The Debt market in Chile Rodrigo Cifuentes Bank of England October 21st, 2005

Outline I.Public and private debt in local currency up to II.The impact of the Asian crisis in the Debt market. III.Policies to support the Debt market. IV.Current issues and challenges.

I. Public and private debt in local currency up to 1997 Facts: 1980s: Central Bank issues public debt to finance costs of banking crisis of : Flat-coupon, various maturities up to 20 years, indexed. Maturity of bonds issued varies over time (4,6,8,12,14,20 yr). Key determinants of viability of long-term market: Credibility in UF (institutions). Demand by institutional investors, Pension Funds (PF) and Life Insurance Companies (LIC).

I. Public and private debt in local currency up to 1997 Facts: Volumes issued by the Central Bank continue to increase as consequence of exchange rate policy. Private debt market exists but is relatively small. Why?: 80s: Investment restrictions of PFs and LICs. 90s: Cost of Funds lower abroad. –Exchange rate regime: Risks not internalised neither by supply nor demand. –International markets willing to take Chile risk.

II. The impact of the Asian crisis in the Debt market Facts: Flows of funds to emerging market economies reverse. Large increases in sovereign risk spread. Exchange rate policy: Free float since Banks are explicitly required to consider currency mismatches of borrowers in credit risk assessment (capital cost to them)

II. The impact of the Asian crisis in the Debt market Consequences on incentives to market participants: Companies with previous acces to international markets, turn to local market. Development of local expertise in fixed-income securities: Lower cost to new companies to issue debt. Fall in yields imply institutional investors more active in search for return. –Role of Investment Banks

II. The impact of the Asian crisis in the Debt market Impact on Market: Placements of debt in local market increase in , and further from 2001 onwards. Second increase due to new companies.

II. The impact of the Asian crisis in the Debt market Impact on Market: Placements of debt in local market increase in , and further from 2001 onwards. Second increase due to new companies. Market segmented in two tranches: 5-year for PF, 20- year for LIC.

II. The impact of the Asian crisis in the Debt market Impact on Market: Placements of debt in local market increase in , and further from 2001 onwards. Second increase due to new companies. Market segmented in two tranches: 5-year for PF, 20- year for LIC. However: New companies with profile too similar to those of before: Regulated services sectors, and/or large companies.

II. The impact of the Asian crisis in the Debt market Impact on Market: Placements of debt in local market increase in , and further from 2001 onwards. Second increase due to new companies. Market segmented in two tranches: 5-year for PF, 20- year for LIC. However: New companies with profile too similar to those of before: Regulated services sectors, and/or large companies. Liquidity falls at the end of 90s: –Mergers in PF and Banks –Rise in interest rates in 1998

III. Policies to support the Debt market 2002: Fourteen years after start of issuing marketable debt, CB changes structructure of bonds issued. –Bullet –Matutirities comparable internationally: 2, 5, 10 and 20-years –Benchmark issues: less types of bonds in the market to increase depth of any issue and, hence, liquidity. –Start issuing nominal (peso) bonds in maturities higher than 1 year (2 and 5). Other debt market-friendly reforms: –Capital Markets Reform I (Commercial paper).

IV. Current issues and challenges Expand market to medium-size companies. –Act on regulation to investments of PFs and LICs. Nominal debt –Central Bank issued 10-year nominal bond in –Nominal debt: Credibility replaces indexation. Macro benefit: indexation makes real adjustment of prices more difficult. –Difficult to change market conventions: Nominal private debt issues still scarce. Why, if inflation is low? International investors –Nominal debt may make this easier (UF implied entry costs)

IV. Current issues and challenges Financial Stability:Delivery versus Payments Refinancing on lower rates (2004): Prepayments, Replacement cost (LICs) –Learning-by-doing, now more attention on covenants. Pricing of risks more precise.