GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

[quigleydoor]

The new GEMLOC initiative is a big initiative to develop the capital markets of poor countries around the world. I am trying to figure out what the implications are for Marc Faber's "fountain of credit" model of the monetary system.

GEMLOC is the Global Emerging Markets Local Currency Bond Fund, a project of the World Bank. "It will provide greater liquidity and depth to local currency bond markets and offer investors a broad, diversified portfolio of local currency bonds," the International Finance Corp, the bank's private sector lender, said in a statement. "This innovative move should help drive financial sector development in emerging markets, boost prospects for growth, and help overcome poverty," World Bank President Robert Zoellick said.

GEMLOC will initially invest in 15–20 poor countries, and eventually scale up to 40. The World Bank is targeting to attract $5 billion of capital from public and private institutional investors, such as pension funds, sovereign wealth funds, and central banks.

There are recent news articles on GEMLOC in FT and Reuters. This is a project about helping poor countries develop capital markets in their own currencies, in conformance with the markets of rich countries. The reason I find this interesting is that it will empower indigenous captialists in the poor countries. They will no longer be constrained by dollar-denominated finance, as they have been for the first 50 years of the World Bank's career.

I think this could potentially change the "fountain of credit" model that Marc Faber has written about (see his book, Tomorrow's Gold). Faber saw the monetary system as a fountain with multiple levels of bowls. Money pours into the top bowl, USA. Some of it stays there, and the rest gradually trickles downward into bowls of increasing size. The bowls represent the hierarchy of the monetary system, and the fragility of those countries in the lower ranks and outer fringes of the system.

Until recently, the "emerging market" nations have been at the mercy of "hard currency" capital markets, forced to do financing for capital projects (infrastructure, factories, social safety nets) in "hard currencies" (most commonly dollars). Thus they faced tremendous foreign exchange risk, as their local currencies were extremely volatile and prone to severe inflation. This has been a severe impediment to development. Can you imagine building a bridge in Povertyland, and charging users a fixed price toll in USD?

Nowadays, many of these countries are fiscally in reasonable shape, but they do not yet have the institutional capacity to issue, transact, and custody bonds in the modern fashion. One aim of GEMLOC is to help them build the foundations of local capital markets in the local currencies. The fractional reserve banking system will find new solace in these countries. Their currencies become new sources of money supply. The "fountain of credit" will take a new shape, perhaps something more like an automatic car wash.

The bank is hoping to take advantage of the increasing desire among central banks and other investors to diversify away from dollar-denominated debt; the rise of sovereign wealth funds as a new source of liquidity; the recent resilience of emerging market currencies; and the increasing global outlook of fund managers.

Staff believe the fund has potential partly due to the fact that, of all emerging market debt, about 70 per cent is in local currencies.

Yet only 10 per cent of the $200bn in emerging market assets managed by 25 fund managers the bank has been in contact with is invested in local currency debt.

The aim is to “transform local bond markets into a mainstream asset class”, according to Oliver Fratzscher, senior financial economist in the bank’s capital markets department.

Private sector emerging market local currency bond funds have proliferated in the last five years, with liquidity in the local currency debt market exceeding external debt market liquidity as dollar-denominated sovereign debt issuance has shrunk.

But much of the investor interest has been in derivative instruments – not the bonds themselves.

This helps investors circumvent many of the “market infrastructure” bottlenecks that have long constrained foreign participation in local currency bond markets – like high local taxes, lax regulations or non-existent clearing and custodial systems.

Jerome Booth, head of research at Ashmore Investment Management, a leading emerging markets investment manager, said: “If the offshore, non-deliverable derivative instrument is economically equivalent to holding the local bond locally, then you get around a lot of the local law issues. It’s a much more efficient way to get exposure so that’s often more attractive to institutional investors.”

However, the World Bank believes this approach has in some cases led to a short term investor mentality that has not propelled liquidity in local currency bond markets – and thus countries’ ability to tap them.

