By Paolo Mauro, Nathan Sussman, and Yishay Yafeh
Oxford University Press, March 2006, 200 pp., £40.00/$74.00 (clothbound)
The environment of international financial integration and bond finance in which emerging markets currently operate is in its infancy, having been in place only since the mid-1990s. To learn more about this type of environment, the authors analyze the behavior of spreads on emerging market bonds traded in London during the most recent era with similar characteristics, namely 1870–1913. During that era, London—the world’s main financial center—saw massive bond issuance by emerging markets and active trading by well-informed investors. The authors focus on the determinants and behavior of emerging market bond spreads in 1870–1913 and 1994–2004, identifying both similarities and differences between the two periods.
On the data front, the book’s main contribution is the systematic collection at the monthly frequency of country-specific news items of various categories (such as political, economic, war, and institutional news) from contemporary newspapers and financial magazines, for 18 emerging markets in 1870–1913 and 8 emerging markets in 1994–2004. The authors also compile new datasets on bond spreads at the monthly frequency and macroeconomic indicators (such as debt and exports) at the yearly frequency. Relying on case studies, systematic analysis of salient news and sharp changes in bonds spreads, panel regressions, and a study of mechanisms for creditor coordination in the after-math of defaults, the authors obtain three main results.
First, episodes of politically motivated violence have an immediate and pronounced impact on bond spreads, whereas institutional or structural reforms are seldom found to reduce bond spreads quickly, possibly because investors need time to observe whether new institutions are respected. This finding may help explain political reluctance to undertake reforms. In making the case for reforms, expectations regarding the speed and extent of borrowing cost reductions should therefore be set at realistic levels.
Second, country-specific developments played a more important role in determining spreads in 1870–1913 than in modern times: country-specific fundamentals (news and macroeconomic variables) explain a larger share of variation in historical spreads; moreover, controlling for indicators of fundamentals, comovement of spreads across emerging markets was higher in the 1990s than in the earlier period. Today’s greater role of institutional investors may be a factor underlying these differences.
Third, the authors collect archival evidence on the workings of the Corporation of Foreign Bondholders (CFB), an association of British investors holding bonds issued by foreign governments. The CFB played a key role during the heyday of international bond finance, 1870–1913, and in the aftermath of the defaults of the 1930s. It fostered coordination among creditors, especially in cases of default, blocking capital market access to defaulting governments, and arranging successfully for many important debt restructurings though failing persistently in a few cases. While a revamped creditor association might once again help facilitate creditor coordination, the appeal of defection, compared with coordination, seems to be greater today than it was in the past. The CFB may have had an easier time than any comparable body would have today.
Paolo Mauro is at the IMF; Nathan Sussman and Yishay Yafeh are both at the Hebrew University of Jerusalem and the Center for Economic Policy Research.
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