Redemption Through Indexation: The Chilean Experience

transcript

Redemption Through Redemption Through

Indexation: Indexation:

The Chilean ExperienceThe Chilean ExperienceRodrigo ValdésRodrigo Valdés

Central Bank of ChileCentral Bank of ChileIADB Conference - November IADB Conference - November

20022002

• A few lessonsA few lessons

• Conceptual issuesConceptual issues

AgendaAgenda

• A bit of historyA bit of history

• Financial sector structureFinancial sector structure

• Moving forwardMoving forward

AgendaAgenda

• Indexation can be thought of as a compromiseIndexation can be thought of as a compromise protects against nominal surprises (like FX denominated debt)protects against nominal surprises (like FX denominated debt) but allows for some flexibility (less than domestic currency but allows for some flexibility (less than domestic currency

denominated debt, more than FX denominated)denominated debt, more than FX denominated)

• May enhance credibility, for it removes one May enhance credibility, for it removes one source of inflationary biassource of inflationary bias

• Indexation is not a substitute for fiscal responsibility Indexation is not a substitute for fiscal responsibility

• ““Pillar A” for developing a long term debt market if there Pillar A” for developing a long term debt market if there is no reputation (“Pillar B”: demand or financial saving)is no reputation (“Pillar B”: demand or financial saving)

AgendaAgenda

• 1960’s– Financially repressed system (caps to interest rates)– CAR and UF (indexing unit) created to offer positive real

interest rates. Originally quarterly adjustments (with inflation)

• 1972-76– Average annual inflation reached 312%

• 1977– UF adjustments become daily with the daily-equivalent of last

months’ CPI inflation– Many UF denominated financial transactions allowed

UF and Real Exchange RateUF and Real Exchange Rate(index, average 1990=100)(index, average 1990=100)

Dollars / UF

RER404050506060707080809090

100100110110120120130130140140

7777 8282 8787 9292 9797 0202

Gross and Net Consolidated Public Gross and Net Consolidated Public Debt Debt (% of GDP)(% of GDP)

NetNet

8989 9090 9191 9292 9393 9494 9595 9696 9797 9898 9999 0000 0101 020200

GrossGross

(Gross)(Gross) (Net)(Net)

AgendaAgenda

Domestic Public Debt Structure in Domestic Public Debt Structure in 20022002UF denominated• 17% of GDP• Average maturity: 4.3 years• Interest rates: 3.2 for BCU-5 and 4.8 for BCU-20

Peso denominated• 8% of GDP• Average maturity: 0.5 year• Interest rates: 4.4 for BCP-2 and 6.3 for BCP-5

Dollar indexed• 8% of GDP• Average maturity: 1.8 years• Interest rates: 3.2 for BCD-2 and 4.6 for BCD-5

Bank Lending to the Private SectorBank Lending to the Private Sector(% of GDP)(% of GDP)

9191 9292 9393 9494 9595 9696 9797 9898 9999 0000 0101 0202(Nov.)(Nov.)

Bank Lending StructureBank Lending Structure(% of GDP)(% of GDP)

9999 0000 0101 0202

UF > one year

pesos > one year pesos < one year

UF < one year

Stock of Corporate Bonds in Stock of Corporate Bonds in Domestic MarketDomestic Market(% of GDP)(% of GDP)

9393 9494 9595 9696 9797 9898 9999 0000 0101 0202

Corporate UF Debt Placements Corporate UF Debt Placements (total amount and average term)(total amount and average term)

9292 9393 9494 9595 9696 9797 9898 9999 0000 0101

Typical Mortgage Contract in ChileTypical Mortgage Contract in Chile

• 20 year loan for 75% of property value (5 to 25 years)20 year loan for 75% of property value (5 to 25 years)

• UF indexedUF indexed

• MonthlyMonthly

• Interest rate in 2002Q3 = 6.5%Interest rate in 2002Q3 = 6.5%

• Financing: institutional investors and banksFinancing: institutional investors and banks

• Intermediaries: banks (give warranty and administer)Intermediaries: banks (give warranty and administer)

• Prepayment allowed at contracted interest ratePrepayment allowed at contracted interest rate

Institutional Investors Assets Institutional Investors Assets (% GDP)(% GDP)

19941994 19951995 19961996 19971997 19981998 19991999 20002000 20012001

Pension Funds

Insurance C.

Mutual Funds

AgendaAgenda

• Missing part: risk sharing from foreigners• UF is not easily accepted internationally

– inflation accounting risk– lack of successful experiences – some money illusion (like higher carry)

• Nominalization and internationalization of the Peso Nominalization and internationalization of the Peso – monetary policy interest rate (overnight) a year agomonetary policy interest rate (overnight) a year ago– short-end of the yield curve (5 years) short-end of the yield curve (5 years) – full capital account opening and friendlier tax environment for capital movementsfull capital account opening and friendlier tax environment for capital movements

• Use strong anti-inflation credibility to attract investorsUse strong anti-inflation credibility to attract investors

2 and 5 Year Expected Inflation 2 and 5 Year Expected Inflation (%)(%)

Five years

survey

Two years

1.51.5

2.02.0

2.52.5

3.03.0

3.53.5

4.04.0

4.54.5

MarMar AprApr MayMay JunJun JulJul AugAug SepSep OctOct NovNov

AgendaAgenda

• CPI indexation is way for redemption. Avoid FX denominated CPI indexation is way for redemption. Avoid FX denominated domestic financial system.domestic financial system.

• But it’s not easy to replicate. It needs...But it’s not easy to replicate. It needs...– a long time to get used to it (35 years in Chile!)a long time to get used to it (35 years in Chile!)– high inflation experience to value ithigh inflation experience to value it– demand side (institutional investors)demand side (institutional investors)

• Has some negative collateral effects: prevalent indexation in other marketsHas some negative collateral effects: prevalent indexation in other markets

• Imperfect substitute of full redemption:Imperfect substitute of full redemption:– there is no risk sharing with the rest of the worldthere is no risk sharing with the rest of the world– but it is a way to startbut it is a way to start

• Challenge: issue sovereign debt in pesos to foreigners. Big Challenge: issue sovereign debt in pesos to foreigners. Big question mark: corporate debt?question mark: corporate debt?

Redemption Through Redemption Through

Indexation: Indexation:

The Chilean ExperienceThe Chilean ExperienceRodrigo ValdésRodrigo Valdés

Central Bank of ChileCentral Bank of ChileIADB Conference - November IADB Conference - November

20022002

Redemption Through Indexation: The Chilean Experience

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