Don’t you think the 21st century is more synonymous with Environment depletion, pollution and, degradation? ” A growing number of investors wish to make profits and do good at the same time. They want their portfolios, or part of their portfolios, to be “ESG” – that is to support environmental social, and governance causes.” With efforts taken to “GREEN” the financial system there lies the concept of GREEN BONDS. Source


In its most basic form Green Bonds function by generating funds from investors to develop environmental or eco-friendly projects, in which environmental outcomes are potentially achieved and then investors are paid with interests.


A capital and an energy-intensive company can use a green bond to fund the company’s use of WHRS (Waste Heat Recovery System). The WHRS harnesses waste heat from exhaust gases discharged in industries and converts it into a source of electrical energy. Over here use of WHRS has a prolonged cost saving which is linked to its bond repayment and meeting its environmental objective by minimizing carbon emissions.

Attaching Green Bond with Pay Performance?

There always has to be a third party when it comes to an enterprise undertaking sustainable objectives. In the example above the use of WHRS will require third party contractors who build infrastructure and install the technology. These contractors have the power to ensure that projects meet performance expectations, more than the company who administered the bond. The Bond issuer should link the WHRS contractor’s financial incentives to the bond repayment structure to ensure the achievement of sustainability through innovative ways and new technology.


“India has the potential to be a large market for green finance which will have a positive impact on both the Indian economy and environment,”

– India & UK working group on Green Finance.Source

A new green trading platform has been developed earlier this year as the Bombay Stock Exchange (BSE)’s international arm, INX India. GSM Green serves as a platform for fundraising and trading green, social, and sustainable bonds exclusively. 

“… with a dedicated green platform, issuers, investors and traders will find it more convenient to list and trade green, social and sustainable bonds,”

CEO V Balasubramaniam said. Source

Over the last few years, a lot of renewable energy companies have shown interest in issuing green bonds. Recently, Urja Global Limited has received approval to raise green bonds of up to $500 million to fund its environmental oriented renewable projects and Electric Vehicles (Evs). Azure Power Solar Energy Private Limited has also announced that it would issue a green bond offering of $350 million (~25 billion). The bond is expected to mature in 2024 with an expected US Dollar coupon of 5.65%. The Hyderabad-based Greenko group with a $950 million green bond, made its biggest contribution to the global green bond market.

Adani Green Energy Chief Financial Officer Mr.Ashish Garg said – ” We are excited that a platform like Global Securities Market with a dedicated green segment is being offered now at India INX in India’s very own International Financial Services Centre. This was a long pending gap and will encourage more green financing in the country.”   Adani Green Energy Limited (AGEL), the renewable energy arm of Adani Group has raised $ 362 million by selling green bonds with a tenure of 20 – years, the company informed exchanges on Friday i.e 4th October. The bond will bear interest at the rate of 4.625 percent a year, payable semi-annually. They will be listed on the Singapore Exchange Securities Trading platform. In August, Adani Green had signed an agreement with Essel Infra to buy its 205 megawatts (Mw) of solar assets for Rs 1,300 crore. The acquisition of 205 Mw of operating solar assets has strengthened Adani Green Energy as one of India’s major renewable power producers. Adani Green Energy is a forerunner for a potential dollar bond as Prime Minister Narendra Modi announced the more ambitious plans.


This is how AGEL stock prices got affected by the Green Bond announcements.


India has set a target to reduce the ’emissions intensity’ of its GDP by 33-35% by 2030 from the 2005 level. The Capital requirement is to be fulfilled primarily by the private sector. With the target investment of $370 billion on infrastructural development, a paper supporting notions of executives of the major Investment Banks stated that – 

“Indian government should think of providing tax incentives to mutual funds and their investors for investing in local green bonds. A debt fund where more than 80% of the assets are invested in green paper, can benefit from tax incentives for its investors – where effectively the tax rates are reduced from the current applicable tax rate on income arising from such investments.”



Firms that have adopted green bonds benefit from both positive financial and environmental outcomes. Green bonds have grown rapidly over the last decade. The green bond market is largely dominated by three countries. China with $83 billion worth of green bonds issued over the last decade. The United States with worth $58 billion and France worth $57 billion. India still lags behind these countries but is one of the fastest-growing green bond markets in Asia with worth $5.2 billion for the year 2018. Commentators often see green bonds as a promising tool to address climate change, following the issuance of green bonds companies can reduce their CO2 emissions and achieve a higher environmental rating.


