Brazilian sovereign risk, international crises and foreign portfolio investment flows/Risco soberano Brasileiro, crises internacionais e fluxos de investimentos estrangeiros em carteiras de acoes/El riesgo soberano de Brasil, crisis internacionales y flujos de inversion extranjera en cartera.
| Autor | Callado, Antonio Andre Cunha |
| Cargo | Ensaio--Financas |
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INTRODUCTION
Sovereign risk, focusing on the probability of a government defaulting on debt, plays an important role in literature and in the assessment and administration of risk in international transactions, as can be seen in Frenkel, Karman and Scholtens (2004).
Sovereign risk is a specific concept of the broader term, country risk, measuring the economic and political stability of a country. In international transactions the assessment and administration of country risk is important for the strategies of international investment and the hedging of international positions by financial and nonfinancial corporations.
The use of econometric methods, which are backward looking but open the possibility to establish lead/lag relations for the variables, is also opening an horizon to create possible forward looking risk indicators, that are important for the assessment and administration of international risk by financial and non-financial corporations.
The objective of this paper is to describe the behavior of Brazilian sovereign risk from 1995 to 2005, evaluate the influence of international financial crises on the Brazilian sovereign risk in this period (Mexico 1994/95, Southeast Asia 1997, Russia 1998, Brazil 1998/99, Argentina 2001/2 and Brazil 2002/3), and estimate lead/lag relationships between the Brazilian sovereign risk, other financial and macroeconomic indicators and the foreign portfolio investment flows entering and leaving Brazil in the period.
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BRAZILIAN SOVEREIGN RISK
Since the end of the eighties, the demand for information related to risk analysis has increased in the international financial market. Because of this demand for more precise information on risk assessment, some mechanisms for measuring, monitoring and risk assessment have been widely publicized. Several methodologies have been developed to serve this purpose along with the construction of indicators of the market related to certain types of risk.
Garcia and Didier (2001) define sovereign risk as a reflection of the economic and financial situation of a country, reflecting also the political stability and performance, historically, of fulfilling financial obligations.
About the relevance of sovereign credit risk, Cantor and Packer (1996) believe it is important not only that some of the largest issuers of securities in the international market are national governments, but also that these concepts of risk affect the credit risk of lending to borrowers of the same nationality.
Country risk can be measured in various ways. According to Scholtens (2004), country risk "is the risk that unforeseen events in a foreign country affect the value of international assets, investment projects and their cash flows. Traditionally, the theoretical analysis of country risk distinguished between the ability to pay and the willingness to pay.
The first assumes that if a debtor is able to meet his obligations, he will do so. The debtor will default only if he cannot fulfill his repayment obligations (interest, amortizations). Various macroeconomic solvency and liquidity indicators are used to measure the capacity to pay. However, willingness to pay also appears to play a role. "
More specifically, sovereign risk focuses on the possibility of a default of a government on its debt. There are different forms of evaluating country risk and sovereign risk. Scholtens (2004) shows four approaches to assess country and sovereign risk: "the balanced-score card approach (BSC), the country risk rating, the secondary market analysis, and the option approach. Of course, in practice, all four approaches may be employed in some combination or another."
The characteristics of the terms and conditions of financial transactions carried out by foreign investors, through isions on the allocation of financial resources, have been isive in determining the magnitude and composition of capital flows to developing countries in the ade of nineties.
On the relevance of indicators of sovereign risk in this process, Adams, Mathieson and Schinasi (1999) show the great responsibility and impact that they have on both the cost of borrowing as well as on the desire expressed by institutional investors to keep certain assets in its possession.
Commenting on the characteristics associated with the debt-conversion of external debts of developing countries, Fabozzi (2000) states that the secondary market of these securities is highly liquid in the world, presenting large volumes of daily trading. According to Bhatt (1988), the financial innovations related to the process of securitization also create conditions for the emergence of secondary markets for a large number of financial instruments, such as bills, bonds and shares.