Teresa Barger, director of the IFC’s corporate governance and capital markets advisory department, said some investors had told the bank that GEMLOC could be a way of moving the concept away from being a “tactical bet” by short term investors to creating a “strategic asset class”.

“We want this fund to concentrate in the cash markets, unlike hedge funds which are absolute return investors. We want no net short positions and no more than 50 per cent leverage. We’d like to attract more benchmarked investors,” she told the Financial Times.

Such investors could act as counterparties to the local banks that are often the dominant, but largely passive, investors in local currency bond markets – thus generating liquidity.

[Spartacus]

Re: GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

Katherine Fitts tried to do something like this for the "less developed" parts of the US - take local businesses and real estate and securitize them to get some local benefits (instead of NY and London and Singapore only benefits) of the securitization markets

I don't know what became of her initiative -

www.solari.com

The new GEMLOC initiative is a big initiative to develop the capital markets of poor countries around the world. I am trying to figure out what the implications are for Marc Faber's "fountain of liquidity" model of the monetary system.

I thought Marc is on about a fountain of credit, not liquidity .... has he changed his nomenclature?

[quigleydoor]

Re: GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

I thought Marc is on about a fountain of credit, not liquidity .... has he changed his nomenclature?

Probably I am just a little forgetful. Sorry.

In any case, am I placing too much importance on this development? Even if my reasoning is not very precise, I think this marks a secular shift in the global monetary system.

[Spartacus]

Re: GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

get Tet and Sapiens to chime in.

Probably I am just a little forgetful. Sorry.

In any case, am I placing too much importance on this development? Even if my reasoning is not very precise, I think this marks a secular shift in the global monetary system.

I can't say for sure, but some of the usual considerations for underdeveloped markets apply -

The dollar amounts are probably miniscule compared to existing worldwide flows.

Even if those amounts are significant, they are unlikely to trade at NY or London P/E ratios (or bond yields) for many decades - note that even within in the US, private corporations change hands for far lower P/E ratios than publicly traded ones.

It looks for all the world like China is out-manoeuvering the IMF, so I would think that if it looks like any deals are in the offing under this initiative, China would come in with sweeter financing -

I suppose this would depend on whether China feels the specific deal is good for China, not specifically to tweak the collective noses of the IMF/US/GB/Bechtel

[quigleydoor]

Re: GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

I can't say for sure, but some of the usual considerations for underdeveloped markets apply -

The dollar amounts are probably miniscule compared to existing worldwide flows.

Even if those amounts are significant, they are unlikely to trade at NY or London P/E ratios (or bond yields) for many decades - note that even within in the US, private corporations change hands for far lower P/E ratios than publicly traded ones.

Those are good points. The GEMLOC fund is going to start at $5 billion, which is pretty small. I still think it is a watershed, since the World Bank is using this to teach poor countries how to do finance. It is opening up all kinds of point-to-point trading channels that do not go through New York, London, or Singapore.

The volume will be a trickle at first. I expect it to grow rapidly. As a comparative tool, look at the recent growth in the number of advanced engineering students in developing poor countries. Those same countries, China, India, Turkey, Egypt, Brazil, etc., are likely to participate in GEMLOC. The populations are ready to step up and use tools like the World Bank is providing. The advancement of finance in these countries will be rapid.

It looks for all the world like China is out-manoeuvering the IMF, so I would think that if it looks like any deals are in the offing under this initiative, China would come in with sweeter financing -

I suppose this would depend on whether China feels the specific deal is good for China, not specifically to tweak the collective noses of the IMF/US/GB/Bechtel

Interesting point. Is China going to just give a man a fish, or teach him to fish? The World Bank appears to be teaching, this time. I think the motivation is to gain some influence over those sovereign wealth funds.

[Rajiv]

Re: GEMLOC, Emerging Market Debt, and the Fountain of Liquidity

You might also find http://appropriate-economics.org/ useful