Apart from “HOW DARE YOU” motions this is where we can contribute to creating a sustainable world.  Where our government can frame guidelines for mutual fund houses and insurance companies to encourage investments in green bonds as at present it has a limited investor base. With the pick-up in green bonds floating and annual issuance, a certain long-term minimum investment level can be encouraged or mandated. Where industries have an added advantage to take up environmental friendly methods of business, we end up minting GREEN. 


Radhika Sharma
Team Member-
Fixed Income
(M.Sc. Finance, NMIMS – Mumbai. Batch 2019-21)

Connect with Radhika on LinkedIn

CATASTROPHE BONDS – Fortune From The Disaster

Catastrophe Bonds simply were known as the “Cat Bonds” is a financial instrument where the issuer issues bonds for re-insurance against the natural disaster or a catastrophe. The insurance company issues bonds as collateral against the catastrophe insurance. Cat bonds have a high yielding feature with a duration of 2 years to 5 years. Cat bonds transfer the risk of insurance into the capital market.

History for development of cat bonds can be traced back in the 1990s when the claims filed by clients against hurricane Andrew couldn’t be acknowledged and the insurance industry suffered humongous losses. Many insurance companies that earlier provided catastrophe risks decided to leave the insurance sector and about eleven insurance companies filed for bankruptcy. Therefore, there was a need to cover the capital by catastrophe insurance-linked bonds.

Working of the CAT Bond:

As this bond transfers the risk from insurance company to the financial markets. The amount which is pooled out from the investors is transferred to the Special Purpose Vehicle (SPV). There is a reinsurance agreement between the SPV and the insurance company which dictates the terminology and clauses for the amount to be paid during the catastrophe. The SPV invests it into the capital market and to manage the security. The returns from the financial market are further passed to investors of cat bonds. They are mostly invested in money market instruments with low risk. They are high yield debt instruments. These SPVs fulfill the claims of the risk carrier i.e. insurance company if any catastrophe occurs or as the terms of an agreement are fulfilled.

For instance, a family living in Florida where hurricanes are most likely to happen they approach for Hurricane insurance from the General Insurance Company. The insurance company will provide such insurance since they get good premiums but still hang back because if the hurricane occurs they will have to pay a huge amount as indemnity. The solution to the problem is by issuing cat bonds they won’t incur huge losses. If the event is not triggered at the maturity then the collateral account by SPV will be liquidated and the proceeds will be returned to the investor. But if the event triggers then the collateral is liquidated where some or all the proceeds are passed on to the sponsor.

Figure 1: Process of CAT Bonds

Investor’s Perpective:

A cat bond is a lookalike corporate bond with a pre-determined coupon rate. These bonds are not related in any way to the global markets. A financial crisis has nothing to do with the trigger of a natural disaster or catastrophe. They are built on floating rates notes where the investor benefits the return not only from the risk premium of the cat bond sponsor but also the returns from the money market where the pooled amount is invested. Since these bonds are not linked with capital markets, investors view such bonds to diversify their portfolios to minimize the risk related to markets. Over the years the cat bonds have shown great growth and seemed to be a lucrative investment option. Performance of cat bonds Index, Insurance-Linked Securities-Hedge Fund (ILS-HF), Equities and Bonds Index is shown below. Figure 2 to Figure 4 shows why cat bonds are considered to diversify their portfolio and have been alluring over the years.

Figure 2: Performance of Cat Bond Index versus other Financial Instruments Index










Total Return










Annualized return





Sharpe Ratio





Figure 3: Comparing Returns and Volatility ( Source )








Cat Bond Index*





ILS HF Index**















Figure 4: Correlations ( Source )

Benefit for the Economy:

It is next to impossible to bear the shock of catastrophe alone by the insurance companies. The financial markets are stronger and capable to bear the economic effect of the catastrophe. So, to benefit the quantum of financial markets for the effect of catastrophe, was when the establishment of catastrophe bonds came into existence after Hurricane Andrew 1992.

The use of cat bonds is mainly to protect and manage risk associated with the disaster. The development of cat bonds is growing rapidly over the years for developing economies as well. Countries and regions in the risk-prone areas are many a time not insured or is backed by government funding for the upliftment of the economy.

