Description
Sovereign Risk Learning from Dubai, Greece & US
• Sovereign Risk – Learning from Dubai, Greece and US
1
The Financial Times
• Moody’s downgrades Dubai rating, 26th Nov, 2009 • Dubai banks downgraded – 4th Dec, 2009 • Greece downgraded – 8th Dec, 2009 • Moody’s warns on US ratings – 3rd Feb, 2010
2
Spreads over 10 year bonds
http://economics.soc.uoc.gr/macro/docs/Year/2009/papers/paper_1_174.pdf 3
http://www.efic.gov.au/country/speeches-papers/2009speechesandpapers/Documents/20091222_Speeches%20and%20papers_Economic%20update.pdf
4
What are we talking about
5
Sovereign Risk
• Risk of a sovereign power/government to default on its debt payment • To pay the debt- debtor must be
– Able to pay – have the resources – Willingness to pay – have the intent or political will
6
Sovereign Risk : Situations
• Illiquidity, but solvent – short term payment
problem
• Willing but incapable of paying
• Able but unwilling to pay
7 Roubini
Sovereign Risk
• Sovereign risk indicators –
1. Sovereign ratings by credit rating agencies (inverse relationship) 2. CDS Spreads (proportional relationship)
3. Yield on sovereign bonds (proportional relationship)
8
Variables measuring Sovereign Risk
• Real GDP Growth – comprehensive proxy for the level of
development
• • • •
Short term debt to reserves ratio – short term liquidity Public external debt/fiscal revenue ratio Fiscal balance to GDP ratio Current account balance to GDP ratio – sufficiency of
reserves
• CPI: inflation - sustainability of monetary policy ( Double edged sword) • Political Risk – willingness to pay
• o o o 3 most important fiscal variables that reflect govt.?s quality as a borrower are – Debt/GDP Ratio Deficit/GDP Ratio Govt. Debt Service/Current Govt. Revenue
Nouriel Roubini and Paolo Manasse 9
Variables measuring Sovereign Risk
• If above mentioned fiscal variables are same or close for different countries even then market players and credit rating agencies might treat sovereign bonds differently.
• Reasons - risk is also function of –
1. Relevant history of a country 2. Policy regime ( Price level target or Taylor rule ) 3. Financial structure ( specially integration of secondary markets with rest of world ) 4. Source of Debt ( Domestically sourced or borrowed from international markets ) 5. Liquidity of financial instruments and interest rates offered by a sovereign government
Marting Uribe 10
Dubai
• Dubai requested „standstill? on payments of $26 billion in debt by state-owned conglomerate Dubai World • received $10 billion in surprise aid from Abu Dhabi, used $4.1 billion to repay its Nakheel?s Sukuk maturing on the same day • Abu Dhabi?s direct and indirect support to its neighbor to about US$25 billion
11 Barclays Capital – Emerging Market Research, 8th Jan , 2010
5 Yr. CDS Spread of Dubai and Abu Dhabi
http://www2.standardandpoors.com/spf/pdf/index/SP_CreditDefaultSwap_FAQ.pdf 12
How do we apply theoretical concepts to Dubai Episode
• Dubai was willing to pay but was unable to pay on its own • Dubai had considerable short term debt whose maturity date had arrived therefore it was classic case of short term liquidity problem • CDS and Bonds are traded for more than one reason, speculation being one of them. It can be said that Dubai crises was a bit overblown
– Look at the correlation between Dubai and Abu Dhabi?s CDS spread – Traders were charging premium over Abu Dhabi?s spread because of risk involved – But traders anticipated intervention by Abu Dhabi therefore we see a remarkable similarity between 2 graphs – CDS spread jumped 300 basis points in just few days whereas Greece?s CDS spread climbed gradually which reflects speculators tried to benefit by creating panic in response to worrying reports
13
How do we apply theoretical concepts to Dubai Episode
? ? Any event of default has – short term benefits (S) and Long term Cost (L) Short term benefits of defaulting
• • • Could have continued spending on infrastructure created more jobs with the same money Would have checked Abu Dhabi?s growing influence on Dubai
?
