The Sovereign CCA Model, Financial Crises, and Venezuela Dr. Samuel Malone Profesor Invitado IESA...
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The Sovereign CCA Model, Financial Crises, and Venezuela Dr. Samuel Malone Profesor Invitado IESA
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Transcript of The Sovereign CCA Model, Financial Crises, and Venezuela Dr. Samuel Malone Profesor Invitado IESA...
The Sovereign CCA Model, Financial Crises, and Venezuela
Dr. Samuel Malone
Profesor Invitado
IESA
Dr. Samuel Malone
Profesor Invitado
IESA
2
CCA for Sovereigns vis-à-vis CCA for Firms
Firms and Banks Sovereigns
Market Cap Number of shares*price
=Market Cap
Base Money plus Govt local-currency debt * exchange rate
Distress Barrier Senior Debt Foreign Currency Debt
CDS Spread Drivers
Leverage, asset volatility, and market price of risk (correlation and Sharpe Ratio)
Sovereign leverage, asset volatility, global sovereign market price of risk (correlation and “global Sharpe Ratio”?)
(A proxy for the “global market Sharpe Ratio” is the excess return on global stock
and bond markets per unit of volatility. This is the subject of ongoing research.)
3
Sovereign CCA – Balance Sheets of Central Bank and Government Consolidated into Sovereign Balance Sheet
Reserves
Credit to Government
Other
PV Primary Surplus
- Cont. Liab.
Other
Base
Money
Foreign Def-free Debt FX
Credit from CB
Local Currency DebtLC
Government BS
Central Bank BS
Foreign Debt
Value FX
Base
Money*
local-currency debt*LC
Reserves
PV Primary Surplus
- Cont. Liab.
Other
Sovereign (Consolidated) BS
*Local Currency Liabilities are base money plus local
currency debt
4
Sovereign CCA - Calibrate (Unobservable) Sovereign Asset and Implied Asset Volatility
INPUTS
Value and Volatility of Local Currency Liabilities*
Foreign Currency Debt Distress Barrier Bf (from Book Value)
Time Horizon
*The value and volatility of local currency debt and part of base money, measured in foreign currency terms. See Annex 2 for details
USING TWO EQUATIONS WITH TWO UNKNOWNS
Gives:
Implied Sovereign Asset
Value and
Asset Volatility
Default Probabilities
Spreads, Risk Indicators
$ $Sov 1 2N( ) N( )fr T
fLCL V d B e d
$ $ $ $ 1( )
Sov Sov LCLV LCL N d
$ SovV
5
Robustness of Sovereign Risk Indicators:
There are very high correlations the CCA Risk Indicators and Credit Default Swap Spreads (CDS) & EMBI bond spreads on foreign currency debt.
Highly statistically significant
Note that the Risk Indicators did not use sovereign bond or CDS spreads as an input!
(See IMF Staff Paper 2008 and IMF Working Paper 05/155 for results and robustness tests)
6
SOUTH AFRICA - Default Indicator vs Market 1-yr Credit Spread
0
2
4
6
8
10
12
14
16
10/4/
02
11/29
/02
1/24
/03
3/21
/03
5/16
/03
7/11
/03
9/5/
03
10/31
/03
12/26
/03
2/20
/04
0
20
40
60
80
100
120
140
160
Bas
is P
oin
ts
Default Indicator (Left Scale)Market 1-yr Credit Spread, CDS (Right Scale)
TURKEY- Default Indicator vs Market 1-yr Credit Spread
0
5
10
15
20
25
30
35
6/28
/02
8/23
/02
10/18
/02
12/13
/02
2/7/
03
4/4/
03
5/30
/03
7/25
/03
9/19
/03
11/14
/03
1/9/
04
-50
150
350
550
750
950
1150
1350
Bas
is P
oin
ts
Default Indicator (Left Scale)Market 1-yr Credit Spread, CDS (Right Scale)
KOREA - Default Indicator vs Market 1-yr Credit Spread