This new insurance-linked product has led the World Bank providing a framework for the same known as the “MultiCat Program”. This has given aid to Mexico’s Caribbean islands to issue cat bonds by structuring themselves using the framework provided by the World Bank. The intrinsic value of these bonds is to provide for the recovery of the loss incurred and transfer the risk to those willing to take the risk. Financial investors have turned around to this investment option as an asset class with higher returns and low or no correlation with the financial markets. But today cat bonds are proving themselves as a social-driven investment instrument and new breed for this cat bonds are coming are known as the pandemic bonds which will help to combat the life-threatening diseases.

Indian Scenario about Cat Bonds:

When the world is booming and progressing on different financial products India cannot step back but indeed tries to be in the race. Yes, it is trying to come up with the debutant of its cat bonds in the Indian Economy. General Insurance Corporation of India (GIC), is the country’s foremost reinsurer that has come upon the thought of issuing cat bonds on the wakeup call of the Uttarakhand floods in 2012. GIC had to pay approx. 2000 crores of claims settlement from their treasure chest. E.g. If GIC issued cat bonds worth 1000 crores in 2011 with the maturity of three to five years, on triggering of the event they would have to shed only 1000 crores.

India being a developing economy, many parts of the country are risk-prone areas like aforesaid floods, cyclones, landslides and very rare symptoms of earthquakes in the regions of Rajasthan, etc. Let’s assume India agrees to pay at 12% – 14% coupon on cat bonds in India, it would likely get the subscription of Pension Funds, Hedge funds or high net worth individuals since they are attracted to benefiting from high-interest yields over the short tenure of the bonds. The government should try and come out with such bonds and mitigate the losses for its own.

Thus, Catastrophe Bonds a savior to the economy by passing on the risk to the risk bearing financial investors.

Lorretta Gonsalves
Team Member- Alternate Investments (M.Sc. Finance, NMIMS – Mumbai. Batch 2019-21)

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The Curious Case of Quiescent Inflation & Negative Yielding Junk Bonds

One of the most important questions being asked in financial media today appears to be, “Is the Phillips Curve Dead?”

Before I go jump into the analysis of whether that is the case and what impact will it have on the future course of monetary & fiscal policy, let me give me a brief explainer about the concept of The Phillips Curve.

A.W. Phillips stated that there was a trade-off between unemployment and inflation in an economy. He implied that as the economy grew, unemployment went down, this lead to tighter labor markets. Tighter labor markets warranted higher wage increases. Companies, in order to maintain their margins, would pass this higher input cost to the consumers which would then be reflected in the CPI (Consumer Price Index- a gauge of inflation) that we refer to.

You could say this was the case before the 1980s, however, since then, the relationship between the two seems to have hit a “rough patch” or flattened out.

Source: Bank for International Settlements (BIS)

The above chart regresses PPI Inflation (%) with the growth in Unit Labour Costs (%). As defined by OECD,

“Unit labor costs (ULC) measure the average cost of labor per unit of output and are calculated as the ratio of total labor costs to real output.

A rise in an economy’s unit labor costs represents an increased reward for labor’s contribution to output. However, a rise in labor costs higher than the rise in labor productivity may be a threat to an economy’s cost competitiveness, if other costs are not adjusted in compensation.”1

Just from the chart, one can infer that the slope of the regression, R2 or the link between PPI inflation and ULC growth has flattened significantly when you compare the data pre and post 1985.

Hence, I would like to devote a major portion of this article on exploring the structural changes in world economies that have led to this compelling phenomenon.

Lower bargaining power emanating from a declining share of income that accrues to labor

  • A June 2018 research paper titled, “Productivity and Pay: Is the link broken”2 suggests, that post-industrialization (or since the 1980s), median compensation grew by only 11% in real terms, and production workers’ compensation increased by a meagre 12%, compared to a 75% increase in labor productivity. Since 2000, average compensation has also begun to diverge from labor productivity.
  • Apart from the weaker link between the above two variables, the continued sluggishness in wage growth can largely be attributed to productivity growth being far weaker than it was before the crisis.3

Globalization & The Threat of Production Relocation

  • The increased integration of production and complex supply chains connecting advanced economies with emerging market economies, outsourcing along with the relatively smooth and easy flow of money and information across borders have forced workers in rich countries to compete with those in poorer ones
  • The IMF World Economic Outlook (2017) attributes about 50% of the fall in labor share in developed economies to technological advancement, with the fall in the price of investment goods and advances in ICT encouraging automation of routine tasks

Declining Path of Unionisation

As unionization declines, the collective bargaining power of employees starts diminishing. For example, in the United States % of employees enrolled in a trade-union membership has steadily declined from 20% to 10% over the past few decades.

