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
• A few lessonsA few lessons
• Conceptual issuesConceptual issues
AgendaAgenda
• A bit of historyA bit of history
• Financial sector structureFinancial sector structure
• Moving forwardMoving forward
• 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)
• A bit of historyA bit of history
• Conceptual issuesConceptual issues
AgendaAgenda
• A few lessonsA few lessons
• Financial sector structureFinancial sector structure
• Moving forwardMoving forward
• 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
00
2020
4040
6060
8080
8989 9090 9191 9292 9393 9494 9595 9696 9797 9898 9999 0000 0101 020200
1010
2020
3030
4040
5050
GrossGross
(Gross)(Gross) (Net)(Net)
• Conceptual issuesConceptual issues
AgendaAgenda
• A bit of historyA bit of history
• Financial sector structureFinancial sector structure
• A few lessonsA few lessons
• Moving forwardMoving forward
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)
3030
3535
4040
4545
5050
5555
6060
6565
9191 9292 9393 9494 9595 9696 9797 9898 9999 0000 0101 0202(Nov.)(Nov.)
Bank Lending StructureBank Lending Structure(% of GDP)(% of GDP)
00
1010
2020
3030
4040
5050
6060
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)
00
22
44
66
88
1010
1212
1414
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)
00
55
1010
1515
2020
2525
3030
3535
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)
00
1010
2020
3030
4040
5050
6060
7070
8080
9090
19941994 19951995 19961996 19971997 19981998 19991999 20002000 20012001
Pension Funds
Insurance C.
Mutual Funds
• A few lessonsA few lessons
• Conceptual issuesConceptual issues
AgendaAgenda
• A bit of historyA bit of history
• Financial sector structureFinancial sector structure
• Moving forwardMoving forward
• 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
• A few lessonsA few lessons
• Conceptual issuesConceptual issues
AgendaAgenda
• A bit of historyA bit of history
• Financial sector structureFinancial sector structure
• Moving forwardMoving forward
• 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
