The Debt market in Chile

Rodrigo CifuentesBank of England

October 21st, 2005

Outline

I. Public and private debt in local currency up to 1997.

II. The impact of the Asian crisis in the Debt market.

III. Policies to support the Debt market.

IV. Current issues and challenges.

I. Public and private debt in local currency up to 1997

Facts:• 1980s: Central Bank issues public debt to finance costs of

banking crisis of 1983.• 1989: Flat-coupon, various maturities up to 20 years,

indexed.• Maturity of bonds issued varies over time (4,6,8,12,14,20

yr).

Key determinants of viability of long-term market:• Credibility in UF (institutions).• Demand by institutional investors, Pension Funds (PF)

and Life Insurance Companies (LIC).

I. Public and private debt in local currency up to 1997

Facts:• Volumes issued by the Central Bank continue to

increase as consequence of exchange rate policy. • Private debt market exists but is relatively small.Why?:• 80s: Investment restrictions of PFs and LICs.• 90s: Cost of Funds lower abroad.

– Exchange rate regime: Risks not internalised neither by supply nor demand.

– International markets willing to take ‘Chile risk’.

II. The impact of the Asian crisis in the Debt market

Facts:• Flows of funds to emerging market economies

reverse.• Large increases in sovereign risk spread.• Exchange rate policy: Free float since 1999.• Banks are explicitly required to consider currency

mismatches of borrowers in credit risk assessment (capital cost to them)

II. The impact of the Asian crisis in the Debt market

Consequences on incentives to market participants:• Companies with previous acces to international

markets, turn to local market.• Development of local expertise in fixed-income

securities: Lower cost to new companies to issue debt.

• Fall in yields imply institutional investors more active in search for return.– Role of Investment Banks

II. The impact of the Asian crisis in the Debt market

Impact on Market:• Placements of debt in local market increase in 1998-

2000, and further from 2001 onwards.• Second increase due to new companies.

Total amount and number of PlacementsMillions of USD

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005(Jan-Sep)

0

5

10

15

20

25

30

35

40

45

Amount (LHS) Number (RHS)

Companies with debt and amounts outstandingMillions of USD

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005(Jan-Sep)

0

10

20

30

40

50

60

70

80

90

100

Amount Oustanding (LHS) Companies with debt (RHS)

II. The impact of the Asian crisis in the Debt market

Impact on Market:• Placements of debt in local market increase in 1998-

2000, and further from 2001 onwards.• Second increase due to new companies.• Market segmented in two tranches: 5-year for PF, 20-

year for LIC.

Placements by maturityUSD million

Source: SVS

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1990 1992 1994 1996 1998 2000 2002 2004

0 - 5 yrs 5 - 10 yrs 10 - 15 yrs 15 - 20 yrs 25 - + yrs Más de 25

Placements by ObjectiveUSD million

Source: SVS

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1990 1992 1994 1996 1998 2000 2002 2004

Investment Inv and Refinancing Refinancing General Securitised

II. The impact of the Asian crisis in the Debt market

Impact on Market:• Placements of debt in local market increase in 1998-

2000, and further from 2001 onwards.• Second increase due to new companies.• Market segmented in two tranches: 5-year for PF, 20-

year for LIC.However:• New companies with profile too similar to those of

before: Regulated services sectors, and/or large companies.

Outstanding Debt by sectorUSD Billions

Source: SVS

0

2

4

6

8

10

12

14

90 92 94 96 98 00 02 04

Regulated Services Natural Resources Other Retail Financiero Public Infrastructure

II. The impact of the Asian crisis in the Debt market

Impact on Market:• Placements of debt in local market increase in 1998-

2000, and further from 2001 onwards.• Second increase due to new companies.• Market segmented in two tranches: 5-year for PF, 20-

year for LIC.However:• New companies with profile too similar to those of

before: Regulated services sectors, and/or large companies.

• Liquidity falls at the end of 90s:– Mergers in PF and Banks– Rise in interest rates in 1998

Liquidity in fixed-income

Yearly transactions over stock

* Mortgage-backed securities, corporate bonds and public sector debt

0.0

1.0

2.0

3.0

4.0

96 97 98 99 00 01 02 03 04 05

III. Policies to support the Debt market

• 2002: Fourteen years after start of issuing marketable debt, CB changes structructure of bonds issued.– Bullet– Matutirities comparable internationally: 2, 5, 10 and 20-years– Benchmark issues: less types of bonds in the market to

increase depth of any issue and, hence, liquidity.– Start issuing nominal (peso) bonds in maturities higher than

1 year (2 and 5).

• Other debt market-friendly reforms:– Capital Markets Reform I (Commercial paper).

Denomination and Term structure of Central Bank DebtMillions of USD; December 2003, June 2004, December 2004, August 2005

Source: Central Bank of Chile

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

0 - 1m 1m - 6m 6m - 1yr 1yr - 2yr 2yr - 5yr 5yr - 10yr 10yr - +

Nominal CPI-Indexed Dollar

Stock of Central Bank DebtUSD Million

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05

BCP BCU CEROS PRC

Liquidity of Central Bank DebtRatio of transactions in the Santiago Stock Exchange over Stock outstanding

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05

BCP BCU CEROS PRC

Yields on 5yr bondspercentage

Source: Banco Central de Chile

0

1

2

3

4

5

6

7

Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05

Nominal

CPI Indexed

Spread

Yields on 10yr bondspercentage

Source: Banco Central de Chile

0

1

2

3

4

5

6

7

8

Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05

Nominal

Spread

CPI Indexed

IV. Current issues and challenges

• Expand market to medium-size companies.– Act on regulation to investments of PFs and LICs.

• Nominal debt– Central Bank issued 10-year nominal bond in 2004. – Nominal debt: Credibility replaces indexation. Macro benefit:

indexation makes real adjustment of prices more difficult.– Difficult to change market conventions: Nominal private debt

issues still scarce. Why, if inflation is low?

• International investors– Nominal debt may make this easier (UF implied entry costs)

IV. Current issues and challenges

• Financial Stability:Delivery versus Payments

• Refinancing on lower rates (2004): Prepayments, Replacement cost (LICs)– Learning-by-doing, now more attention on covenants.

Pricing of risks more precise.