This makes it more difficult for the workers to capture a larger share of the productivity gains enjoyed by the firm as a whole.

Hence, we observe that wage growth in real terms has hardly seen a meaningful increase.

The shift from manufacturing to service economies and the era of automation

  • With the heightened contribution of artificial intelligence and automation in the manufacturing process, firms are able to substitute labor with capital and even the high-quality blue-collar jobs are at stake.
  • From an economic efficiency standpoint, it makes sense for a firm to get more work done for the same or lower cost than to waste resources in hiring and training employees. This could partly explain the delinking of productivity and wage growth.
  • With global PMIs crashing into contraction territory across the world economies due to a host of factors such as dollar strength seen in 2018 (80% of global bank trade credit is denominated in dollars), uncertain CapEx or investment environment due to trade wars among others, we have seen consumption stayed relatively resilient.
  • This may be partly attributed to the transition of economies reliance from manufacturing to services, as a result, the share of employment in services has also jumped in recent years.

Quantum Pricing & Long Term Inflation Expectations

  • The traditional theory states that wages are stickier than prices. If so, profit margins should ideally rise if demand increases. However, after studying firm-level behavior we observe that they tend to abstain from margin expansion for the sake of higher market share. Also, firms unable to generate sufficient sales tend not to reduce prices proportionately to avoid losing cash to meet their rising debt and interest burdens (which explains why we saw inflation falling less than expected during the GFC).
  • Firms have since been engaging in “Quantum Pricing” where firms may change the quality or composition of their products to adjust for production cost volatility instead of increasing prices across the board. This, in turn, makes prices stickier while keeping margins stable. It becomes increasingly complex for mainstream macroeconomic models to capture such structural shifts in pricing affecting inflation.4
  • In a nutshell, all the above factors along with weak cyclical pressures drag longer-term inflation expectations lower (as observed by the 5Y5Y forward breakeven inflation, etc). Lower expectations through their negative feedback loop anchor inflation lower to some extent.5

Low Rates, Asset Price Inflation & The Lure of Negative Yields: Glimpse

Markets have set their expectations in stone for rates being “lower for longer” due to the inflation dynamics stated above, secular stagnation going forward and maybe even price level targeting by central banks.

In an environment where markets will pounce on anything with a positive real yield, there may be a real risk of financial instability arising from irrational bidding of risk assets which cannot be more prominently observed than from the negative-yielding junk bonds.

You are essentially paying companies with significant credit risk for (the privilege of) borrowing funds from you!

It may sound absurd but what if I tell you that this negative-yielding Japanese/European debt may in certain cases provide you with a dollar yield that is even higher than the positive yield that you get in treasuries? In other words, (for example) -0.1% (¥) > 2.5% ($)

I shall follow up on the mechanics of how this kind of sorcery is possible (along with the risks associated with the same) in part II of this article.


  1. Retrieved from
  2. Stansbury, A. M., & Summers, L. H. (2017). Productivity and Pay: Is the link broken? (No. w24165). National Bureau of Economic Research
  3. IMF World Economic Outlook, April 2019
  5. IMF Blog “Euro Area Inflation: Why Low For So Long?”
Harsh Shivlani
Team Leader– Fixed Income & Derivatives
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Harsh on LinkedIn

Japanification of the Eurozone Bond Market: Navigating Through Negative Yields

Is the Eurozone heading towards a fate similar to Japan with sticky disinflation, negative interest rate, asset purchase extravaganzas? Can we still generate positive returns from the European sovereign credit markets with relatively low risk, in such a negative yield environment wherein almost 14.63% of bonds have a negative Yield to Maturity (YTM) (Out of which 73% of negative YTM bonds have been issued by Western European countries such as Germany, France & by Japan in Asia)?

Source: Barclays, PIMCO
Source: Barclays, PIMCO

Active management of bond portfolios can help us effectively navigate through this negative yield environment and generate better than expected returns on our investments. In order to select the optimal active bond management strategy for the European sovereign credit market and to learn how we as investors can leverage the same, we need to understand the fundamentals of the economic prospects of the nations in the Eurozone and how they might be in the same boat as the BOJ.

