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We are grateful to Ali Abbas, Jochen Andritzky, Tamim Bayoumi, Fabian Bornhorst, Engin Dalgic, Udaibir S. Das, Reinout De Bock, Mark De Broeck, Selim Elekdag, Luc Everaert, Maximilian Fandl, Anastasia Guscina, Allison Holland, Anna Ivanova, Mariusz Jarmuzek, Peter Lindner, Silvia Merler, Yanliang Miao, Franziska Ohnsorge, Rafael Romeu, Miguel Segoviano, Eriko Togo, Justin Tyson, and participants at the IMF MCM Seminar for their insights and comments and Gabriel Presciuttini for excellent research assistance. Any remaining errors are our own.
Although the dataset is compiled for advanced economies, the methodology can be extended to emerging markets, with a few modifications. In this paper, we focus on advanced economies to avoid a number of technical issues, such as exchange rate valuation adjustments, and to examine asset allocation decisions of a common class of sovereign debt investors that are traditionally interested in interest-rate risk, not credit risk.
Apart from these feedback loop effects between banks and their own sovereign, the health of the domestic banking sector could be influenced by cross-border spillover effects, if the domestic banking sector holds a significant amount of debt of high-risk foreign sovereigns.
Recently, there has also been interest in portfolio balance models of government debt to explain how central bank quantitative easing policies are affecting interest rates. Addressing these issues, which requires empirically identifying the demand function for government debt, is beyond the scope of this paper.
Currency and deposits mainly represent saving certificates and retail bonds that can be redeemed before maturity, and are generally a relatively small share of total debt for most advanced economies. They are usually included in short-term debt unless detailed information is available to make the short-term/long-term attribution.
Although some countries may use the “net debt” concept by subtracting various types of financial assets from gross debt, there is no internationally recognized common definition of net debt.
Norway and Switzerland also provide government debt figures consistent with the definition of “Maastricht debt.” The data for Switzerland are on an annual basis, so quarterly figures are interpolated.
While household or non-financial corporate holdings of government debt account for a sizable portion of nonbanks in some countries (Italy and U.K.), institutional investors usually make up the bulk of nonbank holdings. At end-2010, assets under management of institutional investors in advanced economies amounted to US$70 trillion, of which US$25 trillion belonged to investment funds, US$23 trillion belonged to insurance companies, and US$21 trillion belonged to pension funds, according to OECD estimates.
More details on valuation principles for securities can be found in the BIS Guide to the International Banking Statistics; IMF Coordinated Portfolio Investment Survey Guide; IMF External Debt Statistics: Guide for Compilers and Users; and IMF Monetary and Financial Statistics: Compilation Guide.
External debt statistics in QEDS can sometimes differ from corresponding figures in national flow of fund (FoF) data. We stick to external debt statistics because these are based on a common compilation methodology (IMF’s External Debt Statistics: Guide for Compilers and Users published in 2003), while compilation for FoF data differs across countries. Furthermore, external debt statistics do not include financial derivatives in debt statistics, in line with our definition of government debt, while national FoF data may include them.
While TIC data cover only U.S. Treasury securities, U.S. Federal Reserve flow of funds data indicate that foreign holdings of local and state government debt are relatively small (less than US$90 billion).
Based on IMF Data Template on International Reserves and Foreign Currency Liquidity and IMF CPIS data during 2008–10, we estimated that, on average, 80 percent of foreign exchange reserves consisted of national debt securities, while the rest comprised currency and deposits with foreign banks and central banks, debts of international institutions, and equities. We also checked this assumption for Spain, which used to provide data on foreign central bank holdings of national debt, and latest official estimates were in line with our estimates.
For other countries, foreign official loans are negligible or nonexistent. Only for Norway, external loans are large, but those mainly represent repurchase agreements of the Government Pension Fund (SPU) with foreign financial institutions. These are recorded as liabilities of the SPU and hence the general government. The volume of these operations was reduced significantly after the crisis, in particular in 2011.
