Dilip Ratha (and Suhas Ketkar) Financing for Development, Doha December 1, 2008

Main messages Developing countries, especially private entities, need access to international capital markets. There is need for both tax- based and market-based innovative financing instruments. Shadow ratings will encourage countries to seek sovereign ratings and improve access to international capital. Securitization of future exports and remittances can be a friend in foul weather. GDP-indexed bonds can reduce the pro-cyclicality of debt burden. Diaspora bonds can be a useful tool for tapping the wealth of the diaspora.

Motivation Need for additional funds for poverty reduction and other MDGs Mitigating risk

Outline Early innovations, and recent innovations Diaspora bonds GDP-indexed bonds Future-flow securitization Shadow sovereign rating

Early Innovations

Recent Innovations Future-flow securitization Diaspora bonds GDP- indexed bonds Shadow sovereign ratings Financing Developmen t

US Treasury 10-year Israel DCI bond Discount on Israel diaspora bonds Israel and India have raised nearly $40 billion via diaspora bonds

Comparison of Diaspora Bonds Issued by Israel and India IsraelIndia Annual issuance since 1951Opportunistic issuance 1991, 1998, 2000 Development-oriented borrowingsBalance-of-payments support Large though declining patriotic discountSmall patriotic discount, if any Fixed, floating-rate bonds and notesFixed-rate bonds Maturities 1-20 years, bulletFive year, bullet maturity Direct distribution by DCIDistn by SBI in conjunction w intl banks Targeted, but not limited, to diasporaLimited to diaspora SEC registeredNo SEC registration Nonnegotiable

Diaspora bonds: Top Candidates By emigrant stock (thousands)

Diaspora bonds: Top Candidates By emigrants as % of population

Potential for Diaspora Bonds Country Diaspora stocks ($ thousands) Potential savings ($ billions) South Africa Nigeria Ghana Kenya Ethiopia Somalia Senegal Zimbabwe Sudan Angola Sub-Saharan Africa

GDP-indexed bonds (GIBs) GDP-Indexed Indexed Fixed vs. GDP-indexed coupons Coupon (%) Growth rate (%)

GDP-indexed bonds (GIBs) Debt service on indexed bonds varies with ability to pay It also allows countries to pursue counter-cyclical economic policies

Concerns about GDP-indexed bonds Accuracy of GDP data – under-reporting, data revision moral hazard/adverse selection? How to price GIBs Low liquidity

GIBs: Role of public policy Ensure reliability of GDP data. Reduce product uncertainty and the resultant low liquidity associated with introduction of new products. Investors would require that a large number of countries issue GIBs so as to diversify risk. IFIs can provide help. Provide seed money to financial institutions.

Importance of sovereign credit ratings Borrowing cost rises exponentially as credit rating deteriorates

Importance of sovereign credit ratings Sovereign ratings impacts private flows They affect: Debt FDI Performance-based aid They act as rating ceilings for sub- sovereign entities

Importance of sovereign credit ratings 70+ developing countries are not rated 15+ are rated, but not recently Several factors affect a countrys decision to get rated: –Information requirement –Need for debt –Cost of rating –Fear of low rating Hence the need for SHADOW RATINGS

Predicting shadow ratings Fit a regression model to explain ratings Validate the model Predict shadow ratings

Predicting shadow ratings AA- BBB+ BB B- CC Correlation between Fitch and S&P 0.99; between Moodys and (S&P or Fitch) 0.97

Predicting shadow ratings Fit a regression model of Sovereign rating as a function of –macro variables –rule of law –debt and international reserves –volatility R 2 is high

Shadow ratings results PredictedActual AlbaniaBB to BB+Ba1 [BB+] CambodiaB+B+ and B1 BrazilBBB to A-BBB- PeruBBB- to BBBBBB- GabonBBB- to BBBBB- GhanaBB- to BBB+ Africa premium?

Predicted shadow ratings Shadow ratings for the 55 unrated countries reveal: –8 investment grade –18 B to BB –15 CCC –Only 14 CC or lower

Predicted shadow ratings Shadow ratings for the 55 unrated countries reveal: –8 investment grade!!! –18 B to BB!!! –15 CCC –Only 14 CC or lower

Improving ratings 1. Counting all relevant flows 2. Partial guarantees from donor agencies 3. Securitization of future flows of remittances and other receivables

Improving ratings Present value of external debt as % of exports of goods, services, and remittances

Improving ratings Remittances (% of GDP, 2004) Rating excluding remittances Rating including remittances Spread reduction (basis pts) Lebanon14B+BB-150 Haiti*28CCCB-334 Nicaragua*11CCC+B-209 Uganda*5B-B161 * Calculated using the benchmark model of Ratha, De and Mohapatra (2007)

Improving ratings: FF Securitization YearIssuer Amount (US$ mn) Flow type Transa- ction rating Sover- eign rating 1998 Banco Cuscatlan 50Remit.BBBBB 2004 Banco Salvadoreño 25DPRsBBBBB+ 2002Banco do Brasil 250Remit.BBB+BB-

Future flow securitization Risks involved in exposure overseas include: Sovereign risk Performance risk Product risk Diversion risk FF securitization structure mitigates sovereign risk. Choice of collateral, excess coverage and reputation of issuer mitigate other risks

Future export securitization structure Foreign buyer Local exporter LocalForeign

Future export securitization structure Foreign buyer Local exporter LocalForeign SPV/ Trustee

Remittance senders Remittance securitization structure Correspondent bank Beneficiary Local bank LocalForeign

Remittance senders Remittance securitization structure Correspondent bank Beneficiary Local bank LocalForeign Special trustee

Customers Future flow securitization Special Purpose Vehicle (SPV) Trust Investors On-shore Off-shore Issuer Structure of FF Securitization Proceeds Notes Excess Collection Future Product P & I Product Payment

Heavy crude oil receivables Diversified payment rights (DPRs), airline ticket receivables, telephone receivables, credit card receivables, and electronic remittances Oil and gas royalties and export receivables Paper remittances Tax revenue receivables Hierarchy in Future-Flow-Backed Transactions

Securitization Potential in Sub-Saharan Africa (US$ billions) Source: Authors calculations Note: Based on average for 2003–06. ReceivablePotential Fuel exports5110 Agrl. raw materials exports61 Ores and metals exports163 Travel services131 Remittances81 Total9517

Constraints to FF securitization Paucity of highly rated entities Long lead times High fixed costs (legal and others), somewhat less relevant now Non-transparent legal structure

Policies: to improve ratings Improve rating methodology Develop local currency rating agencies Improve data, macroeconomic management, legal structures, and investment climate

Policies: to facilitate securitization Master Trust arrangements, and receivable pooling, may alleviate the constraint of high fixed costs Beware of negative pledge in the case of public sector borrowers IFIs can help –Provide seed money –Improve legal framework –Assume counter-party risk as in Unibanco –Educate policy makers –Improve remittance data

Summary Developing countries need access to international capital markets Shadow ratings could encourage several countries to seek sovereign ratings removing a constraint on their access to intl capital markets Securitization of future exports and remittances can improve ratings on external financing transactions Diaspora bonds and GDP-indexed bonds also offer additional innovative financing mechanisms