazil tended to be far stronger when Brazilian bond prices fell than when they rose (Box 3.2). Market participants attributed Brazil’s ability to weather the storm of electionrelated uncertainty to a level of international reserves that was more than sufficient to cover external debt service obligations, and a floating exchange rate that permitted a flexible response to difficulties in rolling over maturing domestic debt. The fourth quarter rally in Brazil, which stemmed from a more supportive external environment and favorably received cabinet appointments and policy pronouncements by the new administration, led to the disinversion of the country’s dollar-denominated eurobond curve (though spreads remained quite high). In addition, the dynamic of the local market improved significantly, with capital outflows subsiding, local yields falling, and the real appreciating. Because of Brazil’s large share in the emerging debt indices, investors felt compelled to increase their exposure to Brazil for fear of marked underperformance of their benchmarks. Retail investors appear to have been pushed by low yields on U.S. treasuries and disillusionment with equities to increase their exposure to high yield and emerging bond market mutual funds. Flows into U.S.-based emerging

EMERGING BOND MARKETS TURN IN STRONG PERFORMANCE

Box 3.1. The Risk of War and Emerging Market Vulnerabilities While geopolitical concerns have increasingly weighed on financial markets, investors appear to expect a potential military conflict to be short-lived. If these expectations are disappointed, oil prices and financial markets would likely experience a sharp correction. In such an adverse scenario, consumer and business confidence would be undermined, compounding the drag of higher oil prices on global growth. Investor risk aversion would rise. Emerging market financing flows would slow and the cost of capital would increase. Sub-investment-grade emerging market borrowers, especially those with high financing requirements or located near the scene of hostilities, would be particularly at risk.

Crude Oil: Spot and Futures (West Texas Intermediate, $/bbl) 40

35

30

25 Futures as of 7/1/02 20

2002

As military conflict looms in the Middle East, oil markets have been at the center of market attention. While investors are concerned about near-term supply bottlenecks, long-term supply repercussions are perceived to be limited. The market anticipates a short

Futures as of 2/28/03

Spot price

2003

2004

15

Source: Bloomberg L.P.

conflict. Long-term futures contracts have hardly moved since mid-2002—when war concerns were not yet as pronounced—

Volatility Indicators: January 2000 – February 2003 (In percent) 80 September 11, 2001 70 Oil (30-day volatility) 60 U.S. equity (implied volatility) 50

40

30

20

Gold (30-day volatility) 2000

2001

2002

10

0 2003

Sources: Bloomberg L. P.; and IMF staff estimates.

41

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Box 3.1 (concluded) notwithstanding the spike in spot oil prices (see the first Figure). This suggests market expectations for a short-lived oil price shock, which would have only a limited impact on the world economy. Supporting this view, the implied volatility of the U.S. equity market and the actual volatility of oil and gold prices remain well below peaks of September 11, 2001, notwithstanding an increase since the end of last year (see the second Figure). Indeed, market analysts generally say that they expect an eventual war with Iraq to be over relatively quickly with little disruption to oil supplies and no political fallout for other countries in the region. Notwithstanding this stated sanguine view, however, investors are remaining on the sidelines out of concern about the potential for substantial market volatility while war is waged. Investors also recognize the risk that the widely anticipated benign war scenario may not materialize.

And few have the means to weigh the probability of such an outcome. If, however, the war is concluded quickly with little disruption to oil supplies, no political spillover to countries in the region, and no major terrorist incident, most analysts expect a significant rally in mature and emerging markets, as funds now on the sidelines are shifted to riskier assets. Given the prevalence of this benign scenario, oil prices—and financial markets more generally—are exposed to a significant correction if expectations of a short-lived war are disappointed. At the same time, a prolonged period of uncertainty attributable to the lack of international consensus in favor of war, and uncertainties about the timing and outcome of a war, also risk undermining market sentiment. Indeed, even in the event of a quick and decisive military outcome, a major act of terrorism associated with the conflict—

September 11th and Emerging Market Bond Spreads: July 2001 – February 2003 (In basis points) 1400

2500

September 11

1200

Turkey (left scale)

2000

1000 1500 800

EMBI Global (left scale)

600

1000

400 Egypt (left scale)

500 Pakistan (right scale)

200

0

0 2001

Source: J.P. Morgan Chase.

42

2002

2003

EMERGING BOND MARKETS TURN IN STRONG PERFORMANCE

or seemingly independent of it—would still hurt financial markets. After a volatile year in 2002, emerging markets would be especially vulnerable to a potential slowing of private sector financing flows and an attendant increase in financing costs. Countries with large financing requirements and those in the region of the conflict are most at risk. This is illustrated by the underperformance of bond markets in the Middle East in the aftermath of September 11, including, in particular, Egypt, Pakistan, and Turkey (see the third Figure). In emerging Europe, the Middle East, and Africa, Turkey appears particularly exposed. And this vulnerability does not only stem from its proximity to the potential conflict. While Turkey’s financial markets have remained resilient, their performance has been supported by the expectation of further net financing from bilateral or multilateral sources in the event of war. Any policy setback or potential delay in securing such financing may, however, lead to an unraveling of favorable expectations. Financial market vulnerabilities are further underscored by Turkish

market mutual funds rose in the fourth quarter of last year, to $202 million, the largest quarterly inflow in four years (Figure 3.5). The spike in inflows was consistent with a generalized increase in risk appetite in global markets; U.S. high-yield funds also posted especially strong inflows ($4.6 billion) while flows into high-grade mutual funds decelerated markedly. Institutional investors increased their overweighted portfolio positions and reduced cash holdings beginning in November. Surveys suggest that cash positions held by dedicated emerging market bond investors have fallen below historical averages, and that investors increased their exposure to higher yielding credits during the fourth quarter. This change in portfolio positioning reflects in part the

plans to issue an additional $3.25 billion in sovereign bonds this year according to market estimates, following issuance of $1.25 billion in January. Vulnerabilities in Egypt, in contrast, have been reduced by the recent decision to float the pound. Latin America—because of its relatively large financing needs and sizable share of sub-investment-grade issuers—also appears vulnerable to an increase in global risk aversion and is likely to be hit hard by reduced financing flows. While two key countries completed their planned market financing for 2003 in January (Colombia, $1 billion; and Mexico, $4.5 billion) the financing outlook for other markets remains difficult. In particular, a renewed surge of risk aversion would hurt Brazil and, more broadly, other sub-investment-grade credits in the region. In Asia, the market financing exercise of the Philippines is at risk of falling short of its ambitious $4 billion target. Nevertheless, cumulative issuance reached $1 billion in January and February, while domestic markets may in part mitigate external financing shortfalls.

spread compression experienced in Asian and Eastern European credits. In some cases, this compression brought spread levels to near alltime lows, raising valuation concerns and limiting the perceived scope for further capital appreciation. As a result, such sovereign credits as Colombia have experienced increased demand from dedicated accounts and now appear to be overweighted in investors’ portfolios. Similarly, the wide spreads and potential for further narrowing have pushed investors to adopt a slightly overweighted position on Brazil, except for crossover investors who remain underweighted. Dedicated and crossover investors remain slightly overweighted in Mexico. Investors continue to add to an already overweighted position on Russia, notwithstanding low yield spreads, in anticipa-

43

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.5. Emerging Markets and High-Yield Fund Flows (In millions of U.S. dollars; 4-week moving average) 60

800

High-yield debt (right scale)

50

600 Emerging market debt (left scale)

40

400

30

200

20 10

0

0 Emerging market equity (right scale)

–10

–200 –400 2003

–20 2002 Source: AMG Data Services.

Figure 3.6. Bond Issuance (In billions of U.S. dollars) 50

Other Latin America Asia

40

30

20

10

1994

95

96

Source: Capital Data.

44

97

98

99

2000

01

02

0

tion of further credit upgrades. Russia appeared to be the largest overweighted position in investor portfolios at year end. At the lower end of the credit scale, Venezuela was shunned by investors, who remained largely underweighted, although trading accounts increased their exposure toward year end. Investor positioning on Turkey remained mostly underweighted. Primary markets were closed for much of the second and third quarters of last year and reopened with a bang in November (see the Appendix to this Chapter). Issuance in 2002 was the lowest in years ($61.5 billion total, of which $31.7 billion for sovereigns), partly reflecting the inability of two traditionally large issuers—Argentina and Brazil—to tap the market. Primary market access rebounded modestly in the fourth quarter (to $14.6 billion), but remained well below the issuance levels of the fourth quarter of 2001 (Figure 3.6). Sub-investment-grade issuers came back as a share of total issuance during the fourth quarter. They accounted for slightly over half of total bond issuance, compared to less than 25 percent in the previous quarter. Because of the higher share of sub-investment-grade issuers, new bond issues in the fourth quarter had on average shorter maturities (6.6 years compared to 9.5 years in the third quarter), and higher spreads (472 basis points versus 364 basis points in the third quarter), notwithstanding the improvement in secondary markets. Overall, Asian and EMEA borrowers accounted for almost 80 percent of total issuance during the quarter, with Asian semipublic entities and EMEA sovereigns and corporates taking the lion’s share of the total. On the sovereign side, issuance in the fourth quarter totaled $5.4 billion, some $2.5 billion below that of the fourth quarter of 2001 (Figure 3.7). Sub-investment-grade issuers accounted for almost 75 percent of total issuance in the fourth quarter of last year, compared with less than 40 percent in the third quarter. High-grade issuers led the way into the fourth quarter, with Poland ($622

EMERGING BOND MARKETS TURN IN STRONG PERFORMANCE

million), Chile ($100 million), and El Salvador ($451 million) issuing in October. As market conditions continued to improve, however, primary markets opened for sub-investment-grade sovereign borrowers. These borrowers rushed into the market, raising as much as $2.9 billion (or 85 percent of their total quarterly issuance) during November 15–December 12. Turkey was the largest subinvestment-grade issuer ($1,150 million), taking advantage of the post-election rally. Sub-investment-grade Latin American issuers regained market access after a full quarter of closure, with Colombia and Peru issuing $500 million each. However, the market remained closed to Latin American issuers with single-B credit ratings. Exotic credits continued to enjoy unimpeded access to the market as investors sought diversification benefits. Issuance in the euro market remained depressed, with only one sovereign (Iran’s €375 million issue in December) tapping this market. Overall, the share of euro-denominated issuance accounted for barely 5 percent of total issuance during the quarter, the lowest level for the past four years. This largely reflected the withdrawal of the European retail investor base following Argentina’s default. The Samurai market experienced a modest pickup on the back of a streak of issuance by public entities in Korea and the Philippines, but overall yen issuance remains well below historical levels (Table 3.3). Overall issuance during January 2003 stayed strong. Seasonal factors account for part of this strength. Over the past three years, an average $15 billion in sovereign issuance has occurred in the first quarter. In addition, the prospect of war with Iraq has encouraged issuers to come to the markets quickly following the market closure of the second and third quarters of 2002. During the first three weeks of January, bond issuance totaled $7.5 billion. Of this total, 85 percent was accounted for by sovereign issuers, with highgrade (Mexico and Chile), high-yield (Turkey, the Philippines, Colombia) and exotic issuers.

Figure 3.7. Share of Bond Issues (In percent) 100 90 80 Sovereign and public sector

70 60 50 40 30

Private sector

20 10

1994

95

96

97

98

99

2000

01

02

0

Source: Capital Data.

45

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Table 3.3. Currency of Issuance (Shares in percent)

U.S. dollars Euro Deutsche mark Yen

1999 _______________________

2000 _______________________

2001 ______________________

2002 _____________________

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

62 26 2 2

67 28 0 1

59 36 2 1

53 37 0 8

62 33 0 3

51 28 0 17

65 18 0 14

60 21 0 13

57 31 0 7

72 17 0 6

63 7 0 19

72 20 0 6

77 16 0 1

84 13 0 1

82 9 0 5

83 5 0 6

Source: Capital Data.

Developments in the inclusion of collective action clauses in sovereign bonds are considered in Box 3.3.

Emerging Equity Markets Finished Lower in 2002 Emerging equity markets lost ground last year, notwithstanding a rebound in the fourth quarter. The quarterly pattern of emerging equity returns followed those of their mature equity counterparts and closely tracked changes in the yield on 10-year U.S. treasuries as all markets were similarly affected by the ebb and flow of investor risk appetite (Figure 3.8). Although emerging equity markets finished the year lower, they lost less than their mature market counterparts, in U.S. dollar terms (Table 3.4). Emerging Europe was the only region to generate positive returns in U.S. dollar terms in 2002, largely reflecting the impact of that currency’s decline against the euro. In addition, the South African rand also rose against the dollar, reversing its sharp depreciation in 2001 and benefiting from the surge in gold and platinum prices. In Asia, corporate profitability was supported by relatively strong macroeconomic fundamentals, healthier balance sheets as a result of continued deleveraging since the financial crisis in 1997–98, and attractive valuations. But Asian equities fell nevertheless in 2002, notwithstanding a small contribution to dollar returns from regional currency movements.

46

Latin American equities were the worst performing in dollar terms last year, owing largely to the sizable decline in the value of regional currencies. The pattern of the volatility of emerging equity market returns, with a notable spike in the third quarter, was similar across regions. It closely followed the volatility of the U.S. equity market (Figure 3.9). An examination of local currency returns suggests that exchange rate variability played an important role in increasing the volatility of U.S. dollar returns for Latin America and EMEA stock markets. Asian currencies, on average, remained relatively stable throughout 2002. The correlation of returns with the U.S. stock market differed across regions in the fourth quarter (Figure 3.10). Latin American markets generally remained within a band as they largely had throughout the year, balancing influences from both the domestic and U.S. fronts. Their relationship with the United States appears to have strengthened markedly, however, since the beginning of 2003. In contrast, the correlation of EMEA markets with the U.S. market fluctuated substantially in the fourth quarter, as it did throughout the year, with European Union considerations dominating price action. Asian equities remained significantly tied to developments in the United States given the strong dependence of the region’s important electronics exports on U.S. demand and the high proportion of technology stocks in the region (Figure 3.11). The correlation of Asian returns with the U.S. stock market in the third and fourth quarters was consider-

EMERGING EQUITY MARKETS FINISHED LOWER IN 2002

Table 3.4. Equity Markets Performance, 2002 (In percent, dollar indices) Q1

Q2

Q3

Q4

2002

Emerging Markets Free EMF Asia EMF Latin America EMF EMEA

10.7 14.9 7.1 5.1

–9.0 –6.3 –22.0 –1.8

–16.8 –17.0 –24.7 –10.5

9.8 4.9 19.6 14.6

–8.0 –6.2 –24.8 4.7

Dow S&P 500 Nasdaq ACWI Free ACWI Free, excluding US

3.8 –0.1 –5.4 0.5 1.1

–11.2 –13.7 –20.7 –9.5 –3.5

–17.9 –17.6 –19.9 –18.6 –19.7

9.9 7.9 13.9 7.4 6.6

–16.8 –23.4 –31.5 –20.5 –16.5

Figure 3.8. Emerging Market Equities and U.S. Treasuries 5.5

400

5.0

Sources: Bloomberg L.P.; and Morgan Stanley Capital International. 350

ably higher than in the first half of the year. This pointed to the region’s increasing focus on the outlook for capital expenditure in the United States during those quarters, after pricing in domestic fundamentals earlier in the year. High-tech sectors such as information technology and telecommunications performed less well than more defensive sectors such as health care and consumer goods. In addition, highly leveraged sectors—such as utilities and telecommunications—performed less well than the health care and consumer sectors, which are less leveraged. A comparison of returns relative to volatility across individual stock markets and industry sectors suggests that EMEA and Latin American equities and the consumer staples sector dominated all others in the fourth quarter (Figure 3.12). The NASDAQ and the information technology sector provided the worst trade-off between risk and return. When the fixed income asset class is taken into account, the EMBI+ and U.S. high-yield corporate bonds, along with EMEA equities, dominate the sample. Data from U.S.-based emerging markets and regional funds suggest that outflows from emerging equity funds moderated in the fourth quarter to about $150 million following the massive $500 million withdrawal in the third quarter (Figure 3.13). Only Asian equity funds saw slight inflows ($30 million) in the fourth quarter. For the year as a whole, emerg-

10-year U.S. treasury yields (percent, right scale)

4.5

4.0

Emerging Markets Free index (left scale)

300

3.5

250

2002

2003

3.0

Sources: Bloomberg L.P.; and Morgan Stanley Capital International.

Figure 3.9. Emerging Market Equity Volatility (In percent with 30-day window of U.S. dollar returns) 50 S&P 500 40 Asia

Latin America 30

20 EMEA 10 2002

2003

Source: Morgan Stanley Capital International.

47

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.10. Correlations of S&P 500 with Emerging Markets (30-day rolling averages) 1.0 0.8 Latin America 0.6 Asia 1 0.4 0.2 EMEA 1 0

2002

2003

–0.2

Source: Morgan Stanley Capital International. 1 Adjusted by one trading day.

Figure 3.11. Asian Emerging Market Equities and Semiconductor Chips 190

5

180

Emerging Markets Free index (U.S. dollar price, right scale)

4

170 3

2

1

160 150 DRAM price (U.S. dollars per 256MB chip, left scale)

130

0

2002 Source: Bloomberg L.P.

48

140

2003

120

ing equity markets suffered a net withdrawal of funds (of $330 million). The withdrawal of foreign investors from the secondary market was mirrored by reduced participation in primary markets. Emerging equity issuances in 2002 totaled $16.4 billion, above the level issued in 2001 but significantly short of the $41.8 billion placed in 2000 (Figure 3.14). Nevertheless, equity issuances held up relatively well compared with bond issuances in 2002, but it remained concentrated on a few countries. China represented 33 percent of total equity issuances in emerging markets last year and half of all issuance in the fourth quarter. Even major issuers experienced occasional difficulty, however. The initial public offering (IPO) by China Telecom in the fourth quarter was significantly scaled back due to weak demand. Overall, Asia continued to dominate emerging equity issuance in the fourth quarter, constituting more than 75 percent of the total (Figure 3.15). Issuance in emerging Europe totaled around $1 billion, the largest in almost two years, with Russia’s Lukoil tapping the market for $775 million. Latin corporates were absent from primary markets for the second consecutive quarter. Chile was the only exception, with Corp Banca (the country’s sixth largest lender) selling $150 million of stocks in the country’s first initial public offering since 1997. Elsewhere, several Brazilian corporates swapped debt into equity, as the lack of market access made it impossible to roll over debt obligations. However, these swaps essentially represented balance sheet restructuring, rather than net new financing. Emerging equities as a whole are valued at well below their long-term average valuation of around 14.6. Equities in both the EMEA region and Asia appear to be valued at considerably less than their respective long-run averages. While the P/E ratio for Latin American equities is also below its long-term average, the valuation is not as compelling as in the other regions. (Table 3.5).

SYNDICATED LENDING TURNS UP MODESTLY

Table 3.5. Valuation and Earnings Across Equity Markets Earnings per Share

EMF EMF Asia EMF EMEA EMF Latin America

Price-Earnings Ratio _____________________

(U.S. cents) _________________

Forecast 1

LT Average2

Forecast3

Actual1

9.0 9.4 10.8 8.2

14.6 16.6 15.5 11.2

27.7 11.3 15.3 90.8

28.4 13.4 12.6 63.0

Sources: Morgan Stanley Capital International; I/B/E/S International; and IMF staff estimates. 1As at December 2002. 2From June 1992 to December 2002. 3Twelve-month forward as at December 2001.

Figure 3.12. Returns and Total Risk, 2002:Q4 Return in percent 20 EMF Latin America 16 NASDAQ

EMF EMEA

EMBI+ 12

Financials

In the United States, the gap between forecast and realized earnings appears to have narrowed in the past year, following the bursting of the asset price bubble in 2001, as analysts tempered their optimism in the wake of the global downturn (Figure 3.16). Within the emerging markets, earnings projections for Eastern European stocks appear to be converging with their actual results, which have been only slightly lower than forecast. Meanwhile, realized earnings in Asia have actually surpassed initial projections, supporting claims that the region’s equities are significantly undervalued and therefore provide upside potential in the year ahead. In contrast, market forecasts for earnings to rebound in Latin America remain subject to regional and geopolitical risks.

Health care

Utilities Energy 8

EM Free Telecommunications S&P 500

Industrials US high-yield

Consumer staples

ACWI Free

Materials

4

Consumer discretionary

EMF Asia

IT

0 0

5

10 Volatility in percent

15

20

Sources: Bloomberg L.P.; J.P. Morgan Chase; Merrill Lynch; Morgan Stanley Capital International; and IMF staff estimates.

Figure 3.13. U.S.-Based Mutual Fund Flows into Emerging Market, Emerging Asian, and Latin American Equities (In millions of U.S. dollars) 400 300 200

Syndicated Lending Turns Up Modestly A modest improvement in market sentiment helped boost syndicated loan volumes in the mature markets in the fourth quarter. Cumulative volumes for 2002 ended just 10 percent below those of 2001 in the United States and roughly flat in Europe but were some 40 percent below 2000 levels. Tiering according to credit quality remained pronounced in the fourth quarter. Banks (albeit fewer) continued to tighten lending standards in response to sizable losses on their exposures following the high-profile bank-

100 0 –100 –200

Emerging market Emerging Asian Latin American

–300 –400 –500

2002: Q1

2002: Q2

2002: Q3

2002: Q4

2003: Q1

–600

Source: AMG Data Services.

49

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.14. Cumulative Gross Annual Issuance of Equity (In billions of U.S. dollars) 50

40

2000

30 1997 1999

20

2002 10 1998 2001 Jan. Feb. Mar. Apr. May Jun.

Jul. Aug. Sep. Oct. Nov. Dec.

0

Source: Capital Data.

Figure 3.15. Equity Placements (In billions of U.S. dollars) 14

Other Latin America Asia

12 10 8 6 4 2

1994

95

96

Source: Capital Data.

50

97

98

99

2000

01

02

0

ruptcies of U.S. and European corporates and the default in Argentina. In this context, activity remained buoyant in the high-grade sector where downward pricing pressure persisted. Refinancings continued to dominate this deal flow. In the leveraged sector, deals remained highly structured and featured significantly higher pricing than in 2000–01. As noted in previous issues of the GFSR, merger and acquisitions (M&A) activity remained modest, save for deals in the European power sector. Similar concerns dominated syndicated lending to the emerging markets, where loan volumes remained subdued by historical standards (Figures 3.17 and 3.18). Commitments in the fourth quarter ($14.5 billion) were lower than in the third. This brought total issuance in 2002 to $56.9 billion, well below levels in 2001. Underpinning this reduction was a decline in demand for corporate funding in Eastern Europe as the outlook for eurozone growth dimmed. Banks became more reluctant to extend financing to credits deemed likely to be hurt by military conflict in Iraq. The early part of 2003 has been characterized by similar themes, with a rebound in activity in the loan markets unlikely in the absence of a decisive turnaround in the global economic outlook and a resolution of the uncertainty surrounding Iraq. A few salient features of recent loan market developments warrant highlighting: • After benefiting from a flight to quality earlier in the year, the EMEA region registered the greatest decline in syndicated volumes. Central European corporates pared back demand for cross-border funding in the context of lackluster activity in the eurozone economies and liquidity in local markets remained abundant. Further afield, however, Russian corporates (in the oil and gas and banking sectors) exhibited an increased appetite for funds. Sibneft secured $510 million in collateralized financing ahead of filing a successful $1.86 billion joint bid with Tyumen Oil for the

SYNDICATED LENDING TURNS UP MODESTLY

government’s 75 percent stake in Slavneft in mid-December. • In the fourth quarter, several Turkish banks refinanced maturing 365-day facilities at spreads comparable to those achieved a year ago. However, syndicated loan volumes to Turkey ended 2002 some 30 percent below 2001, and 70 percent below 2000. • In the Persian Gulf, high oil prices have helped spur project finance lending. At the same time, however, high oil prices have resulted in a liquid regional banking sector, reducing borrowers’ reliance on international banks. • Asian loan volumes remained muted in the fourth quarter of 2002. Sovereigns continued to enjoy increasingly comfortable foreign reserve positions, while local bond markets consolidated their role as the region’s preeminent provider of capital for corporates. In any event, Asian corporates exhibited little demand for new money as they continued to work off excess capacity. For those deals coming to market, tiering by credit quality became more pronounced, with increased due diligence by banks translating into more carefully considered pricing and structures. Specifically, risk-averse banks reportedly remain reluctant to lend to Indonesian and Philippine corporates. This was manifested in a retrenchment of cross-border financing in recent years. • In Latin America, the fourth quarter witnessed a resumption of a sizable commitment to an Argentine corporate, as Pecom Energia received a $599 million refinancing deal. Developments on the pricing front were dominated by lumpy loans in the fourth quarter (Figure 3.19). In Asia, the average loan margin increased, primarily owing to the provision of $900 million in three- and six-year financing for a leveraged buyout by a Korean corporate and $1,050 million in (14- and 16year) project financing for a Chinese corporate. However, in risk-adjusted terms, margin compression continued, reflecting ample

Figure 3.16. S&P 500 Earnings Per Share 70 Forecast

65 60 55 50

Actual

45

1998

99

2000

01

02

03

40

Source: I/B/E/S International.

Figure 3.17. Cumulative Gross Annual Loan Issuance (In billions of U.S. dollars) 125 1997 100

2000

2001

75

50

2002 1998

25

1999 Jan. Feb. Mar. Apr. May Jun.

Jul. Aug. Sep. Oct. Nov. Dec.

0

Source: Capital Data.

51

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

bank liquidity and a dearth of lending opportunities. In Latin America, attractive refinancing for Mexico’s Pemex amounting to $1 billion, together with a shortening of tenors in Chile, translated into a decline in the average loan margin.

Figure 3.18. Syndicated Loan Commitments (In billions of U.S. dollars) 40

Other Latin America Asia

35 30 25 20 15 10 5

1994

95

96

97

98

99

2000

01

02

0

Source: Capital Data.

Figure 3.19. Loan-Weighted Interest Margin (In basis points) 600 500 Latin America

400 300 200 100 Asia

1995

96

Source: Capital Data.

52

97

98

99

2000

01

02

0

Banking Sector Performance in Emerging Markets Banking sectors across major emerging markets have offered a mixed performance in recent years. Banks in some countries in Latin America remain in distress, as long-standing weaknesses have been aggravated by the recent economic turmoil. In other countries in the region, banks have realized stronger financial results, reflecting varying initial conditions and economic performance. By contrast, the financial health of banking sectors in the emerging countries of Europe has improved substantially, facilitated by significant bank restructuring efforts and entry of foreign banks in several Eastern European countries. A similar improvement is evident in Asia, although progress has been slower and weaknesses persist in some countries, mainly because of lagging bank and corporate restructuring. The soundness of banking systems is gauged by various indicators (Table 3.6 and Figure 3.20).1 These include indicators of profitability, measured by the return on assets (ROA); loan quality, given by the ratio of nonperforming loans to total loans (NPLs); capitalization, measured by the ratio of shareholder’s equity to assets (EA); financial strength ratings (FSR), based on analysts’ evaluations of the profitability and risk prospects of a banking sector; and market valuation (MV), 1Financial soundness indicators (FSIs) include aggregate information on financial institutions as well as other market-based indicators. A basic set of financial soundness indicators (regarded as core indicators by the IMF) and a broader set (including those whose compilation is encouraged by the IMF) are identified in Sundararajan and others (2002).

BANKING SECTOR PERFORMANCE IN EMERGING MARKETS

Table 3.6. Emerging Market Countries: Financial Soundness Indicators (End of period, in percent) Regions* Latin America Mean Median Standard deviation Eastern Europe Mean Median Standard deviation Asia Mean Median Standard deviation Latin America Mean Median Standard deviation Eastern Europe Mean Median Standard deviation Asia Mean Median Standard deviation Latin America Mean Median Standard deviation Eastern Europe Mean Median Standard deviation Asia Mean Median Standard deviation Latin America5 Mean Median Standard deviation Eastern Europe5 Mean Median Standard deviation Asia5 Mean Median Standard deviation

1997

1998

1999

2000

2001

2002 Latest

Return on Assets1 1.3 1.1 1.2

0.9 0.7 1.8

0.6 0.7 1.7

0.3 0.9 1.7

–0.1 0.2 2.6

–0.1 1.3 6.3

0.7 0.7 0.8

–0.3 –0.5 1.4

0.5 0.5 1.5

1.5 1.2 1.1

1.3 1.1 1.0

1.6 1.4 0.8

–0.1 –0.8 1.3

–4.4 –1.4 8.0

–2.0 –0.2 3.8

0.0 0.1 0.9

0.4 0.6 0.5

1.0 0.8 0.5

Nonperforming Loans to Total Loans2 5.3 5.5 3.1

7.4 7.0 3.6

8.2 8.7 3.2

7.6 8.4 2.9

7.8 8.5 3.5

10.8 9.0 9.0

21.4 20.8 18.2

21.1 16.1 19.7

17.6 13.9 14.2

10.2 10.5 5.6

8.6 7.4 5.2

8.0 5.3 6.8

10.1 5.8 7.3

22.4 14.4 16.4

20.4 14.7 11.2

14.5 15.1 4.5

12.5 11.5 4.8

10.3 10.4 4.0

Capital to Assets3 11.8 11.8 3.4

11.3 10.9 3.0

11.0 11.1 2.6

10.8 10.9 1.9

10.5 9.6 2.5

9.3 9.9 6.4

8.9 8.2 2.7

9.5 9.7 3.6

9.9 9.2 4.1

10.1 9.2 3.0

10.1 10.0 2.3

10.7 10.6 1.7

10.0 8.8 3.8

5.4 8.9 10.9

7.7 8.9 7.0

8.6 8.5 4.3

8.9 8.5 4.0

9.6 9.0 3.9

Moody’s Financial Strength Index4 ... ... ...

... ... ...

... ... ...

... ... ...

28.1 28.8 12.9

20.9 23.3 17.5

... ... ...

... ... ...

... ... ...

... ... ...

26.1 29.2 12

27.9 30.2 12.2

... ... ...

... ... ...

... ... ...

... ... ...

15.4 15.8 10.9

17.5 16.7 10.1

Sources: National authorities; EDSS; IMF staff calculations. *Latin America includes Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay, and Venezuela. Europe includes Bulgaria, Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovak Republic, and Slovenia. Asia includes India, Indonesia, Korea, Malaysia, Pakistan, Philippines, and Thailand. 1For most countries after-tax profit as a percentage of average total assets. 2For most countries gross loans classified as substandard, doubtful and loss as a percentage of gross total loans. 3For most countries shareholders’ equity (including profits) as a percentage of end-period total assets. 4Constructed according to a numerical scale assigned to Moody’s weighted average bank ratings by country. 5Latest data column refers to January 3, 2003.

53

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Figure 3.20. Market Valuation (January 1997 = 100) Median Banking Sector Market Valuation (left scale) Median Intra-Regional Pair-wise Correlations of Banking Market Valuation (right scale) 200

Latin America

180 160

Asian crisis

Russian crisis

02

1.0 0.8 0.6 0.4 0.2 0 –0.2 –0.4 –0.6 –0.8 –1.0 03

02

1.0 0.8 0.6 0.4 0.2 0 –0.2 –0.4 –0.6 –0.8 –1.0 03

02

1.0 0.8 0.6 0.4 0.2 0 –0.2 –0.4 –0.6 –0.8 –1.0 03

Crisis in Argentina

140 120 100 80 60 40

1997

98

99

2000

01

220 200 180

Eastern Europe Asian crisis

Russian crisis

160 140 120 100 80

Crisis in Argentina

60 40

1997

98

200

99

Russian crisis

180

2000

Asia

01

Crisis in Argentina

160 140 120

Asian crisis

100 80 60 40

1997

98

99

2000

01

given by the ratio of banks’ stock index to a broader market index. In addition, interdependencies of bank performance within regions can be inferred from correlations of banking system MVs.2 The weakening trend in key financial soundness indicators in Latin America masks considerable differences across countries. Although bank profitability (as measured by ROA) in the region on average shows a declining trend, the dispersion around this trend has increased. Developments in loan quality and capitalization are also characterized by a worsening on average and wide variation across countries. Financial strength ratings of the banking sectors in the region have also deteriorated, and these trends are confirmed by market valuations, which have been declining steadily since 1997. Reflecting the divergence of performance across countries, interdependence in bank performance—tracked by correlations among Latin American MVs—has been rather low and has turned negative more recently. Developments in some of the countries in the region dominate the overall trends. On the whole, banks have thus far been quite resilient, and have remained well capitalized and have recently resumed profitability. In Argentina, operational losses and NPLs remain high and the solvency of the banks continues to be uncertain. Nonperforming loans have increased rapidly at banks in Uruguay, with the system now recording negative equity. Progress toward a lasting solution of the suspended banks, and on changes in prudential and supervisory regulations, continues to be slow. The asset quality of Venezuelan banks has also deteriorated, and high inflation and political instability are put-

Sources: Datastream; and IMF staff estimates. 2As measured by median pair-wise correlations of banking system MVs. For a region composed of N countries, the median of the N(N – 1)/2 pair-wise correlations of MVs is computed using correlations among the monthly time series of MVs on a rolling window of one-year data.

54

BANKING SECTOR PERFORMANCE IN EMERGING MARKETS

Box 3.2. Emerging Market Contagion in 2002 By virtue of the size of its economy and its importance in the emerging bond market, developments in Brazilian markets can spill over to others. Last year, Brazilian markets were particularly affected by preelection uncertainty that coincided with a period of heightened global risk aversion. While investor discrimination prevailed, cross-correlations with Brazil rose during the height of the sell-off in September, particularly in Latin America.1 The pressure on bond prices experienced by emerging markets during a sell-off in Brazil tended to exceed the price appreciation experienced by these markets during a rally in Brazil—underscoring the vulnerability of emerging bond markets.

Emerging Bond Markets: Average CrossCorrelations 0.7 0.6 0.5 0.4 0.3 0.2 0.1 1998

Emerging market contagion remained high toward the end of the second and throughout most of the third quarters of 2002. Uncertainty over policy continuity ahead of the October elections in Brazil contributed to a broad-based decline in emerging bond prices. Nevertheless, contagion remained below previous peaks, including the levels associated with the 1998 Russian crisis (see the first Figure). A number of developments appear to have mitigated contagion: • Leverage of emerging market investors declined in the aftermath of the Russian crisis, reflecting in part a withdrawal of macro hedge funds from the market as well as a reduction of counterparty risk by intermediaries and an increase in collateral requirements for lending operations. The scope for margin calls to trigger a vicious cycle thus has been reduced. • The credit quality of issuers has been rising steadily. The share of investment-grade sovereign issuers in the emerging bond market

1The analysis is based on daily data since the end of 1997 for 20 countries included in the EMBI Global. Contagion is measured by the average cross-correlation, defined as the simple average of all pair-wise, 30-day rolling return correlations across 20 of the largest constituents of the EMBI Global.

99

2000

01

02

03

0

Sources: J.P. Morgan Chase; and IMF staff estimates. Note: Thirty-day moving simple average across all pairwise return correlations of 20 constituents included in the EMBI Global.

universe rose from 12.8 percent in 1998 to 33 percent in 2002. The attendant improvement in fundamentals is supportive for the asset class, although credit ratings have proven volatile. • Demand for sovereign bonds by local investors has also increased, most recently in Russia and Turkey, thus extending the investor base and potentially mitigating market volatility. • Investor discrimination appears to have risen as the asset class has matured and policies have been strengthened in a number of countries. Nevertheless, average correlation measures tend to mask “cluster points” of high correlations. These may exist within specific geographical regions or among sovereigns with similar credit ratings. Breaking down the average cross-correlation into its regional components illustrates that contagion in Latin America was higher than in Asia and EMEA in 2002 (see the second Figure). The volatility experienced by Brazil also had greater repercussions for its peers in Latin America than in EMEA or Asia. Brazil’s

55

CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Box 3.2 (concluded) Average Regional Cross-Correlations by Region

Average Pair-Wise Correlations with Brazil by Region

Latin America

0.4

Overall

0.8 Overall

0.3

0.6

Latin America 0.4

0.2

0.2

Asia

0.1 0

EMEA 0

2002

2003

Asia

–0.2

–0.1

–0.4 2002

Sources: J.P. Morgan Chase; and IMF staff estimates. Note: Simple average of all pair-wise correlations of all markets in a given region with all other emerging bond markets, regardless of region.

pair-wise correlation with markets in Latin America exceeded on average those with EMEA and Asia for virtually all of 2002 (see the third Figure). Pair-wise correlations with Brazil rose, almost indiscriminately, to comparable levels for a number of the Latin American markets at the height of the Brazil sell-off on September 29, when the EMBI Global subindex spread reached 2,451 basis points (see the fourth Figure). In contrast, the pair-wise correlations with Brazil spanned a wider spectrum for all regions, including Latin America, as Brazilian spreads reached their 2002 low of 699 basis points on March 15 (see the fifth Figure). Investor discrimination, therefore, appears to have weakened at the height of the sell-off. To examine the behavior of correlations during periods of market turbulence, pairwise correlations are calculated conditional on the returns for Brazil and grouped into three bands: (1) positive returns of Brazil exceeding one standard deviation from their five-year mean; (2) negative returns of Brazil exceeding one standard deviation from their five-year mean; and (3) a middle band with

56

EMEA

2003

Sources: J.P. Morgan Chase; and IMF staff estimates. Note: Simple average across pair-wise cross-correlations of all emerging bond markets in a given region with Brazil.

returns ranging within one standard deviation of the five-year norm (see the Table). • Pair-wise correlations with Brazil were asymmetric and correlations tended to rise

2002 Brazil Sell-Off: Pair-Wise Correlations 1.0 Mexico

Peru Russia

Panama Bulgaria

Philippines

Venezuela Turkey

Ecuador

0.6

Colombia

0.2

Croatia Morocco Korea

South Africa Poland Malaysia

–0.2

China

–0.6

0

500

1000 1500 Spreads (in basis points)

2000

–1.0 2500

Sources: J.P. Morgan Chase; and IMF staff estimates. Note: Thirty-day moving simple average as of September 27, 2002; the intra-year high of Brazil’s EMBI+ global sub-index spread.