Eerie Similarities

The “Disinflation” Era:

Annualized Inflation Rates (Japan: 0.3%; Europe: 1.6%; Target: 2%): Bloomberg

Both the European Central Bank (ECB) and the Bank of Japan (BOJ) are struggling through sticky disinflation with the CPI (Consumer Price Index) undershooting their 2% target for most of the past decade. In order to prop up inflation to healthier targeted levels of 2%, the BOJ & ECB both have implemented numerous & sometimes even outrageous policies which sound absurd at first such as negative interest rates, asset purchases (equity & debt), loans at ultra-favorable terms & last but not the least the “Yield Curve Control” by the Bank of Japan (BOJ).

Let’s dig a little deeper to understand how these policies affect the European credit markets and how can use them to structure our trade.

“I want to borrow money & want you to pay me for the same”

If I came to you with the above proposal, you would probably think I’m crazy to even think about it. For years, economists and central bankers have had to deal with the problem of Zero Lower Bound (ZLB) on interest rates, which in turn restricts the extent to which central banks can stimulate the economy by managing monetary policy by navigating interest rates.

To counter this problem, Haruhiko Kuroda (Central Bank Governor, BOJ) & Mario Draghi (President, ECB) implemented this novel idea of “negative interest rates”. Negative interest rate here refers to the deposit rate i.e. the return banks get on their excess reserves (IOER) parked with the central bank. The whole motive behind this move was to disincentive banks from holding excess reserves and extend more credit to the economy. They expected this policy to amplify expenditure, wages and hopefully inflation. However, due to ageing demographics, low business confidence, lower credit demand growth and shrinking bank margins, inflation expectations have been consistently anchored below targets.

“Sir, what would you like to buy today? Japan, please”

Since negative interest rates were struggling in the background, the central banks started buying financial assets such as equities & bonds from the secondary market in order to inject liquidity. The expectation was that if the central bank buys bonds from investors, investors will expend the cash received and there will be scope for higher inflation through higher spending as they likely won’t invest the proceeds in negative yielding instruments available within the country.

Balance Sheet as a % of GDP: Bloomberg

With these expectations, the BOJ (yellow) ballooned its balance sheet away to as much as 100% of GDP! ECB’s assets as a % of GDP (white) have also jumped from 20% to 40% in the last decade. So while the ECB and BOJ were filling the glass (economy) with their rich milkshake (money), the Fed (green) decided to switch off the tap and replace it with a straw. In other words, most of the liquidity or money injected through the above policy measures found itself gravitating towards the US which officially stopped it’s balance sheet expansion and in fact started to “normalize it’s balance sheet”, effectively withdrawing liquidity. This lead to lower spending in the European economy and thus a muted inflation print. The phenomenon is also known as the “Dollar Milkshake Theory”, but that’s a topic for some other post.

“Are you a control freak? BOJ is.”

So in order to have control over the yield curve (which in turn heavily affects borrowing costs and thus spending & economic activity through credit demand), you’ve flirted with negative interest rates, went on an extravagant asset purchase spree, but nothing worked. So what do you do now? You not only control short term borrowing costs but also the long end of the yield curve. BOJ anchored the short end around -0.2% and the long end around 0% with a +/- 0.1% range by claiming to buy unlimited quantity at the upper end, to keep interest rates low for long. They expected this to maintain the steepness in the yield curve which could help soothe banks’ declining margins as they could now lock in a better spread. It would also support asset prices and build consumer confidence.

Japanese & German Yield curve: Bloomberg
ECB’s Capital Key: % Allocation Breakdown (Source: ECB website)

Now since Draghi has been following the footsteps of Kuroda and is probably in the same boat as him, he also might consider pulling a YCC trick out of his hat considering the end of his asset purchase program in December 2018. He even announced the launch of TLTRO-III (Targeted Longer Term Refinancing Operations) in the March 7, 2019, monetary policy review. Both of which, could help maintain an upward sloping yield curve and low yields.

The biggest beneficiaries of the asset purchase program and TLTROs are usually the nations which have the highest holding the ECB’s capital key with Germany, France, Spain & Italy being the top contenders.

For those who aren’t aware of the TLTRO program, here’s a brief explainer from the ECB website.

Since Germany is going to be one of the biggest beneficiaries of TLTROs as mentioned earlier, we can expect further easing in the nation, while interest rate risk from hikes seems to be subdued for the rest of the year. (Interpreted from the market-implied probability of interest rate changes).