0
2
4
6
8
10
12
14
4/5/
02
5/31
/02
7/26
/02
9/20
/02
11/15
/02
1/10
/03
3/7/
03
5/2/
03
6/27
/03
8/22
/03
10/17
/03
12/12
/03
2/6/
04
10
30
50
70
90
110
130
Bas
is P
oin
tsDefault Indicator (Left Scale)Market 1-yr Credit Spread, CDS (Right Scale)
Examples: Risk Indicator vs. Credit Default Swap Spread
Correlations are ~ 90 % for 12 countries
Results from MfRisk model, Sovereign CCA models built for over 20 countries
BRAZIL - Default Indicator vs Market
5-yr Credit Spread
0
5
10
15
20
25
30
35
40
0
500
1000
1500
2000
2500
3000
3500
4000
4500
Default Indicator (Left Scale)
Market 5-year CDS Spread (Right Scale)
7
Example of BRAZIL- Implied Sovereign Asset Value vs Foreign Currency Debt Distress Barrier
Implied Sovereign Asset Value vs Distress Barrier (External and $-linked Debt)
0
50
100
150
200
250
300
350
400
450
500
Billion
US
$
Implied Sovereign Asset Distress Barrier (FX and $-linked Debt)
Sovereign
Leverage Ratio
was
0.8 in 2002
and
0.18 in 2006
8
Rough Estimates of Drivers of Emerging Market (EM) Sovereigns and (EM) Corporate Credit Spreads
EM Sovereigns
Credit Spreads January 2007
100 -190
Increased Market Leverage
+10-20
Change in Volatility +10-20
Mkt Price of Risk Increase
+50-60?
Credit Spreads January 2008
190 to 290 bps
9
Sovereign, Bank, and Corporate Economy-wide CCA Sector Interlinked Balance Sheets
Corporate Sector
Assets
Sovereign
Assets
Equity
Default-free Debt Value
– Put Option
Money &
Local Currency Debt
Foreign Def-free
Debt Value – Put Option
Banking/ Financial
Sector Assets
Deposits and Debt Value – Put Option
Equity
Contingent Liab
Risky Debt = Default-free Value of Debt minus Expected Losses
Expected losses in risky debt are implicit put options, contingent
liabilities are implicit put options, equity and junior claims
are implicit call options
See AnnexImplicit Put Option
10
Economy-wide CCA Balance Sheet Models Capture Non-linear Risk Transmission
Note that if asset volatility in CCA sector balance sheets is set to zero:– Implicit put options go to zero,
– Macroeconomic accounting balance sheets and traditional flow-of-funds are the result
– Measurement of (non-linear) risk transmission is not possible using macroeconomic flow or accounting frameworks
Interlinked implicit options result in compound options that exhibit highly non-linear risk transmission, as seen a variety of financial crises
11
Now let’s relate these concepts to…
Petrodollars, Inflation, and Country Petrodollars, Inflation, and Country Risk in VenezuelaRisk in Venezuela
12
The Price of Oil During the Past DecadeThe Price of Oil During the Past Decade
Cushing, OK WTI Spot Price FOB
0
20
40
60
80
100
Jan-9
7
Jan-9
8
Jan-9
9
Jan-0
0
Jan-0
1
Jan-0
2
Jan-0
3
Jan-0
4
Jan-0
5
Jan-0
6
Jan-0
7
Jan-0
8
US
D p
er
Barr
el
13
The Bull Market for Commodities Over the Past 2.5 Years
Source: see IMF GFSR 2008
14
External Environment: Increase in Volatility and Risk Aversion in International Markets
Source: see IMF GFSR 2008
15
External Environment: A Rise in EMBI Spreads across Geographical Areas
Source: see IMF GFSR 2008
16
The Venezuelan Environment: A Volatile Fiscal The Venezuelan Environment: A Volatile Fiscal Surplus/DeficitSurplus/Deficit
Fiscal Surplus/Deficit Measures
-60%
-40%
-20%
0%
20%
40%
60%