BANKING SECTOR PERFORMANCE IN EMERGING MARKETS

Pair-Wise Correlations with Brazil Conditional on Brazilian Returns

2002 Brazil Rally: Pair-Wise Correlations 0.8

0.6 Venezuela

Ecuador

Russia

0.4

Bulgaria Panama Turkey

South Africa

Philippines Mexico

China

Croatia

0.2

Poland Malaysia Korea Peru Morocco

0

Nigeria

250

0

Colombia

500 750 Spreads (in basis points)

–0.2

1000

–0.4 1250

Sources: J.P. Morgan Chase; and IMF staff estimates. Note: Thirty-day moving simple average as of March 15, 2002; the intra-year low of Brazil’s EMBI+ global sub-index spread

during sell-offs. For all markets, except Venezuela, pair-wise correlations associated with a sell-off in Brazil in excess of one standard deviation exceeded the correlation associated with a positive return in Brazil in excess of one standard deviation. • Pair-wise correlations with Brazil were highest across Latin America. The vulnerability of these markets is underscored by the pronounced increase of correlations during periods of a Brazilian sell-off, including for Mexico. The high correlation with Brazil exhibited across Latin America during the height of last year’s sell-off, captured in the fourth Figure, thus does not appear atypical. • Pair-wise correlations also tended to increase sharply in EMEA during periods of a Brazilian sell-off, most notably for Bulgaria, Croatia, and Morocco. Turkey’s relatively low correlation may in part reflect the increasing share of bond holdings by its domestic investor base.

> +1 σ

+1 σ and –1 σ

< –1 σ

Latin America Average

0.35

0.39

0.49

Argentina Colombia Ecuador Mexico Panama Peru Venezuela

0.29 0.23 0.33 0.54 0.37 0.30 0.42

0.38 0.26 0.33 0.55 0.42 0.38 0.43

0.34 0.51 0.50 0.62 0.54 0.54 0.41

Emerging Europe, Middle East & Africa Average 0.17 Bulgaria 0.29 Croatia 0.26 Morocco 0.21 Nigeria 0.09 Poland 0.26 Russia 0.14 South Africa 0.18 Turkey –0.10

0.20 0.37 0.11 0.27 0.13 0.18 0.31 0.03 0.19

0.43 0.56 0.57 0.47 0.38 0.42 0.42 0.34 0.28

Asia Average

0.01

0.15

0.31

–0.08 0.13 –0.06 0.04

0.05 0.16 0.11 0.26

0.07 0.50 0.19 0.46

Brazil Return

China Korea Malaysia Phlippines

Sources: J.P. Morgan Chase; and IMF staff estimates.

• Pair-wise correlations with Brazil are lowest in Asia across the entire return spectrum, largely reflecting Asia’s higher credit ratings as well as differences in investor bases. Within Asia, the Philippines and Korea, however, stand out as their respective correlations with Brazil rose sharply during periods of a sell-off. In the case of Korea, this outcome however appears to have been dominated by market behavior in the aftermath of the Asian crisis. As Korea regained its investment-grade status, correlations have broken down, also illustrated by the negative correlation exhibited in the fourth Figure. In contrast, the Philippines appear to have remained vulnerable to a Brazilian sell-off, as captured by its relatively high correlation exhibited in the fourth Figure.

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Box 3.3. Collective Action Clauses: Latest Developments At the end of 2002, emerging market international sovereign bonds issued with collective action clauses (CACs) amounted to about 30 percent of total sovereign bonds issued by the emerging markets (see the Table and Figure). However, little evidence suggests that investors actually eschew bonds issued with CACs. Rather, the terms of the bonds are typically determined by a variety of factors, including changes in the issuer and investor base, the desired currency denomination of the issue, and debt management considerations. While several emerging market issuers have shown interest in including collective action clauses in their non-London issuances in principle, countries have thus far been reluctant to issue bonds with CACs under New York law. Among industrial countries, the EU member states, Canada, and Switzerland have announced the intention to introduce CACs in their foreign law bonds. In late February, Mexico became the first large emerging market issuer to include CACs in their newly issued $1 billion New York law governed bonds.1 This Mexican issue will allow investors holding 75 percent of the bonds to modify the payment terms, and investors holding 25 percent of bonds to accelerate the bonds following an event of default. It will also make the use of exit consent more difficult by increasing the voting threshold from 66
/3 percent to 75 percent, for changing, among others, the governing law provisions and the waiver of immunity. The bonds, maturing March 3, 2015, carry a coupon of 6.625 percent, and were priced to yield 6.918 percent, or a spread of 312.5 basis points over 10-year U.S. treasuries. There was no evidence of a CAC premium priced in the new bond. 1Even though Egypt (2001), Lebanon (2000), and Qatar (2000) had issued bonds with majority restructuring clauses governed by New York law before, Mexico is the first large emerging market issuer who had publicly announced including such clauses in the bond issuance.

58

Emerging Markets Sovereign Bond Issuance by Jurisdiction1 2001 ______________ Q1 Q2 Q3 Q4

2002 ______________ Q1 Q2 Q3 Q4

With CACs2 Number of issuance 14 10 2 10 Volume of issuance 5.6 4.9 1.8 2.2

6 5 2 4 2.6 1.9 0.9 1.4

Without CACs3 Number of issuance 16 17 6 18 17 12 5 10 Volume of issuance 6.7 8.5 3.8 6.2 11.6 6.4 3.3 4.4 Source: Capital Data. 1Number of issuance is in units. Volume of issuance is in billions of U.S. dollars. 2English and Japanese laws. 3German and New York laws. However, the Egyptian issuance of $1500 million out of New York in June 2001 contains CACs and thus reclassified.

There is broad agreement that the inclusion of contingency clauses in bond contracts could facilitate the restructuring process. However, discussions are still ongoing on what would constitute best practice for model contingency clauses. Efforts are under way in both the official community and the private

Emerging Market Sovereign Bond Issuance by Governing Law 1 (In percent of total volume) 100

80

New York English German Japanese

50000

40000

Issuance volume (in millions of U.S. dollars; right scale)

60

30000

40

20000

20

10000

0

1994 95

96

97

98

99 2000 01

02

Sources: Capital Data; and IMF staff estimates. 1The total is the sum of bond issuance governed by New York, English, German, and Japanese laws.

0

BANKING SECTOR PERFORMANCE IN EMERGING MARKETS

sector to define a set of model clauses that could improve the process of debt restructuring for a sovereign in financial distress without compromising creditor rights. More specifically, the official community through a working group of the Group of Ten (G-10) has consulted with market participants, issuers, and legal experts, and has developed a set of recommendations that aim at bringing about a positive change in the debt restructuring process. In its report issued in September 2002, the G-10 proposed a set of clauses based on existing practices with respect to bonds governed by English law and reflect the principles of (1) fostering early dialogue, (2) ensuring effective re-contract, and (3) minimizing litigation by minority creditors. Six prominent private sector financial groupings (EMCA, EMTA, IIF, IPMA, SIA, and TBMA) communicated an initial proposal of a set of model clauses in May 2002.2 Following the IMF Annual Meetings,

2Emerging Markets Creditors Association (EMCA), Emerging Markets Traders Association (EMTA), Institute for International Finance (IIF), International Primary Market Association (IPMA), Securities Industry Association (SIA), and The Bond Market Association (TBMA).

ting further pressure on their core profitability. But the banking system in Brazil appears to have weathered considerable stress. Profitability, loan quality, and capital adequacy of the banking system in Mexico have improved recently. The banking system in Chile also remains robust despite a modest increase in NPLs. Bank performance indicators in emerging markets in Europe have generally improved substantially since 1998. From being negative in 1998, average ROA has climbed to a remarkable 1.6 percent, while the NPL ratio has declined by 11 percentage points and cap-

these associations plus the International Securities Market Association (ISMA) continued to refine these clauses with the objective of reaching agreement within the private sector on a market standard for contingency clauses in bonds under New York and English laws. There is broad agreement that a set of marketable model clauses must contain provisions on initiation, representation, majority restructuring, and enforcement. There is also broad agreement that model clauses would need to call for enhanced transparency and the provision of more information by the issuers in the event of a default. One key area where official and private sector approaches have differed thus far is the voting threshold on changing key terms that would bind minority shareholders. More work needs to be done to achieve a broad international consensus on a consistent set of contingency clauses. Moreover, emerging market issuers have yet to embrace more broadly the inclusion of CACs into their new bond issuance. While it is still early to draw firm conclusions, the recent Mexico issue may be viewed as a welcome move from theory to practice and as a test of market acceptability of meaningful clauses under New York law that could pave the way forward.

italization has increased by about 2 percentage points. The generalized improvement is also evidenced by the sharply declining dispersion of financial soundness indicators across countries, higher financial strength ratings, and climbing market valuations. Measured interdependencies of bank performance in the region, however, have been low and have increased only in the past year. Profitability and asset quality continued to strengthen in key countries in the region, including Bulgaria, the Czech Republic, Hungary, Romania, and Russia. Nonperforming loans remain above 20 percent in Poland,

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although loan classification criteria there is stricter than in most other countries, and the banking system continues to be viewed positively by the market. The distress in the banking system continues to persist in Turkey, with deteriorating asset quality and capital adequacy, and depressed profitability. Resolution of problem banks continues to lag behind and is a significant drag on the system, reflected also in weaker financial strength ratings. Developments in bank soundness indictors are generally encouraging in Asia. Profitability has improved in most countries, with the average ROA turning from negative in 1997– 1999 to about 1 percent more recently. The quality of the loan portfolio has improved, although the average NPL ratio remains slightly higher than 10 percent. Capitalization remains stable—with an average EA of about 9 percent—and financial strength ratings and market valuation have improved. Interdependencies in bank performance within the region spiked during the Asian crisis and remained high until the end of 1999, but have declined substantially since then, owing to varying performance across countries. Improvements in bank performance in Asia have been somewhat uneven. Banks in Malaysia and Korea have made remarkable progress in terms of profitability, and asset quality, helped by progress in NPL disposals and corporate restructuring. Although banks in Thailand and Indonesia show signs of improving profitability, market analysts remain cautious in assessing banking and financial sector performance. Continuing concerns stem from the fact that the decline in NPLs largely reflects transfers of nonperforming loans to their asset management corporations, and credit risk, particularly in Indonesia, continues to be a concern. Banks in India have shown some improvement in asset quality, profitability, and market valuation, while those in the Philippines continue to experience a further worsening of several financial soundness indicators as well as declines of the market valuation of the banking sector.

60

Among the other emerging markets, banks in Lebanon remained highly exposed to sovereign risk, owing to their large exposure to government debt. Credit quality remains a problem in Egypt, especially in public sector banks, and the system is still vulnerable to further credit quality problems due to a weak economy and a sharp exchange rate depreciation. Although South African banks have performed satisfactorily, their asset quality is likely to suffer from the increase in corporate defaults currently experienced in several sectors.

Outlook The past year highlights the vulnerability of emerging markets to reversals in investor sentiment and capital flows that can arise from either external or internal developments. The combination of an unsupportive external environment and investor concerns over the risk of policy discontinuity in key emerging market countries limited the availability and raised the cost of capital to emerging market borrowers. These developments highlight the importance of “self-insurance” as a means of mitigating the impact of externally induced volatility. Indeed, a number of emerging market countries have taken steps to insulate themselves from external financial market developments through, among other moves, the development of local financial markets (see Chapter IV). The past year also illustrates that the sustained pursuit of sound policies pays off. Marked investor discrimination was evident in both the secondary and primary emerging bond markets. Contagion thus remained low, reflecting changes in the structure of the emerging market investor base, steps to promote transparency to help investors distinguish among borrowers, and policies aimed at promoting financial stability. The latter policies have been reflected in notable improvements in banking sector regulation and capitalization, although these have varied by

OUTLOOK

region, and much more is needed to bolster domestic banking systems. Credit spreads widened most for borrowers with low credit ratings or perceived to be most at risk for an unfavorable reorientation of policies. These same borrowers met the most resistance in the primary markets. In contrast, investment-grade borrowers enjoyed relatively easy market access, and spreads in the secondary market for these issuers in Asia and Eastern Europe fell to near record lows (Figure 3.21). Most Asian borrowers are likely to continue to benefit from strong regionally driven demand for new issues. There is now little sign that the enthusiasm over EU accession will unravel in a disruptive manner. But the degree of spread compression raises the likelihood of occasional reversals, especially if the market’s current expectations of a smooth path to accession is disappointed. The current marked bifurcation in the secondary emerging bond market is likely to persist, barring a substantial improvement in investor sentiment toward high-yielding emerging market borrowers. The risk that the external environment could again become unsupportive remains palpable: • The hesitant and uneven global economic recovery could once again be put in doubt, undermining investor expectations for corporate earnings growth and the basis for current stock market valuations. In that event, falling equity markets could once again increase investor risk aversion and perception of risk and contribute to a renewed curtailment of capital flows to emerging markets. • While a continued gradual decline in the dollar is unlikely to prove problematic to emerging markets, a precipitous fall in the context of heightened and generalized risk aversion could be more problematic. • The risks to emerging markets posed by a possible war with Iraq could be transmitted through higher oil prices; reduced consumer and business sentiment and expenditure leading to slower global growth; and

Figure 3.21. Sovereign Spreads Versus Historical Lows (In basis points) EMBI+ Non-Latin Latin Brazil Bulgaria Colombia Ecuador Egypt Malaysia Mexico Morocco Nigeria Panama Peru Philippines Poland Russia South Africa Turkey Ukraine Venezuela

Historical lows February 28, 2003

0

250

500

750

1000

1250

1500

1750

Source: J.P. Morgan Chase.

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heightened investor risk aversion that raises the cost and reduces the availability of capital to emerging markets. Markets appear to have taken a rather sanguine view on the impact of an eventual war (see Box 3.1). A less benign outcome could heighten risk aversion, trigger flows to safe haven assets, and amplify the home-market bias of investors. A renewed curtailment of flows to emerging markets focused in particular on sub-investment-grade credits would likely result from a war-induced heightening of risk aversion. In the primary bond market, issuance is expected to remain muted this year. Most analysts expect sovereign bond issuance to total some $25 billion, about $7 billion less than 2002. Moreover, notwithstanding the rebound in sub-investment-grade issuance in January, most analysts expect credit tiering to persist this year. Investment-grade borrowers in Latin America, Eastern Europe, and Asia are expected to retain unimpeded market access, while sub-investment-grade issuers, especially in Latin America, are likely to experience periods of difficult access. The primary market is expected to remain closed to sovereign issues by Brazil until spreads fall considerably further from about the 1,300 basis points prevailing at the end of January. Uruguay, Venezuela, and Ecuador would have difficulty accessing the markets at present. Argentina is out of the markets until it goes through its debt restructuring. Other Latin American countries should be able to retain market access. However, if investor concerns about Brazil were to re-intensify, the market would once again close to most sub-investment-grade Latin American issuers as it did for an extended period last year (see Box 3.2 and the Appendix to this Chapter). In addition, market access may become more restrictive for Turkey and the Philippines, notwithstanding the support they have received from strong local investor demand and placements in recent months.

62

In the secondary emerging bond market, most analysts expect returns to moderate from the stellar performance of last year. Nevertheless, these returns are generally expected to continue to compare favorably with alternative investments. The main source of return is expected to derive from the high coupon on emerging market bonds. U.S. treasury yields, which contributed to emerging market bond returns last year, are not expected to fall significantly further. Moreover, the scope for further spread compression appears concentrated in a few high-yielding countries, including in particular Brazil, as spreads are approaching all-time lows in the case of some Asian and Eastern European issuers. As a result, returns for 2003 are widely expected to be about 7 to 10 percent. The relatively strong risk-adjusted performance of emerging market bonds in recent years (Figure 3.22), mounting disenchantment with equities, and low yields on safer government bonds have kindled institutional investor interest in emerging market bonds. Emerging market bond mandates were initiated by institutional investors in the fourth quarter of last year and most emerging market bond managers expect continued inflows. A further technical factor seen supporting the market this year is the high amount of coupon and amortization payments falling due in 2003. Some $20 billion in sovereign payments are due from EMBI+ countries, and some $30 billion from EMBIG (Diversified), against a backdrop of falling gross issuance. Brazil, Colombia, Mexico, Venezuela, Russia, Turkey, and the Philippines all have bonded payments substantially exceeding $1 billion (over $4 billion in the case of Brazil, Turkey, Russia, and Mexico), and, with the exception of the Philippines and Turkey—which have relatively small weights in the index—none of these countries has a stated goal of being a net issuer this year. The baseline outlook of positive but slow global economic growth; limited inflationary pressure; low yields on major domestic gov-

APPENDIX

ernment bonds; and continued progress in strengthening the balance sheets of the household, corporate, and financial sectors in the major economies could create a favorable environment for emerging market bonds. Some of the accumulation of cash by both retail and institutional investors (see Chapter II) could be allocated to emerging market bonds, attracted by their high yields and track record of solid risk-adjusted returns, especially relative to alternative investment opportunities. Provided that these flows are based on a realistic assessment of fundamental relative strengths, and do not merely reflect an attempt to reach for yield in an environment of limited return prospects elsewhere, emerging markets should benefit.

Appendix: A “Feast or Famine” Dynamic Prevails in Emerging Primary Markets Emerging debt markets have regularly been punctuated by periods of primary market closure to a wide variety of issuers. Some issuance “famines” have affected all issuers irrespective of region or credit rating. Others have been more selective, focusing on particular regions or points along the credit quality spectrum. Such periodic interruptions result in a “feast or famine” dynamic in primary markets in which periods of closure are followed by a glut of issues that can quickly saturate the market, and cause subsequent “indigestion” in secondary markets as well (Figure 3.23). The most recent issuance famine covering most of May–November of last year was concentrated on, but not limited to, sub-investment-grade Latin American issuers. The behavior of markets suggests that the strength of this dynamic may have increased over time. Moreover, the growing influence of changing global investor sentiment and liquidity conditions on emerging primary debt markets renders the mitigation of the feast or famine dynamic difficult period looks strange, particularly for lower rated emerging market countries.

Figure 3.22. Risk Versus Return, January 1998– December 2002 Return 10 U.S. treasury EMBI+ U.S. investment grade corporate Global investment grade corporate

5

U.S. high-yield corporate

EMF EMEA 1

0 S&P 500 European equities

MSCI All Country World index

NASDAQ

EMF Asia

–5

Topix MSCI Emerging Markets Free (EMF) –10 EMF Latin America

–15 0

5

10

15

20

25

30

35

40

Standard deviation Sources: Bloomberg L.P.; J.P. Morgan Chase; Merrill Lynch; Morgan Stanley Capital International; and IMF staff estimates. 1Data available from July 2001 only.

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Figure 3.23. EMBI+ with Periods of Opening and Closure (In basis points) Periods of market closure

EMBI+/EMBI splice 2000 1750 1500 1250 1000 750 500 250 0

1994

95

96

97

98

99

2000

01

02

03

Sources: J.P. Morgan Chase; and IMF staff estimates.

Figure 3.24. EMBI+ Volatility During Market Closures (In percent) 60 T=0

T + 22

50

In the aftermath of the Asian and Russian crises in 1997–98, the investor base in the secondary market for emerging market bonds has changed in a way that increases stability in part by reducing the degree of leverage in the system (see Box 3.2). Until the fairly recent increase in leveraged investor activity, hedge funds had diminished considerably in importance, and some crossover investors have provided increased support, particularly for investment-grade issuers. Meanwhile, local investors in Asia, the Middle East, some countries in Latin America, and the Caribbean have burgeoned. In Eastern Europe, “convergence” funds that invest in the local bond and money markets of Central and Eastern European markets on the road to EU accession have also made their presence felt. Such factors have frequently been cited as a cause for diminished contagion in secondary markets, and a maturing of the asset class. At first glance, the generally diminished role of hot money and a widening investor base might normally be expected to contribute to the maturing of primary markets as well, leading to a smoother path of access of creditworthy issuers to primary markets. Building on prior work,3 this Appendix analyzes the dynamics of market closure and reopening and puts the closure of last year in perspective. It concludes with some comments on the scope for mitigating the impact of the feast or famine dynamic in the primary market for emerging market bonds.

40

Current Market Reopening in Perspective

T–60 –50 –40 –30 –20 –10

0 Days

30 +10 +20 +30 +40 +50 +60

The fourth quarter of 2002 saw the end of yet another issuance famine. Sub-investmentgrade credits, particularly in Latin America, were largely shut out of the primary markets

Sources: J.P. Morgan Chase; and IMF staff estimates. 3See IMF (2001a and b). The former (2001a) documents the existence and basic features of market closures, and the latter (2001b), while not exclusively focused on closures, explores explanatory variables for the level of emerging market debt issuance.

64

APPENDIX

for 20 of the 27 weeks following the second week of May. By historical standards, this was indeed a severe closure. Much of the severity was attributed to economic and political uncertainty surrounding Brazil, and its potential spillovers to the Latin American region. While Brazil-related uncertainty did play a part, some global factors were at play, including a slump in global equity markets, increased equity market volatility, and what financial market participants deemed to be a large spike in risk aversion leading to dislocation in most credit markets. That these broader global factors did play a significant role is well illustrated by the fact that issuance of emerging market bonds was curtailed even for investment-grade issuers—a fate that their corporate counterparts in U.S. credit markets were also unable to escape completely. Subsequent to the market closure ending in late October 2002, the usual pattern of an issuance glut followed, with over $20 billion of new issuance hitting the markets over the subsequent 9–10 weeks. To put this episode in some context, it is useful to begin with three enduring (and intuitive) stylized facts regarding market closures, derived from the previous studies cited: • Closures typically occur following a period of heightened secondary market volatility, and do not appear to be dependent on the level of secondary market spreads. • They may occur either due to binary events or expectations of such events in emerging markets, or due to extreme uncertainty in the external environment. • The duration of closures purely due to external environment considerations is typically shorter than those caused by emerging market specific events.

The weekly issuance data of emerging market bonds during 1994–2002 suggest that there have been 21 periods of market closure, 13 of which affected the broad spectrum of emerging market issuers, while the others affected mainly sub-investment-grade issuers.4 The definition of a closure (see footnote 4) reduces the variation considerably, with the caveat that there are several more one to two week periods during which issuance seems depressed. On average, closures so defined last 22 days. Most of these closures are associated with emerging market specific risks (credit events, devaluations, and their buildups). The remainder are associated with the external environment (interest rate anxieties, mature equity market downturns, mature spread market concerns). To gain better insight into such periods, several variables were examined both prior to a closure and subsequent to a reopening. The salient results are presented in the form of an event study. The event graphs have a vertical line at T = 0 signifying either an opening or a closing of primary markets, and the average path of that variable for two months before and after the closure. For example, Figure 3.24 shows rolling two-week EMBI+ index volatility, with a vertical line at T = 0 signifying closure of the market. Figure 3.24 clearly shows that closures are associated with an abrupt spike in secondary bond market volatility, and reopenings (on average at T + 22) are associated with an equally sharp reduction in volatility. Among the external factors influencing the feast and famine dynamic, mature equity market implied volatility stands out. Market closures seem to be quite strongly associated with a rising level of the VIX index5—a measure of

4A market closure is defined as a period of more than two weeks during which overall emerging market sovereign issuance is 20 percent or less of the period’s trend. Additionally, we applied a 40 percent or lower filter for subinvestment-grade issues, which produced seven “additional” closures. Seasonal effects have been taken into account in both filters. 5The index is a gauge of future market volatile based on the weighted average of eight puts and calls traded on the Chicago Board Options Exchange, with a rising VIX index implying higher expected volatility.

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Figure 3.25. VIX Index and Primary Market Closures (1994–96) 17.0 T – 22

T=0 16.5

+1 Standard deviation

Mean

16.0 15.5 15.0 14.5

–1 Standard deviation

14.0 13.5

T–60 –50 –40 –30 –20 –10

0 +10 +20 +30 Days

+40 +50

13.0 +60

Sources: Bloomberg L.P.; and IMF staff estimates.

Figure 3.26. VIX Index and Primary Market Closures (1997–2002) T – 22

32

T=0

31 +1 Standard deviation

30 29 28

Mean

27 –1 Standard deviation

26 25

T–60 –50 –40 –30 –20 –10

0 +10 +20 +30 Days

Sources: Bloomberg L.P.; and IMF staff estimates.

+40 +50

24 +60

implied U.S. equity market volatility—and openings with a gradual falling off in the index (Figures 3.25 and 3.26). After the Asian crisis, this link appears much stronger than during 1994–96.6 The return and volatility of the EMBI+ index appear to be influenced by changes in the VIX index. While the data do not support the hypothesis that the VIX index Grangercauses EMBI+ returns or volatility, large changes in the VIX index have a clear correspondence with both EMBI+ returns and volatility, with a stronger correspondence with EMBI+ volatility. To further examine the possibility that primary market closures may have become more linked to external environment conditions over the years, we also looked at U.S. corporate bond market spread differentials across the credit quality spectrum (Figures 3.27 and 3.28). Two frequently cited gauges of risk aversion in these markets are the spread differentials between double-B and triple-B rated corporate spreads (the “junk” bond premium), as well as the triple-B to single-A spread differentials (risk premium in the high-grade market). Once again, we observe that emerging market closures are increasingly associated with a rising corporate junk bond premium after 1997, while reopenings are associated with a falling premium. There was no discernible similar pattern with the high-grade market risk premium. However, it may be premature to conclude that highgrade secondary market dynamics have little bearing on emerging primary market activity. Clearly, in periods during which banks are shrinking their balance sheets to lower risk, the coincidence of rising high-grade risk premia and increased volatility in emerging secondary and primary markets will likely be strong, as seen in the third quarter of 2002. Furthermore, this link is also likely to be

6In these and all subsequent graphs T = 0 indicates a “reopening” of the market.

66

APPENDIX

strengthened in the future as the share of emerging market bonds that are investment grade rated rises, making the ownership of high-grade corporate debt and emerging market sovereign debt increasingly integrated. In periods preceding emerging market closures when there has been no proximate emerging markets-specific cause, the volatility of the EMBI+ does not rise in a smooth fashion even though the “junk bond premium” may have been rising quite steadily for up to three months before the market closure. There appears instead to be an abrupt move up in EMBI+ volatility followed by primary market closure. In other words, there is some “catch up” price correction in the secondary emerging bond market, and this has not lessened over time. A closer look at market reopenings provides an insight into the “feast or famine” dynamic. Periods of closure generally tend to shut out the riskiest credits (or the most frequent borrowers) first. The period of closure appears to create pent-up pressure to issue as soon as possible into the reopening. This pent-up demand partly reflects the tendency for the riskiest credits or the most frequent borrowers to be the first to be shut out of the primary market. In addition, issuers perceived that it is beneficial to be among the first issue into a reopening. As a result, there is a tendency to have an issuance glut at the time of reopening, which almost invariably causes secondary market indigestion a few weeks later. For example, sub-investment-grade new issue volumes in the first week of a reopening have become increasingly large since 1996. During 1996–2002, the average first week of reopening typically saw sub-investment-grade issuance volume of some 40 percent higher than “normal” levels, with such above-normal issuance continuing (typically for three weeks) before another period of short closure (one to four weeks). The top issuers that have historically come to market in large volumes immediately following a reopening include Argentina, Turkey, Mexico, and the Philippines, in that order.

Figure 3.27. BBB - BB Spread Differentials and Primary Market Closures (1994–96; in basis points) T – 22

120

T=0

118 116 +1 Standard deviation

114 112 110

Mean

108 –1 Standard deviation

106 104 102

T–60 –50 –40 –30 –20 –10

0 +10 +20 +30 Days

+40 +50

100 +60

Sources: Merrill Lynch; and IMF staff estimates.

Figure 3.28. BBB - BB Spread Differentials and Primary Market Closures (1997–2002; in basis points) 220 T – 22

T=0 210

+1 Standard deviation

200 190

Mean 180

–1 Standard deviation

170 160

T–60 –50 –40 –30 –20 –10

0 +10 +20 +30 Days

+40 +50

150 +60

Sources: Merrill Lynch; and IMF staff estimates.

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CHAPTER III

EMERGING MARKET DEVELOPMENTS AND FINANCING PROSPECTS

Given that all of these issuers have experienced individual loss of market access, even when the broader market was open, another interesting question is whether there is a secondary market spread level at which market access is restored to an individual borrower. A simple rule of thumb suggests that market access appears to become increasingly difficult beyond a spread of 900 basis points. It is not possible, however, to discern whether this is a supply side effect driven by issuer reluctance to lock in high rates, or whether it stems from the demand side, as investors consider the risks associated with such spreads incompatible with primary market purchases. Argentina appears to be an exception to this rule of thumb and has twice issued at spreads of 1,100 basis points or more. Setting aside global and macro factors, market participants are (somewhat predictably) divided as to whether the structure of the market itself tends to encourage the issuance gluts that follow reopenings. Investment banks (the “sell side”) commonly argue that these spurts are unavoidable and broadly follow the changing appetite of the end investors (the “buy side”) in a risky asset class where the “fear and greed” dialectic is an entrenched feature. The “buy side” on the other hand argues that investment banks frequently exaggerate such factors to issuers and encourage them to issue more and tend to cluster new issues as each investment bank wants to lead a transaction earlier than its competition. They also point to the fact that investment banks have been increasingly squeezed on their fees for managing transactions in one of the few relatively risk-free activities from their standpoint. Some on the “buy side” therefore argue that issuance gluts following reopenings are, at least in part, a volume-driven response by the “sell side” to shrinking fees. Is This Reopening Different? With this backdrop, it would appear that the reopening that began in the fourth quar-

68

ter of 2002 differs significantly from other reopenings: • It is the first reopening of emerging primary markets since the advent of the euro in which the U.S. dollar market has had to bear the brunt of the new issues. The share of dollar issuance in the fourth quarter of 2002 climbed to 83 percent, its highest quarterly value since 1999 (compared with a low of 51 percent in the second quarter of 2000). This picture is unlikely to change as the retail-dominated euro investor base (which absorbed just 5 percent of bond issues in the fourth quarter of 2002) suffered a long-term setback following the Argentine default. The yen market remains moribund, with only a few select issuers seen as having successful issuance prospects this year. Heavy reliance on the dollar market raises the risk that the issuance glut could lead to a more pronounced than usual bout of secondary market indigestion, adding further fuel to the “feast or famine” dynamic. Mitigating this risk at present is the absence from the market of two traditionally large issuers, Brazil and Argentina. • Issuance patterns strongly illustrate that “tiering” remains prevalent. Of the approximately $20 billion in bonds that have been issued in the 9–10 weeks following this “reopening” of emerging primary bond markets since October 1, roughly 45 percent of the issuance is accounted for by investment-grade issuers. The picture is strengthened when the lens is further focused on sovereign debt issuance. Of the roughly $9 billion in sovereign issuance since October 1, nearly 50 percent is accounted for by investment-grade issuers. Previous reopenings of primary markets were usually characterized by a much higher share of sub-investment-grade issuers, precisely because these were the issuers that were hit hardest by market closures. The fact that sovereign bond issues have much more “crossover” investor sup-

REFERENCES

port now compared to even two or three years ago masks the true degree of difficulty in obtaining financing from a “dedicated” pool of world savings. • Conditions in emerging primary markets in the most recent reopening showed a closer correspondence (in terms of timing and secondary market behavior) with mature credit markets than any other previous reopening, perhaps reflecting a trend toward closer financial market integration linked to changes in the investor base for emerging markets. For countries seen as having sturdier fundamentals and in particular a growing domestic investor base, the development of local markets (toward which external investors are also becoming increasingly open) provides one possible means of insulation from the feast or famine dynamic. However, the efficacy of this backstop depends largely on the extent to which there is true domestic sponsorship for debt securities. Otherwise, such dynamics in external markets would merely replicate themselves in local markets.

Finally, on a second order level, if issuance gluts following reopenings are truly affected by the imperfect ability of both issuers and the “sell side” to accurately gauge investor appetite, this boils down largely to a “traffic regulation” problem. To some limited extent, this can be remedied by the establishment of more direct communication links between issuers and end-investors themselves, as part of broader efforts to strengthen investor relations.

References International Monetary Fund, 2001a, Emerging Markets Financing (February). Available on the Internet at http://www.imf.org.external/pubs/ft/emf/ index.htm. ———, 2001b, International Capital Markets, World Economic and Financial Surveys (Washington). Sundarajan, V., Charles Enoch, Armida San José, Paul Hilbers, Russell Krueger, Marina Moretti, and Graham Slack, 2002, Financial Soundness Indicators: Analytical Aspects and Country Practices, IMF Occasional Paper No. 212 (Washington: International Monetary Fund).

69

CHAPTER IV

LOCAL SECURITIES AND DERIVATIVES MARKETS IN EMERGING MARKETS: SELECTED POLICY ISSUES

he development of local securities and derivatives markets is just one response of many emerging markets to global volatility since the mid-1990s, particularly the sudden losses of access to international capital markets and periods of high global asset price volatility. While previous issues of the Global Financial Stability Report (GFSR) have examined the recent development of local equities, bonds, and derivatives markets in emerging markets, this chapter examines key policy issues related to the role of these markets as an alternative source of funding for sovereign and corporate entities and a means of attracting foreign capital inflows. The capital flows and asset price volatility that has characterized the global financial system since the mid-1990s has raised the issue of how emerging market economic and financial systems can be made more resilient to such volatility. Clearly, the loss of access to international markets associated with unsustainable macroeconomic and exchange rate policies can best be addressed by adopting stronger domestic policies. However, coping with a loss of market access associated with contagion from a crisis in other emerging markets and/or volatility in capital flows and asset prices associated with developments in mature markets is a more complex issue. Many emerging markets have adopted a variety of measures to self-insure against such volatility. While these measures have differed across regions, they have typically included changing sovereign external asset and liability management practices; adapting exchange rate arrangements to the degree of capital account openness; strengthening domestic financial institutions and enhancing prudential supervision and regulation in order to increase resilience to volatility; and

T

70

developing local securities and derivatives markets. The development of local securities and derivatives markets is seen as a means of creating a more stable source of local currency funding for both the public and corporate sectors, thereby mitigating the funding difficulties created by “sudden stops” in cross-border capital flows and reducing dependence on bank credit as a source of funding. In addition, the development of these markets is seen as a vehicle for improving the efficiency and stability of financial intermediation, reducing the currency and maturity mismatches associated with cross-border lending, and creating new opportunities and instruments for hedging various financial and exchange rate risks. The measures adopted to further the development of local securities and derivatives markets have typically encompassed efforts to strengthen market infrastructure and create benchmark issues, expand the set of institutional investors, and improve corporate governance and transparency. However, there are several key policy areas where no consensus has emerged regarding either the factors that will influence the likely outcomes or the most appropriate policies. Issues remain regarding: • the use of instruments indexed to changes in such variables as the price level and exchange rates; • the government’s role in promoting the development of local equity markets; • the role of foreign investors in local securities and derivatives markets; • the degree of development of local derivatives markets; and • the sequencing of reforms in local securities and derivatives markets. This chapter first examines how the recent interest in local securities and derivatives markets is part of a response to the volatile inter-

LOCAL MARKETS AS SELF-INSURANCE AGAINST VOLATILE CAPITAL FLOWS

national capital flows and asset prices and systemic banking crisis. It then reviews the extent to which local securities markets have become an important source of funding for the corporate and public sectors, and considers the most common measures used to develop local securities and derivatives markets. The chapter concludes with a discussion of “gray areas” concerning policies related to developing local securities and derivatives markets.

Local Markets as Self-Insurance Against Volatile Capital Flows Much of the recent interest in developing local securities and derivatives markets reflects the experience of many emerging markets with volatile international capital flows and asset prices and systemic banking system crises. While the scale of gross and net private capital flows rose steadily during the first half of the 1990s, the remainder of the 1990s witnessed greater volatility of capital flows, as well as a decline in the overall level of flows (especially after 1997).1 Moreover, “sudden stops” (or even reversals) of capital flows were often key features of many of the most severe balance of payments and systemic banking crises of the period (particularly in the Mexican crisis of 1995 and the Asian crisis of 1997).2 To an important degree, the banking system problems in turn reflected the debt servicing difficulties of domestic corporates (especially those with large foreign currency debts). While sudden stops in capital flows often reflected increased investor concerns about weaknesses in domestic economic and political fundamentals and domestic financial systems in emerging markets, empirical studies3 suggest that developments in mature markets

(such as greater mature market asset price volatility that reduces investors appetite for “risky assets” in general) have played a key role in reducing emerging markets’ access to international capital markets.4 The volatility of capital flows since the mid1990s has raised the issues of both how emerging markets can achieve more stable access to international capital markets and how these economies can cope with whatever volatility does occur. While establishing sound and sustainable macroeconomic policies has been one obvious element in strengthening domestic economic fundamentals and perceived creditworthiness, many emerging markets have taken additional measures designed to “self-insure” against volatile capital flows and asset prices. These measures can be grouped into four general areas: • changes in external asset and liability management practices; • adapting exchange rate arrangements to the degree of capital account openness; • strengthening domestic financial institutions and enhancing prudential supervision and regulation in order to increase resilience to volatility; and • developing local securities and derivatives markets to provide an alternative source of funding for the public and corporate sectors and to facilitate the management of the financial risks associated with periods of high asset price volatility. External Asset and Liability Management In the period following the Asian crisis of 1997, some commentators suggested that emerging markets increase their holdings of international reserves to provide a degree of

1The next GFSR will examine in greater detail the experience with private capital flows to emerging markets since 1990. For a discussion of the experience with volatility on income and consumption, see Prasad and Wei (forthcoming). 2See the Appendix to Chapter III for an analysis of the experience with market closures since the mid-1990s. For analyses of sudden stops in capital flows, see Calvo (1998) and Calvo and Reinhart (2000). 3See Calvo (1999) and Annex III in IMF (2001). 4See Chapter II for an examination of the experience with volatility in mature markets.

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LOCAL SECURITIES AND DERIVATIVES MARKETS IN EMERGING MARKETS

Table 4.1. Reserves: Level and Ratio to GDP (In percent) 1990–1994 Average 1995–1999 Average 2000 2001 ________________________ ________________________ ________________________ ________________________ Level Level (In billions of Ratio to GDP (In billions of U.S. dollars) (In percent) U.S. dollars)

Level Ratio to GDP (In billions of (In percent) U.S. dollars)

Level Ratio to GDP (In billions of (In percent) U.S. dollars)

Ratio to GDP (In percent)

Emerging markets

490.2

9.3

943.3

13.9

1,206.4

16.6

1,321.7

18.2

Asia of which: China Taiwan Province of China Korea Philippines Thailand Malaysia Indonesia

298.8

15.3

553.3

19.2

728.3

22.8

807.6

25.3

34.5

7.4

127.0

14.4

168.9

15.6

216.3

18.7

83.3 18.3 4.0 21.1 18.2 10.3

41.3 5.6 7.4 18.7 29.9 7.2

92.3 42.6 9.5 32.7 25.6 19.7

33.3 10.4 12.5 22.7 29.8 13.1

107.4 96.2 13.4 32.1 29.6 28.6

34.7 20.8 17.9 26.3 32.8 18.8

122.8 102.8 13.8 32.5 30.5 27.4

43.5 24.3 19.3 28.3 34.7 18.8

Latin America of which: Argentina Brazil Mexico Venezuela Chile Colombia Peru

84.0

6.3

154.7

8.3

155.6

8.0

158.2

8.3

10.0 21.3 15.6 9.7 9.1 7.0 3.4

4.6 4.7 4.5 17.5 20.1 13.4 9.1

21.2 47.4 25.7 11.9 15.3 8.9 9.7

7.4 6.6 6.6 13.7 20.0 9.4 17.5

25.1 31.5 35.5 13.6 14.7 8.9 8.4

8.8 5.3 6.1 11.2 19.7 11.5 15.9

14.6 35.8 44.8 9.7 14.2 10.2 8.7

5.4 7.1 7.2 7.7 21.4 12.3 16.5

Europe of which: Poland Czech Republic Hungary Turkey

31.2

3.8

101.2

10.0

132.8

13.8

145.4

14.5

4.5 5.1 4.6 6.4

5.6 13.2 12.0 4.1

21.4 12.3 10.1 18.3

14.5 22.4 21.9 9.6

26.7 13.0 11.2 22.7

16.9 25.4 24.0 11.2

25.8 14.4 10.7 19.0

14.6 25.3 20.7 12.8

Africa of which: South Africa

20.4

5.2

36.8

8.6

53.1

12.3

64.7

15.4

1.4

1.1

4.1

2.9

6.4

5.0

6.3

5.6

Source: IMF, World Economic Outlook.