Since the setup for Germany is ready now, considering soft inflation, low-interest rate risk, upward sloping yield curve & negligible credit risk (AAA rated), we can employ a strategy known as “Roll Down” or “Rolling down the yield curve” to enhance our returns within a short horizon of 1 to 3 years rather than just blindly accepting a 0% or even negative YTM on short-dated bonds by just holding them till maturity.

The strategy involves the purchase of a bond with a maturity in the higher yielding section of the yield curve and selling the bond prior to maturity when it reaches a lower yielding section.

Riding the Yield Curve (Source: Bloomberg, Balance Sheet Solutions)

The strategy can benefit investors by providing:

1. Higher incremental income: Purchasing bonds with a higher current yield

2. Higher capital appreciation through liquidation: Depending on the characteristics of the bond, a capital gain or reduced capital loss

3. Diminishing bond price volatility: As the bond moves close to maturity, the duration (interest rate sensitivity) of the bond also reduces.

In order to demonstrate how effectively this strategy has played out in the past one year on the German Sovereign curve, we need to discover the steepest section of the yield curve as on 10th March 2018, which we shall roll down from.

German Sovereign Yield Curve as of 10th March 2018 (Yellow) & 10th March 2019 (Green): Bloomberg

Just from eye-balling, we can deduce that the 5Y Yield at 0.008% and 4Y Yield at -0.23% seems to be steep enough for our strategy. So according to the strategy we buy the 5Y German Bund on 10th March 2018 with a YTM of 0.008% and 0% coupon at a price of €99.958.

5Y German Sovereign Bund, OBL 0 04/14/23: Bloomberg

In our base case, considering no change in rates across the curve, the yield on this bond should slide towards -0.23% leading to a price appreciation of €0.992 or 0.9924% within a span of one year. However, due to changes in the yield curve, we may incur capital gains/losses. In our case, it is observed that the yield on the new 4Y German Bund has moved down further to -0.44%, leading to a total price appreciation of €1.86 out of which as we calculated earlier €0.992 is attributable to the roll down effect and the rest €0.87 gain is on account of the yields moving down.

German 5Y to 4Y Bund Price Movement (OBL 0 04_14_23): Bloomberg

Adversely, yields could move higher if global growth picks up and inflation/IIP data delivers a shocker. We can model these scenarios for the next year by estimating the volatility of interest rates and running a sensitivity analysis of our total returns to these yield curve changes. This interest rate risk can then be effectively hedged with Out-of-the-Money (OTM) interest rate options, thus, locking in an effective gain of close to 0.9924% (after deducting the option cost).

Strategy’s sensitivity to interest rate changes (Source: Bloomberg, Author’s calculations)

As we’ve seen with this example, it is possible to generate positive returns that outperform the broader market by playing with the yield curve dynamics. As they say, it’s all about finding positivity (returns) when you are surrounded by negativity (yields).

Note: This information has been provided by Harsh Shivlani (Department Head, Fixed Income & Derivatives, Finvert) and is for informational purposes only. It is not intended to provide legal, accounting; tax, investment, financial or other advice and such information should not be relied upon for providing such advice.

Harsh Shivlani
Team Leader– Fixed Income & Derivatives
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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Pakistan’s Rupee Devaluation of Little or No Avail

Pakistan’s fiscal and monetary conditions have only worsened in the past few years leading to the devaluation of the currency by as much as 15% YTD (2018).

Let’s look at a few charts that matter:

When a country devalues its currency their goal is to spur export growth by making their goods & services cheaper and curtail high imports.

However, in case of Pakistan, the imports have remained elevated and exports have slowed down considerably even in the event of devaluation.

Post devaluing the PKR 3 times this year (2018), the imports have remained stubborn at 676 PKR billion whereas exports plunged from around 250 odd PKR billion to 224 PKR billion, down to pre-devaluation levels.

As a result, the country’s CAD or Current Account Deficit has deteriorated to unhealthy levels, the lowest since 2010.

Maybe we owe this divergence in import-export to the so called Michael-Lerner Equation & the J curve effect?

The concept states that currency devaluation’s initial impact is a worsened BOP as there’s usually a lag between the pickup in exports (drop in imports) and devaluation.

The economy takes some time in order to structurally shift and realize that the imports are now expensive (so reduce them) and the exports are cheaper (so importing countries find it attractive and import more).