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Year
Pe
rce
nta
ge
Fiscal Surplus as % ofM1
Fiscal Surplus as % ofGDP
Source: Banco Central de Venezuela
17
A High Rate of Money Growth From January 2003 Onward A High Rate of Money Growth From January 2003 Onward
Money Growth
0
20.000.000
40.000.000
60.000.000
80.000.000
100.000.000
120.000.000E
ne-9
7
Ene
-99
Ene
-01
Ene
-03
Ene
-05
Ene
-07
Mil
lio
ns
of
VZ
B
Base Money
Deposits
M1
Source: Banco Central de Venezuela
18
Consequences of Monetary Expansion and Fiscal VolatilityConsequences of Monetary Expansion and Fiscal Volatility
19
High Rates of Consumer Price InflationHigh Rates of Consumer Price Inflation
Monthly CPI, Base Year 2007
0,00
20,00
40,00
60,00
80,00
100,00
120,00
Ene-9
7
Ene-9
8
Ene-9
9
Ene-0
0
Ene-0
1
Ene-0
2
Ene-0
3
Ene-0
4
Ene-0
5
Ene-0
6
Ene-0
7
Ene-0
8
Source: Banco Central de Venezuela
20
Monthly CPI Inflation
-2,00-1,000,001,002,003,004,005,006,00
Ene
-97
Ene
-98
Ene
-99
Ene
-00
Ene
-01
Ene
-02
Ene
-03
Ene
-04
Ene
-05
Ene
-06
Ene
-07
Ene
-08
% p
er m
on
th
Source: Banco Central de Venezuela and author’s calculations
21
Annualized Monthy Inflation Rate
-20,00
0,00
20,00
40,00
60,00
80,00
100,00E
ne-9
7
Ene
-98
Ene
-99
Ene
-00
Ene
-01
Ene
-02
Ene
-03
Ene
-04
Ene
-05
Ene
-06
Ene
-07
Ene
-08
% p
erye
ar
Source: Banco Central de Venezuela and author’s calculations
22
Negative Real Interest RatesNegative Real Interest Rates
Expected Real Interest Rates
-80,00
-60,00
-40,00
-20,000,00
20,00
40,00
60,00
Ene
-97
Ene
-99
Ene
-01
Ene
-03
Ene
-05
Ene
-07
An
nu
al Y
ield
(%
)
Real Lending Rate
Real Deposit Rate
Source: Banco Central de Venezuela and author’s calculations
23
Depreciation of the Parallel Exchange RateDepreciation of the Parallel Exchange Rate
"Market" Exchange Rate VS. Official Rate
010002000300040005000600070008000
Ene
-97
Ene
-98
Ene
-99
Ene
-00
Ene
-01
Ene
-02
Ene
-03
Ene
-04
Ene
-05
Ene
-06
Ene
-07
Ene
-08
VZ
B /
US
D
24
Spending of Petrodollars Causes Expansion of Real Spending of Petrodollars Causes Expansion of Real Output…Output…
Real GDP
02000000400000060000008000000
1000000012000000140000001600000018000000
Abr
-98
Abr
-99
Abr
-00
Abr
-01
Abr
-02
Abr
-03
Abr
-04
Abr
-05
Abr
-06
Abr
-07M
illi
on
s o
f 19
97 B
oli
vare
s
Source: Banco Central de Venezuela
25
……While Monetary Expansion Coupled with an Overvalued Exchange While Monetary Expansion Coupled with an Overvalued Exchange Rate Causes Import BoomRate Causes Import Boom
Importaciones1950-2007
45,463
32,226
23,693
17,021
10.483
25
5025
10025
15025
20025
25025
30025
35025
40025
45025
50025
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
En el 2007 tuvimos un ¨boom¨ de US$ 45.463 millones (mas de cuatro veces
superiores a las del 2003…)...
En el 2007 tuvimos un ¨boom¨ de US$ 45.463 millones (mas de cuatro veces
superiores a las del 2003…)...
45,463
62,555
Importaciones Export. Petroleras
Representarían casi el 75% de las
Export. Petroleras
(source: Malone and Puente, forthcoming)(source: Malone and Puente, forthcoming)
26
Domestic Debt has Increased in Absolute Terms…Domestic Debt has Increased in Absolute Terms…
Total Gross Internal Debt
-
5.000
10.000
15.000
20.000
25.000
30.000
35.000
40.000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007/a
Año
Mil
lon
es d
e B
s.F
.