“self-insurance” against a sudden reversal of capital flows.5 Indeed, holdings of foreign exchange reserves by emerging markets nearly doubled between the end of 1995 and the end of 2001 (see Table 4.1).6 Reserve accumulation was particularly notable for some countries that experienced “sudden stops” (or

reversals) of capital flows (such as Korea, Taiwan Province of China, and Mexico). Emerging market borrowers have also shown deftness in adapting to the volatile nature of market access.7 In part, this has involved turning to the syndicated loan market when access to bond markets has been

5Feldstein (1999) encouraged emerging markets to accumulate reserves as insurance against the disruptive financial effects of an abrupt reversal of capital flows. According to Greenspan (1999), the Deputy Finance Minister of Argentina, Pablo Guidotti, proposed that the level of usable reserves should exceed the one-year scheduled amount of foreign currency debt amortization (assuming no rollovers). Greenspan (1999) extended Guidotti’s proposal by arguing for a “liquidity-at-risk” standard that would require a country to hold liquid reserves sufficient to ensure that they could avoid new borrowing for one year with a certain ex ante probability, such as 95 percent. 6Moreover, the ratio of emerging markets’ foreign exchange reserves to nominal GDP at the end of 2002 was at the highest level since 1990. Similar results hold for the ratios of reserves to imports and reserves to broad money (M2). 7The response of emerging market borrowers is analyzed more extensively in Chapter III of IMF (2001).

72

LOCAL MARKETS AS SELF-INSURANCE AGAINST VOLATILE CAPITAL FLOWS

restricted. In addition, emerging market borrowers have attempted to develop access to the retail and institutional bond markets denominated in euros and yen when the U.S. dollar bond market has been closed. Moreover, they have employed staff in debt management agencies with extensive investment banking and trading experience, and exploited “windows of opportunity” to prefund their yearly financing requirement. They have also engaged in debt exchanges to extend the maturity of their external debt and avoid a bunching of maturities, established benchmark external bond issues both to improve secondary market liquidity and to facilitate the pricing of external corporate debt issues, and made greater use of local debt markets. While changes in public sector external asset and liability practices have been key elements of the self-insurance response to the volatility of capital flows, the authorities in many countries have continued to use capital controls in part to affect the private sector’s external asset and liability position. Indeed, the evidence for the period 1998–2000 shows that there has also been a slowdown in the removal of capital controls by countries that have had restricted capital accounts.8 Moreover, data for 2001 do not suggest any significant change in the use of capital controls. Indeed, controls on foreign direct investment and on institutional investors rose slightly. These de jure capital controls do not

necessarily provide a measure of possible changes in the de facto level of capital market integration. But they do provide a measure of the relative unwillingness of the authorities to undertake further capital account liberalization in an environment of volatile capital flows and global asset prices. Although external asset and liability management techniques can provide a buffer against volatile capital flows and asset prices, emerging markets have also been adapting policies and the strength of their financial institutions to the degree of openness of their capital account. These adaptations have been most noticeable in the nature of exchange rate arrangements and in efforts to strengthen the ability of banking systems to withstand volatile capital flows and asset prices. Exchange Rate Policies While the accumulation of larger foreign exchange reserves could create more scope for the authorities to fix the exchange rate, countries have generally moved away from pegged but adjustable exchange rate arrangements since the mid-1990s, especially those with access to international capital markets.9 For countries with access to international capital markets, the move to either a flexible exchange rate or a hard peg represents alternative solutions to the well-known problem of trying to maintain a fixed exchange rate and an independent monetary policy with a high

8Habermeier and Ishii (forthcoming) reported, for example, that during 1998–2000, the number of countries maintaining controls on both current and capital account transactions remained relatively unchanged (falling from 74 percent to 70 percent of all IMF members). Moreover, although the overall use of capital controls did not change, a growing number of countries began to regulate selected transactions. In particular, the number of countries maintaining controls on institutional investors rose sharply. While many of these controls were prudential in nature (such as limits on purchase of foreign assets), some specified the channels’ markets, and/or institutions for permitted cross-border transactions. 9For example, Bubula and Ötker-Robe (2002) found that between 1995 and 2001 the proportion of emerging markets with de facto floating exchange rates rose from 9 percent to 50 percent. At the same time, the proportion of countries with a hard peg also rose from 9 percent to 16 percent. This evidence is consistent with what Fischer (2001) described as the “hollowing out” of exchange rate arrangements. However, Reinhart and Rogoff (2002) argue that the shift in exchange rate arrangements has been much more complex than indicated by official classifications. Their analysis suggests that many official pegs were de facto much more flexible and conversely that many floating exchange rates showed considerable rigidity.

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CHAPTER IV

LOCAL SECURITIES AND DERIVATIVES MARKETS IN EMERGING MARKETS

degree of capital mobility. Moreover, it reflects the difficulties that a number of emerging markets experienced in attempting to defend a fixed exchange rate during periods of sudden stops or reversals of capital flows. Financial Policies While the changes in exchange rate arrangements removed some of the incentives for banks to borrow abroad—a major cause of the emerging market crises in the second half of the 1990s—the authorities still faced the difficulties of restructuring and recapitalizing the banks (and heavily indebted corporates), as well as ensuring that banks improve their risk management techniques amid volatile capital flows and asset prices (see Chapter III). In short, since 1997, the results have been mixed. Asia, for example, has shown a slow but steady improvement in its soundness indicators. In contrast, Latin America witnessed an overall worsening of banking soundness, although the results vary, with countries such as Mexico and Chile continuing to improve but Argentina and Uruguay deteriorating. Central Europe has achieved the sharpest improvement in bank soundness. (For a complete discussion of soundness indicators, see the section on banking sector performance in Chapter III.) Development of Local Securities and Derivatives Markets The efforts to develop local securities and derivatives markets have been motivated by a number of considerations, especially the desire to provide an alternative source of funding in order to self-insure against capital flow reversals. Another motivation has been a desire to stimulate domestic savings by offering savers new financial instruments that

broaden the set of investment opportunities and allow for better portfolio diversification. In many emerging markets, for example, domestic residents have traditionally had access to only two types of domestic instruments—bank deposits and domestic equities—and little access to international markets. Still another consideration has been to improve the intermediation of domestic savings and to attract foreign investors. This has become particularly important as a greater number of emerging markets have privatized their pension systems. In some countries, such as Chile, the private pension funds and insurance companies have been key sources of demand for high-quality corporate bonds, reflecting a desire to achieve a rate of return higher than can be obtained on bank deposits and also to obtain longer duration assets (which better match their long duration obligations). In Central Europe, foreign investors have provided a steady source of demand for sovereign bonds. Moreover, as already noted, emerging markets have also sought to develop alternative sources of funding for both the public and corporate sectors to either domestic bank lending or international capital markets.10 In addition, local derivatives markets have been seen as providing a vehicle for managing financial risks, especially those related to exchange rates and interest rates.

Extent of Securities Market Development as an Alternative Source of Funding Given the efforts to develop local securities markets, to what extent have these markets begun to provide an alternative source of funding to either domestic bank lending or international capital flows for both the private sector and the public sector? As will be discussed, a number of key conclusions emerge

10Drawing on lessons from recent emerging markets crises, Greenspan (1999) noted that well-developed bond markets can act like a “spare tire” and substitute for bank lending as a source of corporate funding when bank lending dries up.

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EXTENT OF SECURITIES MARKET DEVELOPMENT AS AN ALTERNATIVE SOURCE OF FUNDING

Table 4.2. Private Sector (In billions of U.S. dollars)

Emerging

markets1

1997

1998

1999

2000

2001

1997–2001

319.80

250.04

191.94

417.39

296.71

1,475.87

Domestic Equities Bonds Bank loans

217.48 37.28 11.15 169.06

203.01 32.70 11.70 158.61

131.64 43.42 10.47 77.75

324.07 25.50 98.01 200.57

229.35 19.02 114.47 95.86

1,105.55 157.91 245.79 701.85

International Equities Bonds Bank loans

102.32 18.42 41.63 42.27

47.03 5.59 19.86 21.59

60.30 15.76 22.15 22.39

93.32 31.90 21.84 39.59

67.35 8.81 30.90 27.64

370.32 80.47 136.37 153.47

207.30

156.80

220.46

300.84

241.99

1,127.38

154.87 28.11 0.00 126.75

144.69 16.69 0.00 128.00

193.59 35.52 0.83 157.24

245.59 20.65 42.66 182.28

198.66 10.76 53.57 134.33

937.39 111.73 97.06 728.60

International Equities Bonds Bank loans

52.43 10.50 19.60 22.34

12.11 4.05 3.41 4.65

26.87 13.92 8.24 4.71

55.25 26.45 12.45 16.35

43.34 7.65 21.50 14.18

189.99 62.56 65.20 62.23

Central Europe

11.00

23.72

4.07

7.59

16.38

62.76

Domestic Equities Bonds Bank loans

5.36 1.31 0.50 3.55

18.67 6.60 0.28 11.80

–0.14 3.35 0.33 –3.82

2.60 1.29 0.17 1.14

13.29 0.95 0.32 12.02

39.79 13.49 1.61 24.69

International Equities Bonds Bank loans

5.64 2.60 1.26 1.78

5.05 1.47 2.14 1.44

4.20 1.17 1.78 1.26

4.99 0.38 0.83 3.78

3.09 0.00 1.86 1.22

22.97 5.61 7.88 9.49

Asia Domestic Equities Bonds Bank loans

Latin America

101.50

69.52

–32.58

108.96

38.33

285.73

Domestic Equities Bonds Bank loans

57.26 7.86 10.64 38.76

39.64 9.41 11.42 18.81

–61.81 4.55 9.32 –75.67

75.88 3.56 55.17 17.15

17.40 7.31 60.58 –50.49

128.38 32.69 147.13 –51.44

International Equities Bonds Bank loans

44.25 5.33 20.77 18.14

29.87 0.07 14.31 15.49

29.23 0.67 12.13 16.43

33.08 5.07 8.55 19.46

20.93 1.16 7.54 12.23

157.36 12.30 63.30 81.75

Sources: Capital Data; IMF, International Financial Statistics; S&P EMDB; and Hong Kong Monetary Authorities. 1Emerging markets: China, Hong Kong SAR, Korea, Malaysia, Singapore, Thailand, Argentina, Brazil, Chile, Mexico, Czech Republic, Hungary, and Poland.

from the data on local and international issuance during the period 1997–2001. First, there has been a surge of local corporate bond issuance, particularly in Asia and Latin America. Indeed, local corporate bond issues grew by a factor of 10 between 1997–99 and 2000–01. Second, local bond markets have been the dominant source of funding for the public sector in all regions. Third, while emerging markets have traditionally been viewed as bank dominated financial systems,

local bond markets have become the largest single source of domestic and international funding. As already noted, this primarily reflects the heavy reliance of the public sector on bond issuance. Nonetheless, domestic corporate bond issuance rose from 5 percent of total corporate domestic and international funding in 1997–99 to 31 percent in 2000–01; whereas domestic bank credit fell from 52 percent of total corporate funding in 1997–99 to 40 percent in 2000–01.

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CHAPTER IV

LOCAL SECURITIES AND DERIVATIVES MARKETS IN EMERGING MARKETS

For the private sector, Table 4.2 compares the domestic issuance of corporate bonds, equities, and bank lending with the issuance of international corporate bonds, equities, and syndicated loans for selected emerging markets across different regions from 1997 until 2001.11 During this period, domestic bank lending was the dominant source of corporate funding, accounting for 48 percent of total domestic and international funding. Nonetheless, domestic corporate bond issuance rose from an annual average of $11 billion in 1997–99 to $106 billion in 2000–01; and, for the period as a whole, domestic corporate bond issues represented just under 17 percent of total funding. Domestic equity issues accounted for only about 11 percent of total funding. International issues of bonds, equities, and syndicated loans by the corporate sector accounted for just over 25 percent of total funding between 1997 and 2001 (see Table 4.2). However, international corporate bond issues amounted to only roughly half of such bonds issued domestically. Indeed, while the annual average value of domestic corporate bond issuance rose between 1997–99 and 2000–01, the annual average value of international corporate bond issuance declined from $28 billion to $26 billion. Moreover, international equity issuance amounted to about half of domestic equity issuance; while syndicated lending was equivalent to around 20 percent of the extension of domestic credit. Thus, while domestic bank credit has been the primary corporate source of funding for this group of emerging markets, domestic bond markets have been an increasingly important source of funding. Indeed, domestic corporate bond issues rose from 5 percent

of total corporate domestic and international funding in 1997–99 to 31 percent in 2000–01. During the same period, domestic bank credit fell from 52 percent of total corporate funding in 1997–99 to 40 percent in 2000–01. Between 1997 and 2001, the pattern of corporate funding revealed sharp regional differences. In Asia, domestic bank lending accounted for 65 percent of total domestic and international financing. Moreover, domestic equity issuance was the second largest source of corporate funding ($112 billion) and slightly exceeded corporate bond issuance ($97 billion). Nonetheless, domestic corporate bond issuance rose from an annual average of $276 million in 1997–99 to $48 billion in 2000–01. International issues of equity, bonds, and syndicated loans represented about 17 percent of total corporate domestic and international funding in 1997–2001. In Central Europe, domestic bank lending was also the largest source of corporate finance during 1997–2001; but privatization helped make domestic equity issuance ($13 billion) the second largest source of funding. Domestic bond issuance remained limited. In contrast to other regions, domestic bond issues ($147 billion) became the dominant source of corporate funding in Latin America between 1997 and 2001. Indeed, local bond issues nearly equaled the total of international issues of bonds, equities, and syndicated lending ($157 billion). Moreover, domestic bank lending contracted (by $51 billion). While local securities markets have played an increasingly important role as an alternative source of funding for the domestic corporate sector, they were an even more important source of funding for the public sector (see Table 4.3).12 Domestic government bond

11The economies include China, Hong Kong SAR, Korea, Malaysia, Singapore, Thailand, Argentina, Brazil, Chile, Mexico, the Czech Republic, Hungary, and Poland. The countries were selected on the basis of the availability of data on corporate bond issuance. The data on local bond issuance cover various types of instruments, including fixed interest rate bonds, floating interest rate bonds, and bonds indexed to such items as the price level or the exchange rate. In general, it is not feasible to segment the data by type of instrument. 12The public sector is defined as the central government, government-owned financial institutions, and public sector enterprises.

76

EXTENT OF SECURITIES MARKET DEVELOPMENT AS AN ALTERNATIVE SOURCE OF FUNDING

Table 4.3. Public Sector1 (In billions of U.S. dollars) 1997

1998

1999

2000

2001

1997–2001

Emerging Domestic Equities Bonds Bank loans International Equities Bonds Bank loans

514.12 452.41

705.49 662.15

454.89 413.91

462.19 417.34

417.01 380.48

2,553.70 2,326.30

387.87 64.54 61.71

626.82 35.29 43.33

397.87 16.00 40.98

388.39 28.91 44.85

319.95 60.50 36.53

2,120.91 205.25 227.40

41.63 20.08

28.52 14.82

34.82 6.16

32.66 12.19

29.32 7.20

166.95 60.46

Asia Domestic Equities Bonds Bank loans International Equities Bonds Bank loans

31.58 5.23

112.07 98.80

88.31 74.61

95.21 79.96

153.78 140.72

480.95 399.34

6.85 –1.62 26.35

42.70 56.11 13.26

45.88 28.73 13.69

55.75 24.21 15.25

94.18 46.54 13.06

245.37 153.97 81.61

14.07 12.28

6.00 7.26

9.86 3.83

7.78 7.47

10.15 2.91

47.86 33.75

Central Europe Domestic Equities Bonds Bank loans International Equities Bonds Bank loans

39.68 37.15

55.49 51.66

59.10 55.52

54.13 52.43

78.48 74.80

286.89 271.57

42.93 –5.77 2.53

47.31 4.35 3.83

59.45 –3.93 3.59

56.77 –4.34 1.70

64.76 10.04 3.68

271.22 0.35 15.32

1.26 1.26

2.52 1.31

2.70 0.89

1.27 0.43

2.21 1.47

9.96 5.37

Latin America Domestic Equities Bonds Bank loans International Equities Bonds Bank loans

442.85 410.02

537.93 511.69

307.48 283.78

312.85 284.94

184.75 164.96

1,785.86 1,655.40

338.09 71.93 32.83

536.85 –25.16 26.24

292.57 –8.79 23.70

275.91 9.04 27.90

161.04 3.92 19.79

1,604.47 50.93 130.46

26.29 6.54

20.00 6.24

22.26 1.44

23.61 4.29

16.97 2.82

109.13 21.33

markets2

Sources: Capital Data; IMF, International Financial Statistics; S&P EMDB; and Hong Kong monetary authorities. 1Incorporates both public sector and sovereign issuance data. 2Emerging markets: China, Hong Kong SAR, Korea, Malaysia, Singapore, Thailand, Argentina, Brazil, Chile, Mexico, Czech Republic, Hungary, and Poland.

issues have clearly been the dominant source of funding for the public sector throughout 1997–2001. Indeed, public sector domestic bond issuance was nearly 13 times larger than international foreign currency bond issues. This primarily reflects the heavy reliance on domestic bond issuance in Latin America and, to a lesser extent, in Central Europe. Nonetheless, even in Asia, domestic bond issuance is the largest single source of public sector funding.

Despite the dominant role of domestic bond markets in all regions, the financing mix for the public sector has differed sharply across the three regions. In Asia, the public sector has relied more on credit from the banking system than in other regions. Moreover, the public sector in Asia met a great proportion of their financing from international sources (17 percent) than in other regions. In contrast, the public sectors in Latin America and Central Europe

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Table 4.4. Total of All Sectors1 (In billions of U.S. dollars) 1997

1998

1999

2000

2001

1997–2001

833.92

955.52

646.83

879.58

713.71

4,029.57

Domestic Equities Bonds Bank loans

669.89 37.28 399.02 233.59

865.16 32.70 638.51 193.90

545.55 43.42 408.34 93.75

741.41 25.50 486.40 229.48

609.84 19.02 434.42 156.36

3,431.85 157.91 2,366.70 907.10

International Equities Bonds Bank loans

164.03 18.42 83.25 62.35

90.36 5.59 48.37 36.41

101.28 15.76 56.97 28.55

138.17 31.90 54.50 51.78

103.88 8.81 60.23 34.84

597.72 80.47 303.32 213.93

238.88

268.86

308.76

396.05

395.77

1,608.33

160.10 28.11 6.85 125.13

243.49 16.69 42.70 184.11

268.20 35.52 46.71 185.97

325.55 20.65 98.41 206.49

339.38 10.76 147.75 180.87

1,336.73 111.73 342.42 882.57

International Equities Bonds Bank loans

78.78 10.50 33.67 34.61

25.37 4.05 9.40 11.92

40.56 13.92 18.10 8.54

70.50 26.45 20.24 23.82

56.40 7.65 31.65 17.10

271.61 62.56 113.06 95.98

Central Europe

50.68

79.21

63.17

61.72

94.86

349.65

Domestic Equities Bonds Bank loans

42.51 1.31 43.43 –2.23

70.34 6.60 47.59 16.15

55.38 3.35 59.78 –7.75

55.03 1.29 56.94 –3.20

88.09 0.95 65.08 22.07

311.35 13.49 272.83 25.04

8.17 2.60 2.53 3.05

8.88 1.47 4.65 2.76

7.79 1.17 4.48 2.14

6.69 0.38 2.09 4.22

6.77 0.00 4.07 2.69

38.29 5.61 17.83 14.86

544.35

607.45

274.90

421.81

223.08

2,071.59

467.28 7.86 348.74 110.69

551.33 9.41 548.27 –6.35

221.97 4.55 301.89 –84.47

360.83 3.56 331.08 26.19

182.37 7.31 221.63 –46.57

1,783.77 32.69 1,751.60 –0.51

77.08 5.33 47.06 24.69

56.12 0.07 34.31 21.73

52.93 0.67 34.39 17.87

60.98 5.07 32.16 23.75

40.72 1.16 24.51 15.05

287.82 12.30 172.43 103.09

Emerging markets2

Asia Domestic Equities Bonds Bank loans

International Equities Bonds Bank loans Latin America Domestic Equities Bonds Bank loans International Equities Bonds Bank loans

Sources: Capital Data; IMF, International Financial Statistics; S&P EMDB; and Hong Kong Monetary Authorities. 1Incorporates sovereign issuance data. 2Emerging markets: China, Hong Kong SAR, Korea, Malaysia, Singapore, Thailand, Argentina, Brazil, Chile, Mexico, Czech Republic, Hungary, and Poland.

obtained most of their funding through domestic bond issuance (93 percent and 95 percent, respectively). Indeed, Latin American authorities issued nearly 15 times as many domestic bonds as international foreign currency bonds.

Despite the rapid expansion of local bond markets (see Table 4.4),13 it remains unclear whether local securities markets have developed to the point that they will be able to offset banking system weaknesses that curtail bank lending or a loss of access to interna-

13The role of local derivatives markets in supporting both local market activities and capital flows was discussed in the December 2002 Global Financial Stability Report, Chapter IV.

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tional markets.14 Moreover, emerging markets will need ongoing access to global capital markets if they are to receive the transfers of technology and capital needed for sustained growth and development. Nonetheless, the continued development of local securities and derivatives markets could eventually provide an additional “cushion” to help mitigate the most adverse effects of banking crises and/or loss of access to international capital markets by creating a longer duration domestic source of funding that may not immediately dry up when a crisis occurs, and by providing some vehicles for hedging risks prior to a crisis.

Common Practices in Emerging Local Securities Markets Given the growing importance of local securities markets as a source of funding for both the corporate and public sectors, the question arises of what policies have proven most effective in stimulating the development of these markets. Some of these common practices are briefly reviewed in this section. There is broad agreement that improvements in market infrastructure and transparency, combined with better corporate governance and the development of benchmarks and domestic institutional investors, all contribute to the development of local securities markets. While the development of market infrastructure, institutional investors, and transparency are uncontroversial steps, countries’ experience and the arguments behind some other aspects of the development of local securities markets (the “gray areas”) are less clear-cut. These include the use of indexed bonds, credit risk pricing, government policies toward the development of local stock

markets, the role of foreign investors, the development of local derivatives markets, and the sequencing of local securities markets reforms. Nonetheless, despite the ambiguities concerning policies in these areas, some conclusions seem warranted. For instance, the existence of indexed instruments and derivatives can contribute to lengthen and deepen fixed-income markets, but they may require careful monitoring to prevent undesirable mismatches and excessive leveraged positions. Moreover, stock market reforms that improve the conditions under which corporations issue and trade shares should be welcomed, but they should not involve the protection of local exchanges or the domestic brokerage industry from domestic or foreign competition. Similarly, foreign investors can contribute to the deepening of local markets, even if they may add to volatility during crises episodes. In this section, some of these common practices are briefly reviewed.15 In the following section other selected policy issues related to the development of local securities markets (the “gray areas”) are discussed. Market Infrastructure and Benchmarks A large number of emerging markets have improved the market infrastructure for local securities and have established relevant benchmark yield curves (see IMF, 2002b). Although the provision of a robust financial infrastructure for trading, clearing, and settlement of transactions is generally considered to be a public good, many authorities have felt that the establishment of a liquid government security benchmark yield curve in order to facilitate the pricing of corporate securities is also a desirable policy objective (see, for

14Indeed, a strong banking system is likely to play a key role in facilitating the development of local securities and derivatives since banks in emerging markets often are key underwriters of securities, investors in bonds, providers of credit to securities houses, and suppliers of over-the-counter derivative products. 15Surveys on some of these issues, mostly for local bond markets, include World Bank and IMF (2001); BIS (2002); and OECD (2001).

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instance, Yam, 2001). In principle, benchmarks could be provided by other instruments issued by quasi-public entities (such as the mortgage agencies in the United States) or even private instruments (including swaps), but it is unlikely that they would reach the level of issuance and liquidity needed to perform benchmark functions.16 In Malaysia, for instance, mortgage (Cagamas) and asset management (Khazanah) agency bonds had been used as benchmarks, but their role has recently diminished in favor of government securities. Similarly, in the Czech Republic, some corporate bonds and the swap markets have traditionally acted as benchmarks, but the small size of corporate instruments and reduced foreign participation has reduced liquidity and paved the way for the introduction of government benchmark issues. Institutional Investors Many emerging markets have realized the importance of developing a local institutional investor base to support local securities markets. The growth of such an investor base has usually been slow, however, and tight regulations on asset allocations have constrained the potentially beneficial role that they could bring to local securities markets. Local pension funds have made a particularly important contribution to the development of local securities markets in Latin America and Central Europe, and their role is beginning to be felt in some of the Asian local markets. Following the lead of Chile in the 1980s, most Latin American countries have established private pension funds that have become an important source of demand for local securities, as well as for the development of market infrastructure and improved corporate governance and transparency. Similar

trends are emerging in Central Europe, where mandatory private pension funds were introduced somewhat later. The provident funds systems in many Asian countries are largely under public administration and to date have not played a very active role in local market development, but some countries are gradually outsourcing funds to private asset managers. Most countries maintain tight regulation over pension funds’ asset allocations to prevent excessive risk taking and to develop local markets, but this may be a double-edged sword. Some countries restrict funds’ purchases of local equities, as they are perceived as a risky investment: an extreme case is Mexico, which until recently allowed no allocation to equities. The legislation was changed last year but the regulatory agency has not yet approved the implementation of the new portfolio allocations.17 Other countries restrict the allocation to offshore instruments, seeking to develop local securities markets and to provide cheaper funds to local corporates. The recent experience in Argentina suggests, however, that local pension funds could be used as captive demand for government debt that could ultimately yield dismal returns. Indeed, in the second half of 2001, domestic holders of Argentine government bonds (primarily local pension funds and banks) were approached by the authorities to participate in a debt swap, and they were pressured into accepting new claims with lower interest rates and longer maturities. Corporate Governance and Transparency A number of countries have adopted measures to improve transparency and corporate governance, as they see these as critical for local capital market development. Studies have shown that countries with less protection

16Even in the mature markets, the low credit risk and high liquidity features of government securities have made them natural providers of benchmark interest rates (see IMF, 2001). 17The Mexican Congress has also approved the use of derivatives, but the pension funds still have to comply with some prudential rules and operating requirements (see Cervera and Quedry, 2003).

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for minority shareholders have less developed equity markets, that firms in these countries use less outside finance and have higher debtequity ratios, making them more vulnerable to shocks.18 In response to this evidence, as well as to high-profile shareholder conflicts, some countries have recently changed the laws governing capital markets (including Brazil, Chile, the Czech Republic, and Mexico) while others (including Korea, Malaysia, Hong Kong SAR, Poland, and Singapore) have approved codes of best practice designed to improve disclosure, protect minority shareholders’ rights, and maximize shareholder value. Better corporate governance can be implemented through several mechanisms, such as improved laws, enhanced regulation and supervision, and stronger enforcement of private contracts; and, whenever changing the law has proven difficult, other mechanisms have proven to be good substitutes to some extent. A number of studies have argued that investor protection and the judicial enforcement of contracts are stronger in common-law countries than in civil law countries.19 However, the recent experiences of Brazil and Chile, among others, show how difficult it could be to change securities laws, which generally results in substantial changes in cash flow and control rights of existing shareholders. It took the Brazilian Congress about four years to approve a new corporate law that strengthened several aspects of corporate gov-

ernance in 2001, and the final legislation was watered down after protracted debates and negotiations. In particular, the law introduces a limit on the issuance of nonvoting shares (of 50 percent of total equity) only for new and nonlisted companies, but existing corporations may keep their two-thirds share of nonvoting stock even for future share issuance.20 At the same time, the São Paulo Stock Exchange (BOVESPA) created the Novo Mercado, a new segment of the market where companies agree to the one-share-one-vote principle, allow for full tag-along rights, and enhanced corporate governance principles. Similarly, the new capital market law in Chile establishes that any transaction between a buyer and a controlling group that would change control of the target company must be extended to remaining investors on a pro rata basis, but it leaves an opt-out option for three years.21 Among countries perceived by market participants and academics as having relatively weak legal systems, Poland is usually cited as an example of a country where a strong stock market regulation has to a large degree acted as an effective substitute for judicial enforcement of contracts (Johnson and Shleifer, forthcoming). While recent changes have improved the protection given to minority shareholders, some analysts see a risk of severely restricting the development of the market if overregulation imposes large costs on potential issuers. Minority shareholder rights in Brazil were

18See La Porta and others (2000). Corporate governance and the development of local capital markets have been associated with macroeconomic outcomes such as output growth and the severity of exchange rate crises and output volatility (see Johnson and Shleifer, forthcoming, and references therein). 19See, for instance, La Porta and others (2000) and references therein. The authors provide measures of investor protection for 49 countries and classify them by legal origin. Besides the provision of adequate (clear and regular) information about firm performance and external audits, investor protection is usually measured by the voting rights of minorities, their ability to exercise their vote by mail and call extraordinary shareholder meetings, to participate in executive boards and have mechanisms to sue or get relief from board decisions, as well as preemptive rights to new issues and tag-along rights in the case of changes in control—to protect them from dilution by controlling shareholders. 20The system was devised with the aim of providing family-owned companies an incentive to list while retaining control—indeed, ownership of 17 percent of a company would ensure control. See Barham (2001). 21Market participants, however, doubt that many corporates will take advantage of this provision as the large pension funds may have reduced incentives to invest in an opted-out company.

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reduced in 1997 for macroeconomic reasons, namely to speed up and maximize the revenues from the privatization process. In a number of cases, foreign multinationals paid a premium price to obtain a controlling interest and then bought out the minorities at lower prices, but several shareholder conflicts led to the current reforms. However, some analysts worry that the government might now go too far in favoring minorities and scare away foreign investors. Similarly, a recent string of high-profile shareholder conflicts involving foreign investors in Poland has left fund managers worried that they may be seen as a threat to foreign strategic investors.22

Selected Policy Issues While the development of market infrastructure, institutional investors, and transparency are uncontroversial steps, countries’ experience and the arguments behind some other aspects of the development of local securities markets are less clear-cut. This section considers other selected policy issues related to the development of local securities markets, in particular those issues that could affect macroeconomic policies and/or financial stability and capital flows. Indexed Bonds There is broad agreement that the introduction of inflation-indexed or inflationlinked bonds provides risk-sharing opportunities for issuers and investors, and that they contribute to complete and deepen local bond markets. The issuance of inflationlinked bonds by the government is generally seen as reducing the cost to private issuers of educating investors about the benefits of these instruments as well as reducing coordination problems in the adoption of alternative units of account. However, indexation may be diffi-

cult to reverse and foreign investors tend to shun indexed instruments. Moreover, indexation to foreign currencies—in particular, dollarization of local debt—could lead to financial instability and defeat the purpose of local debt as a self-insurance against lost access to international capital markets. The important role of inflation-linked bonds in the development of a long-dated corporate bond market is best exemplified by the experience of Chile (see IMF, 2002b, Chapter IV). Most corporate bonds in Chile are indexed to the Unidad de Fomento (UF, a unit of account linked to the Chilean consumer price index), and analysts argue that the development of a government bond market in UF, together with the adoption of a legal framework that favors (and sometimes requires) the use of such unit of account, has been central to the development of a longterm market in corporate bonds (see, for instance, Walker, 2002). To satisfy the growing demand of local institutional investors, local corporates have issued bonds with up to 30year maturities. Although the market for indexed bonds has been in existence for more than 20 years, it has tripled in size since 2000—when the worsening of external conditions pushed corporates to issue in the local market (see Figure 4.1). Maturities have also been extended, from an average of 10–15 years in the first half of the 1990s, to 15–20 years more recently. The introduction of financial indexation could complicate the achievement of monetary policy objectives and could have temporary, undesirable effects in the development of local fixed income and derivatives markets. Analysts have argued that the provision of a hedge against inflation may remove the incentives for price stability, and that financial indexation could spill over to labor contracts and increase the costs of disinflation. In the case of Chile, the authorities have been trying

22While most of the issues discussed in this section refer to equity markets, weak transparency and corporate governance are also a significant constraint for the development of corporate bond markets (see Sharma, 2000).

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to nominalize the short end of the curve to improve the conduct of monetary policy, but the change initially disrupted the interest rate swap market and the pricing of long-term UF instruments with maturities of less than one year. 23 Another drawback of indexation is that foreign investors seem to dislike the complication of calculating the performance of their investments in a generally unknown unit of account. International investors, in particular pension funds and even large asset managers, seem to prefer plain vanilla bonds, where they can take a clean exposure to the currency and the underlying credit. A large number of countries, particularly in Latin America, have managed to develop their local bond markets mostly by issuing U.S. dollar-denominated or dollar-linked debt. Analysts have offered a number of reasons for the dollarization of local bonds, some of which are of a purely macroeconomic nature and others that are related to the development of local financial markets, or even to features of the international financial system. The standard argument against governments issuing nonindexed bonds denominated in domestic currency is that, since they also control monetary policy, they have an incentive to inflate away their debts. However, as Calvo (2000) points out, this type argument would not apply to private debt—unless the monetary authority gives more weight to the welfare of debtors compared to that of creditors. Jeanne (2002) argues that a higher share of dollarized corporate debt may be the result of a firm’s optimal financial choices, when the lack of a credible monetary policy leads to high domestic interest rates. Finally, if companies expect to be bailed out by governments— especially when a pegged exchange rate is abandoned—they will tend to issue mostly dol-

Figure 4.1. Chile: Amount Outstanding of Private Nonfinancial Sector Bonds 6000

320 280

5000

240

In millions of U.S. dollars (left scale)

4000

200

3000

2000

160 In million Unidad de Fomento (UF) (right scale)

120 80

1000

0

40 1994

96

98

2000

021

0

Source: Superintendencia de Valores y Seguros, Banco Central de Chile. 1 Estimate.

23The nominalization of the short end of the curve has deprived the fixed-for-floating UF interest rates swap market of the reference rate for the floating leg of the transaction.

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lar-denominated debt (Dooley, 2000; and Burnside, Eichenbaum, and Rebelo, 2001).24 The limited development of local financial markets could also be a significant factor behind the large share of dollar-denominated debt in some emerging markets. For domestic firms choosing an optimal financing mix in an uncertain operating environment, domestic currency-denominated debt could insure against low-return scenarios, especially when low returns are associated with lost or restricted access to international capital markets. However, Caballero and Krishnamurthy (forthcoming) demonstrate that when local markets are underdeveloped and firms face credit constraints, corporates tend to underestimate the value of that insurance and issue excessive amounts of dollar-denominated debt. Firms that have good projects and could maintain access to international capital markets cannot channel resources to firms facing refinancing needs, because the latter are unable to pledge enough income to make their securities attractive to the former. More specifically, Caballero (2002) argues that the fact that large corporates moved inward to borrow in local markets during recent crises, rather than passing on their international access to smaller firms, suggests that local emerging markets remain underdeveloped and that this underdevelopment could amplify the effects of lost access to international markets.25 Some analysts have argued that the large share of foreign-currency-denominated emerging market debt is not just a result of weak national policies and institutions, but

also a consequence of the limited incentives for currency diversification by global investors.26 Between 1993 and 1998, four countries (the United States, the United Kingdom, Japan, and Switzerland) issued only one-third of global debt, but more than twothirds of global debt was denominated in their own currencies. Meanwhile, developing countries issued 10 percent of global debt but had only 1 percent denominated in their own currencies. Countries belonging to the euro area show a more balanced relationship, especially after the introduction of the euro. Among the emerging markets, the share of dollar-denominated debt is smaller in the EU accession countries and highest in Latin America. Eichengreen, Hausmann, and Panizza (2002) demonstrate that standard measures of weak policies—such as high inflation—do a relatively poor job of explaining the share of dollar-denominated bonds in emerging markets, and that the only robust determinant of what the authors call “original sin” is country size. As a result, the authors claim that the solution to this problem lies not just in strengthening domestic policies and institutions but also in overcoming the difficulties created by the structure and operation of international financial markets (see Box 4.1). While dollar-linked debt provides a foreign currency hedge for investors, it can lead to financial instability if the excessive use of this instrument results in sizable currency mismatches that create solvency concerns about the issuers—like the sovereign and/or nonexporters whose tax revenues or receipts are mostly denominated in local currency.27 The

24A credible monetary policy framework and a credible commitment not to bailout debtors are obvious policy implications of these analyses. 25The argument applies equally to bank lending as to local bonds. Caballero and Krishnamurthy (forthcoming) show that the limited development of local financial markets also reduces the incentives for foreign specialists— who would be willing to bring foreign capital to lend against domestic currency collateral—to enter the local market, reinforcing the underinsurance problem. 26Eichengreen, Hausmann, and Panizza (2002) note that transaction costs in a world of heterogeneous countries and network externalities may give a small number of vehicle currencies a special attractiveness. 27Similar issues arise in economies with dollarized deposits; see IMF (2003) for a discussion of prudential and crisis management aspects of dollarized banking systems.