Long term costs of defaulting and implications of this episode on Dubai
• Emirate?s image suffered but outright default would have led to foreign firms packing their bags and moving out of Dubai which would have resulted in long term revenue loss Capacity to raise funds in the near term is hurt but now investors are assured of intervention by cash rich neighboring countries in time of crises. Had default occurred it would have been very difficult for Dubai to raise any funds Ability of its banking system to finance economic growth is stymied Reliance on the largesse of its much stronger neighbor, Abu Dhabi, has increased.
•
• •
14
US
2008 2009 2010*
Greece
2008 2009
Nominal GDP
(% Change)
3.6 1.2 4.1
-0.4 -2.2 0.1 5%
2.5 1.5 1.7 3% 10.6 54.2
6.5 2.9 4.2 14.4 5 97.6
1.7 -0.9 1.8 12 5.1 103.4
Real GDP
(% Change)
Inflation
(% Change)
Current account deficit as % of GDP General govt deficit % of GDP Public debt % of GDP
4.5 40.8
9.4 50.5
AAA
A-
BBB+
Budget of the U.S. Government – Fiscal Year 2010, http://www.cbo.gov/ftpdocs/99xx/doc9957/01-07-Outlook.pdf; 15
Popular Delusions – Societe Generale, 11th February 2010 16 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
0.5% primary Surplus that Greece should have
Almost 1.5% primary deficit that Greece actually has
Popular Delusions – Societe Generale, 11th February 2010 17 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
Greece: Over the last decade
• Budget deficit rose to 5 per cent of GDP in 2008, which activated
the European Commission?s excessive deficit procedure
• Greek public debt-to-GDP ratio at 97.6 % in 2008 - second highest in the EU and rising • Governments failed to take advantage of the good times to put the public finances in order
• Reducing debt-to-GDP ratio to 60 % Maastricht reference level within the next decade means primary surpluses of 4-5 % of GDP
It’s time for the Greeks to turn things round – again - George Pagoulatos. http://www.ft.com/cms/s/0/95d5dd9c4fe0-11de-a692-00144feabdc0,dwp_uuid=d1833cf2-4fe7-11de-a692-00144feabdc0,s01=1.html 18
Structural Weakness
• Competitiveness has declined, due to inflation, persistently higher than the euro zone avg • Higher corporate profit margins, a major cause of inflation
• Number of important reforms are incomplete
• High rates of youth unemployment, long-term unemployment and female unemployment • Ageing population
It’s time for the Greeks to turn things round – again - George Pagoulatos. http://www.ft.com/cms/s/0/95d5dd9c4fe0-11de-a692-00144feabdc0,dwp_uuid=d1833cf2-4fe7-11de-a692-00144feabdc0,s01=1.html 19
Options
• Attempt austerity - tackling tax and social
security evasion, fiscal discipline throughout government
• Greece forced out – no legal basis • A bail out – under consideration, better rated EU
countries offer help at lower than market rates
• IMF intervention – (Faber fears, EMU wouldn't be
able to help)
20
US Debt Situation
• Deficit as % of GDP – 10.7% • Debt as % of GDP – 92%
• Note, however, that the 92 per cent figure does not include off-budget items such as losses from federal mortgage guarantees that, if counted, would balloon the debt to GDP to a more realistic 130 per cent.
• Concern?
