should mexico issue diaspora bonds?

SHOULD MEXICO ISSUE DIASPORA BONDS?

Policy Memo to the Ministry of Finance in Mexico, Dr. Ernesto Cordero

Dileimy Orozco Fabio Sola

Sergio Vera

1.  Diaspora bonds: idea and rationale

2.  Why Mexico?

The Emigrants: a)  Importance b)  Potential market for diaspora bonds

The Government: a)  Attraction of diaspora bonds

3.  Implementation challenges a)  Expansion of banking services b)  Marketing strategy

4.  Policy Recommendation

  Definition: debt instruments which are denominated in hard currency,

addressed to the diaspora (ownership restriction)

  World Bank: “attractive vehicle for securing a stable and cheap source of

external finance”

  Main examples: Israel (since 1951), India (since 1991)

  In recent years others (Lebanon, Sri Lanka, Ethiopia, Philippines), also planned

by Greece

1. Diaspora bonds 2. Why Mexico? 3. Implementation challenges 4. Policy Recommendation

Relevant facts:

  Increasing importance of international migration: more than 215 million people (3 percent of the world population) live outside their country of birth

  Remittance flows have become an important source of external financing in many developing countries ($325 billion in 2010) - more than official development aid

Rationale:

  Innovative way of tapping into the diaspora’s wealth accumulated abroad

  Potentially cheaper source of borrowing, possible reasons:  patriotism (Kethar and Ratha, 2010)   lower default risk (Gande and Puri, 2002)   lower default costs

  lower renegotiation costs   bigger value of the collateral (domestic currency)

  Attractive alternative investment opportunity for the diaspora


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China- United States Phillipines - United States

Afghanistan - Iran, Islamic Rep

India- United States Puerto Rico - United States

China- Hong Kong SAR, China

India - United Arab Emirates Turkey - Germany Bangladesh - India

Mexico-United States

  Mexico - United States is the largest migration corridor in the world (destination for approximately 97% of Mexican emigrants)

  The remittances to Mexico have become a significant source of external inflows, and are the second largest source of external finance after oil, surpassing FDI

Source: Migration and Remittances Factbook 2011

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5,000

10,000

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35,000

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96

1997

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98

1999

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00

2001

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02

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20

04

2005

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06

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20

08

2009

FDI ODA

Portafolio Equity Remittances

Source: World Bank Indicators database


where:

DiasporaStockij = number of diaspora members from country i residing in destination j si = average propensity to save ωj = share of diaspora in the working age group yij = average earnings of the diaspora members in the working age

In order to address the potential for diaspora bonds, the World Bank has developed a methodology to estimate the diaspora savings of developing countries (Ratha and Mohapatra, 2011):

DiasporaSavingsi = Ʃj DiasporaStockij * si * (ωj * yij)

Source: Migration and Development Brief, 2011


Main assumptions:

a)  Share of emigrants of working age (15-64) is similar to that of the country of destination

b)  Average migrant income:

•  High skilled = average US household income

•  Low skilled = 35% of average US household income

c)  Propensity to save of migrants = 20% (average saving rates of developing countries)

  Based on the World Bank calculations, Mexico has highest diaspora savings of all developing countries (46.9 billion USD)

Source: Migration and Development Brief, 2011


However, there are two main flaws in the World Bank approach that lead to an overestimation of the potential market:

  The assumption that all remittances are considered as potential savings

  The largest fraction of remittances is used for consumption

  In Mexico, 91 percent of remittances are used for consumption (MMP 2008*)

  Standardization of the assumptions to make the analysis comparable across countries

  Important to consider country specific data regarding the determinants of migrants income and savings (e.g. education attainment, wage, occupation, marital status, duration of the trip)

* Mexican Migration Project 2008.