But has not grown dramatically as a % of nominal GDP
27
External Public Debt (including PDVSA) Increased External Public Debt (including PDVSA) Increased Substantially in the Past YearSubstantially in the Past Year
Deuda Pública Externa
05.000
10.000
15.00020.00025.00030.000
35.00040.00045.000
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Año
Mil
lon
es d
e U
SD
Deuda Pública (conempresas públicas)
Deuda Pública (sinempresas públicas)
Higher leverage contributes to higher spreads.
Source: Banco Central de Venezuela and author’s calculations
28
After Falling Sharply in mid-2007, International Reserves Have After Falling Sharply in mid-2007, International Reserves Have Recovered Recently Due to the Recent Spike in Oil PricesRecovered Recently Due to the Recent Spike in Oil Prices
International Reserves
05.000
10.00015.00020.00025.00030.00035.00040.000
Mill
ion
s o
f U
SD
But high reserve volatility contributes to a high sovereign asset volatility…and that also contributes to higher spreads.
29
Country Risk (EMBI+)Country Risk (EMBI+)
Venezuelan spreads have risen much more dramatically during the past 15 months than EMBI+ spreads as a whole.
30
An apparent paradox: rising oil prices and rising external An apparent paradox: rising oil prices and rising external spreads for VZspreads for VZ
Because of the increase in the oil price during the past year, we Because of the increase in the oil price during the past year, we should expect the EMBI spread for VZ to decrease…yet we should expect the EMBI spread for VZ to decrease…yet we observe precisely the opposite trend: rising oil prices observe precisely the opposite trend: rising oil prices coupled with a rising EMBI spread. coupled with a rising EMBI spread.
This effect cannot be explained solely by recent turmoil in the This effect cannot be explained solely by recent turmoil in the international markets, because the VZ spread has increased international markets, because the VZ spread has increased much more than the Latam or EM spread averages.much more than the Latam or EM spread averages.
Higher leverage, in the form of higher debt burdens, has a Higher leverage, in the form of higher debt burdens, has a positive effect on country risk. So does higher sovereign positive effect on country risk. So does higher sovereign asset volatility.asset volatility.
The markedly increased borrowing needs of PDVSA during the The markedly increased borrowing needs of PDVSA during the past year have contributed to the level of foreign past year have contributed to the level of foreign indebtedness and this appears to have played a role in indebtedness and this appears to have played a role in increasing the cost of borrowing for VZ in international increasing the cost of borrowing for VZ in international markets.markets.
31
FDI: Negative and Trending DownwardFDI: Negative and Trending Downward
Foreign Direct Investment
-4,000-3,000-2,000-1,000
0
1,0002,0003,0004,0005,000
Mil
lio
ns o
f U
SD
Source: Banco Central de Venezuela and author’s calculations
32
Recent Policy DilemmasRecent Policy Dilemmas
Money creation causes inflation. Money creation causes inflation.
However, the government has committed to a wide variety of However, the government has committed to a wide variety of transfer programs and spending initiatives that keep the transfer programs and spending initiatives that keep the rent income flowing into the economy.rent income flowing into the economy.
The increase in the money supply, coupled with a fixed The increase in the money supply, coupled with a fixed exchange rate, creates a high level of demand for imports exchange rate, creates a high level of demand for imports of traded goods and services.of traded goods and services.
This high import demand creates a drain on the government’s This high import demand creates a drain on the government’s international reserves, especially as seen during 2007.international reserves, especially as seen during 2007.
The government has used a series of debt issues to drain The government has used a series of debt issues to drain liquidity from the domestic market. This has worked to liquidity from the domestic market. This has worked to lower the parallel market rate and, if the situation lower the parallel market rate and, if the situation persists, should effectively lower the drain on foreign persists, should effectively lower the drain on foreign reserves.reserves.
33
Recent Policy Dilemmas
Nonetheless:Nonetheless: the increased rate of debt issuance raises the the increased rate of debt issuance raises the degree of leverage of the government. This will translate degree of leverage of the government. This will translate into higher spreads on both domestic and foreign debt.into higher spreads on both domestic and foreign debt.