The securitization also contributed to the reintegration process of developing countries into international financial market, because of the boundary limits of operations and simplified procedures for attracting external resources. Barros and Mendes (1994) suggest several factors related to the expansion of credits securitization, which are:
* Generalization of the culture of aversion to risk;
* Progress of information and communication technologies;
* Dissemination of international financial innovation;
* Growth of operations "out of balance";
* Increasing participation of so-called institutional investors.
Pinheiro (2005) considers that securitization is a transaction that allows a renegotiation of debt, financial and trade, through the placement of long-term securities market with operational guarantees.
The secondary market of debt securities is regarded as a reference and an active orientation for the expectations of economic performance and is one of the parameters of the climate for capital flows in relation to a debtor country.
About the dynamics of this secondary market for securities, Assaf Neto (2008) says that in the globalized economy, negotiations with these titles are almost instant, linking the various financial markets. Among the various types of securities issued by Brazil in the renegotiation of external debt, the C-Bond is the best known and is highly liquid.
Technical information is regularly issued by financial institutions that operate globally on the secondary market of debt bonds, to investors with regard to economic analyses as well as their expectations for the short and long term, including Brady Bonds in the calculations, where among the Brazilian securities traded, the C-Bonds are computed.
Commenting on the analysis of the market about the debt rescheduling of external debt as a source reference to the associated risk of a country, Fortuna (2005) says that fulfillment can be associated with the price in which the C-Bond is being negotiated in the secondary market. Dooley, Fernandes-Arias and Kletzer (1996) show that the value of foreign debt securities in the secondary market is a useful barometer for a country's credibility.
On the expectations of investors with the analysis of secondary markets bonds, Fortuna (2005) states that in relation to Brazil, the C-Bonds are monitored according to the prices for which they are being negotiated.
In this paper the assessment of sovereign risk is made by the secondary market analysis, using the information from the trade in assets of a country (Scholtens, 2004). More specifically, the Brazilian sovereign risk in this paper is evaluated as the spread of effective yields of Brazilian C-bonds in secondary markets over the effective yields of US Treasury securities, seen as "risk free" assets.
Further in the paper the spread of effective yields of Brazilian C-bonds over the effective yields of US Treasury securities is called C-bond spread. The C-bond, a highly liquid security emitted by the Federal Republic of Brazil in 1994 with maturity in 2014, is part of the JP Morgan Emerging Market Bond Index Plus (EMBI+) and of the index EMBI+ Brazil (Banco Central do Brasil, 2005) and is used in other papers referring to the Brazilian sovereign risk, such as Loureiro and Barbosa (2004) and Moreira and Rocha (2003).
Sovereign risk for emerging markets is normally rising in a currency and financial crisis, because the expectations of the actors on the international financial markets are changing negatively in a crisis, evaluating the probability of a default on the sovereign debt of the country, as rising.
With rising probability of default for sovereign debt, on the secondary markets the supply of the securities is rising (the supply curve shifts to the right), while the demand is falling (the demand curve shifts to the left), with prices of the securities also falling. With falling prices, the effective yield of the securities is rising, consequentially leading to rising spreads of the sovereign securities over US Treasuries (higher sovereign risk), while the prices and yields of US Treasuries are supposedly constant.
[GRAPHIC 1 OMITTED]
The Graph 1 shows this behavior of the C-bond spread, the C-bond spread rising in the aftermath of the crisis of Mexico in 1995, in the Asian crisis in 1997, in the Russian and Brazilian crises in 1998/99, in the Argentine crisis in 2001, and in the most expressive rise during the Brazilian crisis in the election period 2002/03.
As shown in Graph 1 in every financial crisis, the C-bond spread was significantly rising, showing contagion from crises in other countries and the loss of confidence of the international financial markets, and possibly anticipating the financial crisis.
Also considered was the influence of financial crises on the C-bond spread and on the foreign portfolio investment flows to and from Brazil. Some might wonder if there are any leading indicators for pressure situations in the exchange markets leading to a financial crisis. A leading indicator has importance for the assessment and administration of risk in international transactions, especially for foreign portfolio investments and also for national macroeconomic policies in...
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