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SELECTED POLICY ISSUES

Box 4.1. An International Solution for the Original Sin Most emerging markets cannot issue international bonds denominated in their own currencies, a fact that Eichengreen, Hausmann, and Panizza (2002) refer to as the “original sin.” These economists recently proposed that the World Bank and other regional development banks sponsor a mechanism that would allow emerging markets to issue more debt denominated in their own currencies. The proposal is inspired by the fact that international financial institutions (IFIs) have issued almost half of all internationally placed bonds in exotic currencies during 1992–98. In most cases, the debt-service obligations were swapped back into U.S. dollars, providing additional support to foreign currency swap markets. The proposal involves a number of steps. The first step would involve the development of a currency basket index that would include a well-diversified set of emerging market currencies and would contribute to overcome the relative small size of some issuers. The index would be calculated as the end-of-period exchange rate (divided by the CPI in the same month) and the weights in the index would be the countries’ relative GDPs adjusted at purchasing power parity. As an illustration, the authors constructed two indices and showed that their volatility is in line with that of some major currencies and that they display a negative correlation with real private consumption growth in seven mature economies. They conclude that these characteristics of the indices would make them an attractive form of diversification for institutional and retail investors. The next steps would have the World Bank and other IFIs issue debt denominated in the index, eventually followed by similar efforts by the Group of Ten (G-10) countries. The World Bank could also convert the U.S. dollar loans made to the countries in the index into local currency CPI-indexed loans and elimi-

nate the currency mismatch generated by the issuance of the proposed bonds. Similarly, the authors argue that the G-10 countries could undertake currency swaps with each individual country in the index, allowing the former to eliminate the currency mismatch and providing the latter with a useful hedge against their original sin. Finally, once a liquid market in that type of indexed-debt develops, investors may want to add credit risk to the index. They could do so by buying local currency debt of the countries in the index, which will facilitate the development of these local markets. The proposal is innovative, but analysts are skeptical about its implementation and acceptance by investors, as well as its remaining risks for the IFIs. In particular, market participants, IFI representatives, and academics are concerned that the proposal may reduce incentives to address the more fundamental issues preventing a number of emerging markets from issuing in their own currency, namely weak macroeconomic policies and related poorly developed local financial markets. In addition, potential borrowers may prefer to use their access to IFI loans in terms of foreign exchange at favorable interest rates than local currency loans. Analysts are further worried about international investors’ lack of appetite for emerging markets inflation-linked bonds. They also suggest that, despite the adjustment of the index to each of the countries’ CPI, emerging markets could have an incentive to depreciate their currencies in the days before the coupons are fixed in order to lower their debt obligations. Moreover, they are concerned that the index would provide incentives to do this in a concerted fashion, creating another channel for contagion in foreign exchange markets. As a result, it may also be the case that the stronger emerging market players would not find it advantageous to participate in the index.

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higher volatility of the exchange rate vis-à-vis the price level, especially during capital flow reversals, causes a deterioration in these issuers’ balance sheet positions that is likely to magnify the initial problem of lost access to international capital markets and capital outflows.28 This kind of vicious circle has meant that countries with a high degree of dollarization are likely to have more volatile output and capital flows. Indeed, Eichengreen, Hausmann, and Panizza (2002) estimate that the large share of dollar-denominated debt in emerging markets accounts for one-fourth of the difference in volatility (in GDP and capital flows) relative to mature markets. Credit Risk Pricing Market participants regard the lack of sophistication in pricing credit risk as a major constraint to the growth of emerging corporate bond markets. But the development of a credit culture takes time, and it is unclear how much the authorities can do to speed up this process. A few aspects of the institutional structure that could be improved include the standardization of securities contracts, the requirement of ratings, and appropriate incentives for independent securities’ research. The standardization of bond contracts could contribute to a more accurate assessment of credit risk but it could also constrain the issuer’s financial flexibility. In several emerging markets, bond contracts have a variety of features—coupons linked to different reference rates, embedded options and other enhancements, different types of collateral, covenants and priority rules—that make it difficult to price the credit risk associated with the bond. Some degree of standardization and homogeneity in bond contracts would facilitate the pricing of credit risk, and securi-

ties’ regulators could ensure a minimum set of guidelines for such contracts. In Brazil, for instance, the authorities are discussing with market participants the optimal degree of standardization, as some issuers fear that too much standardization could restrict companyspecific financing needs. Rating agencies appear to be useful in credit markets, but it is unclear to what extent regulations have to force the use of their services or whether market participants themselves would find their credit assessments useful in their pricing or allocation decisions. The requirement that local pension funds invest only in rated instruments has contributed to the development of a rather sophisticated credit risk culture in Chilean local markets. Several other emerging markets are also requiring that issuers obtain one or two ratings for their corporate bond issues. The recent Brazilian experience shows, however, that regulations do not have to be the only driving force: even though local regulations require only one rating per issue, several issuers provide two in order to reassure investors. Finally, independent research would contribute to better credit risk assessments and pricing, but there is little the regulatory authorities can do in this area. In many emerging markets, most research available is done by the underwriters, and this could create serious conflicts of interest. This is an issue also for equities, in particular in Asian local equity markets (see, for instance, Norton, 2002; and Davies, 2002). Local Equity Markets and the Role of Stock Exchanges The sharp fall in domestic equity issuance in 2000–02, combined with structural developments in global equity markets, has raised

28Experience shows that the CPI is less volatile than the exchange rate, especially during crises; price indexation is also a superior alternative to indexation through floating interest rates, as the latter are also quite volatile in emerging markets.

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doubts about the long-term prospects of initial public offerings (IPOs) in local markets as an alternative source of funding in emerging markets.29 The bear market in equities has shrunk trading volumes literally everywhere, and the combination of a drop in IPOs associated with the reduction in privatization and a spate of delistings has called into question the viability of many stock exchanges in emerging markets. Moreover, the competitive pressures created by declining costs—associated with automated electronic trading systems and the migration of listings toward exchanges with greater liquidity and a lower cost of funding—have stimulated both changes in stock exchange governance and increased international integration of exchanges. These developments have in turn raised the question of the proper role of the public sector in either facilitating or promoting these structural changes. While a well-functioning stock exchange can yield efficiency gains by providing a key source of funding for the corporate sector and of liquidity for investors, there has been considerable debate about the extent of public sector involvement in helping to develop stock exchanges. There is general agreement that the development of equity markets will be facilitated by a sound macroeconomic environment, open access to foreign investors, political stability, and enforceable property rights. Properly designed and executed privatization programs can also stimulate the development of equity markets, and improvements in corporate governance and the protection of minority shareholders’ interests are generally moves in the right direction.30

Paradoxically, the stock exchanges that have followed the best practices and have successfully developed their local markets are also encountering the highest degree of outward migration in capital raising, listing, and trading activities. However, as Claessens, Klingebiel, and Schmukler (2002) also note, migration has been beneficial in many ways: corporates have been able to raise capital at lower costs by tapping wider investor bases and investors have been able to trade shares at more liquid exchanges.31 The authors conclude that emerging markets should focus on creating the conditions—such as improving shareholder rights and the quality of local legal systems—that allow corporations to issue and trade shares abroad in an efficient way, rather than adopt measures designed to protect local exchanges. In addition, they follow Steil (2001) and suggest that countries, especially those with small markets, should work toward having their local trading systems tightly linked or merged with global markets. There are, however, several “gray” areas where there is much less of a consensus about the appropriate degree of official intervention.32 One such area is the extent of corporate disclosure and accounting standards that should be mandated by the official sector. For example, Hong Kong SAR’s stock exchange recently backed away from a proposal to introduce quarterly financial reporting, on the basis that it would increase companies’ costs and could lead investors and management to become too focused on short-term profits—an issue also debated in some mature markets. Also, while everyone agrees that appropriate

29These concerns are particularly serious in the case of small stock markets. See IMF (2002a) for further details on domestic equity markets as a source of funding and an investment alternative for international investors. Structural issues in global and emerging equity markets are dealt with in IMF (2001). 30Claessens, Klingebiel, and Schmukler (2002) show that countries that follow these types of policies tend to have larger and more liquid stock exchanges. However, they also show that as such fundamentals improve, the degree of migration to other exchanges also increases. 31Pagano and others (2001), also show that the need for greater liquidity appears to be one of the most important factors in the decision to cross list shares and issue American Depository Receipts/Global Depository Receipts. 32The focus here is on structural policies. The issue of official intervention in stock and bond markets in the context of speculative attacks is dealt with in Chapter V of IMF (1999).

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accounting standards should be put in place, there is considerable debate about whether these should follow Generally Accepted Accounting Principles (GAAP) or International Accounting Standards (IAS). In the end, either standard would probably work well as long as it is generally applied and enforced. Similarly, there is no general agreement about the degree to which consumer protection and more general supervision of the exchanges should be undertaken by self-regulatory organizations (SROs) or by the authorities. While consumer protection issues (especially those related to retail investors) are often overseen by official agencies, analysts suggest that the most appropriate mix is likely to depend on the mix of local retail and institutional investors (with greater reliance on SROs being relied upon more heavily when institutional investors dominate), the degree of sophistication of investors and other exchange participants, and the degree of market expertise in the official sector. Whatever mix is decided upon, it is generally agreed that regulation and supervision should not be designed to stifle competition. Perhaps the most contentious issue in many emerging markets is the role of the authorities in promoting changes in the ownership structure of the stock exchanges, particularly from a mutual to a publicly owned corporate structure. A growing number of analysts are recommending that the authorities support the demutualization of their exchanges. In many instances, this intervention is justified on the basis of a collective action problem—namely, that under a mutual ownership structure some vested interests (particularly small brokers) may block the adoption of new computer and telecommunication technologies that allow for more efficient trading platforms because such platforms would allow for more direct access to the trading floor that could reduce brokerage revenues (see, for instance, Steil, 2001). These analysts also see a role for the official sector to help develop the telecommunication sector, especially when there are

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large fixed costs associated with developing such systems. However, others argue that these decisions should be left up to the exchanges themselves and that competitive pressures (especially from abroad) will bring about the necessary changes. The Role of Foreign Investors in Local Markets Foreign investors are an important source of demand for local securities, and several emerging markets have opened their local markets to foreign investors in an attempt to widen and diversify the investor base. Foreign participation in local equity markets appears to be larger than in local bond markets, but measurement of the latter is generally problematic and tends to underestimate foreign presence (see IMF, 2002b). Although there may be differences in investment strategies among different types of foreign investors, market participants perceive foreign investors as playing a supportive role in local markets. For instance, recent inflows to Central European countries motivated by the prospect of convergence with the European Union have been generally perceived as driven by “real money” institutional investors that have a positive long-term view on the region and contribute to the depth of local markets. Also, foreign investors usually impose positive pressure for developing robust market infrastructure and transparent market practices. Some analysts are concerned, however, that foreign investors may be less informed than local ones and may contribute to market volatility and crises. The empirical evidence on this, however, is rather limited and inconclusive. Some argue that foreign investors seeking diversification benefits may not have an incentive to invest in the necessary information required to understand local markets and may be more prone to herding behavior; while others state that because foreign investors tend to be quite sensitive to risk and to manage actively their portfolios, they may make local markets more volatile and prone

SELECTED POLICY ISSUES

to crises. These hypotheses are difficult to test empirically and only a couple of experiences may shed light on the issue. Analysts have suggested that it was local rather than foreign investors that were the first to leave the Mexican local market in December 1994 (see IMF, 1995; and Frankel and Schmukler, 1996). Kim and Wei (2002) examine the transactions of different types of portfolio investors in Korea before and during the Asian crisis. They find that nonresident institutional investors were always positive feedback traders, while resident investors were contrarian traders before the crisis but became positive feedback traders during the crisis.33 Choe, Kho, and Stulz (1999) also study transaction data from the Korean stock market during the crisis and find evidence for return-chasing and herding among foreign investors before the crisis period, but no evidence for a destabilizing effect of foreign investors over the entire sample period. Derivatives Markets Local derivatives markets have grown in some of the large emerging markets, but notional amounts and trading volumes remain much smaller than in the mature markets.34 The main reasons for the underdevelopment of local derivatives markets are the underdevelopment of the underlying securities markets themselves, as well as tight regulations that restrict their use by banks and investors. Once the underlying securities markets reach a certain level of development, the efficiency gains of derivative products—in terms of unbundling and reallocating risks—become apparent and, barring regulatory obstacles, derivatives markets are likely to thrive. An example of how such gains can be achieved

was recently provided in Brazil, with the unbundling of U.S. dollar-linked debt instruments into a pure local fixed-income instrument and a foreign currency swap. Investment banks in Brazil were selling U.S.-dollar-linked debt to mutual funds while simultaneously entering into two swap contracts: one that involved transferring the currency exposure to the banks—as the funds were interested in a pure fixed-income exposure—and another one that involved the sale of a dollar hedge to corporate customers that held U.S. dollar debts. To reduce the steps (and the associated intermediation spreads) involved in providing foreign exchange protection to end users, the central bank moved to replace U.S.-dollarlinked debt with fixed-income instruments and a foreign currency swap. The changes lowered transaction costs and better accommodated the financial needs of different investors.35 Despite a growing acceptance that derivatives can contribute to the efficiency and stability of local financial markets, regulators in a number of emerging markets remain concerned about the potential risks involved in using instruments that have quite often been associated with financial crises. However, as noted in IMF (2002c), financial derivatives have at times magnified volatility and the effects of a financial crisis, but they were seldom the cause of the crises themselves. From the string of crises in the 1990s, it has become clear that the problem was not the use of derivatives per se, but the underlying weaknesses in domestic and global financial systems as well as shortcomings in macroeconomic policies (see also Khor, 2001). In the aftermath of crises, a large number of emerging markets have strengthened their regulatory and supervisory framework—

33Positive feedback traders are those that buy past winners and sell past losers; negative feedback traders (or contrarians) follow the opposite trading strategy. 34Chapter IV in IMF (2002c) presents estimates of the size of emerging derivatives markets. 35By end-December 2002, U.S.-dollar–linked debt had fallen to $40 billion (from $77 billion the previous year), while the level of swaps outstanding had reached $26 billion.

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including for the use of derivatives. Market participants note that in some markets the main constraint to the development of onshore derivatives markets is not the legislation, but the regulators’ concern about the lack of knowledge and understanding of the products (see, for instance, Ransley, 2002). Analysts also note that there are risks related to the nonexistence of hedging instruments, or to the fact that they may be developed offshore. For instance, the recent rapid expansion of local bond markets was supported by a low interest rate environment, and some market participants are concerned that investors may not have instruments available to hedge against the forthcoming reversal in the interest rate cycle. Derivatives bring together hedgers and speculators that normally tend to increase the liquidity and smooth price changes in the underlying securities. Problems arise when the market becomes one-sided, as in Brazil’s foreign exchange market by mid-2002, when the only supplier of foreign exchange hedge was the sovereign itself.36 Similarly, as the experience with equity markets demonstrates, if capital controls or other regulatory obstacles send markets offshore, it may be difficult to reverse the flow and develop the onshore markets. The possibility that the rapid growth of derivatives may outstrip the risk management capabilities of end-users and the supervisory capabilities of regulatory authorities is nevertheless a legitimate concern. Regulators, therefore, have to strike a balance between the need to allow for better risk management and market development and the risk of increased exposure to potential vulnerabilities. The first line of defense against the latter are sound and credible macroeconomic policies. The second line of defense are policies geared toward enhanced risk management capabilities of financial institutions, com-

bined with up-to-date risk assessment capabilities of regulators. Both kinds of measures point to the need to foster transparency and prompt disclosure of relevant information. A number of emerging markets have strengthened financial regulation and adopted Basel-type guidelines for capital adequacy—including for derivatives instruments—and this would go a long way toward preventing and mitigating derivatives-related vulnerabilities. Frequent contact with market participants and the discussion and consultation of regulatory changes with the industry are also useful for the early detection of these vulnerabilities. Finally, investor protection arguments suggest that, even if retail investors exposures are not large, efforts should be made to clarify the nature of risks associated with different instruments, either through warnings in the contracts or other means of investor education. Sequencing The development of local securities markets raises a number of interesting questions about the optimal sequencing vis-à-vis the development of other financial markets and institutions—such as money markets and banks—as well as other macroeconomic and regulatory policies. Broadly speaking, a comparison of different types of financial systems, and their evolution over time, is a complex issue and there are no simple answers to what would be an optimal development strategy (see Allen and Gale, 2000). Nevertheless, a gradual and complementary approach is beneficial as a general rule, though in some cases, a given sequencing may be preferable. Some analysts suggest that it may be optimal to develop first a deep local debt market before opening up the capital account. An example of the former strategy is the path fol-

36The availability of derivative instruments and markets to trade them should not be confused with the availability of an abundant supply of “hedge”—the latter being related to the credibility of macroeconomic policies and the willingness to take one side of the market.

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SELECTED POLICY ISSUES

lowed by Australia (see Eichengreen and Hausmann, 1999), which has developed a deep local bond market and has some 44 percent of its external debt denominated in local currency.37 This seems to be the path chosen by two large emerging markets—China and India—that have sizable local debt markets and have not yet fully opened up to foreign investors (see IMF, 2002b; and BIS, 2002). The potential benefits of developing local markets in isolation from international markets have to be weighed against traditional arguments against capital controls (such as misallocation of resources, increased costs of funding, and evasion; see Dooley, 1996), as well as to the fact that market participants argue that controls have in some instances reduced liquidity and hence hindered the development of local securities markets.38 Developing external debt markets may also have positive benefits for the development of local securities markets, as firms that access international markets learn issuance techniques that can be transferred later on to their local issuance programs. Countries such as Chile and Mexico have developed first an external bond market for the sovereign, which was then followed by the corporate sector, and afterwards used that experience to grow their local markets.39 The development of well-functioning money markets appears to be a critical first step in developing corporate bond markets (see Schinasi and Smith, 1998), as well as derivatives markets. Money markets provide an anchor to the short end of the yield curves and are critical for the pricing of fixed-income securities and derivatives. Korea and Thailand provide examples of the difficulties of developing a secondary bond market and the associated derivatives markets without the support

of a well-developed money market (see Cha, 2002; and IMF, 2002b). Although local securities markets can provide an alternative source of funding to the banking sector, especially during banking crises (Greenspan’s “spare tire”), a sound and well-regulated banking system can be a necessary complement to the development of local securities markets. Banks can play a number of supporting roles for securities markets: they can be large holders of securities, underwriters and market makers, issuers, guarantors, as well as arrangers of securitizations (see Hawkins, 2002). The large involvement of banks in the securities business requires appropriate regulations (“firewalls”) to prevent the issuance of bonds to repay loans and subsequent sale of the bonds to an asset manager subsidiary at higher-than-market prices. Banking and bond markets could be developed in tandem, building appropriate regulatory and institutional framework to encompass both. However, in the absence of a large institutional investor base, domestic debt holdings may become too concentrated in the banking system. This could in turn constrain the resolution of debt crises, as haircuts on the debt could compromise the solvency of the banking system. Finally, local securities markets remain highly segmented in most regions, and a number of measures would have to be undertaken to develop fully integrated, regional markets. Despite their recent growth and deepening, Asia’s domestic currency bond markets, for instance, are largely insulated from each other. Domestic investors in several countries are not allowed to invest in international markets, and foreign investors are not attracted by the low yield and costly hedges. Analysts note that, besides the removal of controls and har-

37The authors caution, however, against attempts to follow this path—namely to reverse the opening of the capital account—for countries that have already followed alternative sequencing strategies. 38Chile is sometimes mentioned as an example; see Cifuentes, Desormeaux, and Gonzalez (2002). 39Yuan (2000) shows that issuance of sovereign bonds in international markets creates informational externalities that improve the liquidity of corporate bonds.

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monization of taxes, several institutional aspects of bond markets—such as contracts, underwriting, and settlement conditions— would have to be standardized to some extent before a pan-Asian market could be created (see, for instance, Parsons, 2001). However, a series of overlapping proposals to develop a regional bond market in the region may focus the authorities’ efforts on the removal of some of these barriers and contribute to speed up the process.40

Concluding Remarks Local securities and derivatives markets have grown substantially over the last five years. Despite the rapid expansion of local markets—in particular, local bond markets— they have not yet developed enough to provide full insurance against the closure of banking or international markets. Nonetheless, continued efforts to develop these markets could eventually provide a significant cushion against future closures. In particular, these efforts should focus on continuing to adopt measures geared toward strengthening market infrastructure, developing benchmarks and local institutional investors, and improving corporate governance and transparency. Moreover, despite the existence of ambiguities concerning some policies (the “gray areas”) related to the development of local securities and derivatives markets, several measures could still be undertaken, while monitoring and controlling their potentially negative side effects. For instance, well-developed derivatives markets provide efficient instruments for risk management, and experience shows that sound macroeconomic and regulatory policies can largely mitigate their potentially negative

effects on financial stability. Similarly, indexed instruments contribute to increase duration in fixed-income markets, but excessive indexation to foreign exchange could lead to balance sheet mismatches and unstable debt dynamics and, hence, should be discouraged.

References Allen, Franklin, and Douglas Gale, 2000, Comparing Financial Systems (Cambridge, Mass.: MIT Press). Bank for International Settlements, 2002, The Development of Bond Markets in Emerging Economies, BIS Papers No. 11 (Basel: BIS). Barham, John, 2001, “A Compromise Solution,” Latin Finance (October), pp. 40–43. Bubula, Andrea, and Inci Ötker-Robe, 2002, “The Evolution of Exchange Rate Regimes Since 1990: Evidence from De Facto Policies,” IMF Working Paper No. 02/155 (Washington: International Monetary Fund). Burnside, Craig, Martin Eichenbaum, and Sergio Rebelo, 2001, “Hedging and Financial Fragility in Fixed Exchange Rate Regimes, European Economic Review, Vol. 45 (June), pp. 1151–93. Caballero, Ricardo, 2002, “Coping with Chile’s External Vulnerability: A Financial Problem,” in Economic Growth: Sources, Trends, and Cycles, ed. by Norman Loayza and Raimundo Soto (Santiago: Central Bank of Chile). ———, and Arvind Krishnamurthy, forthcoming, “Excessive Dollar Debt: Financial Development and Underinsurance,” Journal of Finance. Calvo, Guillermo A., 1998, “Capital Flows and Capital Market Crises: The Simple Economics of Sudden Stops,” Journal of Applied Economics, Vol. 1 (November), pp. 35–54. ———, 1999, “Contagion in Emerging Markets: When Wall Street Is the Carrier.” Available on the Internet at http://www.bsos.umd.edu/econ/ ciecalvo.htm. ———, 2000, “Capital Markets and the Exchange Rate: With Special Reference to the Dollarization Debate in Latin America” (unpublished; Center

40These include work aimed at developing local bond markets by APEC, the ASEAN+3 group, and a recent proposal by the Asian Cooperation Dialogue (ACD). The latter would involve a set of Asian governments launching a regional bond fund, financed by Asian central banks, that would “catalyze” larger investments from institutional investors and would invest initially in U.S. dollars, euro, and other nonregional currency bonds, later diversifying into local currency bonds from government and corporate issuers.

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REFERENCES

for International Economics, University of Maryland). _____, and Carmen M. Reinhart, 2000, “When Capital Inflows Suddenly Stop: Consequences and Policy Options,” in Reforming the International Monetary and Financial System, ed. by Peter B. Kenen and Alexander K. Swoboda (Washington: International Monetary Fund). Cervera, Alonso, and Audra Quedry, 2003, “Polling Mexico’s Pension Funds,” Credit Suisse First Boston (CSFB) Emerging Market Economics. Cha, Hyeon-Jin, 2002, “Analysis of the Sluggish Development of the Secondary Market for Korean Government Bonds, and Some Proposals” (unpublished; Seoul: The Bank of Korea, Financial Markets Department, May). Choe, Hyuk, Bong-Chan Kho, and René M. Stulz, 1999, “Do Foreign Investors Destabilize Stock Markets? The Korean Experience in 1997,” Journal of Financial Economics, Vol. 54 (October), pp. 227–64. Cifuentes, Rodrigo, Jorge Desormeaux, and Claudio Gonzalez, 2002, “Capital Markets in Chile: from Financial Repression to Financial Deepening,” in The Development of Bond Markets in Emerging Economies, BIS Paper No. 11 (Basel: Bank for International Settlements). Claessens, Stijn, Daniela Klingebiel, and Sergio L. Schmukler, 2002, “Explaining the Migration of Stocks from Exchanges in Emerging Economies to International Centers,” World Institute for Development Economic Research (WIDER) Discussion Paper No. WOP 2002/94 (Helsinki: United Nations University—WIDER). Davies, Ben, 2002, “Equity Research—In Crisis?” AsiaMoney (November). Dooley, Michael, 1996, “A Survey of the Literature on Controls over International Capital Transactions,” IMF Staff Papers, International Monetary Fund, Vol. 43 (December), pp. 639–87. ———, 2000, “A Model of Crises in Emerging Markets,” The Economic Journal, Vol. 110 (January), pp. 256–72. Eichengreen, Barry, and Ricardo Hausmann, 1999, “Exchange Rates and Financial Fragility,” NBER Working Paper No. 7418 (Cambridge, Mass.: National Bureau of Economic Research). ———, and Ugo Panizza, 2002, “Original Sin: The Pain, the Mystery, and the Road to Redemption,” paper presented at the IDB Conference on Currency and Maturity Matchmaking:

Redeeming Debt from Original Sin (November). Feldstein, Martin, 1999, “Self-Protection for Emerging Market Economies,” NBER Working Paper No. 6907 (Cambridge, Mass.: National Bureau of Economic Research). Fischer, Stanley, 2001, “Exchange Rate Regimes: Is the Bipolar View Correct,” Journal of Economic Perspectives, Vol. 15 (Spring), pp. 3–24. Frankel, Jeffrey, and Sergio Schmukler, 1996, “Country Fund Discounts and the Mexican Crisis of 1994: Did Local Residents Turn Pessimistic Before International Investors?” Open Economies Review, Vol. 7 (Supplement 1), pp. 511–34. Greenspan, Alan, 1999, “Lessons from the Global Crises,” remarks before the World Bank Group and the International Monetary Fund, Annual Meetings Program of Seminars (Washington, September 27). Available on the Internet at http://www.federalreserve.gov/Boarddocs/Speeches/ 1999/199909272.htm. Habermeier, Karl, and Shogo Ishii, forthcoming, “Exchange Arrangements and Foreign Exchange Markets—Developments and Issues,” World Economic and Financial Surveys (Washington: International Monetary Fund). Hawkins, John, 2002, “Bond Markets and Banks in Emerging Economies,” in The Development of Bond Markets in Emerging Economies, BIS Paper No. 11 (Basel: Bank for International Settlements). International Monetary Fund, 1995, International Capital Markets: Developments, Prospects, and Key Policy Issues, World Economic and Financial Surveys (Washington). ———, 1999, International Capital Markets: Developments, Prospects, and Key Policy Issues, World Economic and Financial Surveys (Washington). ———, 2001, International Capital Markets: Developments, Prospects, and Key Policy Issues, World Economic and Financial Surveys (Washington). ———, 2002a, Global Financial Stability Report, World Economic and Financial Surveys (Washington, June). ———, 2002b, Global Financial Stability Report, World Economic and Financial Surveys (Washington, September). ———, 2002c, Global Financial Stability Report, World Economic and Financial Surveys (Washington, December). ———, 2003, “Financial Stability in Dollarized Economies,” (unpublished; Washington:

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Monetary and Exchange Affairs Department, International Monetary Fund). Jeanne, Olivier, 2002, “Why Do Emerging Economies Borrow in Foreign Currency?” paper presented at an IMF Research Department Seminar (Washington, March 6). Johnson, Simon, and Andrei Shleifer, forthcoming, “Privatization and Corporate Governance,” in Governance, Regulation and Privatization, East Asia Seminar on Economics, Volume 12, ed. by Takatoshi Ito and Anne O. Krueger (Chicago: The University of Chicago Press). Khor, Hoe E., 2001, “Derivatives and Macroeconomic Management in Post-Crisis Asia” (Monetary Authority of Singapore). Kim, Woochan, and Shang-Jin Wei, 2002, “Foreign Portfolio Investors Before and During a Crises,” Journal of International Economics, Vol. 56 (January), pp. 77–96. La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, 2000, “Investor Protection and Corporate Governance,” Journal of Financial Economics, Vol. 58 (Issues 1–2), pp. 3–27. Norton, Guy, 2002, “The Fall and Rise of Rouble Bonds,” Euroweek (October). Organization for Economic Cooperation and Development, 2001, “Bond Market Development in Asia” (Paris: OECD). Pagano, Marco, Otto Randl, Alisa Röell, and Josef Zechner, 2001, “What Makes Stock Exchanges Succeed? Evidence from Cross-Listing Decisions,” CEPR Discussion Paper, No. 2683 (London: Centre for Economic Policy Research). Parsons, Nick, 2001, “The Bond Markets in Asia,” Euroweek (June). Prasad, Eswar, and Shang-Jin Wei, forthcoming, “Effects of Financial Globalization on Developing Countries: Some Empirical Evidence,” IMF Occasional Paper (Washington: International Monetary Fund).

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Ransley, Anuszka, 2002, “Eastern Europe: Game On,” FOW (May). Reinhart, Carmen M., and Kenneth S. Rogoff, 2002, “The Modern History of Exchange Rate Arrangements: A Reinterpretation,” NBER Working Paper No. 8963 (Cambridge, Mass.: National Bureau of Economic Research). Schinasi, Garry, and R. Todd Smith, 1998, “Fixed Income Markets in the United States, Europe, and Japan: Some Lessons for Emerging Markets,” IMF Working Paper No. 173/98 (Washington: International Monetary Fund). Sharma, Krishnan, 2000, “The Underlying Constraints on Corporate Bond Market Development in South East Asia,” United Nations, DESA Discussion Paper No. 14 (September). Steil, Benn, 2001, “Borderless Trading and Developing Securities Markets,” in Open Doors: Foreign Participation in Financial Systems in Developing Countries, ed. by Robert E. Litan, Paul Masson, and Michael Pomerleano (Washington: Brookings Institution Press). Walker, Eduardo, 2002, “The Chilean Experience with Completing Markets with Financial Indexation,” in Inflation and Monetary Policy, ed. by Le-Fort and Schmidt-Hebbel (Santiago: Central Bank of Chile). World Bank and IMF, 2001, Developing Government Bond Markets: A Handbook (Washington: World Bank). Yam, Joseph, 2001, “Developing and Positioning Hong Kong’s Bond Market,” speech delivered at the Forum on China’s Government Securities Market in the New Century (Hong Kong, November 19). Available on the Internet at http://www.info.gov.hk/hkma/eng/speeches/index.htm. Yuan, Kathy, 2000, “Information Externality of Sovereign Bonds on the Liquidity of Corporate Bonds: An Empirical Exploration” (unpublished; Cambridge, Mass.: MIT, April).

GLOSSARY

Balance sheet mismatch

A balance sheet is a financial statement showing a company’s assets, liabilities, and equity on a given date. Typically, a mismatch in a balance sheet implies that the maturities of the liabilities differ (are typically shorter) from those of the assets and/or that some liabilities are denominated in a foreign currency while the assets are not.

Banking soundness

The financial health of a single bank or of a country’s banking system.

Benchmark issues

High-quality debt securities, typically bonds. Investors use their yield for comparison purposes and to price other bond issues.

Capital account liberalization

Removal of statutory restrictions on cross-border private capital flows, an important part of financial liberalization. In particular, the relaxation of controls or prohibitions on transactions in the capital and financial accounts of the balance of payments, including the removal of foreign exchange convertibility restrictions.

Carry trade

A leveraged transaction in which borrowed funds are used to buy a security whose yield is expected to exceed the cost of the borrowed funds.

Collective action clause

A clause in bond contracts that includes provisions allowing a qualified majority of lenders to amend key financial terms of the debt contract and bind a minority to accept these new terms.

Contagion

The transmission or spillover of financial shocks or crises across countries and/or across asset classes, characterized by an apparent increase in the comovement of asset prices.

Convergence fund

A fund that invests in Eastern European countries’ debt securities on the assumption that interest rates in these countries will converge to those in the European Union.

Convexity

A measure of the sensitivity of bond prices to interest rate changes. When interest rates are rising (falling), the price of a bond with negative convexity will decline (rise) by more (less) than one with positive convexity, all other things equal.

Corporate governance

The governing relationships between all the stakeholders in a company—including the shareholders, directors, and management—as defined by the corporate charter, bylaws, formal policy, and rule of law.

Credit default swap

A financial contract under which an agent buys protection against credit risk for a periodic fee in return for a payment by the protection seller contingent on the occurrence of a credit/default event.

Credit spreads

The spread between sovereign benchmark securities and other debt securities that are comparable in all respects except for credit qual-

95

GLOSSARY

ity, (e.g., the difference between yields on U.S. treasuries and those on single-A-rated corporate bonds of a certain term to maturity).

96

Credit tiering

Differentiation of borrowers by their credit quality (typically resulting in high cost and/or lower flows to borrowers with low credit quality).

Crossover investors

Investors who typically invest in mature markets and may cross over to emerging markets on an opportunistic or long-term basis.

Defined benefit pensions

A retirement pension plan where the benefits that retirees receive are determined by such factors as salary history and the duration of employment. The company is typically responsible for the investment risk and portfolio management.

Derivatives

Financial contracts whose value derives from underlying securities prices, interest rates, foreign exchange rates, market indexes, or commodity prices.

Dollarization

The widespread domestic use of another country’s currency (typically the U.S. dollar) to perform the standard functions of money—that of a unit of account, medium of exchange, and store of value.

Double gearing

Situations where multiple companies use shared capital to protect against risk occurring in separate entities. For example, an insurance company may purchase shares in a bank as a reciprocal arrangement for loans. In these cases, both institutions are leveraging their exposure to risk.

Emerging markets

Developing countries’ financial markets that are less than fully developed, but are nonetheless broadly accessible to foreign investors.

(Equity) put option

A financial contract that gives the buyer the right, but not the obligation, to sell an asset (equity) at a set price on or before a given date.

Foreign direct investment

The acquisition abroad (i.e., outside the home country) of physical assets, such as plant and equipment, or of a controlling stake (usually greater than 10 percent of shareholdings).

Forward price-earnings ratio

The multiple of future expected earnings at which a stock sells. It is calculated by dividing the current stock price (adjusted for stock splits) by the estimated earnings per share for a future period (typically the next 12 months).

Hedge funds

Investment pools, typically organized as private partnerships and often resident offshore for tax and regulatory purposes. These funds face few restrictions on their portfolios and transactions. Consequently, they are free to use a variety of investment techniques—including short positions, transactions in derivatives, and leverage—to raise returns and cushion risk.

Hedging

Offsetting an existing risk exposure by taking an opposite position in the same or a similar risk, for example, by buying derivatives contracts.

GLOSSARY

Interest rate swaps

An agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will make fixed-rate and receive variable-rate interest payments.

Intermediation

The process of transferring funds from the ultimate source to the ultimate user. A financial institution, such as a bank, intermediates credit when it obtains money from depositors and relends it to borrowers.

Investment-grade issues (Sub-investment-grade issues)

A bond that is assigned a rating in the top four categories by commercial credit rating agencies. S&P classifies investment-grade bonds as BBB or higher, and Moody’s classifies investment-grade bonds as Baa or higher. (Sub-investment-grade bond issues are rated bonds that are below investment grade.)

Leverage

The magnification of the rate of return (positive and negative) on a position or investment beyond the rate obtained by direct investment of own funds in the cash market. It is often measured as the ratio of on- and off-balance-sheet exposures to capital. Leverage can be built up by borrowing (on-balance-sheet leverage, commonly measured by debt-to-equity ratios) or by using off-balancesheet transactions.

Nonperforming loans

Loans that are in default or close to being in default (i.e., typically past due for 90 days or more).

Offshore instruments

Securities issued outside of national boundaries.

(Pair-wise) correlations

A statistical measure of the degree to which the movements of two variables (e.g., asset returns) are related.

Pension funding gaps

The difference between the discounted value of accumulating future pension obligations and the present value of investment assets.

Primary market

The market where a newly issued security is first offered/sold to the public.

Risk aversion

Describes an investor’s preference to avoid uncertain outcomes or payoffs. A risk averse investor will demand a risk premium when considering holding a risky asset or portfolio.

Risk capital

Money allocated to investments in risky securities or speculative investment activities.

Samurai market

The market for yen-denominated debt securities that are issued in Tokyo by issuers that are not Japanese.

Secondary markets

Markets in which securities are traded after they are initially offered/sold in the primary market.

Spread

See “credit spread” above (the word “credit” is sometimes omitted). Other definitions include: (1) the gap between bid and ask prices of a financial instrument; (2) the difference between the price at which an underwriter buys an issue from the issuer and the price at which the underwriter sells it to the public.

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GLOSSARY

98

Swaptions

Options on interest rate swaps.

Syndicated loans

Large loans made jointly by a group of banks to one borrower. Usually, one lead bank takes a small percentage of the loan and partitions (syndicates) the rest to other banks.

Total return swaps

A swap in which the non-floating-rate side is based on the total return of an equity or fixed-income instrument with a life longer than the swap.

Yield curve

A chart that plots the yield to maturity at a specific point in time for debt securities having equal credit risk but different maturity dates.

ANNEX

CONCLUDING REMARKS BY THE ACTING CHAIR

The following remarks by the Acting Chair were made at the conclusion of the Executive Board's discussion of the Global Financial Stability Report on March 14, 2003.

xecutive Directors welcomed the first in the new series of semiannual Global Financial Stability Reports (GFSRs). They appreciated the strengthened analytical content of the GFSR, including the analysis of financial soundness indicators and the increasing focus on policy implications, and looked forward to its further development as a key instrument of multilateral surveillance. Directors observed that the global financial system has remained resilient, despite significant geopolitical uncertainties and a hesitant and uneven global economic recovery. Markets continue to work off the excesses of the equity asset price bubble. Directors noted that the bursting of the bubble has revealed underlying structural weaknesses, which require carefully crafted policy responses. Directors noted that, in the current unsettled international environment, consumers, businesses, and investors remain on the sidelines. They felt that this uncertainty could well persist for some time, going beyond immediate geopolitical concerns. Directors stressed that, in this difficult environment, policies to improve market confidence on a sustained basis remain of critical importance. They underlined their endorsement of continued supportive macroeconomic policies and wideranging measures in the structural area to address underlying market vulnerabilities.

E

Key Developments and Sources of Financial Risk in the Major Financial Centers Directors noted that a gradual improvement of financial conditions in mature markets has

recently begun to take hold and, in particular, U.S. household and corporate sectors’ balance sheets have strengthened somewhat. They cautioned, however, that this progress is still fragile, and that underlying vulnerabilities will require continued vigilance and policy attention. The corporate sector in a number of countries faces growing funding gaps in defined-benefit pension plans, as a result of lower equity prices and higher present values of pension liabilities due to lower interest rates. The improvement in the U.S. household sector’s balance sheet rests crucially on continued strength in the housing market. Directors noted that the financial sector in the mature economies presents a mixed picture. While banks with a strong retail franchise have performed reasonably well, wholesale and investment banks have been hard hit. Despite the authorities’ renewed initiative to tackle the situation, the persistent weaknesses of Japanese banks remain a matter of concern. A number of Directors also highlighted the difficult situation facing the German banks in a context of low earnings, high costs, a deterioration in loan quality, and an erosion of hidden reserves as a result of the decline in the German equity market. Directors called for close monitoring of the deteriorating financial condition in the insurance sector in several European countries. The protracted weakness of equity markets has resulted in lower returns on assets and prompted sales of equity holdings, in some cases, to comply with solvency regulations. Directors noted that the tendency of investors to remain on the sidelines has resulted in a significant accumulation of high-

99

ANNEX

CONCLUDING REMARKS BY THE ACTING CHAIR

quality, short-term cash balances by retail and institutional investors. They saw the potential for deployment of these balances into more productive assets once investor sentiment recovers as a generally positive factor in the outlook. At the same time, a number of Directors cautioned that a sudden shift in asset preferences and prices could expose the unhedged positions of commercial banks and broker-dealers to considerable interest rate risk. A number of Directors expressed concern about the capital strength of the government-sponsored mortgage agencies in the United States. A number of Directors also pointed to the increased sensitivity to interest rate differentials resulting from the sizable reallocation of net capital flows to the United States away from equities and direct investment toward fixed-income securities.

