Aurelia Butler

Last week, I discussed the dire financial situation of the poorest countries. This week’s “summit for a new global financing pact” in Paris offers an opportunity to deal with this challenge. It also offers a chance of making the investments needed for a transition to a low-emissions economy.This is the central point of a new paper by Avinash Persaud, who advised Prime Minister Mia Mottley of Barbados on the influential Bridgetown Agenda for the Reform of the Global Financial Architecture. In “Unblocking the green transformation in developing countries with a partial foreign exchange guarantee”, he analyses how to make sufficient affordable finance available for renewable energy projects in emerging and developing countries, an issue also considered in last year’s expert group report, Finance for Climate Action.Over the past 270 years, Europe and North America have contributed more than 70 per cent of the stock of anthropogenic greenhouse gases. This has also exhausted almost all of the planet’s carbon budget. But today emerging and developing countries generate some 63 per cent of emissions, a share that is bound to grow. It follows that there must not only be huge cuts in emissions, but a huge part of those cuts, particularly relative to trend, must be made by emerging and developing countries. To achieve this, investment in the green transition in these countries (other than China) needs to reach some $2.4tn a year (6.5 per cent of gross domestic product) by 2030.In high-income countries, 81 per cent of green investment is funded by the private sector. In emerging and developing countries, the private share is a mere 14 per cent. It is highly unlikely, even with a successful outcome to this week’s summit, that official external assistance will fill it either. As Persaud notes, “global expenditure on aid is less than one-tenth of the cost of the green transformation”. Moreover, “developing countries do not have the space on their balance sheets for the debt required even if they wished to finance it themselves”.The solution is to secure private finance for potentially profitable projects. which represent about 60 per cent of the needed investments, the rest being for such things as adaptation. The latter will not yield direct financial returns and so must be financed by official assistance. But, notes Persaud, even where projects are financeable, in theory, punitively high interest costs for private lending to emerging and developing countries are forbidding obstacles. Thus, for a similar solar farm, the average interest cost in leading emerging countries is a prohibitive 10.6 per cent per annum, against only 4 per cent in the EU.Yet, argues Persaud, the cause of this huge spread is not project-specific risk. A solar farm, qua solar farm, is no riskier in India than Germany. More than all of the risk premium represents market estimates of macroeconomic (specifically, currency and default) risks. He also argues that these risks are not just exaggerated, but cyclically so: in “risk on” periods, overpayment for insurance is smaller than in “risk off” ones.The paper calculates this by looking at the cost of hedging foreign currency risk. That is expressed in terms of the difference between the price of buying foreign currency with local currency in future (the forward rate) and today (the spot rate). This gap can then be turned into an annual percentage rate.The conclusion from the evidence is that markets are too risk averse: the risks are not as great as they fear. This is particularly true when the markets are at their most risk averse: on average, “overpayment” for hedges has been 2.2 percentage points when their cost is below the three-year moving average, but 4.7 percentage points when the cost is above its moving average.In sum, argues Persaud, we have a free lunch: a stabilising speculator could make money, while doing good, by removing the excessive risk premia.Why might such a free lunch exist? Investors might simply be uncomfortable with unfamiliar markets. They might also be unhappy with such volatile markets. Moreover, stabilising speculators have to take large contrarian positions over long periods. Financing such positions on the scale needed is risky: it is easy to run out of money long before the market sees sense. For such reasons, markets will persistently overprice the hedges.As Persaud puts it, “private investors are leaving money on the table. But even more significant are the far greater social gains from . . . boosting green growth in developing countries that are being left alongside.” This is a “planet sized” market failure.His proposal then is for a joint agency of the multilateral development banks and the IMF to offer foreign currency guarantees and pool currency risks. Projects could come to the guarantee agency from the MDBs. The guarantee agency could then prioritise projects that have the most significant positive impact on the climate. To limit risks of loss, the agency would wait until hedging costs were above the three-year average and so until risks are deemed large.In brief, this clever paper makes four points: first, macroeconomic risk makes climate projects unfinanceable in developing countries; second, the global climate challenge cannot be met if these projects are not financed on an enormous scale; third, markets exaggerate these risks, especially in bad times; and, finally, the expected gains of official intervention would exceed the costs, partly because so much is at stake.If you are not persuaded by this logic, what is your plan for financing the huge investments the world needs? After all, climate change will not be solved by investments made just in rich [email protected] Martin Wolf with myFT and on Twitter More

The philosopher Ice Cube once said “life ain’t a track meet, it’s a marathon”, wisdom that increasingly applies to UK mortgage borrowing.With 2-year rates on house loans topping 6 per cent in recent days, warnings of a mortgage apocalypse have been dominating the British press, a process that looks something like this:

(There’s an excellent piece on renters by mainFT’s Joshua Oliver here; we’re gonna talk about mortgages anyway.)FT Alphaville wrote about the Bank of England/gilt market side of this equation yesterday and last week, but the UK, it turns out, is endlessly fascinating. Here, via Moneyfacts, is the chart that launched a thousand takes:

It’s underpinned by this gilt yield chart (yoinked from explainer here):Which is underpinned by this chart of Bank of England rate expectations:

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Which is underpinn—hopefully you get it.The danger is that a chunk of Britons who locked in ultra-low-interest-rate mortgages a few years ago are now facing a massive increase in their repayment costs. Economists say the burden of this, because homebuyers are more leveraged than in the past, and because the shifts are proportionately larger, will be bigger than under the double-figure interest rate mortgage regimes of the past.Analysis by the Resolution Foundation think-tank says this could costs thousands of pounds extra for households:Annual repayments are now on track to be £15.7 billion a year higher by 2026 compared with prior to the Bank’s rate tightening cycle starting in December 2021 – up from a projected £12 billion increase at the time of the most recent Monetary Policy Report in early May. Annual repayments for those remortgaging next year are set to rise by £2,900 on average – up from £2,000.There are basically two imperatives at work here, one economic, one political:— A spike in mortgage rates will lead households to cut spending, resulting in repayment delinquencies and repossessions— A spike in mortgage rates will cause homeowners, many of whom like the Conservative party, to like the Conservative party lessThere’s an obvious a tension between those two factors. A version of the former is exactly what the Bank of England wants as it tries to cool the economy, as Capital Economics writes:Our own forecast is that rates will need to rise to a peak of 5.25%, rather than to 5.75%, to weaken the economy enough to reduce wage growth and core inflation to levels consistent with the 2.0% inflation target. But the risk is that the labour market remains resilient and interest rates need to rise further. Either way, the further rise in mortgage rates this week is a necessary part of the process.Whereas the latter — if the Tories are tempted into offering some kind of relief — could easily metastasise into an inflation-stoking policy (nb current UK leadership does not have an unblemished record on smart policy).Though direct support has been ruled out by Chancellor Jeremy Hunt, Citi’s Benjamin Nabarro says additional private support now seems likely:The government can exert considerable pressure on the banks here via threats on: 1) taxation or 2) reserve remuneration. With more homes owned outright, the main impact would likely be to slow transmission from interest burdens to house prices. With more homes owned outright, that may prove significant. The risk of mission creep is also significant. Fundamentally, any attenuation of monetary policy transmission risks a worse trade off for monetary policy…[Any] intervention here would put the UK on a dangerous path. By pushing back the house price correction in particular, this would add to the risk in our view of a further 25bps hike in September, as well as cuts only later in 2024.What’s to be done? Morgan Stanley reckons the rise in bank rate isn’t even that important, given the backdrop of falling prices elsewhere. In her preview of Thursday’s Monetary Policy Committee decision, economist Bruna Skarica writes:Bank Rate at 5%+ is less of a financial stability headache this year than in 4Q22, when a potential spike in mortgage payments came alongside a likely surge in utility bills too, implying, at one point, non-discretionary spending at unmanageable levels for a relatively large share of mortgagors. MS reckons households utility bills are likely to be about £500 per year lower at the end of this year than last. Skarica, cont.:[Mortgage] rates at these levels are painful – but not an acute financial stability risk . . . two-thirds of the outstanding mortgage debt is held by 30% of top income earners (they account for ~45% of all mortgage holders, and take out bigger mortgages). They have attained, on average, ~7% pay growth at the start of 2023. With mortgage rates at 6%, 90% of that improvement now has to be allocated to higher mortgage payments this year – compared to ~65% prior to the recent repricing in Bank Rate expectations. This is challenging even without taking into account increases in food prices, council tax, water and broadband bills. But repayment issues are only likely to arise for the bottom 20% of income earners with a mortgage, who account for 10% of households with mortgages, and for less than 5% of all outstanding mortgage debt. Long story short, the economy muddles through, the housing market takes a hit – especially with the squeeze in the buy-to-let market boosting supply – but financial stability risks look manageable . . .The recently floated media reports about some chance of MIRAS (mortgage interest relief) returning are another example of fiscal and monetary policy potentially working in the opposite direction.This is the brutal base case at the moment: the poorest households get crushed, but that’s the price you pay to slow the economy down. It’s Farquaad economics — but those homeowners should have fully educated themselves on epidemiology, quantitative easing and global supply chains before they dared expose themselves to rate risk.

