Hannah Audino: Hello and welcome to our latest economics in business podcast. My name is Hannah Audino and I am an economist here at PwC.
Today, I am joined by Nick Forrest, who heads up our economics team. We are going to be talking about recent report we produced for Euroclear, a financial services firm, who specialise in settling international securities transactions.
We will be discussing how Euroclear is facilitating international finance, the economic and market impacts, and the outlook for emerging capital markets.
Kicking off, Nick, if we start by talking about how important capital markets actually are to countries and companies today…
Nick Forrest: Thanks Hannah.
International capital markets are central to the way that money, finance moves around the world, and essentially links up those countries and individuals that have more money and savings with those countries, companies and individuals that need money and need to borrow. It is capital markets that enable that flow of money and that means savers can earn return and interest on their savings, and borrowers can borrow. That borrowing can be used for investment, so if you want to build a new infrastructure in countries. But it also can be used for more day to day purposes, so paying for public sector workers. Access to those international financial markets gives countries their source of finance and can be really helpful in managing their sovereign finances.
Hannah : There obviously are also some down sides, I am thinking about the Southeast Asian crisis. Can we touch upon the other side of the coin.
Nick: Yes, you are right.
The money that moves around the world, can move faster in one direction, and it can move faster in another direction, and some of the criticisms of that have been how money has moved back away from countries, in particular, when they’ve needed it. But, we need to trade off the risk of money moving around quickly against the benefits of access to international finance, but also what can be done to show up the stability of the global financial system and avoid some of those events where money is moving around adversely.
Hannah : Absolutely. So what is euroclearability?
Nick: Euroclearability is all about connecting domestic bond markets in countries with international finance. By domestic bond markets, nations can have their own bonds that they issue, sovereign bonds issued in their own currency, and issued locally. But if they are only being bought by local investors, that’s quite a limited set of investors. So what Euroclear is doing, it is connecting those investors to the broader international global capital markets, much wider set of investors, and just enabling those flows of finance.
Hannah: Your report was focused on looking at the benefits and the impact of euroclearability - can you talk through the top three benefits countries and economies?
Nick: Sure, so firstly access to international investors. We think about a country, you can issue bonds domestically, you can issue bonds in your currency to savers in your economy, but then you are constrained just to that local system. If you can get access to international investors, then there’s a world out there of investors, and you can find the one that is particularly interested in your investment, in terms of risk profile, or its maturity. That access to investors is great in terms of broadening out your investor base and then it’s more likely this will stay with you as a long-term investment.
The second area is lower cost. Whenever we see financial markets that are bigger, deeper and more liquid, they become more efficient. That leads to lower borrowing costs. If you are an issuer that means you can benefit from a lower interest rate. That’s great if you think about ourselves, if we are borrowing a loan, or have a mortgage, a lower interest rates means we have more money than we would have with our interest rate. We can use that difference to spend on renovating house, buying a car, holidays, don’t take your pics.
It’s no different really to a country, if they’ve got lower interest rates, then they can spend that money on infrastructure, or public services and civil servants, and spending on those workers, or they can use it to cumulate debts less quickly. That means that the debt burden of the countries would be lower. There are lots of benefits of lower borrowing cost. What we found was that the lower borrowing costs for those countries that have recently become euroclearable was 28 basis points, so a meaningful difference to the customer.
Then thirdly, reduce volatility. So, because you’ve got access to a broader set of international investors, what we find is the volatility in the bond deal is less. The reason why is that it’s quite important for countries that like to plan, like you and I do, their finances. If the interest cost is moving around all over the place, what they are paying in interest that interest is going to move around too. It’s all easier to plan and forecast your government finances if your bond deals are more stable, so that’s a third benefit.
Hannah : Your report was focused on putting in numbers these benefits and quantifying it, how did you go about doing that?