Specifically, we use the following sources for these countries: Australia (Australian Bureau of Statistics, Flow of Funds), Canada (Bank of Canada, Chartered Bank Balance Sheets), Korea (Bank of Korea, Flow of Funds), New Zealand (Reserve Bank of New Zealand, Table D2), Norway (Statistics Norway), Switzerland (Swiss National Bank, Banks in Switzerland), and United Kingdom (Bank of England, MFI Consolidated Balance Sheets). The data for Switzerland are on an annual basis, so quarterly figures are interpolated.
The national data for these countries have been recently collected into a database and made publicly available by Bruegel (“Bruegel database of sovereign bond holdings”), as described in Merler and Pisani-Ferry (2012a).
A more comprehensive list of statistical reclassifications can be found directly from our data sources.
At the same time, these estimates cannot attribute country origin with complete accuracy, in particular if a security is purchased by a foreign investor and held in a custodial account in another country, say, an offshore center. Put differently, these estimates reflect exposures on an immediate borrower, not ultimate risk, basis.
Z-scores are defined as the distance from the mean, measured in units of the standard deviation. Specifically, we calculate z-scores for each observation, based on the 4-quarter moving average of foreign investor flows. The mean and the standard deviation are calculated for each country, using an expanding window starting from 2004Q1, in line with the sudden stop identification methodology of Calvo et al (2004).
A notable example of this trend is the Norwegian sovereign wealth fund, which recently announced a strategy to gradually reduce the fund’s share of European bonds, while increasing bond investments in other regions.
IMF (2010) discusses some of the reasons why some investors may be more sensitive to rating actions, rather than market signals.
The 2011 EBA stress tests suggested that major European banks may have a collective shortfall of −1.2 trillion that must be filled with liquid assets such as government bonds. Santos and Elliott (2012) estimate that European, Japanese, and U.S. banks may collectively need US$ 2 trillion of net additional liquid assets in the next three years before the Liquidity Coverage Ratio (LCR) becomes effective in 2015. At the same time, another Basel III liquidity measure, Net Stable Funding Ratio (NSFR), scheduled take effect in 2018, may induce some banks to reduce demand for long-term government debt.
Merler and Pisani-Ferry (2012b) argue that the interdependence between banks and sovereigns is especially strong in the euro area, due to the absence of a supranational banking resolution framework and domestic banks holding a considerable share of the debt issued by their domestic government.
Foreign private investors include foreign banks and foreign nonbanks. We exclude foreign official sector holdings because, to a large extent, these take the opposite direction as foreign private holdings during a crisis.
In some countries, such as Belgium, domestic retail investors have also increased their holdings of sovereign debt when there were large foreign outflows. However, the pattern of retail investors varies across countries and hence, for this analysis, we assume holdings of these investors remain broadly unchanged, unless through their indirect holdings of sovereign debt via financial intermediaries.
This is a conservative assumption, as interest payments and the resulting overall fiscal deficit may increase if borrowing costs rise under the shock scenarios, amplifying worries about debt sustainability.
In all scenarios, the foreign share of the fiscal funding needs and rollover needs is based on the foreign share of the total debt stock as of end-2011.
The share of foreign investors in the short-term and long-term debt markets can be calculated based on data available from BIS, Eurostat, QEDS, and national authorities. Taking these into account, we have re-run the analysis. The results were broadly the same for most countries.
This is an average across all countries in the sample during the post-crisis period. We have also calculated median correlations and the results were similar, suggesting results were not driven by outliers.
Our index is based on historical correlations during the post-crisis period, including 2010 and 2011. In that sense, this should not be seen as an out-of-sample test of our index. We provide it only for illustrative purposes.
The “Stockholm Principles” are a set of guiding principles for managing sovereign risk and high levels of public debt, as facilitated by the IMF and agreed by the debt managers and central banks who attended the 10th Annual Consultations on Policy and Operational Issues facing Public Debt Management on July 1–2, 2010.