This threatens a sharp fall in investor appetite just when financing is most needed – and could result in much larger outflows today than a few years ago.
A meeting of IMF’s Public Debt Management Forum has been told that there has been a steady increase in EM sovereign debt bought by non-banks in recent years.
“A substantial share of these new investors, or perhaps converted investors, base their investment strategies on indices and benchmarks,” said Tobias Adrian, financial counsellor and director of the Fund’s monetary and capital markets department.
“It is premature to pass judgment on this trend, but certain implications must be acknowledged. For example, with this change, an adverse external shock could result in much larger outflows today than a few years ago.
“A large portion of investors may react in the same way to changes in benchmarks, possibly with discontinuities: a small change may typically have an insignificant effect, but a large effect can be induced when some threshold is crossed.”
The event in Tokyo brought together public debt managers, government and international agencies, and private sector executives to exchange views on sovereign debt.
Tobias noted that that debt markets have become more international and also involve new players investing in new instruments.
The IMF’s International Investor Position survey indicates that a traditional “home bias” in the holding of government securities has changed, especially in larger economies, with more now being held abroad.
This means that global conditions will have a stronger effect on the pricing of bonds.
New investors in EM sovereign debt – especially non-bank financial institutions – base their investment strategies on indices and benchmarks, and react swiftly to changes.
Tobias said that “a small change may typically have an insignificant effect, but a large effect can be induced when some threshold is crossed”.
He pointed to the IMF estimates suggesting that reactions to a shock have become “markedly” more pronounced since the 2013 “taper tantrum” – a surge in US Treasury yields caused by the Federal Reserve’s use of tapering to reduce the amount of money entering the economy.
“Under the rather calm and benign conditions that currently prevail, this sensitivity is not very apparent, or it is manifest in surges in capital towards EMs and higher risk assets,” Tobias said.
“The concern is that, when conditions turn less favourable, or when a country’s policies put it at odds with a benchmark, flows might become much more volatile.
“Investor appetite might diminish sharply just when financing is most needed.”
