Origins of the Maturity and Currency Mismatches in the Balance Sheet of Emerging Countries: a Theoretical Approach

The aim of this paper is to highlight the origins of the currency and maturity mismatches in the balance sheets of emerging countries. We show that short-term debt in the form of demandable debt works as a commitment device of the financial intermediary and as a form of protection of foreign lenders in a context of poor enforceability of contracts. The currency mismatch in the non-tradable sector is mainly viewed as a supply-side phenomenon. It results from the choice of foreign lenders whose anticipations of exchange rate risk overpass those of default of the banking and/or private sector following a real adverse shock. Finally, when it comes to simultaneously explain the maturity and the currency composition of debt, the paper shows that the short-term foreign currency denominated debt, with the option of early withdrawal of the demandable debt, allows investors to offset the debtor default risk if a currency depreciation occurs.maturity mismatch, currency mismatch, real exchange rate, international financial crises.

A Twin Crisis Model Inspired by the Asian Crisis

In this paper, we propose a twin crises synthetic model. We show that there may be multiple equilibria on the exchange market as well as on the international financial one and emphasize the possible connections between currency and financial crises. On the exchange market, the currency devaluation is the outcome of a trade-off by the government in presence of implicit safety nets of the banking sector. The crisis occurs whenever the anticipated devaluation rate by the market is equal to the "optimal" devaluation rate of the government. As far as the international financial market is concerned, the passage from one equilibrium to another is triggered by the evolution of the ratio Currency Reserves/Short Term Debt as a fundamental factor. Combining bank run dynamics and fundamental factors, we aim at reconciling the two major interpretations of currency and banking crises, namely the fragility of emerging financial systems and the ex-post worsening of domestic fundamentals originating in debtors or domestic government moral hazard.twin crises models, multiple equilibria, bank runs, capital flows

Exchange rate anchoring - Is there still a de facto US dollar standard?

The paper provides a measure of exchange rate anchoring behaviour across 149 emerging market and developing economies for the 1980-2010 period. An extension of the Frankel and Wei (2008) methodology is used to determine whether exchange rates are pegged or floating, and in the case of pegs, to which anchor currencies they are pegged. To capture the role of major currencies over time, an aggregate trade-weighted indicator is constructed based on exchange rate regimes of individual countries. The evolution of this aggregate indicator suggests that the US dollar has continuously dominated exchange rate regimes, despite some temporary decoupling during major financial crises. JEL Classification: F30, F31, F33de facto exchange rate regimes, emerging and developing economies, global currencies, international monetary system

Signals from housing and lending booms

The contribution of this paper is to revisit the Early Warning System (EWS) literature by analysing selected episodes of financial market crisis, i.e. those preceded by a spell of credit and real estate expansions. The aim is to disentangle instances when this constitutes a natural phenomenon associated with a process of financial development and innovation from those where it constitutes a worrisome signal. We identify economic variables that have leading indicator properties, thus helping to distinguish between “benign” episodes from those likely ending with downward pressures on the exchange rate or even a fully-fledged banking crisis. We find that a large current account deficit, a fall in price competitiveness, strong real growth and high public debt-to-GDP ratio increase the probability that a lending or housing boom would be accompanied by financial market tensions shortly after the peak. JEL Classification: E32, F31, F37credit booms, Early Warning System, Financial crises, House prices

Un modèle de crises jumelles inspiré de la crise asiatique

Dans cet article, nous proposons un modèle synthétique qui relie crise bancaire et crise de balance de paiements. Nous identifions une configuration d'équilibres multiples tant sur le marché des changes que sur le marché financier international et mettons en lumière les liens entre le déclenchement de la crise sur chacun de ces deux marchés. Sur le marché des changes, la dévaluation est le résultat d'un arbitrage du gouvernement en présence de garanties publiques du secteur bancaire et se produit lorsque la dévaluation anticipée par les spéculateurs coïncide avec la dévaluation « optimale » du gouvernement. Sur le marché financier international, le passage d'un état d'équilibre à un autre est déterminé par l'évolution du ratio Réserves de change/Dettes à court terme en tant qu'expression d'un équilibre fondamental. A travers la prise en compte des fondamentaux dans une dynamique de panique bancaire au niveau international, nous concilions les deux approches majeures de la modélisation actuelle des crises jumelles, à savoir la fragilité des systèmes financiers domestiques et la détérioration ex post d'une grandeur fondamentale en présence d'aléa de moralité.crises jumelles, paniques bancaires, aléa de moralité, équilibres multiples, flux de capitaux internationaux