– Debt levels unsustainable – Contingent liabilities make it worse than it looks – Ageing population, health and pension costs
Sovereign Default- Where does the greatest risk lie? ,Malaeb; http://english.alrroya.com/content/sovereign-defaultwhere-does-greatest-risk-lie American Exceptionalism in Debt Concerns, Jamus Lim; http://blogs.worldbank.org/prospects/american21 exceptionalism-in-debt-concerns#comment-34
0.5% primary deficit that US should have
Almost 3% primary deficit that US actually has
Popular Delusions – Societe Generale, 11th February 2010 22 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
Wikipedia
23
Options
• Default – a sudden collapse of the system • Monetize debt – wait for inflation to save their day
24
Debate: Inflating away Debt
• Post WWII reason – it worked then.
– Similarities –
• High Debt overhang • Low inflation
– Differences
• Greater share of foreign creditors (48% vs 0%)
• Slightly higher inflation for shorter duration
http://www.nber.org/papers/w15562.pdf?new_window=1
25
Inflation : No help
• Inflation raises nominal interest rate – debt
service cost rises
• Uncertain inflation - investors demand a premium for the
uncertainty - real yields tend to rise - further adds to government borrowing costs
• Individual bondholder vs Collective market individual holder will lose out as a result of inflation, but governments can not rely on markets to remain indifferent to inflation
26
Threat to AAA?
• No possibility of a default and a downgrade
– Dollar Reserve currency- Enormous privilege - allowing it “to borrow almost without limit
– All its liabilities in Dollars – and it can always print dollars – Taxing capacity of US larger France 49%) (govt rev aborsb 33% of NI vs UK – 42%, Germany 43%,
– No “serious contender” to threaten the dollar?s status as a global reserve currency - The euro is the “only credible alternative” to the dollar,
though it?s “not mature enough,” -Kraemer
• Moody?s Warning - negative pressure on rating in the future due to
– assessment of the long-term growth prospects – ability of the government to return to a sustainable debt trajectory
27
Illiquidity, but solvent – short term payment problem
Willing but incapable of paying
Able but unwilling to pay
Dubai Greece US
X X X
Economic resilience (or vulnerability) and political events would steer countries? Sovereign risk.
28
Thank you
29
doc_471934548.pptx
Sovereign Risk Learning from Dubai, Greece & US
• Sovereign Risk – Learning from Dubai, Greece and US
1
The Financial Times
• Moody’s downgrades Dubai rating, 26th Nov, 2009 • Dubai banks downgraded – 4th Dec, 2009 • Greece downgraded – 8th Dec, 2009 • Moody’s warns on US ratings – 3rd Feb, 2010
2
Spreads over 10 year bonds
http://economics.soc.uoc.gr/macro/docs/Year/2009/papers/paper_1_174.pdf 3
http://www.efic.gov.au/country/speeches-papers/2009speechesandpapers/Documents/20091222_Speeches%20and%20papers_Economic%20update.pdf
4
What are we talking about
5
Sovereign Risk
• Risk of a sovereign power/government to default on its debt payment • To pay the debt- debtor must be
– Able to pay – have the resources – Willingness to pay – have the intent or political will
6
Sovereign Risk : Situations
• Illiquidity, but solvent – short term payment
problem
• Willing but incapable of paying
• Able but unwilling to pay
7 Roubini
Sovereign Risk
• Sovereign risk indicators –
1. Sovereign ratings by credit rating agencies (inverse relationship) 2. CDS Spreads (proportional relationship)
3. Yield on sovereign bonds (proportional relationship)
8
Variables measuring Sovereign Risk
• Real GDP Growth – comprehensive proxy for the level of
development
• • • •
Short term debt to reserves ratio – short term liquidity Public external debt/fiscal revenue ratio Fiscal balance to GDP ratio Current account balance to GDP ratio – sufficiency of
reserves
• CPI: inflation - sustainability of monetary policy ( Double edged sword) • Political Risk – willingness to pay
• o o o 3 most important fiscal variables that reflect govt.?s quality as a borrower are – Debt/GDP Ratio Deficit/GDP Ratio Govt. Debt Service/Current Govt. Revenue
Nouriel Roubini and Paolo Manasse 9
Variables measuring Sovereign Risk
• If above mentioned fiscal variables are same or close for different countries even then market players and credit rating agencies might treat sovereign bonds differently.
