International Monetary Fund. Western Hemisphere Dept.
This Selected Issues paper examines the profitability of the foreign exchange (FX) swaps issued the Central Bank of Brazil (BCB) between May 2013 and February 2019 to shed light on the rationale for FX intervention. Using interest rate and exchange rate forecasts, the paper shows that that FX swaps have been profitable in expectation, even though actual returns were negative due to unexpected exchange rate depreciations. Moreover, the scale of FX intervention is correlated with the expected profitability of the swaps, further suggesting that the BCB used FX intervention to stem abnormal movements of the exchange rate. Despite being profitable in expectation, swaps incurred realized losses due to unexpected exchange rate depreciations. The analysis suggests that the BCB used FX intervention to lean against temporary excessive movements of the exchange rate. The expected profitability of FX swaps can be monitored in real time and may thus provide guidance on the appropriate level of intervention.
International Monetary Fund. Monetary and Capital Markets Department
Brazil’s financial markets are generally liquid and sophisticated. Brazil is blessed with a wide array of instruments which investors can use to manage and hedge interest rate and FX risks. The infrastructure supporting markets appears sound and is widely attributed by market participants to ensuring the resiliency of Brazil’s markets despite a multitude of significant shocks. A key foundation of the resiliency of Brazil’s markets is the large structural liquidity surplus (around 20 percent of GDP) and Brazil’s substantial FX reserves. Market participants generally have ample cash reserves that provide a key buffer against liquidity shocks.
Brazilian investors have a strong preference for high quality short term liquid investments. Brazil’s history of economic instability drives investors towards short term liquid investments of the highest credit quality such as overnight repos and short-term government bonds. Dollarization is low reflecting restrictions on FX investments available within Brazil but hedges against FX risk are widely available and give investors’ confidence to hold Real. Government bonds are the centerpiece of the securities markets.
Two types of currency in circulation models are identified: (1) a first generation derived from
the theory of money demand and (2) a second generation aimed at producing daily forecasts
of currency in circulation. In this paper, we transform the currency demand function into a
VAR to capture the dynamic link between interest rates and the demand for cash. We also
apply ARIMA modeling to forecast the daily currency in circulation for Brazil, Kazakhstan,
Morocco, New Zealand, and Sudan. Our empirical work shows that some of the conclusions
in the economic literature on the impact of interest rates on the demand for currency do not
necessarily hold, and that central banks would benefit from running both generations of
currency in circulation models. The fundamental longer-run determinants of the demand for
cash are distinct from its short-run determinants.
This paper presents a new measure of capital flow pressures in the form of a recast Exchange
Market Pressure index. The measure captures pressures that materialize in actual international
capital flows as well as pressures that result in exchange rate adjustments. The formulation is
theory-based, relying on balance of payments equilibrium conditions and international asset
portfolio considerations. Based on the modified exchange market pressure index, the paper
also proposes the Global Risk Response Index, which reflects the country-specific sensitivity
of capital flow pressures to measures of global risk aversion. For a large sample of countries
over time, we demonstrate time variation in the effects of global risk on exchange market
pressures, the evolving importance of the global factor across types of countries, and the
changing risk-on or risk-off status of currencies.
Mr. Jorge A Chan-Lau, Cheng Hoon Lim, Jose Daniel Rodríguez-Delgado, Mr. Bennett W Sutton, and Melesse Tashu
This paper suggests a novel approach to assess corporate sector solvency risk. The approach uses a Bottom-Up Default Analysis that projects probabilities of default of individual firms conditional on macroeconomic conditions and financial risk factors. This allows a direct macro-financial link to assessing corporate performance and facilitates what-if scenarios. When extended with credit portfolio techniques, the approach can also assess the aggregate impact of changes in firm solvency risk on creditor banks’ capital buffers under different macroeconomic scenarios. As an illustration, we apply this approach to the corporate sector of the five largest economies in Latin America.
A mechanism is proposed that aims to reduce the risk of a banking sector liquidity crisis—which is a quintessentially systemic event and thus the object of macroprudential policy—and moderate the effects of a crisis should one occur. The instrument would give banks more incentive to build up buffers of systemically liquid assets as a proportion of their total liabilities, yet these buffers would be usable in times of stress. The modalities of the instrument are considered with a view to making it effective, efficient, and robust.
In recent years, portfolio flows to emerging markets have become increasingly large and volatile. Using weekly portfolio fund flows data, the paper finds that their short-run dynamics are driven mostly by global “push” factors. To what extent do these cross-border flows and global risk aversion drive asset volatility in emerging markets? We use a Dynamic Conditional Correlation (DCC) Multivariate GARCH framework to estimate the impact of portfolio flows and the VIX index on three asset prices, namely equity returns, bond yields and exchange rates, in 17 emerging economies. The analysis shows that global risk aversion has a significant impact on the volatility of asset prices, while the magnitude of that impact correlates with country characteristics, including financial openness, the exchange rate regime, as well as macroeconomic fundamentals such as inflation and the current account balance. In line with earlier literature, portfolio flows to emerging markets are also found to affect the level of asset prices, as was the case in particular during the global financial crisis.
This Selected Issues paper analyzes the impact of the adoption of inflation targeting (IT) on exchange rate volatility in Russian Federation. Russia has seen an increase in exchange rate volatility during the past few years compared with the period before the global financial crisis, as the authorities have chosen to allow a higher degree of ruble exchange rate flexibility in preparation for the adoption of IT. The average of the 12-month coefficient of variation of the ruble/dollar exchange rate has also increased from 2.2 percent in December 2005–September 2008 to about 3.7 percent in March 2010–June 2013.
The crisis is prompting a reconsideration of capital flows and the policies that affect them. A breakdown in the domestic stability of a large country can spill over into stress in other countries and even to the global system as a whole. The activities of global institutions and markets—some regulated and some not—can bear on the riskiness of flows. Thus, national policies affecting capital flows can transmit multilaterally. This transmission has not been fully appreciated by national policymakers. Further, they may not have incentives to take full account of the cross-border effects of their policies. Looking ahead, the upward trend in the volume of capital flows can be expected to continue, making it ever more important to address the associated cross-border risks.
This paper aims to draw greater attention to the multilateral aspects of policies affecting capital flows. Previous work by the Fund has focused on the policies of recipient countries, mainly emerging market economies (EMEs), and addressed the circumstances in which capital flow management measures (CFMs) would be appropriate. This paper provides a complementary assessment of regulatory and supervisory policies of advanced economies, as well as large advanced economy monetary policy. Moreover, it addresses the multilateral transmission of CFMs.