Emerging Market Financing Directors noted that an unsupportive external environment, together with investor concerns over the risk of policy discontinuity in key emerging market borrowers, had limited the availability and raised the cost of capital for most emerging market borrowers throughout most of last year. They were encouraged that the easing of global financial market conditions in the fourth quarter had led to a reopening of capital markets to many issuers, and that investor concerns about the direction of future polices in some major emerging market economies had abated. It was noted, however, that this recent development should be seen against the backdrop of the longer-term decline in capital flows to emerging market borrowers, which deserves further attention. Directors considered that the continued “feast or famine” dynamic in the primary market for emerging market bonds highlights the importance of self-insurance to mitigate—through sound economic frameworks and institutions—externally induced market volatility. Many Directors saw the recent market developments as providing evidence of

100

increased investor discrimination responding positively to the sustained pursuit of sound policies. Going forward, it will, nevertheless, remain important to consolidate this encouraging development and further reduce risks of contagion. Directors highlighted, in particular, the importance of further efforts, including by the IMF, to help investors distinguish among borrowers, and of policies aimed at promoting financial stability. They welcomed the improvements in banking sector regulation and capitalization in many emerging markets. They noted, however, that progress has varied by region, and that further measures are needed to bolster domestic banking systems. Directors also welcomed the recent issuance by Mexico of a bond that includes Collective Action Clauses (CACs) and encouraged other issuers to include CACs in future bond placements. They encouraged the staff to provide members with necessary advice to further this aim.

Measures to Improve Market Confidence Against the backdrop of these adjustments in global financial markets in a difficult international environment, Directors saw a continued need for strong confidence-building measures. Macroeconomic policies in the major economies need to continue to respond flexibly to signs of an economic downturn. In particular, a continued supportive monetary stance would facilitate the process of balance sheet strengthening in the financial sector. In the structural area, Directors highlighted the need for legal and regulatory frameworks to support corporate and financial sector restructuring. In the case of Japan, the low profitability of Japanese financial institutions and the problem of nonperforming loans need urgent corrective action. German banks will need to address their low earnings through cost reduction measures, including consolidation. Directors underscored the need for timely and sustained action to address the challenges facing insurance companies and the sponsors

MEASURES TO PROMOTE LOCAL SECURITIES MARKETS

of defined-benefit pension funds. In the insurance sector, this will require intensified regulatory efforts to encourage sounder asset risk management practices, and, possibly, judicious adjustments to solvency standards to reduce the need to sell equities into a declining market. In the case of defined-benefit pension schemes, Directors highlighted the need to address the long-standing mismatch between pension fund assets and liabilities. It will also be important to adopt realistic actuarial assumptions for portfolio returns, while avoiding precipitous regulatory changes that could trigger a self-reinforcing decline in equity markets. Directors considered it especially important in the current environment to reassure investors that they face a level playing field in the financial markets and that they have access to full and accurate information on the health of publicly traded firms. The continuation of ongoing efforts to improve corporate governance, accounting, auditing, and investment banking practices therefore remains a high priority. Directors observed that the “feast or famine” dynamic in emerging market financing and persistent credit tiering underscore the need for the consistent implementation of sound macroeconomic policies. In addition, they encouraged continued measures to deepen local securities markets, which can help provide a buffer against changing global financial conditions.

Measures to Promote Local Securities Markets Directors welcomed the discussion in the GFSR of key policy issues related to the role that local securities and derivatives markets can play in strengthening the emerging markets’ capacity to better weather global financial volatility. They noted that these markets can

provide an additional and possibly more stable source of funding for domestic corporations and the public sector, and stimulate domestic savings by broadening the set of investment opportunities. Among the core policies to promote the development and ensure the smooth functioning of local securities markets, Directors highlighted measures to improve market infrastructure and transparency, strengthen corporate governance, develop liquid benchmarks, and promote a domestic institutional investor base. A few Directors noted the supportive role that foreign direct investment in the financial sector can play in this regard. Directors stressed that steps to develop local securities markets need careful sequencing, with the development of money markets typically being a crucial first step in developing bond and derivatives markets. In this connection, a suggestion was also made that country case studies could help guide the development of local securities markets. Directors cautioned against heavy resort to bonds indexed to foreign currencies, which could increase vulnerability to external shocks and contribute to unstable debt structures. However, inflation-indexed bonds can be a useful instrument to deepen local bond markets. While local derivatives markets can facilitate the management of financial risk, Directors stressed that the development of such markets needs to be based on a strong supervisory and regulatory foundation. Although local securities and derivatives markets have grown substantially over the last years, Directors observed that they have not yet developed enough to provide full insurance against the closure of banking or international markets, which in many cases may remain a remote prospect. Directors supported continued efforts to develop these markets given their potential to improve emerging markets’ resilience.

101

STATISTICAL APPENDIX

his issue of the Global Financial Stability Report introduces a statistical appendix that presents data on financial developments in key financial centers and emerging markets. It is designed to complement the analysis in the text by providing additional data that describe key aspects of financial market developments. These data are derived from a number of sources external to the IMF, including banks, commercial data providers, and official sources, and are presented for information purposes only; the IMF does not guarantee the accuracy of the data from external sources. Presenting financial market data in one location and in a fixed set of tables and charts, in this and future issues of the Global Financial Stability Report, is intended to give the reader an overview of developments in global financial markets. The statistical appendix reflects information available up to February 19, 2003, unless otherwise specified.

T

Mirroring the structure of the chapters of the report, the appendix presents data separately for key financial centers and emerging market countries. Specifically, it is organized into three sections: • Figures 1–14 and Tables 1–9 contain information on market developments in key financial centers. This includes data on global capital flows, and on markets for foreign exchange, bonds, and equities, and derivatives as well as sectoral balance sheet data for the United States, Japan, and Europe. • Figures 15 and 16 and Tables 10–21 present information on financial developments in emerging markets, including data on equity, foreign exchange, and bond markets, as well as data on emerging market financial flows. • Tables 22–25 report key financial soundness indicators for selected countries, including bank profitability, asset quality, and capital adequacy.

103

STATISTICAL APPENDIX

List of Tables and Figures Key Financial Centers Figures 1. Global Capital Flows: Sources and Uses of Global Capital in 2001 2. Exchange Rates: Selected Major Industrial Countries 3. United States: Yields on Corporate and Treasury Bonds 4. Selected Spreads 5. Nonfinancial Corporate Credit Spreads 6. Equity Markets: Price Indexes 7. Implied and Historical Volatility in Equity Markets 8. Historical Volatility of Government Bond Yields for Selected Countries 9. Twelve-Month Forward Price/Earnings Ratios 10. Flows into U.S.-Based Equity Funds 11. United States: Corporate Bond Market 12. Europe: Corporate Bond Market 13. United States: Commercial Paper Market 14. United States: Asset-Backed Securities Tables 1. Global Capital Flows: Inflows and Outflows 2. Global Capital Flows: Outstanding Amounts and Net Issues of International Debt Securities by Currency of Issue and Announced International Syndicated Credit Facilities by Nationality of Borrowers 3. Selected Indicators on the Size of the Capital Markets, 2001 4. Global Over-the-Counter (OTC) Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contracts 5. Global Over-the-Counter (OTC) Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contracts by Counterparty, Remaining Maturity, and Currency Composition 6. Exchange-Traded Derivative Financial Instruments: Notional Principal Amounts Outstanding and Annual Turnover 7. United States: Sectoral Balance Sheets 8. Japan: Sectoral Balance Sheets 9. Europe: Sectoral Balance Sheets

105 106 107 108 109 110 111 112 113 113 114 115 116 117 118

120 121 122

123 124 126 127 128

Emerging Markets

104

Figures 15. Emerging Market Volatility 16. Emerging Market Debt

129 130

Tables 10. Emerging Market Equity Indices 11. Foreign Exchange Rates 12. Emerging Market Bond Index: EMBI+ Total Returns Index 13. Emerging Market Bond Index: EMBI+ Yield Spreads 14. Total Emerging Market Financing 15. Emerging Market Bond Issuance 16. Emerging Market Equity Issuance 17. Emerging Market Loan Syndication 18. Equity Valuation Measures: Dividend-Yield Ratios 19. Equity Valuation Measures: Price-to-Book Ratios 20. Equity Valuation Measures: Price-Earnings Ratios 21. United States Mutual Fund Net Flows

131 134 136 137 138 140 141 142 144 145 146 147

Financial Soundness Indicators 22. Bank Profitability 23. Bank Asset Quality 24. Bank Capital Adequacy 25. Moody’s Weighted Average Bank Financial Strength Index

148 149 150 151

KEY FINANCIAL CENTERS

Figure 1. Global Capital Flows: Sources and Uses of Global Capital in 2001 Countries That Export Capital 1 Other countries 2 24.4%

Kuwait 2.4% Netherlands 2.4% Hong Kong SAR 2.8%

Japan 20.2%

Belgium 3.0% Saudi Arabia 3.3% China 4.0%

Singapore 4.0% Taiwan Province of China 4.4%

Russia 7.3% Canada 4.5%

France 5.5%

Switzerland 5.7%

Norway 6.0%

Countries That Import Capital 3 Other countries 4 12.4% Australia 1.6% Portugal 1.8% Spain 2.7% United States 69.2%

Mexico 3.1% Brazil 4.1% United Kingdom 5.2%

Source: International Monetary Fund, World Economic Outlook database. 1As measured by countries’ current (capital) account surplus (deficit). 2Other countries include all countries with shares of total surplus less than 2.4 percent. 3As measured by countries’ current (capital) account deficit (surplus). 4Other countries include all countries with shares of total deficit less than 1.6 percent.

105

STATISTICAL APPENDIX

Figure 2. Exchange Rates: Selected Major Industrial Countries Bilateral exchange rate (left scale)1 Nominal effective exchange rate (right scale)2 140

United States

135 130 125 120 115

1999 90

Japan

2000

01

105

1.3

100

95

02

110 03 100

Euro Area

95

1.2

90 1.1

110 85

85 1.0

120

80 75

130 140

1.75

65 1999

2000

01

02

03 135

United Kingdom

131

1.65

0.9 0.8 1.3

75

1999

2000

01

02

70 03 104

Switzerland

102

1.4

100

1.5 127

98 1.6

1.55

96

123 1.7 1.45

1.35

1999

2000

01

02

119

1.8

115 03

1.9

94 92 90 1999

2000

01

02

Sources: Bloomberg L.P.; and the IMF Competitive Indicators System. Note: In each panel, the effective and bilateral exchange rates are scaled so that an upward movement implies an appreciation of the respective currency. 1Local currency units per U.S. dollar except for the euro area and the United Kingdom, for which data are shown as U.S. dollars per local currency. 21995 = 100; constructed using 1989–91 trade weights.

106

03

KEY FINANCIAL CENTERS

Figure 3. United States: Yields on Corporate and Treasury Bonds (Weekly data) 20

Yields (In percent)

16

Merrill Lynch high-yield bond index

Baa

12

8 10-year treasury bond 4 Aaa 0 1978

80

82

84

86

88

90

92

94

96

98

2000

02 1200

Yield Differentials with 10-year U.S. Treasury Bond (In basis points) 1000 Merrill Lynch high-yield bond index 800

600

400

Baa

200 Aaa

1978

80

82

84

86

88

90

92

94

96

0

98

2000

02

–200

Sources: Bloomberg L.P.; and Merrill Lynch.

107

STATISTICAL APPENDIX

Figure 4. Selected Spreads (In basis points) 1200

Corporate Spreads 1

1000

800

600 Merrill Lynch high-yield bond index 400 Baa 200 Aaa 1990 160

92

94

96

Repo Spread 2

98

2000

02

160

Commercial Paper Spread 3

120

120

80

80

40

40

0

0

–40

180

–40 1998

2000

02

TED Spread 4

1998

2000

02 160

Swap Spreads 5 United States

140

Euro area

120

100

80

60

40 Japan

0

20 –20

–40 1998

2000

02

1998

2000

Sources: Bloomberg L.P.; and Merrill Lynch. 1Spreads over 10-year U.S. treasury bond; weekly data. 2Spread between yields on three-month U.S. treasury repo and on three-month U.S. treasury bill. 3Spread between yields on 90-day investment-grade commercial paper and on three-month U.S. treasury bill. 4Spread between three-month U.S. dollar LIBOR and yield on three-month treasury bill. 5Spread over 10-year government bond.

108

0

02

KEY FINANCIAL CENTERS

Figure 5. Nonfinancial Corporate Credit Spreads (In basis points) 120

AA-rated

100 United States 80 60 Euro area

40 20

Japan 0 1998

99

2000

01

02

03 200

A-rated

175 150 United States

125 100 Euro area 75 50

Japan

25 1998

99

2000

01

02

03

0 350

BBB-rated 300 250 200

United States

150 Euro area 100 Japan

1998

99

2000

01

50

02

03

0

Source: Merrill Lynch.

109

STATISTICAL APPENDIX

Figure 6. Equity Markets: Price Indexes (January 1, 1990 = 100; weekly data) 1200

United States

1000

Nasdaq

800 S&P 500 600 400 Wilshire 5000

1990

92

94

96

98

2000

200

02

0

500

Europe Euro area (FTSE Eurotop 300)

400

Germany (DAX) 300

200 United Kingdom (FTSE All-Share)

1990

92

94

96

98

2000

100

02

0

120

Japan 100 80 Topix 60 40 Nikkei 225

1990 Source: Datastream.

110

92

94

96

98

2000

20

02

0

KEY FINANCIAL CENTERS

Figure 7. Implied and Historical Volatility in Equity Markets Implied volatility 60

Historical volatility 70

S&P 500

Nikkei 225 60

50

50

VIX 1

40

40 30 30 20 20 10

10

0 2000

2001

2002

2003

2000

2001

2002

0 2003

70

60 DAX

FTSE 100

60

50

50 40 40 30 30 20 20 10

10 0 2000

2001

2002

2003

2000

2001

2002

0 2003

Sources: Bloomberg L.P.; and IMF staff estimates. Note: Implied volatility is a measure of the equity price variability implied by the market prices of call options on equity futures. Volatilities are expressed in percent rate of change. 1VIX is CBOE’s Volatility index. This index is calculated by taking a weighted average of implied volatility for the eight S&P 100 calls and puts.

111

STATISTICAL APPENDIX

Figure 8. Historical Volatility of Government Bond Yields for Selected Countries 1 60

40 United States

Japan

35

50

30 40 25 30

20 15

20

10 10 5 0

2000

2001

2002

2003

2000

2001

2002

0 2003 25

20 Germany

United Kingdom

16

20

12

15

8

10

4

5

0

0 2000

2001

2002

2003

2000

Source: Bloomberg L.P. 1Volatility calculated as a rolling 100-day standard deviation of annualized yield on 10-year government bonds.

112

2001

2002

2003

KEY FINANCIAL CENTERS

Figure 9. Twelve-Month Forward Price/Earnings Ratios 75

35 Germany (left scale)

Japan (right scale)

30

65

55 25 45 20 35 15 25 United States (left scale)

10

5

1988

90

92

94

15

96

98

2000

02

5

Source: I/B/E/S.

Figure 10. Flows into U.S.-Based Equity Funds 1600

80 S&P 500 (right scale)

1400

60

1200

40

Net flows into U.S.-based equity funds 1 (left scale)

1000

20 800 0 600 –20

Flows into U.S.-based global and aggressive equity funds 1 (left scale)

–40

400 200 0

–60 1992

94

96

98

2000

02

Sources: AMG Sample Data; and Investment Company Institute. 1In billions of U.S. dollars.

113

STATISTICAL APPENDIX

Figure 11. United States: Corporate Bond Market 50

3.0

Investment Grade

45 2.5 40 Aaa Moody’s spread 1 (in percent; right scale)

35

2.0

Issuance (in billions of U.S. dollars; left scale)

30 25

1.5

20 1.0 15 10

0.5

5 0

0 1987

89

91

93

95

97

99

2001

03 12

25

High-Yield Merrill Lynch high-yield spread 1 (in percent; right scale)

10

20 8 15

Issuance (in billions of U.S. dollars; left scale)

6

10 4

5

0

2

1987

89

91

93

95

Sources: Board of Governors of the Federal Reserve System; and Bloomberg L.P. 1Spreads against yields on 10-year U.S. government bonds.

114

97

99

2001

03

0

KEY FINANCIAL CENTERS

Figure 12. Europe: Corporate Bond Market 1 1800

High-Yield Spread 2 (In basis points)

1600 1400 1200 1000 800 600 400 200 0

1998

1999

2000

2001

2002 35

European Corporate Bond Issuance (In billions of U.S. dollars) 30

25

20

15

10

5

1987

89

91

93

95

97

99

01

03

0

Sources: Bondware; and Datastream. 1Nonfinancial corporate bonds. 2Spread between yields on a Merrill Lynch High-Yield European issuers bond and a 10-year German benchmark bond.

115

STATISTICAL APPENDIX

Figure 13. United States: Commercial Paper Market 1 160

Discount Rate Spread 2 (In basis points; daily data)

140 120 100 80 60 40 20 0

1997

98

99

2000

01

02

03 400

Amount Outstanding (In billions of U.S. dollars; monthly data)

350 300 250 200 150 100 50 0

1991

93

95

Source: Board of Governors of the Federal Reserve System. 1Nonfinancial commercial paper. 2Difference between 30-day A2/P2 and AA commercial paper.

116

97

99

2001

03

KEY FINANCIAL CENTERS

Figure 14. United States: Asset-Backed Securities 200

ABS Spread 1 (In basis points) 150

100

50

0

–50

–100

1998

99

2000

01

–150 03

02

1600

Total Amount Outstanding 2 (In billions of U.S. dollars)

1400 Automobile 1200

Credit card Home equity

1000

Manufactured housing Other

800 600 400 200 0

1995

96

97

98

99

2000

01

02

Sources: Merrill Lynch; Datastream; and the Bond Market Association. 1Spread between yields on AAA asset-backed securities Merrill Lynch index and 10-year government bond. 2Data for 2002 refer to 2002:Q3.

117

STATISTICAL APPENDIX

Table 1. Global Capital Flows: Inflows and Outflows1 (In billions of U.S. dollars) Inflows _____________________________________________________________________________________________ 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

United States Direct investment Portfolio investment Other investment Reserve assets Total capital flows

23.2 57.5 30.1 n.a. 110.8

19.8 72.0 78.9 n.a. 170.7

51.4 111.0 119.7 n.a. 282.1

46.1 139.4 120.5 n.a. 306.0

57.8 210.4 170.4 n.a. 438.6

86.5 332.8 131.8 n.a. 551.1

105.6 333.1 268.1 n.a. 706.8

179.0 187.6 57.0 n.a. 423.6

289.4 285.6 167.4 n.a. 742.5

307.7 419.9 288.4 n.a. 1,016.0

130.8 426.1 196.0 n.a. 752.8

Canada Direct investment Portfolio investment Other investment Reserve assets Total capital flows

2.9 27.5 –0.3 n.a. 30.2

4.8 20.5 –2.2 n.a. 23.1

4.7 41.4 –6.7 n.a. 39.4

8.2 17.2 16.0 n.a. 41.4

9.3 18.4 –3.9 n.a. 23.9

9.6 13.7 15.7 n.a. 39.1

11.5 11.7 28.0 n.a. 51.2

22.7 16.6 5.4 n.a. 44.8

24.5 2.3 –11.5 n.a. 15.3

66.0 9.9 1.7 n.a. 77.6

27.4 19.8 6.8 n.a. 54.0

Japan Direct investment Portfolio investment Other investment Reserve assets Total capital flows

1.3 127.3 –108.2 n.a. 20.4

2.8 9.6 –105.2 n.a. –92.9

0.1 –6.1 –32.7 n.a. –38.7

0.9 64.5 –5.6 n.a. 59.8

0.0 59.8 97.3 n.a. 157.1

0.2 66.8 31.1 n.a. 98.1

3.2 79.2 68.0 n.a. 150.4

3.3 56.1 –93.3 n.a. –34.0

12.3 126.9 –265.1 n.a. –125.9

8.2 47.4 –10.2 n.a. 45.4

6.2 60.5 –17.6 n.a. 49.1

United Kingdom Direct investment Portfolio investment Other investment Reserve assets Total capital flows

16.5 18.2 18.5 n.a. 53.2

16.6 16.2 96.4 n.a. 129.1

16.5 43.6 191.4 n.a. 251.6

10.7 47.0 –10.8 n.a. 46.9

21.7 58.8 106.2 n.a. 186.7

27.4 68.0 254.4 n.a. 349.7

37.4 43.5 328.4 n.a. 409.2

74.7 35.3 97.2 n.a. 207.2

89.5 186.1 79.7 n.a. 355.3

119.9 258.3 423.3 n.a. 801.6

63.1 61.6 305.6 n.a. 430.3

Euro area2 Direct investment Portfolio investment Other investment Reserve assets Total capital flows

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

... ... ... n.a. ...

211.1 281.9 208.3 n.a. 701.3

400.0 263.9 338.2 n.a. 1,002.1

138.1 290.1 230.3 n.a. 658.4

Emerging markets Direct investment Portfolio investment Other investment Reserve assets Total capital flows

35.2 26.2 33.5 n.a. 95.0

37.7 43.1 78.9 n.a. 159.7

44.0 75.9 36.4 n.a. 156.3

63.5 88.2 –10.2 n.a. 141.4

88.3 34.0 103.5 n.a. 225.8

105.5 92.9 46.6 n.a. 244.9

135.5 63.3 39.9 n.a. 238.7

129.9 32.9 31.3 n.a. 194.1

159.9 54.4 –63.8 n.a. 150.6

152.6 36.6 –41.8 n.a. 147.4

162.5 –7.4 1.3 n.a. 156.4

Sources: International Monetary Fund, World Economic Outlook database; and International Financial Statistics. 1The total net capital flows are the sum of direct investment, portfolio investment, other investment flows, and reserve assets. “Other investment” includes bank loans and deposits. 2For Belgium and Luxembourg, data are not available.

118

KEY FINANCIAL CENTERS

Outflows _________________________________________________________________________________________________________________ 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

–37.9 –45.7 13.4 5.8 –64.4

–48.3 –49.2 19.1 3.9 –74.4

–84.0 –146.2 31.0 –1.4 –200.5

–80.2 –60.3 –40.9 5.3 –176.0

–98.8 –122.5 –121.4 –9.7 –352.4

–91.9 –149.8 –178.9 6.7 –413.9

–104.8 –119.0 –262.8 –1.0 –487.6

–142.6 –136.1 –74.2 –6.7 –359.7

–188.9 –128.4 –169.0 8.7 –477.6

–178.3 –127.5 –300.4 –0.3 –606.5

–127.8 –94.7 –143.5 –4.9 –371.0

–5.8 –10.2 0.9 1.8 –13.2

–3.5 –9.8 –3.5 4.8 –12.1

–5.7 –13.8 –0.4 –0.9 –20.8

–9.3 –6.6 –20.4 0.4 –35.9

–11.5 –5.3 –8.3 –2.7 –27.9

–13.1 –14.2 –21.1 –5.5 –53.9

–23.1 –8.6 –16.2 2.4 –45.4

–34.1 –15.1 9.4 –5.0 –44.8

–15.6 –15.6 9.4 –5.9 –27.7

–47.3 –41.9 –2.8 –3.7 –95.7

–35.6 –24.5 –8.9 –2.2 –71.1

–31.6 –81.6 26.5 8.4 –78.4

–17.4 –34.0 46.6 –0.6 –5.4

–13.8 –63.7 15.1 –27.5 –90.0

–18.1 –92.0 –35.1 –25.3 –170.4

–22.5 –86.0 –102.2 –58.6 –269.4

–23.4 –100.6 5.2 –35.1 –154.0

–26.1 –47.1 –192.0 –6.6 –271.6

–24.6 –95.2 37.9 6.2 –75.8

–22.3 –154.4 266.3 –76.3 13.4

–31.5 –83.4 –4.1 –49.0 –168.0

–38.5 –106.8 46.6 –40.5 –139.2

–16.8 –56.9 35.3 –4.7 –43.0

–19.7 –49.3 –60.5 2.4 –127.0

–27.3 –133.6 –68.5 –1.3 –230.5

–34.9 31.5 –42.4 –1.5 –47.4

–45.3 –61.7 –74.9 0.9 –181.0

–34.8 –93.1 –215.3 0.7 –342.6

–62.4 –85.0 –275.9 3.9 –419.4

–122.1 –53.0 –26.8 0.3 –201.6

–201.6 –33.1 –94.1 1.0 –327.7

–266.2 –99.9 –411.5 –5.3 –783.0

–34.2 –134.4 –257.6 4.5 –421.8

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

... ... ... ... ...

–338.1 –331.1 –34.6 11.6 –692.3

–398.5 –384.3 –166.1 16.2 –932.8

–228.6 –258.3 –219.2 16.9 –689.3

–2.7 1.9 33.7 –46.0 –13.2

–2.3 –1.2 –23.5 –58.7 –85.7

9.7 12.1 –5.9 –64.3 –48.4

16.9 24.5 –35.7 –69.0 –63.3

9.9 8.9 –17.1 –118.6 –116.9

9.2 0.6 –38.5 –108.7 –137.3

4.9 –10.7 –86.9 –76.6 –169.2

21.4 –16.6 –81.9 –48.7 –125.9

10.0 –24.5 –67.0 –100.0 –181.5

9.5 –31.3 –105.5 –128.1 –255.5

23.4 –31.3 –38.0 –127.5 –173.4

119

STATISTICAL APPENDIX

Table 2. Global Capital Flows: Outstanding Amounts and Net Issues of International Debt Securities by Currency of Issue and Announced International Syndicated Credit Facilities by Nationality of Borrowers (In billions of U.S. dollars) 2002 ________________________ Outstanding amounts of international debt securities by currency of issue U.S. dollar Japanese yen Pound sterling Canadian dollar Swedish krona Swiss franc ECU/Euro Other1 Total Net issues of international debt securities by currency of issue U.S. dollar Japanese yen Pound sterling Canadian dollar Swedish krona Swiss franc ECU/Euro Other1 Total Announced international syndicated credit facilities by nationality of borrowers All countries Industrial countries Of which: United States Japan Germany France Italy United Kingdom Canada

1994

1995

809.7 380.8 170.4 83.0 4.5 156.4 90.9 570.2 2,265.9

1998

1999

2000

2001

Q1

Q2

Q3

875.6 1,114.6 1,434.8 437.8 464.7 446.1 175.6 225.7 266.7 83.2 76.5 67.2 5.1 5.1 4.1 178.8 151.2 138.5 90.4 74.3 65.2 705.8 826.7 862.5

1,834.2 464.5 322.6 55.5 7.5 153.5 158.8 1,058.7

2,358.3 499.5 391.2 56.4 7.2 135.5 1,452.3 98.6

2,908.7 454.3 453.1 51.7 7.7 132.0 1,770.0 97.5

3,613.8 413.2 506.4 47.4 8.2 123.6 2,289.9 110.8

3,779.7 391.4 504.4 51.0 8.8 126.9 2,414.8 116.1

3,920.8 444.4 561.3 48.4 10.3 150.5 2,935.7 135.0

3,979.8 434.8 587.3 47.6 10.3 149.5 2,995.4 139.6

2,552.3 2,938.8 3,285.1

4,055.3

4,999.0

5,875.0

7,113.3

7,393.1

8,206.4

8,344.3

1997

68.6 81.0 13.5 7.0 1.0 –8.5 –10.1 90.0

65.9 76.8 6.7 –2.2 –0.1 –0.3 –6.7 93.0

238.8 81.7 30.8 –6.5 0.2 –1.3 –12.4 165.9

320.3 34.0 46.4 –6.2 –0.4 –1.6 –1.3 154.9

399.4 –33.0 54.1 –7.5 3.6 6.3 87.0 136.6

524.1 –23.5 77.8 –2.3 0.1 4.0 508.4 14.8

550.3 10.9 92.4 –2.7 1.2 –0.2 423.9 9.3

705.0 18.7 65.4 –1.1 1.4 –5.2 624.1 19.4

166.0 –17.5 7.4 1.6 0.3 3.7 148.7 7.1

141.1 7.5 15.6 0.9 0.4 5.2 159.6 5.9

59.0 –2.7 14.9 0.4 0.2 –0.4 93.2 7.7

242.5

233.1

497.2

546.1

646.5

1,103.4

1,085.1

1,427.7

317.3

336.2

172.3

501.9

703.3

839.3 1,080.6

905.3

1,025.8

1,464.9

1,388.8

233.0

427.1

320.2

442.6

610.5

732.1

904.9

820.2

960.5

1,328.0

1,280.1

216.7

401.7

288.3

320.1 4.9 1.1 7.4 5.2 24.4 15.0

393.1 4.7 13.3 20.5 15.4 55.4 22.4

490.3 9.5 8.6 23.5 5.5 66.3 26.0

616.5 9.0 13.8 39.4 9.8 97.7 38.4

577.3 12.9 13.4 19.8 6.1 78.2 41.6

624.6 15.4 47.6 33.7 15.9 92.9 23.2

805.4 21.7 42.4 74.2 35.2 125.3 38.4

853.7 26.0 35.8 50.1 35.9 100.6 41.6

150.2 4.2 11.9 17.1 1.9 14.5 5.0

282.4 2.9 13.8 10.8 1.6 45.1 7.7

158.8 10.1 30.3 8.8 13.3 19.9 13.7

Source: Bank for International Settlements. 1For 1994–1998, data include euro area currencies.

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Table 3. Selected Indicators on the Size of the Capital Markets, 2001 (In billions of U.S. dollars, unless noted otherwise)

GDP

Total Reserves Minus Gold

World

30,995.0

2,136.3

28,875.1

22,157.0

19,635.2

41,792.2

79,401.8

150,069.1

484.2

EU-15

7,906.9

267.6

6,763.0

4,868.8

6,974.6

11,843.4

32,939.7

51,546.2

651.9

Euro area

6,113.0

198.4

4,276.7

4,181.3

5,310.8

9,492.1

24,463.9

38,232.7

625.4

10,787.4 705.2 10,082.2

91.6 34.0 57.6

14,523.7 697.1 13,826.6

10,227.8 529.8 9,698.0

9,119.8 313.5 8,806.3

19,347.6 843.3 18,504.3

23,303.9 1,146.5 22,157.4

57,175.2 2,686.9 54,488.3

530.0 381.0 540.4

Japan

4,164.9

395.2

2,293.8

5,317.1

1,608.0

6,925.1

12,408.6

21,627.6

519.3

Memorandum items: EU countries Austria Belgium Denmark Finland France

188.7 229.8 161.5 121.0 1,311.7

12.5 11.3 17.1 8.0 31.7

25.2 146.0 85.1 190.5 1,067.6

150.1 294.5 95.6 78.2 791.8

140.5 239.4 196.5 41.3 888.9

290.6 533.9 292.1 119.5 1,680.7

534.7 1,695.3 644.1 290.1 6,089.4

850.5 2,375.3 1,021.4 600.0 8,837.7

450.7 1,033.5 632.6 496.0 673.8

Germany Greece Ireland Italy Luxembourg

1,855.1 116.8 103.4 1,089.8 19.0

51.3 5.2 5.6 24.4 0.1

1,071.7 83.5 75.3 527.5 23.8

868.1 152.6 28.6 1,204.9 0.0

2,191.7 9.2 67.0 721.4 25.5

3,059.8 161.8 95.6 1,926.3 25.5

8,040.5 172.3 407.5 2,653.9 591.0

12,172.0 417.5 578.4 5,107.7 640.3

656.1 357.4 559.4 468.7 3,368.5

Netherlands Portugal Spain Sweden United Kingdom

384.4 109.6 583.7 209.8 1,422.7

9.0 9.7 29.6 14.9 37.3

551.1 46.3 468.2 236.5 2,164.7

187.1 70.7 354.7 144.0 447.9

622.9 72.6 290.4 167.1 1,300.2

810.0 143.3 645.1 311.1 1,748.1

2,312.2 306.2 1,370.9 762.7 7,069.0

3,673.2 495.8 2,484.2 1,310.3 10,981.8

955.6 452.2 425.6 624.5 771.9

7,211.6

1,277.6

1,947.3

1,518.8

825.9

2,344.7

10,064.6

14,356.7

242.7

3,229.7 1,904.4 793.0 432.2 852.2

790.4 158.8 123.5 65.1 139.8

1,310.4 412.0 63.8 84.3 76.8

674.1 513.0 7.6 48.7 275.4

595.9 180.7 10.4 11.6 27.3

1,270.0 693.7 18.0 60.3 302.7

6,722.4 1,593.3 717.9 529.6 501.4

9,302.8 2,699.0 799.7 674.2 880.9

301.2 157.0 368.8 457.9 118.5

North America Canada United States

Emerging market countries of which: Asia Latin America Middle East Africa Europe

Stock Debt Securities1 __________________________ Market Capitalization Public Private Total

Bank Assets

Bonds, Equities, and Bank Assets2

Bond, Equities, and Bank Assets2 (In percent of GDP)

Sources: World Federation of Exchanges; Bank for International Settlements; International Monetary Fund, International Financial Statistics and World Economic Outlook databases; and ©2003 Bureau van Dijk Electronic Publishing–Bankscope. 1Domestic and international debt securities shown by the nationality of the issuer; for domestic, debt data refer to 2002: Q2; and for international debt, data refer to 2002: Q3. 2Sum of the stock market capitalization, debt securities, and bank assets.

121

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Table 4. Global Over-the-Counter (OTC) Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contracts1 (In billions of U.S. dollars) Notional Amounts Gross Market Values _____________________________________________ ______________________________________________ End-June End-Dec. End-June End-Dec. End-June End-June End-Dec. End-June End-Dec. End-June 2000 2000 2001 2001 2002 2000 2000 2001 2001 2002 Total

94,008

95,199

99,755

111,115

127,564

2,572

3,183

3,045

3,788

4,450

Foreign exchange Outright forwards and forex swaps Currency swaps Options

15,494 10,504 2,605 2,385

15,666 10,134 3,194 2,338

16,910 10,582 3,832 2,496

16,748 10,336 3,942 2,470

18,075 10,427 4,220 3,427

578 283 239 55

849 469 313 67

773 395 314 63

779 374 335 70

1,052 615 340 97

Interest rate2 Forward rate agreements Swaps Options

64,125 6,771 47,993 9,361

64,668 6,423 48,768 9,476

67,465 6,537 51,407 9,521

77,513 7,737 58,897 10,879

89,995 9,146 68,274 12,575

1,230 13 1,072 145

1,426 12 1,260 154

1,573 15 1,404 154

2,210 19 1,969 222

2,468 19 2,214 235

Equity-linked Forwards and swaps Options

1,645 340 1,306

1,891 335 1,555

1,884 329 1,556

1,881 320 1,561

2,214 386 1,828

293 62 231

289 61 229

199 49 150

205 58 147

243 62 181

Commodity3 Gold Other Forwards and swaps Options

584 261 323 168 155

662 218 445 248 196

590 203 387 229 158

598 231 367 217 150

777 279 498 290 208

80 19 61 ... ...

133 17 116 ... ...

83 21 62 ... ...

75 20 55 ... ...

78 28 51 ... ...

12,159

12,313

12,906

14,375

16,503

392

485

417

519

609

n.a. 15,494

n.a. 15,666

n.a. 16,910

n.a. 16,748

n.a. 18,075

937 ...

1,080 ...

1,019 ...

1,171 ...

1,316 ...

Other Memorandum items: Gross credit exposure4 Exchange-traded derivatives

Source: Bank for International Settlements. 1All figures are adjusted for double-counting. Notional amounts outstanding have been adjusted by halving positions vis-à-vis other reporting dealers. Gross market values have been calculated as the sum of the total gross positive market value of contracts and the absolute value of the gross negative market value of contracts with non-reporting counterparties. 2Single-currency contracts only. 3Adjustments for double-counting are estimated. 4Gross market values after taking into account legally enforceable bilateral netting agreements.

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Table 5. Global Over-the-Counter (OTC) Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contracts by Counterparty, Remaining Maturity, and Currency Composition1 (In billions of U.S. dollars) Notional Amounts ______________________________________________

Gross Market Values _____________________________________________ End-June End-Dec. End-June End-Dec. End-June End-June End-Dec. End-June End-Dec. End-June 2000 2000 2001 2001 2002 2000 2000 2001 2001 2002

Total

94,008

95,199

99,755

111,115

127,564

2,572

3,183

3,045

3,788

4,450

15,494

15,666

16,910

16,748

18,075

578

849

773

779

1,052

5,827 6,421 3,246

5,729 6,597 3,340

5,907 7,287 3,716

5,912 6,755 4,081

6,595 7,210 4,270

168 242 168

271 357 222

229 334 210

237 319 224

371 421 260

By remaining maturity Up to one year2 One to five years2 Over five years2

13,178 1,623 693

12,888 1,902 876

13,012 2,833 1,065

13,427 2,340 981

14,403 2,541 1,131

... ... ...

... ... ...

... ... ...

... ... ...

... ... ...

By major currency U.S. dollar3 Euro3 Japanese yen3 Pound sterling3 Other3

13,961 5,863 4,344 2,479 4,341

14,073 5,981 4,254 2,391 4,633

15,141 6,425 4,254 2,472 5,528

15,410 6,368 4,178 2,315 5,225

15,979 7,298 4,461 2,522 5,890

518 242 157 76 163

771 361 274 82 210

679 322 217 78 250

704 266 313 69 206

948 445 254 112 345

64,125

64,668

67,465

77,513

89,995

1,230

1,426

1,573

2,210

2,468

32,208 25,771 6,146

31,494 27,048 6,126

32,319 28,653 6,494

35,428 32,505 9,580

43,300 36,310 10,385

560 518 152

638 610 179

703 683 187

912 945 353

1,081 1,025 362

By remaining maturity Up to one year2 One to five years2 Over five years2

25,809 24,406 13,910

24,107 25,923 14,638

25,605 26,308 15,553

27,879 30,542 19,092

33,688 34,458 21,849

... ... ...

... ... ...

... ... ...

... ... ...

... ... ...

