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Speeches & Transcripts October 24, 2018

Opening Remarks at Sovereign Debt Management Forum

Ladies and gentlemen, good morning. I am delighted to be here.

It is my pleasure to provide some opening remarks to this edition of the Sovereign Debt Management Forum. I would like to express my thanks to our Treasurer, Ms. Arunma Oteh, for the invitation to join you today.

Ladies and gentlemen, we are faced with massive challenges in many parts of the world, which keep reminding us of the World Bank Group’s ever more critical role as an effective and reliable partner to influence development outcomes. Coming back from our Annual Meetings in Bali, Indonesia, we are grateful and encouraged by the great support our shareholders—your governments— have provided us.

Today, let me give you some thoughts on the global outlook, and then look beyond the cycle to discuss some structural issues with implications on long-term growth and ultimately public debt sustainability.

On the global outlook, low interest rates in the wake of the global financial crisis (GFC) have fueled capital flows to developing countries in search for higher yields. Implications are far-reaching, including the reduction of foreign currency denominated borrowing, with the expansion of vibrant local currency markets. FX debt, nonetheless, remains vital for many of our client countries.

As central banks pursue policy normalization, capital flows to developing countries have declined and funding is becoming harder to obtain while debt, including corporate debt, has reached unprecedented levels. This has translated into challenging market conditions, with swap spreads and government bond yields rising and currencies and equities falling in many markets, including those without major vulnerabilities. Debt sustainability is back on the radar, not only for low-income countries, where growth since 2013 has been significant, but also for other emerging market and developing economies (EMDEs), including those relying mostly on local markets and currencies.

If interest rates rise slowly, supported by strengthening growth, then financing conditions and capital flows to EMDEs could continue to be generally supportive. But even in this generally benign scenario, it is important that countries be prepared to sail through the next 18 to 24 months of gradual global adjustments, until U.S. rates stabilize.

However, there is a spectrum of risks, such as rapid U.S. monetary tightening, a disorderly Brexit, and rising trade tensions. A de-synchronized recovery could lead to monetary divergence with an adverse impact on capital flows, funding costs, and debt service through the FX channel. Significant shifts in economic policy and political arrangements could trigger a sharp repricing in financial markets. In such an environment, EMDEs are particularly vulnerable to both direct and indirect impacts of trade protectionism. Among the latter, we can list: (1) higher uncertainty about the policy strategy of commercial partners, which erodes confidence and the willingness to invest, and (2) less efficient and disrupted global supply chains, which creates uncertainty in sectors that often are drivers of increased productivity. For instance, a significant share of exports from ASEAN countries, for instance, goes to China, illustrating the repercussions of trade tensions throughout the region. Both developments taken together would translate into higher risk premia.

The good news is that, so far, EMDEs have not seen widespread contagion. Countries have been impacted differently by the ongoing headwinds, primarily reflecting country-specific pressures rather than a sudden change in global risk appetite. Thus, net non-resident portfolio inflows to most EMDEs have remained resilient, which can be credited to the commitment of many EMDEs to a sound policy mix, supported by structural reforms. And countries more at risk, such as Argentina, Pakistan, and Ukraine, are taking active steps to address their vulnerabilities through IMF programs with the support of the World Bank. We have stepped up our crisis response capabilities, ranging from contingent financing to governments to instruments aimed at mitigating the risk of famine and pandemics, in conjunction with important structural reform measures.

Let me now shift from the short-term analysis to structural conditions. It is important to recognize that cyclical movements are a natural part of the economic life, but we have to look beyond that and focus on long-term drivers of growth that will take us to the other side of the downturn, and provide the fundamentals to sovereign borrowing programs. Growth among EMDEs is uneven, and there are challenges ahead, but the world will increasingly be shaped by this set of countries, including with respect to sustainability and climate change.

Low global interest rates go beyond monetary policy—they most likely reflect structural trends, some of which predate the GFC. Hypotheses such as that of secular stagnation suggest that low interest rates also reflect an imbalance between higher savings as baby-boomers age and demand for capital drops as new technologies require less capital. In this sense, while the value of controlling companies (with product market power) and intellectual property may have increased, the value of capital as a production factor has dropped, and savings by workers in advanced economies have become less valuable. This raises the question of whether there are efficient outlays for these savings that could generate meaningful long-term income streams.

We believe that investment in EMDEs, notably in climate-friendly (or green) infrastructure, can provide such outlays. Infrastructure is fundamental to increase the productivity of developing countries, and if done adequately it will not only increase the resilience of their economies, including in face of climate change, but also bring a safer and more stable world, while yielding relevant returns to investors.

Here, let me remind you that environmental shocks are very present in many of our client countries, sometimes setting back years of investment in development policies. So we are speeding up our contribution to adaptation and mitigation efforts, including through our Disaster Risk Finance and Insurance Program (DRFI), available to sovereign and sub-sovereign clients. And I am happy to report that the share of our activities with climate co-benefits has already surpassed our 2020 target established at the 2015 Annual Meetings in Lima.

Environmental shocks are also an increasing risk for financial stability, and we have joined a group of central banks and supervisors in the Network for Greening the Financial Sector (NGFS) to ensure that these considerations are integrated into prudential frameworks and that adequate regulation guides the channeling of resources to sustainable investment—including by sovereign borrowers.

In this context, supporting the origination of climate-friendly, quality infrastructure projects attracting local and global private sector investment is a top priority for us at the World Bank Group. More than half of greenhouse gas emissions are related to infrastructure, so well-planned infrastructure boosts private investment and helps reduce the carbon footprint of progress, thus providing global public goods.

Crowding in private investment requires a range of actions. At the World Bank Group, we have been working hard to mobilize private resources, which would help reduce the pressure on government borrowing requirements.

  • We are working through the Global Infrastructure Facility to help prepare projects, design bankable infrastructure programs, and foster standardization to facilitate the securitization of revenue streams. We are also exploring ways of de-risking projects, rather than just lending—using, for instance, liquidity facilities aimed at supporting infrastructure operators in the wake of FX shocks.
  • We continue to support the development of local capital markets and institutional investors to mobilize domestic resources and help attract foreign partners.
  • And we are also engaging financial regulators to reduce the hurdles faced by institutional investors willing to seek higher risk-adjusted returns in this space.

The good news is that the risk profile of infrastructure is better than is usually realized by portfolio investors and regulators as we continue to develop a favorable legal and business environment in host countries. New evidence on the favorable risk profile of infrastructure, particularly in green sectors, could therefore be better reflected in lower regulatory capital charges for insurers and other financial institutions. This approach has already been reflected in the Financial Stability Board’s evaluation of the impact of regulatory reforms on infrastructure finance, which will be submitted to the G20 Leaders at the Buenos Aires Summit at the end of the month, and the just-published Report of the G20 Eminent Persons Group (EPG) on Global Financial Governance. Both recognized the significant scope for reviewing the regulatory treatment of infrastructure finance for long-term institutional investors, which will be among the topics addressed at the Investment Forum, which will bring together top investors, regulators and government leaders on the eve of the G20 Summit in Buenos Aires next month.

To conclude, there are many reasons why investing in EMDEs can be an excellent way to address the effects of potential secular stagnation. And your role as public debt managers is crucial, because, in most cases, financial flows into infrastructure and other investments are priced relative to the public debt. Sovereign risk establishes the baseline for investment decisions as much as it reflects how supportive local conditions are to long-term growth and overall debt sustainability. In any case, we will continue this vital dialogue with investors, asset managers, representatives of savers and governments to help reduce risks and enhance the efficient allocation of capital to sustain economic and social growth in advanced and developing countries.

Thank you very much for your attention.