Nick: This is where we used tool called econometrics. That’s a tool where we can put lots of data into a statistical package, and really tease out what’s influencing. What I mean by that is we are really interested in the study about euroclearability. In fact those countries that are euroclearable, compared to those that aren’t, and we are interested in whether that has an impact on bond yields, or the borrowing cost of nations. Now the problem is, there are lots of other things that impact bonds and their yields. We know that longer maturing bonds tend to have higher yields than shorter maturing bonds. We know that a higher credit risk country will have a high yield than a lower credit risk country.
So, all these things influence the yields in a bond. We have to control for those. We put those variables into our analysis. We control for them. We know they are dealt with. Then we can isolate what the impact of Euroclearability is specifically, and that’s where the econometric technique is great. It uses a lot of data, lots of analysis, but then we can isolate the fact that according to analysis over the last five or six years, there is a 28 basis points reduction in borrowing costs for those countries that can achieve the status of being euroclearable.
Hannah : Okay, let us put that in a bit of context, what does 28 basis points actually mean for a country - how big is this impact?
Nick: Firstly, 28 basis points from a financial economic perspective, 28 basis points is quite significant. If you think about the Bank of England, they move interest rates often by 25 basis points, or a quarter percent, and that’s quite newsworthy. That will be all over the news, and it will have impacts on the economy in due course. It is quite an impactful figure. Now, it is important to know that it is not as important as a lot of other wider factors that will impact borrowing cost, such as fiscal managements, economic stability, even political risks and turmoil, or indeed military type events.
They are far more substantive than the impact of euroclearability. But let’s not dismiss the importance of this; having got the foundation of the economy working well, 28 basis points is quite important, and we can model that in economic terms. That’s improvements to the six countries we looked at, which have most recently become euroclearable. We think it’s worth about 3.8 billion to GDP over the next 10 years. These are quite large sums in terms of nations financing.
Hannah : Yeah, absolutely. Those countries, are they emerging markets, or are they developed nations?
Nick: They are all emerging markets, but to put in context for you, for those economies that is equivalent to around about 1% point increase in the healthcare budget. So that could go to, we estimated, 1500 hospitals or paying doctors and nurses – a nice impact to the Minister for Health and the budget. These are significant impacts.
Hannah : And looking forward, what’s the outlook for emerging capital markets?
Nick: Currently emerging markets are in general terms in a reasonably good place. The reason why we can say that is, we track country risks, through something called a country risk premium analysis. It’s available on our websites, you can go and have a look at it. Looking that every time, as we have done for the last 20 years, the spreads on emerging market bonds are currently relatively low, certainly where they have been historically.
The outlook for emerging market is quite good at the moment, but having said that emerging markets always a very diverse set of countries as an asset class. There are some countries that are improving and doing well, and in the context of this report on euroclearability, Egypt made some strong moves recently to become more euroclearable. Russia has done a lot of issuance of late. There are some countries that are doing well, but there are some in Latin America that are not doing so well at the moment. Broad asset clause, but at the moment the outlook is pretty good for emerging markets.
Hannah : Bringing this a little bit closer to home to finish off, what about the UK, what can we say about the UK’s outlook?
Nick: Interestingly, the biggest driver emerging markets is all from this is political risk. For many years we wouldn’t have seen the UK as being a country with much political risk or uncertainty. But of course recently we have seen that, the Brexit challenges, the negotiations with Europe, have introduced high degree of political uncertainty.
We can see that in the way that bond deals are moving around in the UK. We can also say it translating into fairly lacklustre business investment, consumer confidence. Economic outlook is pretty benign. I think that will carry on for the next six months or so.
Hannah : Great, thank you so much Nick.
It’s often hard to understand the complexity of capital markets, but it is great to talk about how this actually has a significant impact on countries and economies and put a number behind the impacts.
Thank you for listening. If you would like to read more, you can access the full report at the URL in the description, and please subscribe for future podcasts.
Economist, PwC United Kingdom
Tel: +44 (0)207 212 8746
Senior Economist, PwC United Kingdom
Tel: +44 (0)20 7213 1579