Whether Pakistan’s exports are still competitive considering its peers is another question.

Now the natural impact of this is on the FX reserves, which have dropped sharply amid rising oil imports, lower FDI, higher debt burden, rising US interest rates and the list goes on. (with the China CPEC also putting a strain on the country’s BOP)

Here’s a chart by Bloomberg:

Although, the condition is not as worse as in Argentina, Turkey and the like where the outflows have been much higher, this is also worth noting.

Here you can observe that the FX reserves have been declining consistently and have almost halved from their 2015 peak of around $24 billion to around $15.9 billion currently, reducing their import cover.

Pakistan’s real reserves have dropped below the level reached when the country approached IMF the last two times for a bailout, according to Bilal Khan, a senior economist at Standard Chartered Bank Plc. With elections scheduled for July 25, the next government will need to approach the IMF as a “matter of urgency,” said Khan. (Source: Bloomberg) This has thus, lead the State Bank of Pakistan (SBP) to hike rates by almost 100bps (175bps YTD).

Will this able to reverse the flows, reduce CAD (Current Account Deficit) and stabilize the economy with the backdrop of vanishing dollar liquidity and tightening monetary conditions across the globe? Maybe not.

Will we look at an International Monetary Fund (IMF) bailout? IMF is largely influenced by the US and with the on-going tensions between Washington and Beijing; an IMF bailout will be a less likely option for Islamabad.

President Trump probably believes that it would not be in the interest of US tax payers (whose money is being used to fund the IMF) to bailout the Chinese bond holders who have lent money to Pakistan for their ambitious BRI (Belt & Road Initiative) and CPEC (China Pakistan Economic Corridor) projects.

Harsh Shivlani
Team Leader– Fixed Income & Derivatives
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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Empirical Study of Credit Rating versus Credit Spread

Government bonds are subject only to interest rate risk. However, corporate bonds are subject to credit risk in addition to interest rate risk. Credit risk subsumes the risk of default as well asthe risk of an adverse rating change. In this empirical study, we analyze credit rating migration versus yield spread of the bond in US corporate bond market to bring about greater understanding of its credit risk.


The data for this study consists of ratings of the corporate bonds of US corporate bond market given by S&P Global Ratings and credit spread mentioned under description of the security on the Bloomberg Terminal.The sample consist of 15 corporate bonds issuer companies which have defaulted.


Small sample size (Representative Bias)- The sample size for the study is limited to 15 instances of corporate bond default and hence the conclusion cannot be generalized.


One data set focused on the latest available spread of the defaulted US Corporate Bonds. Second data set focused on the before and after credit rating of those defaulted bonds. Both data sets were studied in comparison to figure out which set of data was more predictive of default.

One data set focused on the latest available spread of the defaulted US Corporate Bonds. Second data set focused on the before and after credit rating of those defaulted bonds. Both data sets were studied in comparison to figure out which set of data was more predictive of default.


Following rating grades by Standard & Poor’s are used for analysis:


Following table shows the changes in credit rating and latest credit spread of sampled 15 corporate bonds which defaulted for either of the reasons mentioned as under:

  1. Missed interest or principal payments: 33% of the sample
  2. Debt/distressed exchanges: 20% of the sample
  3. Chapter 11 and Chapter 15 filings–along with foreign bankruptcies—together: 40% of the sample
  4. Unknown: 7% of the sample


The sampled data set reveals that:

  1. All defaulted corporate bonds have the credit spread of 400 bps or more
  2. The ratings of 75% of the bonds were changed to D (Default) on the day or within few days after its default
  3. All the Ratings lie in the ‘Speculative Grade’ defined by S&P Ratings
  4. Following table summarises the data of credit spread (in bps) and credit ratings of the respective sampled bonds. From blue to red bands, the credit rating decreases. Therefore, red signifies that even though the bond rating was relatively better, the bond defaulted 


From the observation of historical defaulted bonds, it can be said that bonds with wider credit spread are most likely to default. Using these findings for currently traded U.S. corporate bonds mentioned in the above table, it can be concluded that Mohegan Gaming and Acosta Inc. may default. (As on 3/29/2018)

Durga Jadhav
(M.Sc. Finance, NMIMS-Mumbai
Batch 2017-19)

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Gauri Gotaphode
(M.Sc. Finance, NMIMS-Mumbai
Batch 2017-19)

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