By major currency U.S. dollar Euro Japanese yen Pound sterling Other

17,606 22,948 12,763 4,741 6,067

19,421 21,311 13,107 4,852 5,977

23,083 22,405 11,278 5,178 5,521

27,422 26,185 11,799 6,215 5,892

32,178 30,671 13,473 6,978 6,695

367 467 207 84 105

486 477 232 113 118

581 461 313 99 119

952 677 304 148 129

1,127 710 327 151 153

1,645

1,891

1,884

1,881

2,214

293

289

199

205

243

584

662

590

598

777

80

133

83

75

78

12,159

12,313

12,906

14,375

16,503

392

485

417

519

609

Foreign exchange By counterparty With other reporting dealers With other financial institutions With nonfinancial customers

Interest rate4 By counterparty With other reporting dealers With other financial institutions With nonfinancial customers

Equity-linked Commodity5 Other

Source: Bank for International Settlements. 1All figures are adjusted for double-counting. Notional amounts outstanding have been adjusted by halving positions vis-à-vis other reporting dealers. Gross market values have been calculated as the sum of the total gross positive market value of contracts and the absolute value of the gross negative market value of contracts with non-reporting counterparties. 2Residual maturity. 3Counting both currency sides of each foreign exchange transaction means that the currency breakdown sums to twice the aggregate. 4Single-currency contracts only. 5Adjustments for double-counting are estimated.

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STATISTICAL APPENDIX

Table 6. Exchange-Traded Derivative Financial Instruments: Notional Principal Amounts Outstanding and Annual Turnover 1986

1987

1988

1989

1990

1991

1992

1993

(In billions of U.S. dollars) Notional principal amounts outstanding Interest rate futures Interest rate options Currency futures Currency options Stock market index futures Stock market index options

370.0 144.0 10.2 39.2 14.5 37.8

487.7 122.6 14.6 59.5 17.8 27.7

895.4 279.0 12.1 48.0 27.1 42.7

1,201.0 386.0 16.0 50.2 41.3 70.5

1,454.8 595.4 17.0 56.5 69.1 93.6

2,157.4 1,069.6 18.3 62.9 76.0 136.9

2,913.1 1,383.8 26.5 71.6 79.8 163.7

4,960.4 2,361.4 34.7 75.9 110.0 232.4

Total North America Europe Asia-Pacific Other

615.7 515.6 13.1 87.0 0.0

729.8 578.0 13.3 138.5 0.0

1,304.3 951.5 177.4 175.5 0.0

1,765.0 1,154.0 250.9 360.1 0.0

2,286.4 1,264.4 461.4 560.5 0.1

3,521.2 2,153.0 710.7 657.0 0.5

4,638.5 2,698.7 1,114.4 823.5 1.9

7,774.9 4,360.7 1,777.9 1,606.0 30.3

(In millions of contracts traded) Annual turnover Interest rate futures Interest rate options Currency futures Currency options Stock market index futures Stock market index options

91.0 22.2 19.9 13.0 28.4 140.0

145.7 29.3 21.2 18.3 36.1 130.9

156.4 30.5 22.5 18.2 29.6 71.8

201.0 39.5 28.2 20.7 30.1 75.3

219.1 52.0 29.7 18.9 39.4 90.4

230.9 50.8 30.0 22.9 54.6 85.2

330.1 64.8 31.3 23.4 52.0 85.8

112.7 22.7 10.0 5.5 21.6 22.3

Total North America Europe Asia-Pacific Other

314.9 288.7 10.3 14.3 1.6

389.6 318.3 35.9 30.0 5.4

336.3 252.3 40.8 34.3 8.9

421.2 288.0 64.3 63.6 5.3

478.2 312.3 83.0 79.1 3.8

510.4 302.6 110.5 85.8 11.5

635.6 341.4 185.1 82.9 26.2

210.9 96.0 75.4 27.2 12.3

Source: Bank for International Settlements.

124

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2002 ______________________________ 1994

1995

1996

1997

1998

1999

2000

2001

Q1

Q2

Q3

(In billions of U.S. dollars) 5,807.6 2,623.2 40.4 55.7 127.7 242.8

5,876.2 2,741.8 33.8 120.4 172.2 337.7

5,979.0 3,277.8 37.7 133.4 195.7 394.5

7,586.7 3,639.9 42.3 118.6 211.3 809.5

8,031.4 4,623.5 31.7 49.2 292.1 907.9

7,924.8 3,755.5 36.7 22.4 344.2 1,522.1

7,907.8 4,734.2 74.4 21.4 377.3 1,162.9

9,265.3 12,492.8 65.6 27.4 341.7 1,605.2

10,040.7 12,474.3 66.6 28.1 367.5 1,861.6

9,409.0 12,477.6 48.2 31.5 364.5 1,751.6

10,326.8 16,142.0 37.6 30.9 323.3 1,757.1

8,897.3 4,823.6 1,831.8 2,171.8 70.1

9,282.0 4,852.4 2,241.3 1,990.2 198.1

10,017.9 4,841.0 2,828.1 2,154.0 194.8

12,408.3 6,349.1 3,587.4 2,235.7 236.1

13,935.7 7,355.1 4,398.1 1,882.5 300.0

13,605.7 6,930.6 4,024.2 2,401.3 249.6

14,278.0 8,167.8 4,217.7 1,606.2 286.3

23,798.0 16,198.9 6,179.5 1,308.4 111.2

24,838.9 16,641.6 6,649.1 1,426.8 121.4

24,082.4 15,570.8 7,002.0 1,376.9 132.7

28,617.6 17,855.5 9,335.1 1,304.8 122.2

(In millions of contracts traded) 137.5 26.5 22.9 4.1 27.9 34.9

121.5 51.1 23.8 7.2 27.6 25.7

146.9 26.3 19.4 5.5 23.4 20.6

182.0 29.9 14.6 5.0 33.2 22.5

162.1 32.2 9.5 2.1 50.3 18.2

147.9 25.7 8.8 1.7 49.7 16.7

179.0 26.2 11.3 1.8 63.1 15.5

290.8 62.8 14.9 3.1 97.8 15.5

275.6 53.5 10.1 4.4 97.0 15.4

281.1 56.4 11.9 4.9 114.5 17.8

317.6 67.5 10.5 3.4 156.7 22.8

270.3 126.2 80.5 30.8 32.8

275.2 97.9 86.3 23.5 67.5

263.1 96.1 105.0 27.6 34.4

310.4 124.6 121.2 37.5 27.1

313.3 126.3 118.5 49.8 18.7

329.3 100.5 151.8 52.5 24.5

430.8 115.1 164.6 113.2 37.9

905.6 189.8 256.9 391.4 67.5

861.8 192.8 248.8 378.0 42.2

969.6 221.0 237.1 466.6 44.9

1,147.8 255.8 309.8 546.0 36.2

125

STATISTICAL APPENDIX

Table 7. United States: Sectoral Balance Sheets1 (In percent) 1995

1996

1997

1998

1999

2000

2001

2002

Corporate sector Debt/equity Short-term debt/total debt Interest burden

45.4 41.7 11.9

40.5 41.0 10.2

34.6 40.5 10.6

32.5 40.3 12.1

27.6 39.1 13.0

36.3 39.5 15.2

44.9 34.5 17.8

66.7 32.3 16.8

Household sector Net worth/assets Equity/total assets Equity/financial assets Home mortgage debt/total assets Consumer credit/total assets Total debt/financial assets Debt-service burden2

84.4 23.3 35.1 10.3 3.4 23.5 12.9

84.7 25.8 38.1 10.1 3.4 22.6 13.3

85.3 29.7 42.9 9.6 3.2 21.2 13.4

85.5 31.5 45.0 9.5 3.1 20.7 13.4

86.0 35.0 49.2 9.2 2.9 19.6 13.7

84.9 30.9 45.0 9.9 3.2 22.0 13.9

83.6 26.5 40.2 11.0 3.5 24.8 14.4

81.9 ... ... 12.5 3.7 29.2 14.0

1.2 0.4 2.1 0.5

1.1 0.6 2.0 0.6

1.0 0.6 1.9 0.6

1.0 0.6 1.8 0.7

1.0 0.6 1.7 0.6

1.0 0.6 1.7 0.7

1.3 0.8 1.7 1.0

1.5 1.1 1.9 1.1

Capital ratios Total risk-based capital Tier 1 risk-based capital Equity capital/total assets Core capital (leverage ratio)

12.7 10.2 8.1 7.6

12.5 10.0 8.2 7.6

12.2 9.6 8.3 7.6

12.2 9.5 8.5 7.5

12.2 9.5 8.4 7.8

12.1 9.4 8.5 7.7

12.7 9.9 9.1 7.8

13.0 10.2 9.2 8.0

Profitability measures Return on assets (ROA) Return on equity (ROE) Net interest margin Efficiency ratio

1.2 14.7 4.3 61.8

1.2 14.5 4.3 60.8

1.2 14.7 4.2 59.2

1.2 13.9 4.1 61.0

1.3 15.3 4.1 58.7

1.2 14.0 4.0 58.4

1.2 13.1 3.9 57.7

1.4 14.8 4.1 54.9

Banking sector Credit quality Nonperforming loans/total loans Net loan-losses/average total loans Loan-loss reserve/total loans Net charge-offs/total loans

Sources: U.S. Board of Governors of the Federal Reserve System, Flow of Funds; U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Federal Deposit Insurance Corporation; and U.S. Federal Reserve Bank of St. Louis. 1For 2002, data refer to 2002: Q3. 2Ratio of debt payments to disposable personal income.

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Table 8. Japan: Sectoral Balance Sheets (In percent)

Corporate sector Debt/shareholder’s equity (book value) Short-term debt/total debt Interest burden Debt/operating profits Memorandum items: Total debt/GDP Household sector Net worth/assets Equity Real estate Interest burden Memorandum items: Debt/equity Debt/real estate Debt/income Debt/net worth Equity/net worth Real estate/net worth Total debt/GDP

1995

1996

1997

1998

1999

2000

2001

225.4 42.1 51.2 1,554.5

206.3 40.5 38.2 1,344.7

207.9 41.8 39.1 1,498.5

189.3 39.0 46.5 1,813.8

182.5 39.4 36.3 1,472.1

156.8 37.7 28.4 1,229.3

156.0 36.8 32.3 1,480.0

114.9

105.8

106.8

106.7

107.0

102.1

100.6

85.0 4.7 42.1 5.5

85.7 4.3 40.9 5.2

85.6 4.0 39.7 4.9

85.4 2.7 39.9 4.7

85.8 4.9 37.7 4.6

85.6 4.2 36.5 4.5

... ... ... ...

257.3 28.8 97.1 14.3 5.5 49.5 63.3

283.3 29.7 97.5 14.2 5.0 47.7 62.6

310.9 31.3 99.1 14.5 4.7 46.4 63.8

456.5 31.2 98.3 14.6 3.2 46.7 64.4

249.0 32.2 97.9 14.2 5.7 43.9 64.1

296.3 34.0 99.0 14.5 4.9 42.6 64.4

... ... ... ... ... ... ...

Banking sector Credit quality Nonperforming loans/assets

3.65

2.75

3.73

3.92

4.12

4.05

5.57

Capital ratio Stockholders equity/assets

3.33

3.41

2.88

4.45

4.76

4.55

3.85

–14.18

1.03

–18.74

–13.14

2.66

–0.37

–16.91

Profitability measures Return on equity (ROE)

Sources: Ministry of Finance, Financial Statements of Corporations by Industries; Cabinet Office, Economic and Social Research Institute, Annual Report on National Accounts; Bank of Japan, Financial Statements of Japanese Banks; and Financial Services Agency, The Status of Nonperforming Loans.

127

STATISTICAL APPENDIX

Table 9. Europe: Sectoral Balance Sheets1 (In percent) 1995

1996

1997

1998

1999

2000

2001

Corporate Debt/equity Short-term debt/total debt Interest burden Debt/operating profits

90.8 35.9 18.7 254.2

90.8 36.5 17.9 262.1

90.1 38.1 17.1 262.9

88.0 37.3 16.7 258.0

90.4 38.0 17.1 287.5

89.8 39.7 18.8 312.2

90.0 40.1 19.6 322.2

Memorandum items: Financial assets/equity Liquid assets/short-term debt

1.5 100.5

1.6 100.3

1.7 94.5

1.8 92.9

2.1 89.2

2.0 86.7

1.9 89.4

Household sector Net worth/assets Equity/net worth Equity/net financial assets Interest burden

85.7 11.7 34.3 6.6

85.7 12.5 35.3 6.4

86.0 14.4 37.8 6.3

86.0 15.2 39.3 6.7

86.4 17.9 44.0 6.4

86.0 17.7 44.5 6.6

... ... 41.2 6.4

Memorandum items: Nonfinancial assets/net worth Debt/net financial assets Debt/income

65.8 51.7 85.3

64.3 50.3 87.1

61.4 45.9 88.6

60.7 44.7 91.0

58.6 41.8 94.2

59.8 43.3 96.0

... 46.9 96.3

Banking sector3 Credit quality Nonperforming loans/total loans Loan-loss reserve/nonperforming loans Loan-loss reserve/total loans Loan-loss provisions/total operating income4

... ... ... ...

... ... ... ...

5.0 74.3 3.7 13.2

6.1 65.9 4.0 11.7

5.6 66.3 3.7 9.1

5.0 70.9 3.5 7.6

4.6 75.7 3.5 11.5

Capital ratios Total risk-based capital Tier 1 risk-based capital Equity capital/total assets Capital funds/liabilities

... ... ... ...

... ... ... ...

10.7 7.2 4.3 6.4

10.6 7.0 4.3 6.4

10.5 7.2 4.1 6.4

10.4 7.2 4.4 6.7

10.4 7.1 4.5 6.8

Profitability measures Return on assets, or ROA (after tax) Return on equity, or ROE (after tax) Net interest margin Efficiency ratio

... ... ... ... ...

... ... ... ... ...

0.3 7.6 1.9 64.6

0.4 9.8 1.7 62.4

0.5 12.5 1.4 62.7

0.7 15.8 1.4 64.3

0.5 12.2 1.3 65.0

sector2

Sources: ©2003 Bureau van Dijk Electronic Publishing–Bankscope; ECB Monthly Bulletin, August 2002; and IMF staff estimates. 1GDP-weighted average for France, Germany, and the United Kingdom, unless otherwise noted. 2Corporate equity adjusted for changes in asset valuation. 3Fifty largest European banks. Data availability may restrict coverage to less than 50 banks for specific indicators. 4Includes the write-off of goodwill in foreign subsidiaries by banks with exposure to Argentina.

128

EMERGING MARKETS

Figure 15. Emerging and Mature Market Volatility 250

Emerging Market Equity (In percent)

200

150

Emerging Market Free index 1

100

50

1998

99

2000

01

02

0

03

250

Emerging Market Debt (In percent)

200

150 EMBI+ index 2 100

50

1998

99

2000

01

02

0

03

60

Mature Market Equity

50 VIX 3

40

30

20 VDAX 4 1998

99

2000

01

02

03

10

Sources: For “Emerging Market Equity,” Morgan Stanley Capital International; and IMF staff estimates. For “Emerging Market Debt,” J.P. Morgan Chase; and IMF staff estimates. For “Mature Market Equity,” Bloomberg L.P. 1Data utilize the Emerging Markets Free index in U.S. dollars to calculate 30-day rolling volatilities. 2Data utilize the EMBI+ total return index in U.S. dollars to calculate 30-day rolling volatilities. 3The VIX is a market estimate of future stock market volatility, and is based on the weighted average of the implied volatilities of 8 Chicago Board Options Exchange calls and puts (the nearest in- and out-of-the-money call and put options from the first and second month expirations). 4The VDAX represents the implied volatility of the German DAX assuming a constant 45 days remaining until expiration of DAX index contracts.

129

STATISTICAL APPENDIX

Figure 16. Emerging Market Debt 0.7

Average Cross-Correlations, 1998–03 1

0.6 0.5 0.4 0.3 0.2 0.1 1998

99

2000

01

02

03

0

0.7

Average Regional Cross-Correlations, 1998–03 2

0.6 Overall

0.5 Latin America

0.4 0.3 0.2

EMEA 1998

99

2000

0.1

Asia

0 01

02

–0.1 03 0.5

Average Cross-Correlations, 2002–03 1 0.4 0.3 0.2 0.1

2002

2003

Average Regional Cross-Correlations, 2002–03 2

0 0.4

Latin America

0.3

Overall 0.2 0.1

Asia EMEA

0 –0.1

2002

2003

Sources: J.P. Morgan Chase; and IMF staff estimates. 1Thirty-day moving simple average across all pair-wise return correlations of 20 constituents included in the EMBI Global. 2Simple average of all pair-wise correlations of all markets in a given region with all other emerging bond markets, regardless of region.

130

EMERGING MARKETS

Table 10. Emerging Market Equity Indices End of Period Latest ______________________________ 2/19/03 Q1 Q2 Q3 Q4 World

1999

2000

2001

2002

12-Month 12-Month All-Time All-Time High Low High Low

761.2 1,003.6

907.8

738.2

792.2 1,420.9 1,221.3 1,003.5

792.2

1,024.4

703.7

1,448.8 423.1

285.4

319.8

266.1

292.1

292.1

364.1

254.8

587.1 175.3

0.0 0.0 667.7 280.0 655.4 278.8 577.6 378.9 71.9 52.7 2,029.3 1,302.2 198.4 144.1 111.5 56.1

1,352.5 185.6 2,052.2 152.6 1,306.4 84.1 1,119.6 180.2 183.8 41.2 2,193.1 306.7 311.6 73.5 278.4 56.1

Emerging Markets Emerging Markets Free EMF Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela EMF Asia China India Indonesia Korea Malaysia Pakistan Philippines Taiwan Province of China Thailand EMF Europe, Middle East, & Africa Czech Republic Egypt Hungary Israel Jordan Morocco Poland Russia South Africa Turkey EMF Sectors Energy Materials Industrials Consumer discretionary Consumer staple Healthcare Financials Information technology Telecommunications Utilities

351.4

489.4

333.8

317.4

616.5 938.8 731.9 551.0 658.9 1,121.9 915.6 876.2 658.9 549.1 511.5 338.4 361.7 470.3 1,667.6 1,232.7 959.6 470.3 361.2 627.1 464.7 281.8 395.4 889.5 763.2 597.1 395.4 432.6 561.6 471.2 392.6 445.5 728.4 604.7 568.7 445.5 63.9 57.2 61.9 57.6 68.3 71.6 42.1 57.7 68.3 1,337.8 1,988.2 1,597.7 1,353.8 1,442.8 1,866.4 1,464.9 1,698.2 1,442.8 194.2 171.8 160.3 150.0 182.7 170.6 125.0 144.1 182.7 64.2 91.1 77.1 65.4 77.7 105.3 106.1 95.4 77.7 138.6 15.0 144.0 474.1 175.9 251.8 131.2 212.0 191.7 139.1

172.0 16.2 152.7 572.5 247.0 280.5 100.8 348.1 277.8 134.9

161.2 16.4 141.0 604.4 215.8 270.6 89.9 259.1 227.3 135.6

133.8 14.0 129.5 508.7 184.6 238.9 104.6 254.3 178.9 116.8

140.4 14.1 148.8 519.6 184.7 244.0 146.0 210.1 189.5 130.2

250.0 33.5 209.5 899.7 226.5 296.3 103.5 519.4 385.2 205.0

143.6 22.8 173.4 456.4 125.6 245.2 99.1 352.6 222.2 102.5

149.7 16.8 141.2 437.2 190.4 250.7 67.4 292.2 255.6 107.5

140.4 14.1 148.8 519.6 184.7 244.0 146.0 210.1 189.5 130.2

0.0 18.0 160.9 678.2 266.0 301.3 160.1 363.8 290.0 151.1

0.0 13.4 124.3 372.1 167.2 232.7 75.7 206.6 162.8 113.4

106.4 108.2 105.7 94.6 108.4 ... . . . 103.5 108.4 0.0 0.0 121.4 106.0 99.6 110.9 116.2 102.0 107.6 97.5 116.2 124.1 93.4 115.1 107.5 97.3 97.8 97.4 251.4 154.9 101.9 97.4 130.8 89.9 512.6 573.3 494.4 493.7 535.5 724.9 582.9 507.9 535.5 631.1 451.3 89.5 110.9 91.9 87.5 90.8 157.1 196.0 132.7 90.8 118.3 83.7 153.8 156.8 167.8 153.9 153.5 154.0 116.1 149.5 153.5 173.5 145.7 148.3 168.8 148.5 137.0 138.5 249.2 198.9 180.1 138.5 171.9 127.1 814.0 959.8 861.0 766.6 861.0 1,373.3 1,307.9 891.9 861.0 1,016.4 746.1 272.9 281.1 276.6 255.2 270.7 223.0 155.2 237.8 270.7 332.2 239.7 254.1 324.5 315.7 278.1 272.7 247.7 244.8 309.3 272.7 350.5 254.1 191,988 202,644 155,689 144,758 169,900 245,020 163,012 234,490 169,900 232,455 144,442 162.5 176.4 63.5 138.6 83.4 168.8 98.5 100.3 67.4 71.8

185.1 206.8 72.0 163.9 102.3 148.9 115.0 151.3 92.3 95.4

170.3 199.3 67.9 157.9 94.7 157.9 109.1 124.6 79.1 80.7

149.6 173.7 56.9 128.5 81.9 152.7 88.8 100.4 66.6 65.6

163.1 182.8 61.8 138.8 88.2 169.8 98.6 103.9 72.7 72.4

197.3 178.2 125.9 215.9 129.2 172.6 148.7 237.7 165.2 127.6

148.5 140.8 73.4 126.0 103.1 173.9 112.6 130.9 113.8 95.7

162.1 173.9 63.8 130.6 94.6 146.5 107.7 134.2 91.9 91.5

163.1 182.8 61.8 138.8 88.2 169.8 98.6 103.9 72.7 72.4

192.9 214.1 75.3 182.5 106.1 176.1 124.8 158.0 94.3 98.9

147.0 167.0 54.2 123.2 80.4 143.8 84.7 89.4 65.4 63.1

433.0 104.1 136.9 12.9 323.9 77.7 1,077.7 280.0 266.0 59.5 465.7 88.3 228.9 54.4 917.3 132.6 483.5 103.9 669.4 72.0 120.1 150.3 287.3 941.4 236.2 247.4 302.1 1,792.9 538.4 350.5 329,685

85.2 62.8 89.9 77.1 67.6 103.1 99.6 99.6 30.6 99.7 426

240.0 214.1 276.8 236.8 148.6 180.2 185.0 300.0 211.5 247.8

81.7 98.5 52.6 74.1 80.4 83.3 74.6 73.1 65.4 63.1

131

STATISTICAL APPENDIX

Table 10 (continued) Quarter

to

Period on Period Percent Change ______________________________ Q1

Q2

Q3

Q4

1999

2000

2001

2002

–3.9

0.0

–9.5

–18.7

7.3

23.6

–14.1

–17.8

–21.1

... ...

...

...

...

–2.3

10.7

–9.0

–16.8

9.8

63.7

–31.8

–4.9

–8.0

...

...

...

...

EMF Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela

–6.4 16.8 –8.7 –2.9 –6.5 –7.3 6.3 –17.4

7.1 –46.7 5.0 –1.2 –1.0 17.1 19.2 –4.5

–22.0 –33.8 –25.9 –16.1 8.1 –19.6 –6.6 –15.4

–24.7 6.9 –39.4 –16.7 –6.9 –15.3 –6.4 –15.2

19.6 30.0 40.3 13.5 18.6 6.6 21.8 18.9

55.5 30.0 61.6 36.4 –19.8 78.5 16.3 1.7

–18.4 –26.1 –14.2 –17.0 –41.2 –21.5 –26.7 0.8

–4.3 –22.2 –21.8 –6.0 37.1 15.9 15.3 –10.0

–24.8 –51.0 –33.8 –21.7 18.3 –15.0 26.8 –18.6

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

EMF Asia China India Indonesia Korea Malaysia Pakistan Philippines Taiwan Province of China Thailand

–1.2 6.1 –3.2 –8.8 –4.7 3.2 –10.1 0.9 1.1 6.8

14.9 –3.6 8.1 30.9 29.7 11.9 49.7 19.1 8.7 25.5

–6.3 1.1 –7.6 5.6 –12.6 –3.5 –10.8 –25.6 –18.2 0.5

–17.0 –14.5 –8.2 –15.8 –14.4 –11.7 16.3 –1.8 –21.3 –13.9

4.9 0.8 14.8 2.1 — 2.1 39.6 –17.4 6.0 11.5

67.7 10.2 89.1 70.3 79.2 48.1 50.5 6.0 47.4 51.8

–42.5 –32.0 –17.2 –49.3 –44.6 –17.3 –4.3 –32.1 –42.3 –50.0

4.2 –26.0 –18.6 –4.2 51.6 2.3 –32.0 –17.1 15.0 4.9

–6.2 –16.0 5.3 18.9 –3.0 –2.7 116.7 –28.1 –25.8 21.1

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

EMF Europe, Middle East, & Africa Czech Republic Egypt Hungary Israel Jordan Morocco Poland Russia South Africa Turkey

–1.8 4.5 18.2 –4.3 –1.4 0.2 7.1 –5.5 0.8 –6.8 13.0

4.6 8.7 5.6 12.9 –16.5 4.9 –6.2 7.6 18.2 4.9 –13.6

–2.4 –6.0 –9.5 –13.8 –17.1 7.0 –12.1 –10.3 –1.6 –2.7 –23.2

–10.5 11.3 0.6 –0.1 –4.8 –8.3 –7.7 –11.0 –7.7 –11.9 –7.0

14.6 4.8 –0.4 8.5 3.8 –0.3 1.1 12.3 6.1 –1.9 17.4

... 24.3 80.7 30.7 56.3 1.7 –6.4 53.9 246.2 60.6 492.2

... 5.5 –38.4 –19.6 24.7 –24.7 –20.2 –4.8 –30.4 –1.2 –33.5

... –9.4 –34.2 –12.9 –32.3 28.8 –9.5 –31.8 53.2 26.3 43.8

4.7 19.2 –4.4 5.4 –31.6 2.6 –23.1 –3.5 13.9 –11.8 –27.5

... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ...

EMF Sectors Energy Materials Industrials Consumer discretionary Consumer staple Healthcare Financials Information technology Telecommunications Utilities

–0.4 –3.5 2.7 –0.1 –5.5 –0.6 –0.2 –3.5 –7.3 –0.8

14.2 19.0 12.8 25.5 8.2 1.7 6.8 12.7 0.5 4.2

–8.0 –3.6 –5.7 –3.7 –7.4 6.0 –5.2 –17.6 –14.4 –15.4

–12.2 –12.8 –16.1 –18.6 –13.5 –3.3 –18.5 –19.4 –15.8 –18.7

9.1 5.2 8.6 8.0 7.6 11.2 11.0 3.5 9.2 10.4

97.3 78.2 25.9 115.9 29.2 72.6 48.7 137.7 65.2 27.6

–24.7 –21.0 –41.7 –41.6 –20.2 0.7 –24.3 –44.9 –31.1 –25.0

9.2 23.5 –13.1 3.6 –8.2 –15.8 –4.3 2.6 –19.2 –4.4

0.6 5.2 –3.2 6.3 –6.7 15.9 –8.4 –22.6 –20.9 –20.9

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

World Emerging Markets Emerging Markets Free

132

12-Month 12-Month All-Time All-Time High Low High Low

Date

...

...

...

EMERGING MARKETS

Table 10 (concluded)

Developed Markets Australia Austria Belgium Canada Denmark Finland France Germany Greece Hong Kong SAR Ireland Italy Japan Netherlands New Zealand Norway Portugal Singapore Spain Sweden Switzerland United Kingdom United States

Developed Markets Australia Austria Belgium Canada Denmark Finland France Germany Greece Hong Kong SAR Ireland Italy Japan Netherlands New Zealand Norway Portugal Singapore Spain Sweden Switzerland United Kingdom United States

Latest 2/19/03

End of Period ________________________________

570.1 92.3 48.9 814.5 1,355.4 88.6 74.9 50.9 45.6 4,924.4 56.9 67.8 524.9 58.4 90.8 801.8 53.9 750.9 69.8 3,513.0 548.8 1,097.4 793.3

686.6 106.5 76.9 978.5 2,099.2 152.4 125.0 103.7 66.4 6,033.7 79.2 95.2 664.9 107.3 93.7 1,361.5 78.0 1,058.4 96.2 5,853.4 849.9 1,600.9 1,083.7

Q1

12-Month 12-Month All-Time High Low High

Q2

Q3

Q4

1999

2000

2001

2002

647.6 101.3 69.7 888.6 1,840.6 104.8 104.7 84.4 63.6 5,667.0 70.2 81.3 640.6 90.9 93.2 1,137.4 68.0 897.5 79.4 4,434.7 766.2 1,405.5 925.7

593.7 86.0 50.5 762.6 1,432.8 89.6 75.4 53.5 50.6 4,758.2 55.4 63.8 570.5 61.9 92.2 863.5 48.1 776.0 61.7 3,156.9 622.6 1,116.3 762.6

604.4 91.8 55.3 818.3 1,448.8 100.3 81.3 56.0 46.8 4,808.4 56.8 69.6 524.3 66.0 90.0 898.3 57.0 764.9 69.9 3,517.4 603.2 1,179.2 824.6

617.3 104.9 98.7 1,070.1 2,122.6 293.7 150.0 139.1 172.9 9,231.5 100.7 115.4 1,013.7 123.3 111.8 1,361.5 104.4 1,580.0 121.3 8,971.5 957.8 1,974.2 1,445.9

640.1 96.9 85.8 1,156.4 2,333.3 267.5 152.0 124.0 106.1 7,690.1 92.1 119.9 808.2 124.5 83.9 1,458.0 97.9 1,173.4 107.7 7,735.0 1,017.0 1,841.4 1,249.9

690.8 94.6 78.6 965.8 2,060.1 171.8 123.1 100.1 76.8 6,058.0 93.1 91.2 650.3 100.4 94.2 1,278.4 79.5 936.8 99.0 6,178.8 813.4 1,586.2 1,084.5

604.4 91.8 55.3 818.3 1,448.8 100.3 81.3 56.0 46.8 4,808.4 56.8 69.6 524.3 66.0 90.0 898.3 57.0 764.9 69.9 3,517.4 603.2 1,179.2 824.6

706.1 111.6 80.3 994.5 2,110.1 170.3 125.0 104.9 71.5 6,518.5 80.3 95.7 716.6 107.3 98.9 1,373.1 79.6 1,066.1 99.1 6,130.0 855.7 1,614.0 1,106.3

8.0 ... ... 43.4 29.3 ... ... 39.1 72.9 55.4 ... ... 45.7 ... 11.1 36.6 ... 99.0 21.3 87.4 7.4 13.3 20.9

3.7 –7.6 –13.1 8.1 9.9 –8.9 1.4 –10.8 –38.6 –16.7 –8.5 3.9 –20.3 1.0 –24.9 7.1 –6.2 –25.7 –11.2 –13.8 6.2 –6.7 –13.6

7.9 –2.4 –8.3 –16.5 –11.7 –35.8 –19.0 –19.3 –27.6 –21.2 1.1 –24.0 –19.5 –19.4 12.2 –12.3 –18.8 –20.2 –8.0 –20.1 –20.0 –13.9 –13.2

–12.5 –3.0 –29.7 –15.3 –29.7 –41.6 –34.0 –44.0 –39.1 –20.6 –39.0 –23.6 –19.4 –34.3 –4.4 –29.7 –28.3 –18.4 –29.5 –43.1 –25.8 –25.7 –24.0

... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ...

QTD ______

Period on Period Percent Change _______________________________

–5.7 0.5 –11.5 –0.5 –6.4 –11.6 –7.8 –9.2 –2.6 2.4 0.1 –2.6 0.1 –11.6 0.9 –10.7 –5.5 –1.8 –0.1 –0.1 –9.0 –6.9 –3.8

–0.6 12.6 –2.2 1.3 1.9 –11.3 1.5 3.6 –13.6 –0.4 –15.0 4.5 2.2 6.9 –0.6 6.5 –1.9 13.0 –2.9 –5.3 4.5 0.9 –0.1

–5.7 –4.9 –9.4 –9.2 –12.3 –31.2 –16.2 –18.6 –4.1 –6.1 –11.3 –14.7 –3.7 –15.3 –0.5 –16.5 –12.8 –15.2 –17.4 –24.2 –9.8 –12.2 –14.6

–8.3 –15.1 –27.5 –14.2 –22.2 –14.5 –28.0 –36.6 –20.4 –16.0 –21.1 –21.5 –10.9 –31.9 –1.1 –24.1 –29.3 –13.5 –22.3 –28.8 –18.7 –20.6 –17.6

1.8 6.8 9.5 7.3 1.1 11.9 7.8 4.7 –7.5 1.1 2.6 9.1 –8.1 6.6 –2.4 4.0 18.6 –1.4 13.2 11.4 –3.1 5.6 8.1

All-Time Low

560.7 712.9 250.2 79.7 111.6 79.7 47.3 100.2 47.3 705.8 1,511.4 338.3 1,311.3 2,776.6 556.5 80.3 383.1 80.3 71.9 178.6 71.9 49.6 163.6 41.4 44.4 197.2 44.4 4,573.4 10,165.3 1,995.5 51.9 107.3 51.9 62.0 132.1 62.0 508.4 1,655.3 508.4 56.3 134.9 56.3 87.6 141.0 56.7 801.8 1,599.1 455.9 48.1 123.1 48.1 721.7 1,624.2 508.2 61.1 133.7 27.4 2,914.9 12,250.4 787.2 541.9 1,032.8 158.1 1,045.7 1,974.2 585.4 726.5 1,493.0 273.7

... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ...

Source: Data are provided by Morgan Stanley Capital International. Regional and sectoral compositions conform to Morgan Stanley Capital International definitions.

133

STATISTICAL APPENDIX

Table 11. Foreign Exchange Rates (Units per U.S. dollar) Latest 2/19/03

End of Period ______________________________ Q1

Q4

End of Period ______________________________

Q2

Q3

1999

2000

3.20 2.94 3.61 2.33 746.75 656.50 2,936.00 2,273.00 10.82 9.04 3.48 3.44 1,598.00 906.00

3.81 2.82 686.15 2,404.25 9.95 3.51 1,380.50

3.74 3.74 749.25 2,870.00 10.21 3.63 1,462.75

3.36 1.00 1.00 3.54 1.80 1.95 720.25 529.30 573.85 2,867.00 1,872.50 2,236.00 10.37 9.51 9.62 3.51 3.51 3.53 1,388.80 648.75 699.51

8.28 8.28 47.70 48.82 8,880.00 9,825.00 1,195.00 1,327.00 3.80 3.80 57.83 60.05 54.30 51.00

8.28 48.89 8,713.00 1,201.30 3.80 60.05 50.40

8.28 48.38 9,000.00 1,222.50 3.80 58.95 52.40

33.54 41.51

34.86 43.26

12-Month 12-Month All-Time High Low High

All-Time Low

2001

2002

1.00 2.31 661.25 2,277.50 9.16 3.44 757.50

3.36 3.54 720.25 2,867.00 10.37 3.51 1,388.80

2.00 2.27 641.05 2,252.85 9.00 3.43 835.50

8.28 8.28 8.28 8.28 47.98 43.55 46.68 48.25 8,950.00 7,100.00 9,675.00 10,400.00 1,185.70 1,140.00 1,265.00 1,313.50 3.80 3.80 3.80 3.80 58.25 51.80 57.60 59.90 53.60 40.24 50.00 51.60

8.28 47.98 8,950.00 1,185.70 3.80 58.25 53.60

8.28 8.28 5.96 8.92 47.70 49.05 16.92 49.05 8,545.00 10,210.00 1,977.00 16,650.00 1,165.40 1,331.60 683.50 1,962.50 3.80 3.80 2.44 4.71 57.75 60.16 21.18 64.35 49.35 54.30 23.10 54.75

Emerging Markets Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela Asia China India Indonesia Korea Malaysia Pakistan Philippines Taiwan Province of China Thailand

34.80 43.02

34.95 43.50

34.64 43.11

31.40 37.49

33.08 43.39

34.95 44.21

34.64 43.11

32.85 40.39

3.86 3.95 759.75 2,980.00 11.02 3.65 1,921.80

35.19 44.18

Europe, Middle East, & Africa Czech Republic 29.36 35.46 29.67 30.73 30.07 35.84 37.28 35.60 30.07 28.90 36.73 Egypt 5.53 4.63 4.66 4.65 4.62 3.44 3.89 4.58 4.62 4.58 5.53 Hungary 229.23 279.31 246.77 246.72 224.48 252.51 282.34 274.81 224.48 222.18 284.62 Israel 4.86 4.75 4.75 4.88 4.74 4.15 4.04 4.40 4.74 4.62 5.01 Jordan 0.71 0.71 0.71 0.71 0.71 0.71 0.71 0.71 0.71 0.71 0.72 Morocco 9.96 11.69 10.61 10.64 10.18 10.08 10.56 11.59 10.18 9.89 11.78 Poland 3.88 4.11 4.05 4.15 3.83 4.15 4.13 3.96 3.83 3.78 4.23 Russia 31.58 31.21 31.48 31.69 31.96 27.55 28.16 30.51 31.96 30.88 31.96 South Africa 8.23 11.33 10.30 10.54 8.57 6.15 7.58 11.96 8.57 8.23 11.93 Turkey 1,641,550 1,349,100 1,587,500 1,664,100 1,655,100 544,300 668,500 1,450,100 1,655,100 1,295,550 1,697,600 Developed Markets Australia1 Canada Denmark Euro1 Hong Kong SAR Japan New Zealand1 Norway Singapore Sweden Switzerland United Kingdom1

134

0.60 1.50 6.89 1.10 7.80 118.13 0.56 6.93 1.74 8.42 1.36 1.67

0.53 1.59 8.53 0.87 7.80 132.73 0.44 8.84 1.84 10.36 1.68 1.43

0.56 1.52 7.49 0.99 7.80 119.47 0.49 7.50 1.77 9.16 1.48 1.54

0.54 1.59 7.53 0.99 7.80 121.81 0.47 7.41 1.78 9.26 1.48 1.56

0.56 1.57 7.08 1.05 7.80 118.79 0.52 6.94 1.73 8.69 1.38 1.61

0.66 1.45 7.39 1.01 7.77 102.51 0.52 8.02 1.67 8.52 1.59 1.61

0.56 1.50 7.92 0.94 7.80 114.41 0.44 8.80 1.73 9.42 1.61 1.49

0.51 1.59 8.35 0.89 7.80 131.66 0.42 8.96 1.85 10.48 1.66 1.45

0.56 1.57 7.08 1.05 7.80 118.79 0.52 6.94 1.73 8.69 1.38 1.61

0.60 1.50 6.83 1.09 7.80 115.81 0.56 6.83 1.72 8.41 1.35 1.67

0.51 1.61 8.60 0.86 7.80 134.68 0.42 8.95 1.85 10.57 1.71 1.41

0.98 — 295.18 689.21 2.68 1.28 45.00

24.48 23.15

3.86 3.95 759.75 2,980.00 11.02 3.65 1,921.80

35.19 55.50

25.39 42.17 3.29 5.53 90.20 317.56 1.99 5.01 0.64 0.72 7.75 12.06 1.72 4.71 0.98 31.96 2.50 12.45 5,036 1,697,600 0.84 1.12 5.34 1.19 7.70 80.63 0.72 5.51 1.39 5.09 1.12 2.00

0.48 1.61 9.00 0.83 7.82 159.90 0.39 9.58 1.91 11.03 1.82 1.37

EMERGING MARKETS

Table 11 (concluded) Q1

Q2

Q3

Q4

Period on Period Percent Change ______________________________ 1999 2000 2001 2002

5.2 –1.9 –3.5 –2.4 –4.2 1.0 –13.1

–65.9 –0.6 0.7 0.2 1.4 — –16.4

–23.0 –17.5 –4.3 –5.5 –9.2 –1.9 –34.4

2.0 –24.7 –8.4 –16.2 –2.5 –3.4 –5.6

11.2 5.6 4.0 0.1 –1.6 3.3 5.3

— –32.8 –10.6 –17.2 4.1 –10.0 –13.0

0.2 –7.7 –7.8 –16.3 –1.2 –0.5 –7.3

–0.2 –15.6 –13.2 –1.8 5.1 2.4 –7.7

–70.2 –34.7 –8.2 –20.6 –11.7 –2.0 –45.5

... ... ... ... ... ... ...