• Reasons - risk is also function of –
1. Relevant history of a country 2. Policy regime ( Price level target or Taylor rule ) 3. Financial structure ( specially integration of secondary markets with rest of world ) 4. Source of Debt ( Domestically sourced or borrowed from international markets ) 5. Liquidity of financial instruments and interest rates offered by a sovereign government
Marting Uribe 10
Dubai
• Dubai requested „standstill? on payments of $26 billion in debt by state-owned conglomerate Dubai World • received $10 billion in surprise aid from Abu Dhabi, used $4.1 billion to repay its Nakheel?s Sukuk maturing on the same day • Abu Dhabi?s direct and indirect support to its neighbor to about US$25 billion
11 Barclays Capital – Emerging Market Research, 8th Jan , 2010
5 Yr. CDS Spread of Dubai and Abu Dhabi
http://www2.standardandpoors.com/spf/pdf/index/SP_CreditDefaultSwap_FAQ.pdf 12
How do we apply theoretical concepts to Dubai Episode
• Dubai was willing to pay but was unable to pay on its own • Dubai had considerable short term debt whose maturity date had arrived therefore it was classic case of short term liquidity problem • CDS and Bonds are traded for more than one reason, speculation being one of them. It can be said that Dubai crises was a bit overblown
– Look at the correlation between Dubai and Abu Dhabi?s CDS spread – Traders were charging premium over Abu Dhabi?s spread because of risk involved – But traders anticipated intervention by Abu Dhabi therefore we see a remarkable similarity between 2 graphs – CDS spread jumped 300 basis points in just few days whereas Greece?s CDS spread climbed gradually which reflects speculators tried to benefit by creating panic in response to worrying reports
13
How do we apply theoretical concepts to Dubai Episode
? ? Any event of default has – short term benefits (S) and Long term Cost (L) Short term benefits of defaulting
• • • Could have continued spending on infrastructure created more jobs with the same money Would have checked Abu Dhabi?s growing influence on Dubai
?
Long term costs of defaulting and implications of this episode on Dubai
• Emirate?s image suffered but outright default would have led to foreign firms packing their bags and moving out of Dubai which would have resulted in long term revenue loss Capacity to raise funds in the near term is hurt but now investors are assured of intervention by cash rich neighboring countries in time of crises. Had default occurred it would have been very difficult for Dubai to raise any funds Ability of its banking system to finance economic growth is stymied Reliance on the largesse of its much stronger neighbor, Abu Dhabi, has increased.
•
• •
14
US
2008 2009 2010*
Greece
2008 2009
Nominal GDP
(% Change)
3.6 1.2 4.1
-0.4 -2.2 0.1 5%
2.5 1.5 1.7 3% 10.6 54.2
6.5 2.9 4.2 14.4 5 97.6
1.7 -0.9 1.8 12 5.1 103.4
Real GDP
(% Change)
Inflation
(% Change)
Current account deficit as % of GDP General govt deficit % of GDP Public debt % of GDP
4.5 40.8
9.4 50.5
AAA
A-
BBB+
Budget of the U.S. Government – Fiscal Year 2010, http://www.cbo.gov/ftpdocs/99xx/doc9957/01-07-Outlook.pdf; 15
Popular Delusions – Societe Generale, 11th February 2010 16 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
0.5% primary Surplus that Greece should have
Almost 1.5% primary deficit that Greece actually has
Popular Delusions – Societe Generale, 11th February 2010 17 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
Greece: Over the last decade
• Budget deficit rose to 5 per cent of GDP in 2008, which activated
the European Commission?s excessive deficit procedure
• Greek public debt-to-GDP ratio at 97.6 % in 2008 - second highest in the EU and rising • Governments failed to take advantage of the good times to put the public finances in order