It potentially misses some nuance, however. After all, pay more or don’t pay aren’t necessarily the only options available to borrowers reaching the end of their mortgage terms. As Pantheon Macroeconomics’ Samuel Tombs notes:. . . many borrowers also are lengthening the term of their mortgage when they refinance in order to limit the jump in monthly payments.Tombs has taken a deep dive into the Mortgage Lending and Administration Return data released by the Bank of England and the Financial Conduct Authority. [extremely clickbait voice] What he found will SHOCK you:Regular mortgage repayments have been remarkably stable. They equalled £5.0B in April, up only £304M, or 6.5%, on a year earlier and £424M from the end of 2021. The proportion of all households’ nominal disposable income absorbed by regular repayments has remained steady at 3.7%. This stability is surprising, given that the effective interest rate on the stock of mortgages rose to 2.76% in April, from 2.05% a year ago and a low of 2.01% in December 2021, when the MPC began to raise Bank Rate. Monthly regular repayments would have risen by £860M since December 2021, if households had simply rolled over their mortgages and accepted the higher repayments entailed by the rise in rates…In theory, households also could have switched to interest-only mortgages in order to mitigate the hit to their incomes when they refinance. But the Mortgage Lending and Administration Return shows that the proportion of new mortgages either fully or partially interest-only has declined to 19.2% in Q1—the lowest since records begin in 2007—from 23.2% a year ago. The MLAR data also show that missed repayments have risen only marginally, with mortgages in arrears accounting for only 3.9% of total loan balances in Q1, up from 2.8% in Q4 2021. Regular repayments in April were 8% lower than they would have been, if they had risen in line with the effective mortgage rate and nothing else had changed, so the rise in arrears can only explain a small fraction of persistently low repayments. By process of elimination, then, we can conclude that the only way households have kept their repayments down is by lengthening their mortgage terms when they refinance.Here are the charts:

This entire dynamic is underpinned by demographic shifts. The average first-time borrower, in 2021, was 36 years old and took out a 27-year loan: ergo, many people expect to be working and paying off their mortgage deep into their 60s. Tombs:Virtually all lenders now are willing to lend for 35-year terms and on the basis of repayments extending until someone is 75 years old, with some, such as Nationwide, willing to lend until the borrower is 85 years old. Accordingly, we still think that the blow to households’ incomes from mortgage refinancing will not be large enough to drive the economy into a recession, especially when the pressure on households’ incomes from higher energy prices is about to fade.If we are entering a period of structurally higher rates, this shift — to a preponderance that housing analyst Neal Hudson has called ‘ultra-marathon’ mortgages — could rapidly accelerate. Hudson highlighted the major problems this could cause in an April FT piece. Extract:Ultimately, the economic picture over the life of these 35-year-plus mortgages will be a major factor in whether first-time buyers have to run the full length of their mortgage terms — but the recent trajectory is far from reassuring. Hopefully, economic growth returns and wage growth continues. If they don’t, then we’re probably facing a more extreme version of the pre-pandemic housing market. Fewer moves, younger households stuck in homes that are too small, older households under-occupying family homes and a torrid time for all the parts of the economy dependent on turnover in the housing market.It’s a grim outlook, but looks increasingly inevitable for many households, who face a choice between multi-decade mortgages or handing their keys over to the bank. Given the latter option probably involves (re)entering even-more-FUBAR rental market, the choice seems pretty obvious. And as for the economic situation: oh well. More