Determinants of government bond spreads in new EU countries

Based on a rich database of government bond spreads and macroeconomic indicators over the period 2001-2008, we propose an empirical assessment of the role of fundamentals in driving long-term sovereign bond spreads of the new EU countries (Bulgaria, Czech Republic, Latvia, Lithuania, Hungary, Poland, Romania and Slovakia). The results of a dynamic panel error correction model that accounts for both common long-run determinants and cross-country heterogeneities in sovereign bond spreads tend to suggest that fundamentals still matter for market’s assessment of a country creditworthiness. Countries’ levels of external debt, fiscal and current account balances, exchange and inflation rates, their degree of trade openness as well as short-term interest rate spreads play an important role in the new EU countries’ access to long-term finance. We furthermore challenge the pooled mean approach in order to check whether other factors may become relevant in the long-run for two sub-groups of countries according to the developments in their current account balances. Fiscal fundamentals seem to matter most for one group of countries, those characterised by widening external imbalances and historically high levels of spreads. In a context of heightened risk aversion and potential for spill over effects, this group of countries are more exposed to domestic sources of vulnerability as well as to swings in market perceptions of sovereign risks. JEL Classification: G12, H60, E62long-term government bond spreads, new EU countries, pooled mean group estimation

COMOVEMENTS IN EMERGING MARKET BOND RETURNS: AN EMPIRICAL ASSESSMENT

The objective of the paper is to empirically assess the comovement of emerging bond returns of the key constituent countries of the EMBI Global benchmark Index since their introduction (broadly in 1997) up to the present. We aim at disentangling the respective roles of common external factors and "pure" contagion in the recent events of market spillovers. The unweighted average of cross-country rolling correlation coefficients, adjusted and unadjusted for the presence of common external factors, provides a first assessment of the joint behavior of emerging markets bond returns during the sample period. We furthermore show that the cross-country average correlations method may not be useful in summarizing market results if the underlying distribution of bond returns is not unimodal (i.e., if there are underlying groups that exhibit high within-group comovement but not between-group comovement). Several methods are used on a year-to-year basis in order to identify periods where the “two-tier paradigm” of emerging markets prevails. The analysis of correlation matrices enables us to identify groups of countries moving together during the recent events in emerging markets. These findings are further refined by performing Principal Component and Cluster Analysis. We provide a method in order to quantify the excess comovement common to all emerging countries as well as the country-specific one. Finally, we find evidence of “market tiering” and investors' discrimination especially during tranquil times: the first three quarters of 1997, from the third quarter of 1999 to the end of 2000 and from 2003 to 2005. We suggest that regional patterns and credit quality differentiation have an important role to play in the investors' discriminating behavior regarding the emerging bond markets whenever the period is free of strong and unforeseen shocks leading to spillover across countries and markets.emerging bond markets, excess comovement, contagion, market segmentation

Emerging Debt Markets: What Do Correlations and Spreads Tell Us?

This paper proposes a conceptual framework to identify the potential sources of contagion in emerging bond markets and the mechanisms through which shocks originating in a particular emerging or mature market are likely to be transmitted across countries and markets. We then apply this framework to the emerging countries initially included in the EMBI Global Index over the period 1997-2005. We put into light that emerging markets became less and less intertwined over the recent period, and that, at present, the risk of contagion may come mainly from events taking place into mature markets. Finally, we derive policy recommendations in order to reduce emerging countries debt variability thus making them less vulnerable to a shock that takes place in mature markets. Sound macroeconomic policies, and in particular, prudent fiscal ones, could enhance government discipline and limit contagion effects in a wake of a global shock or a shock affecting another emerging country.Emerging bond markets, International financial crises, Excess comovement, Contagion, Public debt

The changing role of the exchange rate in a globalised economy.

In addition to its direct effects on the global trading and production structure, the ongoing process of globalisation may have important implications for the interaction of exchange rates and the overall economy. This paper presents evidence regarding possible changes in the role of exchange rates in a more globalised economy. First, it analyses the link between exchange rates and prices, showing that there is at most a moderate decline in exchange rate pass-through for the euro area. Next, it turns to the effect of exchange rate changes on trade flows. The findings indicate that the responsiveness of euro area exports to exchange rate changes may have declined somewhat as a result of globalisation, reflecting mainly shifts in the geographical and sectoral composition of trade flows. The paper also provides a firm-level analysis of the impact of exchange rate changes on corporate profits, which suggests that overall this relationship appears to be relatively stable over time, although there are important crosscountry differences. In addition, it studies the overall impact of exchange rates on GDP and the potential role of valuation effects as a transmission channel in the case of the euro area. JEL Classification: E3, F15, F31.Globalisation, exchange rate, trade exchange rate pass-through, valuation effects.

Emerging Debt Markets: What Do Correlations and Spreads Tell Us?

This paper proposes a conceptual framework to identify the potential sources of contagion in emerging bond markets and the mechanisms through which shocks originating in a particular emerging or mature market are likely to be transmitted across countries and markets. We then apply this framework to the emerging countries initially included in the EMBI Global Index over the period 1997-2005. We put into light that emerging markets became less and less intertwined over the recent period, and that, at present, the risk of contagion may come mainly from events taking place into mature markets. Finally, we derive policy recommendations in order to reduce emerging countries debt variability thus making them less vulnerable to a shock that takes place in mature markets. Sound macroeconomic policies, and in particular, prudent fiscal ones, could enhance government discipline and limit contagion effects in a wake of a global shock or a shock affecting another emerging country