— 0.6 0.8 –0.8 — 0.7 –1.3

— –1.2 5.9 –1.0 — –0.2 1.2

— –0.1 12.8 10.5 — — 1.2

— 1.1 –3.2 –1.7 — 1.9 –3.8

— 0.8 0.6 3.1 — 1.2 –2.2

— –2.4 12.7 5.6 — –4.1 –3.6

— –6.7 –26.6 –9.9 — –10.1 –19.5

— –3.3 –7.0 –3.7 — –3.8 –3.1

— 0.6 16.2 10.8 — 2.8 –3.7

–0.5 0.2

— 1.6

4.2 4.8

–3.8 –4.0

0.6 0.4

2.6 –2.2

–5.1 –13.6

–5.3 –1.9

2.4 –16.4 –2.1 –2.5 — 2.2 –1.2 1.2 4.1 0.8

0.4 –1.1 –1.6 –7.4 — –0.9 –3.6 –2.3 5.6 7.5

19.5 –0.6 13.2 — 0.6 10.2 1.6 –0.8 10.1 –15.0

–3.5 0.3 — –2.7 –0.6 –0.2 –2.5 –0.7 –2.3 –4.6

2.2 0.5 9.9 2.9 –0.1 4.5 8.4 –0.8 23.0 0.5

–15.8 –0.9 –14.3 0.2 — –7.7 –15.4 –25.2 –4.7 –42.0

–3.9 –11.5 –10.6 2.7 –0.3 –4.6 0.4 –2.2 –18.8 –18.6

4.7 –15.1 2.7 –8.1 0.2 –8.9 4.2 –7.7 –36.6 –53.9

Latest 2/19/03

Period on Period Percent Change ______________________________

12-Month 12-Month High Low

All Time High

All Time Low

... ... ... ... ... ... ...

... ... ... ... ... ... ...

... ... ... ... ... ... ...

... ... ... ... ... ... ...

... ... ... ... ... ... ...

... ... ... ... ... ... ...

... ... ... ... ... ... ...

0.9 2.6

... ...

... ...

... ...

... ...

18.4 –0.9 22.4 –7.3 –0.1 13.9 3.5 –4.5 39.6 –12.4

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ... ... ... ...

Emerging Markets Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela Asia China India Indonesia Korea Malaysia Pakistan Philippines Taiwan Province of China Thailand Europe, Middle East, & Africa Czech Republic Egypt Hungary Israel Jordan Morocco Poland Russia South Africa Turkey

Developed Markets Australia Canada Denmark Euro Hong Kong SAR Japan New Zealand Norway Singapore Sweden Switzerland United Kingdom

QTD ____

Period on Period Percent Change ________________________________

7.1 4.5 –2.7 4.8 — 0.6 7.7 0.1 –0.5 3.2 2.0 3.7

3.9 –0.1 –2.1 –2.2 — –0.8 4.8 1.4 0.1 1.2 –1.2 –1.4

5.7 5.1 13.9 13.8 — 11.1 11.4 17.9 4.3 13.1 13.5 7.7

–3.6 –4.4 –0.5 — — –1.9 –4.1 1.3 –0.7 –1.1 0.4 1.3

3.7 1.0 6.4 6.1 — 2.5 10.6 6.7 2.6 6.6 6.6 3.2

Period on Period Percent Change _________________________________ –2.5 6.4 16.3 ... –0.4 10.8 –1.5 –5.8 –1.0 –4.9 –13.5 –2.5

–15.2 –3.5 –6.7 –6.9 –0.3 –10.4 –15.4 –8.9 –4.0 –9.5 –1.3 –7.5

–8.9 –5.9 –5.1 –5.3 — –13.1 –4.5 –1.8 –6.0 –10.2 –3.0 –2.7

9.8 1.3 17.9 18.0 — 10.8 23.8 29.2 6.4 20.6 20.0 11.0

Source: Bloomberg L.P. 1U.S. dollars per unit.

135

STATISTICAL APPENDIX

Table 12. Emerging Market Bond Index: EMBI+ Total Returns Index Latest 2/19/2003

End of Period ____________________________

Q1

Q2

Q3

Q4

1999

2000

2001

2002

12-Month High

12-Month Low

All Time High

All Time Low

236

213

202

200

229

175

202

200

229

236

189

236

62

Latin America Argentina Brazil Columbia Ecuador Mexico Panama Peru Venezuela

59 244 173 276 254 404 356 259

58 257 157 276 223 367 331 259

48 194 159 258 226 351 302 252

55 164 140 199 233 359 285 266

58 230 176 230 252 395 340 276

171 196 117 115 161 277 243 192

184 222 119 177 190 300 244 221

61 238 156 241 217 354 307 233

58 230 176 230 252 395 340 276

68 261 178 298 254 406 356 290

48 153 138 185 222 339 272 242

196 261 178 298 254 406 356 290

48 67 97 61 59 56 52 59

Asia Malaysia Philippines

118 145

101 134

106 137

115 141

116 143

... 103

... 98

... 125

116 143

118 145

100 130

118 145

100 78

Europe, Middle East, & Africa Bulgaria Egypt Morocco Nigeria Poland Russia South Africa Turkey Ukraine

508 122 240 303 313 294 116 154 161

452 ... 233 276 278 227 ... 137 139

459 100 227 265 285 239 102 123 142

463 103 227 238 297 247 108 128 150

494 117 239 281 308 276 113 154 152

338 ... 190 181 212 84 ... 107 ...

356 ... 200 209 246 130 ... 105 ...

447 ... 223 256 272 203 ... 127 126

494 117 239 281 308 276 113 154 152

512 122 242 305 313 294 116 157 161

448 99 224 224 277 223 100 115 134

512 122 242 305 313 294 116 157 161

76 99 73 61 60 24 100 93 106

191 359

184 296

165 304

157 315

187 344

179 160

202 203

174 274

187 344

191 359

149 292

212 359

62 63

Composite

Latin Non-Latin

QTD _____ EMBI+

Period on Period Percent Change ____________________________ Period on Period Percent Change ___________________________

3.1

6.5

–5.2

–1.0

14.5

25.9

15.4

–1.0

14.5

...

...

...

...

1.7 6.1 –1.7 20.0 0.8 2.3 4.7 –6.2

–4.9 8.0 0.6 14.5 2.8 3.7 7.8 11.2

–17.2 –24.5 1.3 –6.5 1.3 –4.4 –8.8 –2.7

14.6 –15.5 –11.9 –22.9 3.1 2.3 –5.6 5.6

5.5 40.2 25.7 15.6 8.2 10.0 19.3 3.8

12.5 40.0 ... –28.6 15.0 8.2 17.4 29.7

7.6 13.3 1.7 53.9 18.0 8.3 0.4 15.1

–66.8 7.2 31.1 36.2 14.2 18.0 25.8 5.4

–4.9 –3.4 12.8 –4.6 16.1 11.6 10.7 18.5

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

Asia Malaysia Philippines

1.7 1.4

... 7.2

5.0 2.2

8.5 2.9

0.9 1.4

... ...

... –4.9

... 27.6

... 14.4

... ...

... ...

... ...

... ...

Europe, Middle East, & Africa Bulgaria Egypt Morocco Nigeria Poland Russia South Africa Turkey Ukraine

2.8 4.3 0.4 7.8 1.6 6.5 2.7 0.0 5.9

1.1 ... 4.5 7.8 2.2 11.8 ... 7.9 10.3

1.5 ... –2.6 –4.0 2.5 5.3 ... –10.2 2.2

0.9 3.0 0.0 –10.2 4.2 3.3 5.9 4.1 5.6

6.7 13.6 5.3 18.1 3.7 11.7 4.6 20.3 1.3

27.1 ... 26.7 1.7 1.0 162.5 ... ... ...

5.3 ... 5.3 15.5 16.0 54.8 ... –1.9 ...

25.6 ... 11.5 22.5 10.6 56.2 ... 21.0 ...

10.5 ... 7.2 9.8 13.2 36.0 ... 21.3 20.6

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

2.1 4.4

5.7 8.0

–10.3 2.7

–4.8 3.6

19.1 9.2

20.9 50.9

12.8 26.9

–13.9 35.0

7.5 25.5

... ...

... ...

... ...

... ...

Latin America Argentina Brazil Columbia Ecuador Mexico Panama Peru Venezuela

Latin Non-Latin Source: J.P. Morgan Chase.

136

End of Period __________________________

EMERGING MARKETS

Table 13. Emerging Market Bond Index: EMBI+ Yield Spreads (In basis points) End of Period ____________________________ Latest 2/19/2003 Q1 Q2 Q3 Q4 EMBI+ Latin America Argentina Brazil Columbia Ecuador Mexico Panama Peru Venezuela Asia Malaysia Philippines Europe, Middle East, & Africa Bulgaria Egypt Morocco Nigeria Poland Russia South Africa Turkey Ukraine Excluding Argentina

Latin America Argentina Brazil Columbia Ecuador Mexico Panama Peru Venezuela Asia Malaysia Philippines Europe, Middle East, & Africa Bulgaria Egypt Morocco Nigeria Poland Russia South Africa Turkey Ukraine Excluding Argentina

1999

2000

2001

2002

12-Month High

12-Month Low

All Time High

All Time Low

715

596

798

1,040

759

824

756

799

759

1,040

585

1,483

585

6,373 1,304 699 1,481 317 416 531 1,364

5,013 717 532 1,037 250 348 418 886

6,791 1,527 614 1,253 321 447 622 1,115

6,629 2,396 1,067 1,980 434 553 874 1,156

6,358 1,439 640 1,794 324 439 606 1,118

533 636 423 3,353 363 410 443 844

773 749 755 1,415 392 501 687 958

4,404 870 516 1,254 308 411 520 1,128

6,358 1,439 640 1,794 324 439 606 1,118

7,199 2,443 1,096 2,200 441 557 897 1,491

3,992 698 527 960 230 337 400 701

7,199 2,443 1,096 4,712 979 592 897 1,668

515 626 402 960 230 337 400 701

141 522

... 376

173 424

171 529

166 524

... 324

... 644

... 470

166 524

330 539

88 339

330 743

88 315

241 311 398 1,732 167 388 203 703 464

415 ... 365 1,105 154 495 ... 599 622

357 ... 498 1,584 200 511 241 890 651

390 572 545 3,931 303 615 305 1,024 663

288 383 390 2,212 178 472 233 687 668

626 ... 380 1,338 212 2,432 ... 420 ...

772 ... 584 2,037 241 1,172 ... 800 ...

449 ... 545 1,488 196 670 ... 720 941

288 383 390 2,212 178 472 233 687 668

435 572 732 3,931 305 615 425 1,074 894

232 295 323 1,054 151 387 195 569 464

1,000 572 891 3,931 307 6,357 425 1,197 1,677

232 295 323 1,054 148 387 195 370 464

...

...

...

920

664

...

...

...

664

920

602

920

602

QTD ______ EMBI+

End of Period ____________________________

Period on Period Spread Change ____________________________

Period on Period Spread Change ___________________________

–44

–203

202

242

–281

–320

–68

43

–40

...

...

...

...

15 –135 59 –313 –7 –23 –75 246

609 –153 16 –217 –58 –63 –102 –242

1,778 810 82 216 71 99 204 229

–162 869 453 727 113 106 252 41

–271 –957 –427 –186 –110 –114 –268 –38

–167 240 –567 113 ... 332 1,743 –1,938 –379 29 –43 91 –169 244 –432 114

3,631 121 –239 –161 –84 –90 –167 170

1,954 569 124 540 16 28 86 –10

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

–25 –2

... –94

... 48

–2 105

–5 –5

... 320

... –174

... 54

... ...

... ...

... ...

... ...

–47 –72 8 –480 –11 –84 –30 16 –204

–34 ... –180 –383 –42 –175 ... –121 –319

–58 ... 133 479 46 16 ... 291 29

–223 146 ... ... –296 204 –182 699 –53 29 –2,908 –1,260 ... ... ... 380 ... ...

–323 ... –39 –549 –45 –502 ... –80 ...

–161 ... –155 724 –18 –198 ... –33 –273

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ... ...

...

...

...

...

...

...

...

...

...

33 –102 ... –189 47 –155 2,347 –1,719 103 –125 104 –143 64 –72 134 –337 12 5 ...

–256

... ...

...

...

Source: J.P. Morgan Chase.

137

STATISTICAL APPENDIX

Table 14. Total Emerging Market Financing (In millions of U.S. dollars) 2003 to Date1 Total

138

1999

148,976.2 163,569.6

2000 216,402.7

2001

2002

162,137.7 136,458.6

Q1

Q2

Q3

Q4

37,044.1

32,886.8

32,096.8

34,431.0

663.8 — — — — — — — — — — — — — — — — 339.1 — 324.6 — — —

3,891.5 — 310.0 — — — — 508.6 130.0 — 23.7 — 280.2 — — — — 2,569.0 — 40.0 — 30.0 —

4,707.2 — — — — — 179.0 30.0 — — — 160.0 322.2 — 90.0 — — 3,423.4 — 352.6 — — 150.0

9,382.8 — — — — — — 320.0 — 7.5 — — 56.4 — — — 50.0 8,698.8 135.0 94.3 20.8 — —

6,992.3 50.0 455.0 22.5 53.8 400.0 15.0 300.0 — 80.2 — — 136.1 200.0 100.0 — — 4,646.7 — 533.0 — — —

7,169.5 150.0 350.0 — — — — 420.0 — — 150.4 — — — 1,000.0 40.0 150.0 4,159.1 — 750.0 — — —

1,330.1 — — — — — — — — — — — — — — 40.0 — 1,290.1 — — — — —

1,910.1 — — — — — — — — — — — — — — — — 1,260.1 — 650.0 — — —

2,220.0 150.0 350.0 — — — — 420.0 — — — — — — — — 150.0 1,100.0 — 50.0 — — —

1,709.3 — — — — — — — — — 150.4 — — — 1,000.0 — — 508.9 — 50.0 — — —

Asia Brunei China Hong Kong SAR India Indonesia Korea Lao P.D.R Macao Malaysia Marshall Islands Nepal Pakistan Papua New Guinea Philippines Singapore Sri Lanka Taiwan Province of China Thailand Vietnam

4,281.7 — 575.5 405.0 — — 1,306.9 — — 230.0 — — — — 1,114.6 35.0 — 614.8 — —

34,210.4 — 6,975.1 2,093.2 1,433.5 374.2 6,259.9 — — 2,527.2 — 57.0 322.6 — 4,113.0 2,466.5 65.0 2,439.1 5,047.1 37.0

55,958.6 — 3,461.8 11,488.3 2,376.2 1,465.3 13,542.3 — — 5,177.2 — — — 232.4 7,181.7 4,338.7 23.0 4,019.9 2,551.7 100.0

85,881.0 — 23,063.4 21,046.4 2,224.2 1,283.1 14,230.4 — 29.5 4,506.4 — — — — 5,021.9 6,079.7 100.0 6,703.5 1,572.5 20.0

67,483.4 — 5,567.3 18,307.3 2,382.2 964.9 17,021.0 — — 4,432.4 — — 182.5 — 3,658.8 10,383.6 105.0 3,794.0 684.4 —

54,755.6 129.0 6,101.0 7,014.7 1,526.6 756.0 14,546.3 30.0 — 5,108.9 34.7 — 85.0 — 5,797.3 2,951.6 — 9,279.0 1,003.1 392.5

13,310.3 — 722.8 2,117.5 412.3 100.0 1,340.4 — — 1,807.7 — — — — 2,400.0 1,208.1 81.9 3,101.6 18.0 —

11,875.4 129.0 1,133.2 736.5 288.9 256.0 2,231.0 30.0 — 2,171.5 — — — — 650.0 104.5 35.3 3,844.0 265.7 —

14,092.5 — 1,087.6 559.1 172.9 250.0 4,956.1 — — 837.7 34.7 — — — 1,240.0 1,054.4 2,724.9 656.4 226.3 292.5

15,477.5 — 3,157.5 744.0 652.6 150.0 6,018.8 — — 292.0 — — 85.0 — 1,507.3 584.6 15.7 1,677.0 493.0 100.0

Europe Azerbaijan Bulgaria Croatia Cyprus Czech Republic Estonia Gibraltar Hungary Kazakhstan Kyrgyz Republic Latvia Lithuania Macedonia, FYR of Malta Moldova

6,013.5 — — 768.1 — — — — 1,081.3 — — — 431.7 — — —

35,582.7 — 10.0 529.1 555.6 1,663.5 381.1 — 3,052.4 185.0 — 114.4 34.7 15.0 502.6 —

26,191.5 77.2 53.9 1,504.9 288.5 540.3 289.2 65.0 3,471.2 417.0 — 288.9 959.7 — 57.0 40.0

37,021.6 — 8.9 1,498.7 86.3 127.1 412.7 80.0 1,308.8 429.6 — 23.0 683.8 — — —

22,787.7 16.0 242.3 1,766.0 633.0 564.6 202.1 — 1,364.7 573.5 — 212.1 247.3 — 85.0 —

30,300.4 — 1,260.8 1,399.1 547.8 463.4 439.7 — 1,056.1 773.5 95.0 74.6 374.3 — — —

7,224.9 — 1,260.8 561.2 479.8 — — — 265.7 135.5 — — 18.8 — — —

7,279.6 — — 306.9 68.1 428.4 241.9 — 95.7 129.5 95.0 74.6 355.6 — — —

6,869.9 — — 324.6 — 10.0 197.8 — 424.2 303.5 — — — — — —

8,926.0 — — 206.4 — 25.0 — — 270.5 205.0 — — — — — —

Africa Algeria Angola Botswana Cameroon Chad Côte d’Ivoire Ghana Guinea Kenya Mali Mauritius Morocco Mozambique, Rep. of Nigeria Senegal Seychelles South Africa Tanzania Tunisia Zaire Zambia Zimbabwe

17,969.0

2002 _______________________________________ 1998

EMERGING MARKETS

Table 14 (concluded) 2003 to Date1

2002 _______________________________________ 1998

1999

2000

2001

2002

Q1

Q2

Q3

Q4

Europe (continued) Poland Romania Russia Slovak Republic Slovenia Tajikistan Turkey Turkmenistan Ukraine Uzbekistan Yugoslavia

1,622.0 — 754.4 79.3 — — 1,276.6 — — — —

4,162.1 338.5 13,155.5 1,501.5 646.7 75.0 6,948.0 612.2 1,099.7 — —

3,780.7 176.0 166.8 994.7 687.7 — 11,900.0 — 290.7 142.0 —

5,252.9 594.4 3,950.7 1,466.7 672.7 — 20,385.4 — — 40.0 —

4,836.6 1,347.2 3,200.1 219.9 827.2 — 6,405.1 — 15.0 30.0 —

6,001.8 1,742.2 8,684.8 143.1 279.0 — 6,385.5 — 514.0 46.0 19.4

876.7 150.0 1,710.2 — 8.6 — 1,742.6 — 15.0 — —

1,000.0 702.3 2,108.0 143.1 55.6 — 1,474.9 — — — —

3,209.8 450.0 1,064.5 — 85.6 — 753.9 — — 46.0 —

915.3 439.9 3,802.1 — 129.2 — 2,414.2 — 499.0 — 19.4

Middle East Bahrain Egypt Iran, I.R. of Israel Jordan Kuwait Lebanon Libya Oman Qatar Saudi Arabia United Arab Emirates

1,600.0 500.0 — — — — — — — — 700.0 400.0 —

9,567.3 650.0 646.9 — 1,146.8 — 365.0 1,769.9 — 100.0 901.7 3,837.0 150.0

15,387.4 361.1 1,533.7 692.0 3,719.0 — 147.5 1,421.4 — 356.8 2,000.0 4,374.8 781.0

14,999.7 1,391.0 919.4 757.7 2,908.5 60.0 250.0 1,752.4 50.0 685.0 1,980.0 2,200.9 2,045.0

11,020.3 207.0 2,545.0 887.0 1,602.6 — 770.0 3,300.0 — — 913.0 275.0 520.7

10,730.4 665.0 570.0 2,671.4 344.4 80.9 750.0 990.0 — 2,417.0 1,571.7 300.0 370.0

3,310.3 — — 500.0 344.4 80.9 450.0 — — 1,300.0 545.0 — 90.0

3,511.8 325.0 485.0 1,185.1 — — 300.0 100.0 — 210.0 606.7 300.0 —

2,855.8 340.0 — 608.3 — — — 890.0 — 437.5 300.0 — 280.0

1,052.4 — 85.0 378.0 — — — — — 469.5 120.0 — —

Latin America Argentina Bolivia Brazil Chile Colombia Costa Rica Dominican Republic Ecuador El Salvador Grenada Guadeloupe Guatemala Jamaica Mexico Paraguay Peru Trinidad & Tobago Uruguay Venezuela

5,410.0 — — 210.0 1,150.0 500.0 450.0 600.0 — — — — — — 2,000.0 — 500.0 — — —

65,724.2 23,162.0 — 14,213.7 5,226.6 1,947.2 274.5 74.1 — 59.8 — — 120.0 250.0 13,514.4 — 861.9 — 550.0 5,470.1

61,324.9 17,844.4 — 12,951.9 8,031.7 3,555.8 300.0 — 73.0 316.5 — — 222.0 — 14,099.5 55.0 1,618.4 230.0 465.0 1,561.7

69,117.6 16,648.5 — 23,238.2 5,782.5 3,093.2 250.0 74.0 — 160.0 — — 505.0 421.0 15,313.4 — 465.4 301.0 602.2 2,263.3

53,854.0 3,423.9 20.0 19,532.9 3,935.3 4,895.0 400.0 531.1 910.0 488.5 — 325.0 325.0 726.5 13,823.5 70.0 137.5 70.0 1,147.4 3,417.5

33,502.6 824.2 90.0 11,032.3 3,011.5 2,221.0 250.0 333.0 10.0 1,251.5 100.0 17.4 44.0 345.0 10,261.7 — 1,993.0 303.0 400.0 1,015.0

11,868.5 56.3 — 7,032.2 170.0 485.0 250.0 188.0 — — — — 44.0 — 1,930.0 — 1,463.0 — 250.0 —

8,309.8 82.0 — 2,900.1 1,029.9 500.0 — — — 500.0 100.0 — — 345.0 2,112.7 — — 90.0 150.0 500.0

6,058.6 86.5 90.0 425.0 406.3 616.0 — — 10.0 300.0 — — — — 3,609.8 — — — — 515.0

7,265.7 599.4 — 675.0 1,405.3 620.0 — 145.0 — 451.5 — 17.4 — — 2,609.1 — 530.0 213.0 — —

Source: Data provided by the Bond, Equity, and Loan database of the International Monetary Fund sourced from Capital Data. 1As of February 21, 2003.

139

STATISTICAL APPENDIX

Table 15. Emerging Market Bond Issuance (In millions of U.S. dollars) 2003 to Date1 Total 14,458.9 Africa 324.6 Mauritius — Morocco — South Africa — Tunisia 324.6 Asia 2,954.5 China — Hong Kong SAR 50.0 India — Indonesia — Korea 1,265.1 Malaysia — Philippines 1,024.6 Singapore — Sri Lanka — Taiwan Province of China 614.8 Thailand — Europe 5,479.8 Bulgaria — Croatia 768.1 Cyprus — Czech Republic — Estonia — Hungary 1,081.3 Kazakhstan — Latvia — Lithuania 431.7 Malta — Poland 1,622.0 Romania — Russia 300.0 Slovak Republic — Slovenia — Turkey 1,276.6 Ukraine — Middle East 500.0 Bahrain 500.0 Egypt — Iran, I.R. of — Israel — Jordan — Kuwait — Lebanon — Qatar — United Arab Emirates — Latin America 5,200.0 Argentina — Brazil 150.0 Chile 1,000.0 Colombia 500.0 Costa Rica 450.0 Dominican Republic 600.0 El Salvador — Grenada — Guatemala — Jamaica — Mexico 2,000.0 Peru 500.0 Trinidad & Tobago — Uruguay — Venezuela —

2002 _______________________________________ 1998

1999

2000

2001

2002

Q1

Q2

Q3

Q4

79,515.8 1,380.5 — — 1,380.5 — 12,399.9 1,794.0 725.4 — — 5,084.4 — 1,890.0 1,500.0 65.0 1,041.0 300.0 24,049.7 — 97.4 480.6 814.9 106.4 1,896.6 100.0 — — 250.0 1,943.3 — 12,106.8 1,336.5 556.1 3,261.5 1,099.7 2,175.0 — — — 650.0 — — 1,525.0 — — 39,510.7 15,614.9 9,190.0 1,063.0 1,388.7 200.0 — — — — 250.0 8,444.0 150.0 — 550.0 2,660.1

82,359.4 2,345.5 160.0 151.5 1,804.7 229.3 23,424.7 1,060.0 7,124.8 100.0 — 4,905.8 2,062.4 4,751.2 2,147.2 — 475.0 798.4 13,872.8 53.9 601.2 288.5 421.7 84.9 2,410.5 300.0 236.7 531.5 — 1,652.6 — — 800.2 439.1 5,761.2 290.7 4,409.8 209.1 100.0 — 1,679.2 — — 1,421.4 1,000.0 — 38,306.7 14,182.8 8,585.8 1,763.8 1,675.6 300.0 — 150.0 — — — 9,854.0 — 230.0 350.0 1,214.7

80,475.4 1,485.8 — — 1,485.8 — 24,501.4 1,770.7 7,058.9 100.0 — 7,653.0 1,419.7 2,467.3 2,333.8 — 1,698.0 — 14,202.5 — 858.0 — — 335.7 540.8 350.0 — 376.2 — 1,553.5 259.5 75.0 978.3 384.7 8,490.8 — 4,670.6 188.5 — — 1,329.8 — — 1,752.4 1,400.0 — 35,615.2 13,024.8 11,382.1 679.7 1,547.2 250.0 — 50.0 — — 421.0 7,078.4 — 250.0 442.7 489.4

89,036.9 2,109.6 — — 1,647.7 462.0 35,869.2 2,341.9 10,458.6 99.3 125.0 7,756.3 2,150.0 1,842.4 8,664.7 — 2,152.4 278.6 11,558.6 223.4 934.0 480.5 50.7 65.5 1,247.8 250.0 180.8 222.4 — 2,773.7 908.6 1,352.7 219.9 490.0 2,158.7 — 5,920.7 — 1,500.0 — 1,120.7 — — 3,300.0 — — 33,578.8 1,500.5 12,238.8 1,536.0 4,263.3 250.0 500.0 353.5 — 325.0 690.7 9,231.7 — — 1,106.1 1,583.2

61,552.5 2,161.1 — — 1,511.1 650.0 22,468.1 602.8 1,951.6 120.0 375.0 6,705.5 1,880.0 4,773.8 560.5 — 5,450.8 48.0 14,966.8 1,247.8 847.5 479.8 428.4 292.6 70.5 209.0 — 355.6 — 2,679.9 1,062.2 3,391.5 143.1 — 3,259.8 499.0 3,706.6 325.0 — 986.3 344.4 80.9 750.0 990.0 — 230.0 18,250.0 — 6,375.5 1,728.9 1,000.0 250.0 — 1,251.5 100.0 — 300.0 4,914.1 1,930.0 — 400.0 —

22,228.0 250.0 — — 250.0 — 7,553.5 500.0 1,710.5 — 100.0 627.4 750.0 2,300.0 408.7 — 1,156.8 — 5,097.7 1,247.8 546.2 479.8 — — 70.5 109.0 — — — 657.9 — 536.5 — — 1,450.0 — 875.3 — — — 344.4 80.9 450.0 — — — 8,451.5 — 4,721.5 — — 250.0 — — — — — 1,800.0 1,430.0 — 250.0 —

15,881.9 1,650.0 — — 1,000.0 650.0 5,029.3 90.0 84.0 — — 420.0 980.0 650.0 8.1 — 2,797.3 — 4,254.7 — 200.6 — 428.4 94.8 — — — 355.6 — 1,000.0 622.3 750.0 143.1 — 659.8 — 725.0 325.0 — — — — 300.0 100.0 — — 4,222.9 — 1,454.0 863.9 500.0 — — 500.0 100.0 — 300.0 355.0 — — 150.0 —

8,834.2 — — — — — 3,957.0 — 157.1 — 125.0 2,616.3 — 400.0 143.7 — 515.0 — 697.8 — — — — 197.8 — 100.0 — — — 400.0 — — — — — — 1,728.3 — — 608.3 — — — 890.0 — 230.0 2,451.0 — 200.0 40.0 — — — 300.0 — — — 1,911.0 — — — —

14,608.4 261.1 — — 261.1 — 5,928.2 12.8 — 120.0 150.0 3,041.8 150.0 1,423.8 — — 981.8 48.0 4,916.5 — 100.7 — — — — — — — — 622.0 439.9 2,105.0 — — 1,150.0 499.0 378.0 — — 378.0 — — — — — — 3,124.6 — — 825.0 500.0 — — 451.5 — — — 848.1 500.0 — — —

Source: Data provided by the Bond, Equity, and Loan database of the International Monetary Fund sourced from Capital Data. 1As of February 21, 2003.

140

EMERGING MARKETS

Table 16. Emerging Market Equity Issuance (In millions of U.S. dollars) 2002 ______________________________________

2003 to Date1

1998

1999

2000

2001

2002

Q1

Q2

Q3

Total

648.0

9,436.3

23,187.4

41,772.8

11,245.9

16,359.4

4,075.9

4,345.2

3,816.0

4,122.3

Africa Mali Morocco South Africa Tunisia

124.1 — — 124.1 —

800.4 23.7 80.2 656.4 40.0

658.7 — — 658.7 —

103.3 — 56.4 46.9 —

150.9 — 6.8 144.1 —

340.5 — — 340.5 —

70.1 — — 70.1 —

260.1 — — 260.1 —

— — — — —

10.3 — — 10.3 —

Asia China Hong Kong SAR India Indonesia Korea Macao Malaysia Papua New Guines Philippines Singapore Sri Lanka Taiwan Province of China Thailand

509.5 509.5 — — — — — — — — — — — —

4,454.8 709.1 437.9 53.2 — 495.5 — — — — 225.9 — 354.1 2,179.2

18,271.8 1,477.4 3,370.0 874.4 522.2 6,590.6 — — 232.4 221.7 1,725.6 — 2,500.4 757.3

31,567.7 20,239.7 3,088.6 916.7 28.2 784.8 29.5 — — 194.6 2,202.2 — 3,951.5 132.0

9,591.5 2,810.4 297.1 467.2 347.2 3,676.4 — 15.4 — — 625.8 — 1,126.6 225.3

12,411.4 2,546.0 2,857.7 264.8 281.0 1,553.7 — 891.2 — 11.3 891.6 — 3,057.9 56.3

2,461.2 112.8 — 171.9 — — — — — — 189.9 81.9 1,904.7 —

3,014.6 103.0 — 42.9 156.0 893.6 — 823.5 — — 6.4 35.3 954.0 —

3,816.0 315.6 — 50.0 125.0 430.8 — 2.7 — — 110.7 2,724.9 — 56.3

3,119.7 2,014.7 — — — 229.2 — 65.0 — 11.3 584.6 15.7 199.2 —

14.4 — — — — — — — — — 14.4 —

2,531.8 205.3 125.8 52.2 383.3 4.4 — 46.0 956.6 45.2 — 713.0

1,411.6 — — 190.3 529.2 — — — 636.3 — 55.8 —

3,339.8 — — — 19.1 — 150.5 — 358.9 — 387.7 2,423.8

259.4 22.3 — — — — — — — — 237.1 —

1,612.4 — — — — 22.7 — — 217.3 — 1,301.0 71.4

456.9 — — — — — — — — — 385.5 71.4

163.2 — — — — 22.7 — — — — 140.5 —

— — — — — — — — — — — —

992.3 — — — — — — — 217.3 — 775.0 —

Middle East Egypt Israel Lebanon Qatar

— — — — —

1,485.8 102.4 496.8 144.9 741.7

2,084.0 89.2 1,994.8 — —

1,618.1 319.4 1,298.7 — —

86.9 — 86.9 — —

— — — — —

— — — — —

— — — — —

— — — — —

— — — — —

Latin America Argentina Brazil Chile Dominican Republic Mexico Peru

— — — — — — —

163.7 — — 72.4 74.1 — 17.2

761.3 349.6 161.4 — — 162.0 88.4

5,143.9 393.1 3,102.5 — 74.0 1,574.3 —

1,157.3 34.4 1,122.9 — — — —

1,995.0 — 1,148.5 — — 846.6 —

1,087.7 — 1,087.7 — — — —

907.3 — 60.7 — — 846.6 —

— — — — — — —

— — — — — — —

Europe Croatia Czech Republic Estonia Hungary Latvia Lithuania Malta Poland Romania Russia Turkey

Q4

Source: Data provided by the Bond, Equity, and Loan database of the International Monetary Fund sourced from Capital Data. 1As of February 21, 2003.