* The MMP provides reasonably representative data on authorized and unauthorized Mexican immigrants in the United States (Amuedo-Dorantes, Bansak et al. 2005)

Diaspora stocks

Diaspora income

Savings in host country

Consumption in host country

Remittances

Consumption in origin country

Potential market for

Diaspora Bonds

Savings in origin country

Alternatively, by using the Mexican Migration Project (MMP) survey database 2008*, which captures country specific characteristics, we estimate a more conservative potential market which only considers part of the remittances as savings:

DiasporaSaving = DiasporaWorkingStock * (AnnualizedSavingsHostCountry + AnnualizedSavingsOriginCountry)

8.3 USD billions


  Comparatively, both the World Bank and the conservative estimates of potential market represent an important amount of resources in the case of Mexico

WorldBankEs-mate

46.9USDbillions

Conserva-veEs-mate

8.3USDbillions

Aspercentageofmaineconomicindicators2010

GDP 4.5% 0.8%

NetPublicDebt 16.8% 3.0%

CurrentAccount 824.3% 145.9%

RemiHances 220.5% 39.0%

FDI 264.6% 46.8%

Aspercentageofgovernmentbudget2011

Infrastructure 635.2% 112.4%

Educa-on 238.0% 42.1%

SocialDevelopment 683.5% 121.0%


  Diaspora bonds are commonly considered a stable source of finance to overcome financial constraints and to raise resources for development

  Although Mexico is experiencing a relatively stable economic environment, with a declining trend in its public debt and a moderate deficit…

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35.5

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36.8

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42.5

45

2006 2007 2008 2009 2010 2011

**


  …the gap between the US and Mexican interest rates opens the opportunity for the government to make diaspora bonds a profitable savings instrument for the immigrants

  And, at the same time, a potentially cheap government source of financing

  The return of the bonds could be similar to the shortest-term domestic Mexican bonds (Cetes), which are also the ones with the lowest return

  Additionally, as mentioned before, diaspora bonds could represent an attractive way of financing development goals (e.g infrastructure, education)

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3 years 5 years 10 years CETES 1 year


Other effects of diaspora bonds

By increasing the emigrants incentives to open a bank account:

  Contribute to overcome the emigrants low access to financial services and savings alternatives, gradually correcting a missing market

  Increase their savings by reducing transactions costs (in remittances and cashing cheques), and reducing the impulse to spend (by holding less cash)

  Chin, Karkoviata and Wilcox (2009) estimate that banked migrants increase their saving as a share of income by 9 percent and reduce their remittances to Mexico by 6 percent

  Shift the savings decisions to the emigrants

  The evidence suggest that emigrants have stronger preferences to save compared to their recipient households – 21% vs 3% of remittances (Ashraf et al. 2008)


  It is critical to extend access to financial services to the emigrants

  Even though the percentage of banked emigrants is low (20 percent in the early 2000s), there has been a significant change in the way they remit money

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51.5

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Personal Checks Wire Transfers Cash Money Orders

Source: World Indicators, World Bank.

  A key factor was the acceptance of the Matrícula Card as a valid ID to open a bank account in 2001, regardless of their legal status in the US

  Interestingly, Mexican emigrants have already experienced a change of financial behavior, moving from money transfer orders to wire transfers

→ higher access to and use of bank services.


A marketing strategy to reach the emigrant potential market will consider:

  Attractive bond characteristics

  Eligibility: restricted to Mexican immigrants living in the US

  Denomination: US dollars

  Low minimum investment

  Tenure: short term maturity

  Secondary markets: Brazilian experience

  Similar return to domestic bonds (Cetes) and higher than US Treasury bonds

  Possibility to cash the investments at any time in the US or Mexico

  Promotional campaign → not very expensive  Well established emigrant networks

 Use existing government infrastructure

  Banks in the US already targeting Mexican immigrants (e.g. Citigroup Inc., Bank of America Corp. and HSBC)


To sum up, the assessment suggests that the Mexican government should issue diaspora bonds

  Reasons:

  Increasing size and wealth of Mexican diaspora

  Attractive amount of potential savings that could be channeled to diaspora bonds

  Policy benefits:

  For the immigrants: less risky, cheaper and more profitable instrument

  For the government: cheap and stable source of financing

  Further policy effects:

  Contribute to correct market imperfections (increasing the access and use of bank services and savings instruments)

  Optimize the use of diaspora wealth in Mexico → decreasing the cost of remittances, increasing the wealth directed to Mexico and making it more productive


THANKS FOR YOUR

ATTENTION

should mexico issue diaspora bonds?

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