These higher borrowing costs will be passed on the These higher borrowing costs will be passed on the domestic firms and individuals, and will act as a domestic firms and individuals, and will act as a disincentive for undertaking much needed investment.disincentive for undertaking much needed investment.
As we learn from the sovereign CCA model: the volatility of As we learn from the sovereign CCA model: the volatility of sovereign assets has a major effect on spreads as well. sovereign assets has a major effect on spreads as well.
Thus volatile reserves and exchange rates (including the Thus volatile reserves and exchange rates (including the parallel market rate) contribute to high spreads. parallel market rate) contribute to high spreads.
Also, volatile oil prices contribute to volatile base money, Also, volatile oil prices contribute to volatile base money, which implies a volatile sovereign asset.which implies a volatile sovereign asset.
34
ConclusionConclusion
The government’s desire to maintain a fixed exchange rate and The government’s desire to maintain a fixed exchange rate and capital controls is unsustainable in the medium term.capital controls is unsustainable in the medium term.
We learned all of this years ago from e.g. Krugman, but the We learned all of this years ago from e.g. Krugman, but the situation in Venezuela has the added interest of being a situation in Venezuela has the added interest of being a Dutch Disease economy combined with an unsustainable Dutch Disease economy combined with an unsustainable exchange rate regime.exchange rate regime.
In addition to the above, the element of indebtedness and In addition to the above, the element of indebtedness and sovereign risk creates the possibility for Venezuela’s “slow sovereign risk creates the possibility for Venezuela’s “slow motion” crisis of high inflation, low investment, and falling motion” crisis of high inflation, low investment, and falling productive capacity in the non-oil traded sector to become a productive capacity in the non-oil traded sector to become a “fast motion” crisis of increasing probabilities of default.“fast motion” crisis of increasing probabilities of default.
There is still room left to correct these imbalances…but the There is still room left to correct these imbalances…but the room to maneuver will decrease dramatically if there is a room to maneuver will decrease dramatically if there is a sustained fall in the oil price.sustained fall in the oil price.
35
Linking the economy-wide CCA models to macroeconomic models
Ideally, we would like to link the sector CCA models to macro models in order to form an integrated model for the economy.
Leonardo will discuss this in detail for Chile.
I will just highlight the issue in two slides.
36
Linking CCA Balance Sheets and Risk Indicators to Simple Macro Monetary Policy Models
Monetary Policy Model (GDP gap, inflation, exchange rate, policy rate set by Taylor Rule)
Include aggregate credit risk indicator (CRI) in GDP gap equation
Include capital adequacy “Taylor-type rule” for the banking sector using CCA with macro variables
Incorporates feedback between interest rates and financial system credit risk
See (i) Macrofinancial Risk Analysis by Gray, Malone (2008) and (ii) Framework for Integrating Macroeconomics and Financial Sector Analysis by Gray, Karam, Malone, N’Diaye (forthcoming)
1( , , )tygap f ygap r CRI
37
Unified Macrofinance Framework (Targets: GDP, Inflation, Financial System Credit Risk, Sovereign Credit Risk)
Sovereign CCA Model
Monetary Policy Model
Economic Capital Adequacy
Interest Rate Term Structure Model
CRIFinancial CCA (Merton-STV) Model (s)
• Fiscal Policy
• Debt Management
• Reserves / SWF
• Policy Rate
• Economic Capital Adequacy
• Bank and Financial Sector Regulations
Domestic and International Factors
Policies:
38
Thank you, for more information see:
Papers by D. Gray, Robert C. Merton, Zvi Bodie:
NBER 12637 (2006)
NBER 13607 (2007)
Sovereign Credit Risk, JOIM v. 5, no. 4, Dec 2007
IMF Global Financial Stability Report (GFSR)
IMF Working Papers: WP 05/155, 04/121, 07/233, Indonesia SIP (2006), Gray and Walsh (WP 08/89), Gray, Lim, Loukoianova, Malone (WP/08), IMF Staff Papers Gapen et. al v 55 #1 2008; Framework for Integrating Macroeconomics and Financial Sector Analysis by Gray, Karam, Malone, N’Diaye (forthcoming)
Macrofinancial Risk Analysis, Gray and Malone (Wiley Finance book Foreword by Robert Merton)