141

STATISTICAL APPENDIX

Table 17. Emerging Market Loan Syndication (In millions of U.S. dollars)

Total

142

2002 _______________________________________

2003 to Date1

1998

1999

2000

2001

2002

Q1

Q2

Q3

Q4

2,862.0

60,024.0

58,022.8

94,154.5

61,854.9

58,546.7

10,740.1

12,659.6

19,446.7

15,700.3

Africa Algeria Angola Botswana Cameroon Chad Côte d’Ivoire Ghana Guinea Kenya Mali Morocco Mozambique, Rep. of Nigeria Senegal Seychelles South Africa Tanzania Tunisia Zaire Zambia Zimbabwe

215.0 — — — — — — — — — — — — — — — 215.0 — — — — —

1,710.6 — 310.0 — — — — 508.6 130.0 — — 200.0 — — — — 532.0 — — — 30.0 —

1,703.0 — — — — — 179.0 30.0 — — — 170.6 — 90.0 — — 960.0 — 123.4 — — 150.0

7,793.7 — — — — — — 320.0 — 7.5 — — — — — 50.0 7,166.1 135.0 94.3 20.8 — —

4,731.8 50.0 455.0 22.5 53.8 400.0 15.0 300.0 — 80.2 — 129.3 200.0 100.0 — — 2,855.0 — 71.0 — — —

4,667.9 150.0 350.0 — — — — 420.0 — — 150.4 — — 1,000.0 40.0 150.0 2,307.5 — 100.0 — — —

1,010.0 — — — — — — — — — — — — — 40.0 — 970.0 — — — — —

— — — — — — — — — — — — — — — — — — — — — —

2,220.0 150.0 350.0 — — — — 420.0 — — — — — — — 150.0 1,100.0 — 50.0 — — —

1,437.9 — — — — — — — — — 150.4 — — 1,000.0 — — 237.5 — 50.0 — — —

Asia Brunei China Hong Kong SAR India Indonesia Korea Lao P.D.R Malaysia Marshall Islands Nepal Pakistan Philippines Singapore Sri Lanka Taiwan Province of China Thailand Vietnam

817.7 — 66.0 355.0 — — 41.7 — 230.0 — — — 90.0 35.0 — — — —

17,355.7 — 4,472.1 929.9 1,380.3 374.2 680.0 — 2,527.2 — 57.0 322.6 2,223.0 740.6 — 1,044.0 2,567.9 37.0

14,262.0 — 924.4 993.5 1,401.8 943.1 2,046.0 — 3,114.8 — — — 2,208.9 466.0 23.0 1,044.5 996.0 100.0

29,812.0 — 1,053.1 10,898.9 1,207.6 1,254.9 5,792.6 — 3,086.7 — — — 2,360.0 1,543.7 100.0 1,054.0 1,440.5 20.0

22,022.7 — 415.0 7,551.6 1,815.7 492.6 5,588.2 — 2,267.0 — — 182.5 1,816.4 1,093.2 105.0 515.0 180.5 —

19,876.2 129.0 2,952.2 2,205.5 1,141.8 100.0 6,287.1 30.0 2,337.7 34.7 — 85.0 1,012.3 1,499.5 — 770.2 898.7 392.5

3,295.5 — 110.0 407.0 240.3 — 713.0 — 1,057.7 — — — 100.0 609.5 — 40.0 18.0 —

3,831.5 129.0 940.2 652.5 246.0 100.0 917.3 30.0 368.0 — — — — 90.0 — 92.8 265.7 —

6,319.5 — 772.0 402.0 122.9 — 1,909.0 — 835.0 34.7 — — 840.0 800.0 — 141.4 170.0 292.5

6,429.7 — 1,130.0 744.0 532.6 — 2,747.8 — 77.0 — — 85.0 72.3 — — 496.0 445.0 100.0

Europe Azerbaijan Bulgaria Croatia Cyprus Czech Republic Estonia Gibraltar Hungary Kazakhstan Kyrgyz Republic Latvia Lithuania Macedonia, FYR of Malta Moldova Poland Romania Russia

519.3 — — — — — — — — — — — — — — — — — 440.0

9,001.3 — 10.0 226.4 75.0 722.8 222.6 — 772.5 85.0 — 110.0 34.7 15.0 206.6 — 1,262.3 293.3 1,048.7

10,907.1 77.2 — 903.6 — 118.6 14.0 65.0 531.6 117.0 — 52.2 428.2 — 57.0 40.0 1,491.9 176.0 111.0

19,479.3 — 8.9 640.7 86.3 127.1 77.0 80.0 748.9 79.6 — 23.0 157.2 — — — 3,340.5 334.9 3,488.1

10,969.7 16.0 18.9 809.8 152.5 513.9 136.6 — 116.9 323.5 — 31.3 24.9 — 85.0 — 2,062.9 438.6 1,610.3

13,721.2 — 13.0 551.6 68.1 35.0 147.1 — 985.6 564.5 95.0 51.9 18.8 — — — 3,104.6 680.0 3,992.3

1,670.3 — 13.0 15.0 — — — — 195.2 26.5 — — 18.8 — — — 218.8 150.0 788.3

2,861.7 — — 106.3 68.1 — 147.1 — 95.7 129.5 95.0 51.9 — — — — — 80.0 1,217.5

6,172.1 — — 324.6 — 10.0 — — 424.2 203.5 — — — — — — 2,809.8 450.0 1,064.5

3,017.2 — — 105.8 — 25.0 — — 270.5 205.0 — — — — — — 76.0 — 922.1

EMERGING MARKETS

Table 17 (concluded) 2003 to Date1 Europe (continued) Slovak Republic Slovenia Tajikistan Turkey Turkmenistan Ukraine Uzbekistan Yugoslavia Middle East Bahrain Egypt Iran, I.R. of Israel Jordan Kuwait Lebanon Libya Oman Qatar Saudi Arabia United Arab Emirates Latin America Argentina Bolivia Brazil Chile Colombia Costa Rica Dominican Republic Ecuador El Salvador Guadeloupe Guatemala Jamaica Mexico Paraguay Peru Trinidad & Tobago Uruguay Venezuela

2002 _______________________________________ 1998

1999

2000

2001

2002

Q1

Q2

Q3

79.3 — — — — — — —

165.1 90.6 75.0 2,973.5 612.2 — — —

194.5 248.6 — 6,138.8 — — 142.0 —

488.3 288.0 — 9,470.9 — — 40.0 —

— 337.2 — 4,246.4 — 15.0 30.0 —

1,100.0 — — — — — — — — — 700.0 400.0 —

5,906.5 650.0 544.5 — — — 365.0 100.0 — 100.0 160.0 3,837.0 150.0

8,893.7 152.0 1,344.5 692.0 45.0 — 147.5 — — 356.8 1,000.0 4,374.8 781.0

8,711.0 1,202.5 600.0 757.7 280.0 60.0 250.0 — 50.0 685.0 580.0 2,200.9 2,045.0

5,012.7 207.0 1,045.0 887.0 395.0

210.0 — — 60.0 150.0 — — — — — — — — — — — — — —

26,049.9 7,547.1 — 5,023.8 4,091.2 558.5 74.5 — — 59.8 — 120.0 — 5,070.4 — 694.8 — — 2,810.0

22,257.0 3,312.1 — 4,204.7 6,267.9 1,880.2 — — 73.0 166.5 — 222.0 — 4,083.6 55.0 1,530.0 — 115.0 347.0

28,358.5 3,230.6 — 8,753.6 5,102.8 1,546.0 — — — 110.0 — 505.0 — 6,660.7 — 465.4 51.0 159.5 1,773.9

Q4

— 279.0 — 3,054.3 — 15.0 46.0 19.4

— 8.6 — 221.2 — 15.0 — —

— 55.6 — 815.1 — — — —

— 85.6 — 753.9 — — 46.0 —

— 129.2 — 1,264.2 — — — 19.4

770.0 — — — 913.0 275.0 520.7

7,023.8 340.0 570.0 1,685.1 — — — — — 2,417.0 1,571.7 300.0 140.0

2,435.0 — — 500.0 — — — — — 1,300.0 545.0 — 90.0

2,786.8 — 485.0 1,185.1 — — — — — 210.0 606.7 300.0 —

1,127.5 340.0 — — — — — — — 437.5 300.0 — 50.0

674.5 — 85.0 — — — — — — 469.5 120.0 — —

19,118.0 1,889.0 20.0 6,171.3 2,399.3 631.7 150.0 31.1 910.0 135.0 — — 35.8 4,591.8 70.0 137.5 70.0 41.3 1,834.3

13,257.6 824.2 90.0 3,508.4 1,282.6 1,221.0 — 333.0 10.0 — 17.4 44.0 45.0 4,501.0 — 63.0 303.0 — 1,015.0

2,329.3 56.3 — 1,223.0 170.0 485.0 — 188.0 — — — 44.0 — 130.0 — 33.0 — — —

3,179.5 82.0 — 1,385.4 166.0 — — — — — — — 45.0 911.1 — — 90.0 — 500.0

3,607.6 86.5 90.0 225.0 366.3 616.0 — — 10.0 — — — — 1,698.8 — — — — 515.0

4,141.1 599.4 — 675.0 580.3 120.0 — 145.0 — — 17.4 — — 1,761.0 — 30.0 213.0 — —

Source: Data provided by the Bond, Equity, and Loan database of the International Monetary Fund sourced from Capital Data. 1As of February 21, 2003.

143

STATISTICAL APPENDIX

Table 18. Equity Valuation Measures: Dividend-Yield Ratios 2003 Jan. 31 Argentina Brazil Chile China Colombia Czech Republic Egypt Hong Kong SAR Hungary India Indonesia Israel Jordan Korea Malaysia Mexico Morocco Pakistan Peru Philippines Poland Russia Singapore South Africa Sri Lanka Taiwan Province of China Thailand Turkey Venezuela Emerging Markets Free EMF Asia EMF Latin America EMF Europe & Middle East ACWI Free

2002 ______________________________ Q1

Q2

Q3

Q4

1998

1999

2000

2001

2002

3.34 5.80 2.75 2.30 4.83 2.35 6.15 3.83 1.44 1.90 4.73 1.51 3.65 1.49 1.98 2.33 4.70 12.09 2.36 1.88 1.94 2.21 2.38 4.07 3.43 1.42 2.33 1.27 5.05

3.20 5.30 2.43 2.03 6.61 2.10 6.03 3.11 1.15 1.94 2.78 2.53 3.34 0.97 1.66 1.70 4.24 12.74 2.55 1.06 1.81 0.91 1.55 3.31 4.57 1.28 2.26 1.51 4.11

3.67 5.63 2.81 2.39 6.10 2.76 7.03 3.34 1.51 1.59 2.97 2.50 3.44 1.25 1.88 2.18 4.50 15.11 2.39 2.33 2.26 1.85 1.90 3.30 3.72 1.46 2.37 1.92 2.41

4.11 6.92 3.27 2.40 5.62 2.48 7.98 3.88 1.52 1.76 4.27 2.52 3.76 1.46 2.01 2.47 4.89 14.07 2.58 1.69 2.06 1.99 2.19 4.08 3.06 1.81 2.78 1.54 2.63

3.42 5.51 2.76 2.41 4.78 2.36 7.53 3.85 1.40 1.81 4.17 1.47 3.77 1.38 2.04 2.30 4.84 10.95 2.37 1.97 1.84 1.87 2.27 3.83 3.35 1.60 2.48 1.35 2.38

3.88 9.34 4.31 3.71 6.02 1.08 8.24 3.87 1.14 2.00 1.16 3.58 3.77 1.19 1.85 2.12 2.01 13.75 4.64 1.24 1.21 0.72 1.41 3.96 2.49 1.15 1.84 3.17 6.93

3.29 2.95 1.88 3.14 6.78 1.36 3.92 2.31 1.14 1.25 0.91 1.87 4.24 0.81 1.15 1.27 2.49 4.00 2.86 1.08 0.70 0.14 0.86 2.09 3.22 0.97 0.70 0.76 5.80

4.62 3.18 2.33 0.95 11.12 0.95 5.75 2.58 1.46 1.59 3.05 2.26 4.54 2.05 1.70 1.63 3.59 5.12 3.38 1.44 0.68 0.92 1.40 2.75 5.59 1.71 2.13 1.91 5.05

5.16 4.93 2.31 1.95 5.63 2.28 6.48 3.25 1.30 2.03 3.65 2.24 3.51 1.54 1.87 1.98 3.97 16.01 3.16 1.43 1.87 1.11 1.80 3.47 4.79 1.42 2.02 1.15 3.89

3.42 5.51 2.76 2.41 4.78 2.36 7.53 3.85 1.40 1.81 4.17 1.47 3.77 1.38 2.04 2.30 4.84 10.95 2.37 1.97 1.84 1.87 2.27 3.83 3.35 1.60 2.48 1.35 2.38

2.47 1.79 3.79 1.84 2.36

2.09 1.45 3.24 1.67 1.70

2.32 1.65 3.71 2.11 1.93

2.58 1.89 4.07 2.11 2.36

2.43 1.81 3.64 1.71 2.25

3.13 1.60 5.18 2.05 1.58

1.52 1.01 2.28 1.16 1.27

2.09 1.71 2.69 1.84 1.46

2.30 1.73 3.37 1.69 1.72

2.43 1.81 3.64 1.71 2.25

Source: Data are from Morgan Stanley Capital International. Note: The countries above include the 27 constituents of the Emerging Markets Free index as well as Hong Kong SAR and Singapore. Regional breakdowns conform to Morgan Stanley Capital International conventions. All indices reflect investible opportunities for global investors by taking into account restrictions on foreign ownership. The indices attempt to achieve an 85 percent representation of freely floating stocks.

144

EMERGING MARKETS

Table 19. Equity Valuation Measures: Price-to-Book Ratios 2003 Jan. 31

2002 ______________________________ Q1

Q2

Q3

Q4

1998

1999

2000

2001

2002

Argentina Brazil Chile China Colombia Czech Republic Egypt Hong Kong SAR Hungary India Indonesia Israel Jordan Korea Malaysia Mexico Morocco Pakistan Peru Philippines Poland Russia Singapore South Africa Sri Lanka Taiwan Province of China Thailand Turkey Venezuela

1.69 1.18 1.05 1.36 1.18 0.82 1.29 1.11 1.86 2.07 1.44 1.74 1.26 1.11 1.60 1.72 1.45 1.80 1.82 0.91 1.30 0.99 1.21 1.65 1.20 1.72 1.94 1.88 0.71

1.39 1.18 1.36 1.79 0.52 0.88 1.44 1.36 2.16 2.29 3.11 1.88 1.45 1.70 1.94 2.27 1.68 1.26 1.63 1.31 1.43 1.54 1.80 2.03 0.83 2.19 2.11 3.08 0.50

1.39 1.20 1.14 1.58 0.80 0.74 1.15 1.27 1.82 2.29 3.08 1.75 1.53 1.47 1.85 1.99 1.50 1.18 1.55 1.07 1.32 1.64 1.51 1.95 1.10 1.71 2.05 2.25 0.75

1.26 0.95 1.05 1.33 0.88 0.81 1.05 1.08 1.83 2.13 2.54 1.72 1.27 1.22 1.52 1.69 1.39 1.38 1.56 1.03 1.22 1.24 1.28 1.68 1.33 1.35 1.72 2.04 0.78

1.61 1.24 1.15 1.30 1.18 0.84 1.05 1.10 1.91 2.15 2.23 1.74 1.26 1.21 1.54 1.77 1.40 2.04 1.84 0.85 1.37 1.22 1.26 1.72 1.22 1.53 1.83 1.76 0.87

1.31 0.52 1.16 0.63 0.71 0.73 2.13 1.31 3.05 2.00 1.39 1.48 1.05 0.99 1.25 1.72 4.27 1.07 1.41 1.48 1.47 0.67 1.55 1.52 1.15 2.21 1.14 2.55 0.57

1.47 1.24 1.69 0.69 0.71 0.80 3.57 2.27 3.35 3.55 2.41 2.53 1.03 1.42 1.98 2.31 3.53 1.48 1.92 1.64 2.12 2.41 2.56 2.75 1.00 3.46 2.04 9.21 0.63

1.04 1.18 1.49 2.75 0.49 1.00 2.32 1.67 2.33 2.71 1.03 3.04 1.02 0.82 1.59 1.91 2.56 1.41 1.13 1.27 2.10 0.90 2.05 2.68 0.60 1.87 1.51 2.72 0.67

0.86 1.11 1.39 1.88 0.53 0.81 1.39 1.38 2.03 2.13 2.72 2.22 1.38 1.33 1.76 1.99 1.79 0.88 1.29 1.11 1.33 1.27 1.63 1.81 0.83 1.98 1.68 3.80 0.48

1.61 1.24 1.15 1.30 1.18 0.84 1.05 1.10 1.91 2.15 2.23 1.74 1.26 1.21 1.54 1.77 1.40 2.04 1.84 0.85 1.37 1.22 1.26 1.72 1.22 1.53 1.83 1.76 0.87

Emerging Markets Free EMF Asia EMF Latin America EMF Europe & Middle East ACWI Free

1.41 1.40 1.37 1.29 2.01

1.79 1.92 1.52 1.71 2.71

1.64 1.65 1.45 1.61 2.40

1.38 1.37 1.26 1.41 1.96

1.45 1.41 1.44 1.42 2.07

1.21 1.40 0.87 1.88 3.49

2.12 2.09 1.57 3.41 4.23

1.64 1.53 1.36 2.15 3.46

1.59 1.68 1.35 1.70 2.67

1.45 1.41 1.44 1.42 2.07

Source: Data are from Morgan Stanley Capital International. Note: The countries above include the 27 constituents of the Emerging Markets Free index as well as Hong Kong SAR and Singapore. Regional breakdowns conform to Morgan Stanley Capital International conventions. All indices reflect investible opportunities for global investors by taking into account restrictions on foreign ownership. The indices attempt to achieve an 85 percent representation of freely floating stocks.

145

STATISTICAL APPENDIX

Table 20. Equity Valuation Measures: Price-Earnings Ratios 2003 Jan. 31 Argentina Brazil Chile China Colombia Czech Republic Egypt Hong Kong SAR Hungary India Indonesia Israel Jordan Korea Malaysia Mexico Morocco Pakistan Peru Philippines Poland Russia Singapore South Africa Sri Lanka Taiwan Province of China Thailand Turkey Venezuela Emerging Markets Free EMF Asia EMF Latin America EMF Europe & Middle East ACWI Free

2002 ________________________________ 1998

1999

2000

2001

2002

–3.26 11.38 16.60 12.72 9.15 10.48 9.02 14.98 9.79 12.33 5.31 –46.11 12.91 8.71 13.72 13.10 10.18 7.03 15.57 18.82 –247.83 8.87 20.91 10.07 14.02 82.56 16.51 108.19 7.97

31.12 9.18 17.60 13.33 393.04 10.01 6.68 19.09 18.66 14.17 10.64 192.41 15.85 19.54 27.10 16.58 10.22 7.47 15.91 49.36 19.91 6.05 24.75 12.26 9.82 22.89 18.91 41.19 13.04

Q1

–8.35 8.92 19.30 13.46 7.31 8.92 7.72 17.23 15.27 12.77 10.93 –32.58 12.89 21.18 21.81 13.64 10.61 5.31 19.84 22.09 19.65 5.92 24.62 12.02 12.67 51.48 18.39 26.59 15.15

Q2

–7.59 9.46 15.72 11.39 8.10 10.02 7.37 14.57 14.47 11.94 7.19 –74.84 12.42 11.71 13.75 12.97 9.77 6.18 17.30 22.48 13.30 5.94 22.06 10.13 15.53 43.95 16.03 21.50 11.90

Q3

–10.92 11.23 17.16 12.14 9.55 10.40 7.33 14.91 10.06 13.56 7.14 –46.62 12.39 11.44 13.21 14.07 9.87 8.07 20.42 18.21 –261.14 7.33 21.07 10.50 14.35 73.13 15.52 101.33 13.43

Q4

12.95 6.60 16.89 10.58 7.62 33.42 7.54 17.82 14.54 11.64 –9.04 16.74 13.30 527.74 –46.93 15.20 22.53 8.15 11.30 17.67 11.86 12.68 25.33 11.35 8.10 23.49 –3.76 7.59 6.93

24.82 18.64 46.40 14.97 20.30 –42.04 16.54 30.81 18.50 22.84 –48.73 25.51 13.51 23.24 –8.41 14.64 18.65 17.60 18.46 142.83 22.33 –126.43 41.18 18.73 7.59 38.26 –8.94 38.60 17.68

20.69 12.83 31.96 40.60 –103.44 16.49 9.35 7.64 14.82 15.61 18.68 23.88 –107.11 8.12 20.63 13.78 9.30 8.39 15.44 –35.06 14.30 5.69 18.94 14.87 4.24 14.06 –14.61 11.77 21.76

19.13 8.49 18.02 14.09 64.91 9.21 6.28 20.47 19.34 13.84 8.37 228.84 15.10 15.23 22.62 14.23 10.77 4.53 14.08 43.72 18.32 5.03 16.53 11.30 8.53 21.08 16.67 25.51 18.43

–10.92 11.23 17.16 12.14 9.55 10.40 7.33 14.91 10.06 13.56 7.14 –46.62 12.39 11.44 13.21 14.07 9.87 8.07 20.42 18.21 –261.14 7.33 21.07 10.50 14.35 73.13 15.52 101.33 13.43

13.39 13.24 14.70 19.48 22.63

15.59 19.07 12.88 13.62 28.46

16.01 21.30 11.88 12.85 30.05

12.87 14.26 12.38 11.82 24.53

13.95 14.85 13.84 16.27 23.18

17.70 83.45 10.58 16.37 29.05

27.17 40.98 18.28 37.25 35.70

14.85 15.47 14.93 14.05 25.44

13.99 16.73 11.67 13.10 26.76

13.95 14.85 13.84 16.27 23.18

Source: Data are from Morgan Stanley Capital International. Note: The countries above include the 27 constituents of the Emerging Markets Free index as well as Hong Kong SAR and Singapore. Regional breakdowns conform to Morgan Stanley Capital International conventions. All indices reflect investible opportunities for global investors by taking into account restrictions on foreign ownership. The indices attempt to achieve an 85 percent representation of freely floating stocks.

146

EMERGING MARKETS

Table 21. United States Mutual Fund Net Flows (In millions of U.S. dollars)

Asia Pacific (Ex-Japan) Corporate High Yield Corporate Investment Grade Emerging Markets Debt Emerging Markets Equity European Equity Global Equity Growth-Aggressive International & Global Debt International Equity Japanese Equity Latin American Equity Funds

2003 Year to Date1

2002 _______________________________

–74 1,835 6,759 115 –265 –135 –1,001 –1,615 624 –373 –42 –16

38 4,322 8,178 168 338 –69 –185 7,377 –248 1,913 –43 203

Q1

Q2 14 146 8,403 28 –25 –236 –1,224 2,118 305 3,235 133 3

Q3

Q4

1998

1999

2000

2001

2002

–119 –821 9,875 49 –507 –267 –2,318 –3,913 –521 –2,017 –85 –119

24 4,436 6,232 204 –137 –472 –1,426 30 –359 1,108 –86 –55

–696 9,857 17,028 523 –1,485 3,087 1,289 5,046 –90 7,373 154 –781

152 –510 7,136 18 24 –1,665 4,673 15,248 –1,582 2,999 731 –121

–1,208 –6,162 4,254 –500 –350 621 12,627 46,610 –3,272 13,322 –831 –95

–496 5,938 21,692 –448 –1,663 –1,791 –3,006 17,883 –1,602 –4,488 –270 –147

–43 8,082 32,688 450 –331 –1,045 –5,152 5,612 –823 4,240 –82 33

1As of February 19, 2003. Source: Data are provided by AMG Data Services and cover net flows of U.S.-based mutual funds. Note: Fund categories are distinguished by a primary investment objective which signifies an investment of 65 percent or more of a fund’s assets. Primary sector data are mutually exclusive, but emerging and regional sectors are all subsets of international equity.

147

STATISTICAL APPENDIX

Table 22. Bank Profitability

Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Uruguay1 Venezuela Eastern Europe Bulgaria Czech Republic Hungary Latvia Lithuania Poland Romania Russia Slovak Republic Slovenia Western Europe France Germany Italy Portugal Spain United Kingdom Turkey Asia India Indonesia Korea Malaysia Pakistan Philippines Thailand United States Japan** Canada

Return on Assets

Return on Equity

(in percent) ________________________________________________________

(in percent) _______________________________________________________

1997

1998

1999

2000

2001

Latest

Date

1997

1998

1999

2000

2001

Latest

Date

1.0 0.5 1.0 1.2 1.2 0.4 1.2 ... 4.3

0.5 0.6 0.9 –2.2 0.8 0.6 0.7 0.9 4.9

0.2 1.6 0.7 –3.2 0.2 0.7 0.3 1.3 3.1

0.0 1.0 1.0 –1.7 –2.8 0.9 0.3 0.9 2.9

0.1 0.2 1.3 0.1 –6.6 0.8 0.4 –0.3 2.8

... 2.0 1.3 1.2 2.1 1.0 0.7 –15.2 6.1

Sep-02 Sep-02 Dec-02 Oct-02 Sep-02 Nov-02 Sep-02 Aug-02

6.3 7.1 13.7 8.6 7.7 5.8 ... 12.8 35.1

4.0 7.4 11.5 –19.6 5.3 6.9 8.4 7.3 41.4

1.5 18.9 9.4 –33.4 1.3 5.8 4.0 7.8 24.0

–0.2 11.3 12.7 –15.8 –21.3 10.4 3.1 4.6 23.1

0.8 2.4 17.7 1.2 –36.0 8.6 4.5 –18.7 20.3

... 23.3 16.6 10.9 22.7 9.7 6.7 –2702 41.1

Sep-02 Sep-02 Dec-02 Oct-02 Sep-02 Nov-02 Sep-02 Aug-02

... –0.2 1.0 ... 0.3 2.1 ... ... 0.1 1.1

... –1.2 –2.2 –1.5 0.9 1.2 ... ... –0.5 1.2

3.3 –0.3 0.5 1.1 0.2 0.9 –0.1 ... –2.3 0.8

4.3 0.7 1.2 1.7 0.5 1.1 2.6 0.7 1.4 1.1

3.4 0.7 1.7 1.3 0.2 1.0 ... 2.1 1.1 0.4

... 1.4 ... 1.4 ... 0.9 ... 3.2 1.1 1.5

Jun-02 Oct-02 Jun-02

... –6.2 11.0 26.0 3.9 37.7 ... ... 2.8 10.3

... –5.2 –24.7 –12.9 11.9 16.1 ... ... –13.4 11.3

10.5 –4.3 6.3 11.0 1.3 12.9 ... ... –36.5 7.8

15.5 13.1 14.4 19.0 5.0 15.2 ... 10.2 25.2 11.3

10.2 14.4 18.3 16.0 1.4 12.9 ... 14.9 25.3 4.8

... 27.6 ... 16.3 ... 9.9 ... 11.3 26.3 18.4

0.4* 0.2 0.6* 0.7 0.9 1.0 –0.4

0.6* 0.2 0.8* 0.6 1.0 0.9 –0.8

0.4* 0.2 0.6* 0.6 0.9 0.6 –1.9

... ... ... ... ... 0.7 0.4

Jun-02 Jun-02

7.6* 10.6 1.0 ... 13.0* 17.2 ...

14.9* 6.1 12.9 15.1 14.0* 14.0 –10.5

10.3 4.6 9.1 15.0 12.7* 9.2 –21.2

... ... ... ... ... 10.9 7.0

0.3* 0.2 0.1* ... 0.8 0.9 2.7

0.3* 0.3 0.5* 0.7 0.9 0.8 1.9

Sep-02 Dec-02 Jun-02

0.7 ... –0.9 ... –1.2 1.7 –0.8

0.8 –19.9 –3.3 ... 0.5 0.8 –5.1

0.5 –9.1 –1.3 1.1 –0.2 0.4 –5.4

0.7 0.1 –0.6 1.1 –0.2 0.4 –1.6

0.6 0.8 0.8 0.8 –0.5 0.4 –0.2

0.8 1.8 0.8 ... ... 0.7 0.7

Mar-02 Sep-02 Sep-02

1.3 0.0 0.7

1.1 –0.6 0.5

1.3 –0.5 0.7

1.2 0.2 0.7

1.1 0.0 0.6

1.4 –0.4 0.5

7.8* 10.2 7.4 15.1 14.4* 14.5 23.1

10.5* 6.5 10.0 14.6 12.2* 17.7 –7.2

Dec-02 Sep-01 Jun-02 Jun-02 Oct-02 Jun-02

Jun-02 Jun-02

... ... –52.5 –0.6 9.1 5.9 –38.5

... ... –23.1 13.3 –6.3 2.9 –47.0

12.8 19.6 –11.9 12.8 –0.3 2.6 –15.9

10.4 13.4 15.9 8.4 –0.1 3.2 –1.9

11.9 19.6 16.1 ... ... 4.8 7.6

Mar-02 Sep-02 Sep-02

Jun-02 Sep-02

... ... –12.8 ... –38.8 13.0 –6.2

Sep-02 Mar-02 Sep-02

15.5 0.8 14.7

13.3 –22.5 12.2

15.7 –11.8 14.2

14.0 3.3 13.9

12.9 –0.1 13.0

15.4 –12.4 9.9

Sep-02 Mar-02 Sep-02

Sources: National authorities, EDSS; IMF staff calculations; (*) ©2003 Bureau van Dijk Electronic Publishing—Bankscope; (**) Moody’s. 1Private banks only. 2Estimate due to negative equity.

148

Sep-02

Jun-02 Sep-02

FINANCIAL SOUNDNESS INDICATORS

Table 23. Bank Asset Quality Nonperforming Loans to Total Loans1

Provisions to Nonperforming Loans2

(in percent) ________________________________________________________

(in percent) _______________________________________________________

1997

1998

1999

2000

2001

Latest

Date

1997

1998

1999

2000

2001

Latest

Latin America Argentina3 Brazil*** Chile*** Colombia Ecuador Mexico*** Peru *** Uruguay4 Venezuela***

5.5 6.3 1.0 5.5 ... 11.1 5.1 ... 2.8

5.3 10.2 1.5 10.7 ... 11.3 7.0 ... 5.5

7.1 8.7 1.7 13.6 ... 8.9 8.7 8.7 7.8

8.7 8.4 1.7 11.0 ... 5.8 9.8 8.5 6.6

13.2 5.7 1.8 10.0 ... 5.1 9.0 9.3 7.9

13.8 6.1 1.9 9.6 ... 4.8 8.4 31.2 10.6

Jun-02 Jun-02 Sep-02 Aug-02

61.2 120.5 160.0 34.8 ... 61.2 90.6 61.1 132.9

61.2 110.9 131.4 37.9 ... 66.1 92.1 62.8 123.4

60.0 125.1 152.9 36.8 ... 107.8 99.5 48.4 101.8

62.9 82.1 145.5 54.5 ... 115.3 104.3 47.5 101.2

66.0 126.1 146.5 73.9 ... 123.8 114.2 45.4 96.5

... 123.3 124.0 80.7 ... 136.2 116.4 45.8 92.2

Eastern Europe Bulgaria5 Czech Republic Hungary Latvia Lithuania Poland Romania Russia Slovak Republic6 Slovenia

24.4 20.8 6.8 10.0 22.2 10.5 65.0 ... 27.2 5.5

19.3 20.7 8.2 6.3 12.9 10.9 71.7 24.5 31.6 5.4

14.6 21.9 4.6 6.2 12.5 13.2 52.6 21.2 23.7 5.1

9.6 19.9 3.3 4.6 11.3 14.9 5.2 12.8 15.3 5.2

6.4 13.7 3.4 3.2 8.3 17.8 3.4 10.0 14.0 5.4

4.5 9.6 3.8 ... 6.0 21.0 3.2 ... ... ...

Oct-02 Sep-02 Sep-02 Sep-01 Oct-02 Jun-02 Aug-02 Oct-01

... 51.1 53.5 74.0 65.6 66.8 27.7 ... ... 51.0

75.0 54.3 45.2 71.7 47.5 63.0 33.6 ... ... 48.0

71.9 52.2 51.4 66.7 37.5 58.4 31.8 ... ... 44.6

79.3 44.9 56.7 65.2 34.6 61.5 70.4 ... ... 40.6

74.3 59.2 53.9 53.1 36.5 66.8 76.7 ... ... 39.1

75.7 78.9 ... ... ... 69.8 59.2 ... ... ...

Western Europe France Germany Italy7 Portugal Spain United Kingdom Turkey

6.7 ... 9.2 4.5 2.9 2.9 2.3

5.9 3.0 8.9 3.3 2.0 3.1 6.7

5.1 2.6 7.4 2.4 1.5 2.8 9.7

4.3 2.2 5.7 2.0 1.2 2.5 9.2

4.1 2.1 4.7 2.0 1.2 2.4 12.6

... ... ... ... 1.2 ... 23.8

60.7 ... 40.9 ... ... 64.0 54.6

58.5 73.3 42.8 ... 69.9 56.0 43.0

60.7 76.9 48.1 ... 71.1 71.2 61.7

60.8 81.8 48.6 68.2 61.0 65.0 60.3

59.9 85.7 50.0 66.7 55.6 69.5 64.5

... ... ... ... ... ... 54.4

15.7 ... 5.8 4.1 20.1 4.7 ...

14.4 48.6 7.6 13.6 19.5 10.4 42.9

14.7 32.9 11.3 11.0 22.0 12.3 38.6

12.8 18.8 8.1 9.7 19.5 15.1 17.7

11.4 12.1 4.9 11.5 19.6 17.3 10.5

10.4 10.6 3.8 10.3 ... 16.4 10.4

Mar-02 Oct-02 Jun-02 Nov-02 Oct-02 Oct-02

... ... ... 21.6 46.6 47.3 ...

... 28.6 ... 21.6 58.6 38.3 22.5

... 77.7 ... 26.8 48.6 46.6 27.9

... 59.4 52.1 27.9 55.0 43.6 32.2

... 97.7 45.3 26.8 56.2 45.2 35.6

... 85.4 45.3 27.5 ... 48.7 49.5

1.0 5.4 1.1

1.0 5.8 1.1

1.0 6.1 1.2

1.2 6.6 1.2

1.5 7.4 1.5

1.6 8.9 1.6

Sep-02 Mar-02 Jun-02

81.0 ... ...

73.7 65.9** 50.3

76.1 52.0** 45.4

98.2 43.7** 42.8

118.2 36.9** 44.0

82.3 32.5** ...

Asia India Indonesia Korea Malaysia Pakistan Philippines Thailand8 United States Japan Canada

Sep-02 Nov-02 Sep-02 Nov-02

Nov-02 Jun-02

Date

Jun-02 Sep-02 Aug-02 Sep-02 Nov-02 Sep-02 Nov-02 Sep-02 Sep-02 Sep-01 Jun-02 Aug-02

Jun-02

Sep-02 Jun-03 Nov-02 Oct-02 Oct-02 Sep-02 Mar-02

Sources: National authorities, EDSS; IMF staff calculations; (*) Bankscope, ©2003 Bureau van Dijk Electronic Publishing—Bankscope; (**) Moody’s. 1NPLs gross of provisions to gross loans. 2For most countries specific provisions to NPLs, (***) including general provisions. 3Uncollectible credits only as a percentage of credits to the private sector. 4Private banks only. 5Loans in arrears to total loans to public and private sector enterprises. 6Excluding KOBL. 7Doubtful loans to total loans. 8The NPL ratio is based on the national definition and excludes doubtful of loss loans that are fully provisioned and written off.

149

STATISTICAL APPENDIX

Table 24. Bank Capital Adequacy Regulatory Capital to Risk-Weighted Assets1

Capital to Assets2

(in percent) ________________________________________________________

(in percent) _______________________________________________________

1997

1998

1999

2000

2001

Latest

Date

1997

1998

1999

2000

2001

Latest

Date

Latin America Argentina*** Brazil Chile*** Colombia Ecuador Mexico Peru Uruguay3 Venezuela

21.0 15.9 11.5 12.4 ... 13.6 10.5 11.3 ...

20.4 15.6 12.5 10.3 ... 14.4 11.2 11.2 ...

20.8 15.5 13.5 10.8 ... 16.2 12.0 10.2 ...

19.5 14.3 13.3 12.4 ... 13.8 12.8 11.7 ...

17.9 15.3 12.7 12.4 ... 14.7 12.8 11.3 ...

... 14.5 13.5 12.1 ... 15.0 12.6 –6.5 ...

11.8 9.4 ... ... 15.9 8.0 8.5 16.3 12.7

11.3 10.5 ... 7.7 14.5 8.3 8.7 15.3 14.0

10.6 11.6 ... 7.7 12.9 8.0 8.9 14.7 13.5

10.1 12.1 ... 7.7 12.9 9.6 9.1 11.7 13.0

12.5 13.6 ... 7.9 8.8 9.4 9.8 8.1 14.0

14.4 12.8 ... 7.7 9.1 10.0 9.9 –4.9 15.8

Jun-02 Nov-02 ... Aug-02 Oct-02 Sep-02 Nov-02 Sep-02 Nov-02

Eastern Europe Bulgaria Czech Republic*** Hungary Latvia Lithuania Poland Romania Russia Slovak Republic Slovenia

26.9 9.5 17.3 21.0 15.3 12.5 13.6 ... 8.0 18.2

36.7 12.0 18.5 17.0 23.8 11.7 10.3 ... 6.6 16.0

41.8 13.6 14.1 16.0 17.4 13.2 17.9 ... 12.7 14.0

35.6 14.9 13.5 14.0 16.3 12.9 23.8 ... 13.1 13.5

31.3 15.5 14.2 15.0 16.8 15.1 28.8 ... 19.7 11.9

26.8 15.3 12.6 ... ... 13.7 26.7 ... ... 11.4

14.0 7.9 9.7 3.7 13.0 7.0 6.1 ... 9.8 13.9

15.3 7.9 9.7 2.0 12.8 7.1 7.6 14.3 8.7 13.5

15.2 8.2 9.8 8.5 12.1 7.2 8.6 12.9 5.9 12.8

13.6 6.7 9.5 9.1 11.5 8.0 12.1 12.5 7.9 10.6

13.1 ... 10.0 9.0 12.1 8.4 12.1 ... 9.6 11.1

Sep-02

Jun-02

— 8.2 9.4 7.0 6.8 7.2 ... ... 9.2 14.5

Western Europe France Germany Italy Portugal Spain*** United Kingdom Turkey

11.2** 10.7 11.4 12.5 12.2 13.6 12.3

10.7** 10.5 11.3 12.4 12.9 12.4 13.0

10.8** 11.3 10.6 11.8 12.6 13.6 8.2

10.9** 10.9 10.3 10.4 12.5 11.8 17.3

10.6** 11.5 10.6 9.3 13.0 12.2 19.9

... ... ... ... ... 12.5 15.2

Jun-02 Jun-02

... 4.2 6.9 ... ... 6.8 9.1

6.4 4.0 6.7 ... 7.1 7.0 8.7

6.8 4.1 7.0 6.7 6.6 7.5 5.2

6.7 4.2 6.9 7.3 7.5 6.5 6.1

6.7 4.3 7.2 ... 7.2 6.6 9.6

... 4.5 ... ... ... 6.7 9.7

Asia India Indonesia Korea Malaysia Pakistan Philippines Thailand4

10.0 ... ... 10.5 4.5 16.0 9.4

11.5 –13.0 8.2 11.8 10.9 17.7 10.9

11.2 –2.4 10.8 12.5 10.9 17.5 12.4

10.7 –18.2 10.5 12.5 9.7 16.2 11.9

11.2 19.2 10.8 13.0 8.8 15.4 13.9

11.8 23.7 10.6 13.1 ... 17.5 14.3

Mar-02 Sep-02 Jun-02 Nov-02 Aug-02 Oct-02

... 8.8 5.1 8.4 ... 12.9 14.7

... –12.9 4.6 8.9 ... 14.8 11.9

... –2.7 5.2 8.9 ... 16.0 11.1

... 5.1 4.6 8.5 ... 15.3 9.2

... 6.4 4.9 8.5 ... 15.4 9.1

... 9.1 5.2 8.7 ... 15.8 9.0

United States Japan** Canada

11.5 9.1 10.0

11.6 9.4 10.7

11.6 11.5 11.7

11.7 11.9 11.9

12.4 10.9 12.3

12.6 10.5 12.6

Jun-02 Mar-02 Jun-02

7.9 3.3 4.1

8.2 2.7 4.2

8.1 4.4 4.7

8.2 4.7 4.7

8.9 4.4 4.6

9.0 3.8 4.6

Sep-02 Sep-02 Sep-02 Jun-02 Aug-02 Sep-02

Sep-02 Sep-02 Sep-02 Sep–01 Sep–01 Jun-02 Aug-02

Sources: National authorities, EDSS; IMF staff calculations; (*) ©2003 Bureau van Dijk Electronic Publishing—Bankscope; (**) Moody’s. 1For most countries national definitions of total capital, (***) Basel. 2For most countries shareholders’ equity (including profits) as a percentage of end-period total assets 3The regulatory capital ratio covers private banks only. 4Including equity of head office and other branches of the same legal entity in the capital to assets ratio.

150

Sep-02 Nov-02 Oct-02 Jun-02 Aug-02 Oct-02 Oct-02

Nov-02

Jun-02 Sep-02

Sep-02 Sep-02 Nov-02 Oct-02 Oct-02 Sep-02 Mar-02 Nov-02

FINANCIAL SOUNDNESS INDICATORS

Table 25. Moody’s Weighted Average Bank Financial Strength Index1 (in percent) Financial Strength Index _____________________ Dec. 2001 Dec. 2002

Outlook ________ Jan. 3, 2003

Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Uruguay Venezuela

13.3 37.9 50.6 23.3 8.3 36.3 22.9 31.3 28.8

0.0 25.0 52.5 24.2 8.3 39.6 23.3 0.0 15.4

0/– + 0.0 0.0 0.0 0/+ 0.0 0.0 0.0

Eastern Europe Bulgaria Czech Republic Hungary Latvia Lithuania Poland Romania Russia Slovak Republic Slovenia

... 29.2 41.7 29.2 ... 29.6 17.3 12.5 9.6 40.2

... 32.5 45.0 32.1 ... 28.3 18.8 10.8 15.0 40.8

... 0/+ 0.0 0.0 ... 0/– 0/+ + + 0.0

Western Europe France Germany Italy Portugal Spain United Kingdom Turkey

71.9 61.7 64.6 64.6 77.1 83.8 30.0

74.2 54.2 63.3 64.2 77.1 83.8 20.4

0.0 0.0 0.0 0.0 0.0 0.0 0.0

Asia India Indonesia Korea Malaysia Pakistan Philippines Thailand

25.8 1.7 14.2 30.4 2.1 17.5 15.8

27.5 5.4 16.7 31.7 5.0 20.4 15.8

0.0 0.0 0.0 0/+ + 0.0 0/+

United States Japan Canada

77.1 16.7 77.1

75.0 12.9 75.0

0/+ 0/– 0/–

Source: Moody’s. 1Constructed according to a numerical scale assigned to the different weighted average bank ratings by country.

151

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