LONDON (Reuters) – Cautious optimism in the developing world that wealthier countries and China had finally fixed the tortuous process of sovereign debt restructurings is fizzling again.Debt crisis veterans gave a weary thumbs up in April to plans to galvanize the G20-led “Common Framework” – a platform supposed to speed up and simplify the process of getting overstretched countries back on their feet.Though Zambia, locked in default for almost three years, does look to be making some progress, many of the thorny issues that have drawn criticism of the Common Framework remain.One is how China, now the largest bilateral lender to the developing world, swallows losses. Another is how much debt poorer countries can carry given ultra-low global interest rates are a thing of the past. The result is that countries trying to restructure their problematic debt have been left to negotiate bespoke arrangements in much the same way they did in the past.”There was optimism that a deal could be clinched relatively quickly,” said Cornell University professor and former head of the IMF’s China Division Eswar Prasad, referring to the April reboot of the Common Framework. “That optimism proved unwarranted.”Even news that Zambia’s public creditors are prepared to make a debt restructuring proposal, after the country had resorted to public pleas for urgency, was “unlikely by itself to signal a breakthrough in negotiations on the broader framework for debt restructuring,” Prasad said. G20 nations launched the ‘Common Framework’ in 2020, when the COVID pandemic upended nations’ finances. Nearly three years later, with Zambia, Chad, Ethiopia and Ghana all in the set-up, it is yet to chalk up a solid success.The core struggle has been how much debt countries need to write off, and coaxing China, after a decade-long lending spree, into debt talks that it views as designed by western powers. The April attempt to reform the Framework saw the IMF promise to share more information earlier, particularly regarding debt sustainability, and to give struggling countries more concessional finance. In exchange, the hope was that China would back down from demands that multilateral lenders relax their “preferred creditor status” and take loan losses.Others said it was far from clear that China had abandoned some of its tough requests, including that multilateral development banks take loan losses.Neither the People’s Bank of China nor China’s Finance Ministry immediately responded to requests for comment. In April, China said it was willing to work with all parties on the Common Framework but it has not commented publicly on the issue since then. “There was a bit of misreporting about a breakthrough,” said Kevin Gallagher, director of the Boston University Global Development Policy Center, adding there are also questions about how much concessional lending multilateral development banks can give. In a note earlier this month, analysts at JPMorgan (NYSE:JPM) said that despite “incremental changes” to the Common Framework, the core tensions remained, making debtor countries subject to it more reluctant to “preemptively pull the trigger” on restructuring.They estimate that the government bonds of 21 countries, with a combined value of $240 billion, are now at “distressed” prices.CREDITOR CLASHES Bringing China into the fold of the traditional Western-led “Paris Club” of creditor nations, and the “London Club” of private creditors like pension and hedge funds, has prompted enormous challenges. That high-profile friction has seen even U.S. Treasury Secretary Janet Yellen publicly accuse China of being a roadblock to deals. This has amplified fiscal pain for countries like Zambia, which has been in default since 2020.”I think they are all slightly fed up as they feel they’re getting trampled on — caught between a broader battle,” said Thys Louw, portfolio manager for emerging markets with Ninety One. Beijing issued some $138 billion in new loans between 2010 and 2021, according to the World Bank, making its sign-off essential as a condition to unlock IMF funds. Zambia owes China some $5.9 billion, roughly 23% of its GDP and close to half of the $12.8 billion of the external debt it is trying to restructure.Zambia even asked French President Emmanuel Macron to use his clout to help. ‘TANGIBLE’ PROGRESSThe IMF, World Bank and the G20 created the Global Sovereign Debt Roundtable (GSDR) early this year to fix the Framework and speed debt restructurings. The IMF said this month it expects “tangible” progress during June GSDR meetings. Louw said Ghana’s relatively speedy IMF staff-level agreement, and Zambia’s forward momentum were positive signs. “I do think we’re much closer now to understanding what’s required from everyone in the room,” Louw said. But until a widely accepted framework is in place, indebted nations are stuck in uncharted waters, slogging through each piece of their debt deals individually. And observers note that Ghana still faces the bigger hurdle of getting creditors to agree on new terms. “Very often people involved in these discussions let their optimism get ahead of the facts…and then once it comes down to brass tax, when people look at who’s going to take how much of a haircut, things start falling apart,” Prasad said. “I think it’s just going to be a grinding negotiation.” More

BENGALURU (Reuters) – The Philippine central bank will leave its key interest rate unchanged at 6.25% for a second straight meeting on Thursday and the remainder of the year as price pressures ease, a Reuters poll of economists found.Inflation has steadily decreased from a 14-year peak in January and slowed for the fourth straight month in May to 6.1%, although still well above the 2-4% target range.Bangko Sentral ng Pilipinas (BSP) Governor Felipe Medalla said on Monday that expectations inflation will fall below 4% before year-end is “a good reason to pause.”All 24 economists polled June 13-19 forecast the BSP will hold its benchmark overnight borrowing rate at 6.25% at its policy meeting on June 22.A strong majority of respondents, 14 of 17, forecast rates will stay at 6.25% for the rest of the year with the remaining three predicting a rate cut by end-2023.The central bank, which had previously closely followed the U.S. Federal Reserve in hiking interest rates, is now charting a distinct course.BSP Deputy Governor Francisco Dakila Jr. said last Thursday it may not move in complete lock-step with the Fed if domestic inflation warrants a different response.”What the BSP will be affected by is the fact that they will not start cutting earlier if the Fed remains hawkish,” said Shreya Sodhani, regional economist at Barclays (LON:BARC).”In later meetings if the Fed hikes, the BSP is likely to stay on hold. But when the Fed starts cutting, that’s when the BSP will start to again replicate what the Fed is doing.”The Fed kept interest rates unchanged at 5.00%-5.25% last week but signaled it may still hike by as much as half of a percentage point by end-2023.Among economists who had a longer-term view on rates, over 70% of respondents, 10 of 14, forecast the BSP will cut rates to 6.0% or lower in the first quarter of 2024, while the remaining four forecast rates to remain unchanged. More