• Reducing debt-to-GDP ratio to 60 % Maastricht reference level within the next decade means primary surpluses of 4-5 % of GDP
It’s time for the Greeks to turn things round – again - George Pagoulatos. http://www.ft.com/cms/s/0/95d5dd9c4fe0-11de-a692-00144feabdc0,dwp_uuid=d1833cf2-4fe7-11de-a692-00144feabdc0,s01=1.html 18
Structural Weakness
• Competitiveness has declined, due to inflation, persistently higher than the euro zone avg • Higher corporate profit margins, a major cause of inflation
• Number of important reforms are incomplete
• High rates of youth unemployment, long-term unemployment and female unemployment • Ageing population
It’s time for the Greeks to turn things round – again - George Pagoulatos. http://www.ft.com/cms/s/0/95d5dd9c4fe0-11de-a692-00144feabdc0,dwp_uuid=d1833cf2-4fe7-11de-a692-00144feabdc0,s01=1.html 19
Options
• Attempt austerity - tackling tax and social
security evasion, fiscal discipline throughout government
• Greece forced out – no legal basis • A bail out – under consideration, better rated EU
countries offer help at lower than market rates
• IMF intervention – (Faber fears, EMU wouldn't be
able to help)
20
US Debt Situation
• Deficit as % of GDP – 10.7% • Debt as % of GDP – 92%
• Note, however, that the 92 per cent figure does not include off-budget items such as losses from federal mortgage guarantees that, if counted, would balloon the debt to GDP to a more realistic 130 per cent.
• Concern?
– Debt levels unsustainable – Contingent liabilities make it worse than it looks – Ageing population, health and pension costs
Sovereign Default- Where does the greatest risk lie? ,Malaeb; http://english.alrroya.com/content/sovereign-defaultwhere-does-greatest-risk-lie American Exceptionalism in Debt Concerns, Jamus Lim; http://blogs.worldbank.org/prospects/american21 exceptionalism-in-debt-concerns#comment-34
0.5% primary deficit that US should have
Almost 3% primary deficit that US actually has
Popular Delusions – Societe Generale, 11th February 2010 22 http://www.sgresearch.com/PUBLICATION/en/19C05683D1CC9042C12576C7003152D1.pub?download=true
Wikipedia
23
Options
• Default – a sudden collapse of the system • Monetize debt – wait for inflation to save their day
24
Debate: Inflating away Debt
• Post WWII reason – it worked then.
– Similarities –
• High Debt overhang • Low inflation
– Differences
• Greater share of foreign creditors (48% vs 0%)
• Slightly higher inflation for shorter duration
http://www.nber.org/papers/w15562.pdf?new_window=1
25
Inflation : No help
• Inflation raises nominal interest rate – debt
service cost rises
• Uncertain inflation - investors demand a premium for the
uncertainty - real yields tend to rise - further adds to government borrowing costs
• Individual bondholder vs Collective market individual holder will lose out as a result of inflation, but governments can not rely on markets to remain indifferent to inflation
26
Threat to AAA?
• No possibility of a default and a downgrade
– Dollar Reserve currency- Enormous privilege - allowing it “to borrow almost without limit
– All its liabilities in Dollars – and it can always print dollars – Taxing capacity of US larger France 49%) (govt rev aborsb 33% of NI vs UK – 42%, Germany 43%,
– No “serious contender” to threaten the dollar?s status as a global reserve currency - The euro is the “only credible alternative” to the dollar,
though it?s “not mature enough,” -Kraemer
• Moody?s Warning - negative pressure on rating in the future due to
– assessment of the long-term growth prospects – ability of the government to return to a sustainable debt trajectory
27
Illiquidity, but solvent – short term payment problem
Willing but incapable of paying
Able but unwilling to pay
Dubai Greece US
X X X
Economic resilience (or vulnerability) and political events would steer countries? Sovereign risk.
28
Thank you
29
doc_471934548.pptx