Prior to the start of the global crisis in late 2008, global imbalances, reserve accumulation and regulatory changes fostered greater cross-border integration of sovereign debt markets as measured by the share of government securities held by non-residents.
Today, this integration has reversed. Aside from safe haven flows, domestic investors are relied on to take up and roll over a larger stock of government debt (Presbitero et al. 2012). This resembles the situation in Japan since its crisis in the 1990s, where domestic institutional investors increased their share of Japanese government securities in their portfolios, compounding sovereign-financial linkages. Recent Eurozone policy changes have strengthened the trend in Europe (Wyplosz 2012).
In a new paper, I analyse the composition and evolvement of the investor base across the advanced G20 countries and the Eurozone (Andritzky 2012). The analysis shows that a ten percentage point increase in the share of bonds held by non-residents is associated with a drop in yields by about 40 basis points and higher volatility.
The investor base for government bonds: What are the facts?
A new dataset on the investor composition of government securities in advanced G20 countries shows a large degree of region- or country-specific patterns (Figure 1). Canada, the UK, and the US – countries with very deep financial markets and highly developed financial systems – exhibit a diversified investor base with significant holdings by all investor types. European countries (and Australia) show deep ties with non-resident investors. In contrast, Japan and Korea have a low share of non-resident holdings but sizable holdings of government entities and state-owned enterprises.
Figure 1. Holders of government securities in G20 advanced countries and the Eurozone
Source: Country authorities, IMF staff calculations
During the last decade, the share of non-resident holdings has markedly increased in all countries with the exception of Canada and Japan and often makes up the largest share of the investor base (Figure 2). Prior to the crisis, global imbalances and reserve flows were key factors behind the increase in non-resident holdings. Financial regulation further catalysed financial integration, for instance by applying a zero risk weight under bank prudential rules for all government bonds in the Eurozone.
Figure 2. Non-resident holdings of government securities
Sources: Country authorities, IMF staff calculations
Notes: 1/ Last observation refers to 2012; 2/ Last observation refers to 2002
The crisis has slowed or even reversed this trend. Reserve accumulation has ceased to act as the main driver of non-resident government bond holdings for reserve currency issuers. In other, riskier markets, the crisis triggered a marked pullback of foreign investors, repeating the typical pattern of increased home bias in the aftermath of crises. As result, non-resident holdings have stagnated in many countries, and have fallen in Greece, Ireland, Portugal, and Spain. The recent tightening of prudential rules may have cemented this development.
As a flipside to international financial integration, the share of government securities held by domestic accounts (which are dominated by financial institutions) decreased prior to the crisis. Banks’ portfolio allocation towards government securities was traditionally low in market-based financial systems such as the UK and the US (Figure 3). In more bank-based financial systems of the Eurozone (and Canada), banks traditionally held a larger share of their assets in government securities. However, in countries where financial systems deepened significantly or credit booms took place, such as in pre-crisis Greece, banks’ portfolio share of government bonds dropped dramatically.
Figure 3. Share of domestic government security holdings in financial institutions
Sources: Country authorities, ECB, OECD, IMF staff calculations
Notes: The category 'other financial institutions' is used for countries where a breakdown between non-bank financial intermediaries and private insurance and pension funds is unavailable. The central bank is included in 'banks' for Spain, and in 'other financial institutions' for Greece. No data other than for banks are available for Germany. Total unconsolidated assets are from annual OECD data. Latest data is for 2010 except for Germany and France (2009).
Mirroring lower non-resident flows, financial sector holdings rose in many countries in the post-crisis period, which is marked by deleveraging, flight for safety, and higher government financing needs. The future outcome could possibly resemble the development in Japan over the last decade where increasing government debt and financial sector restructuring has lead to a sizeable concentration of sovereign exposure in the financial sector. As a result, financial stability becomes closely intertwined with the stability of the government bond market.
Does the investor base matter for bond yields?
Specific drivers affecting the composition of the investor base have been found to correlate with bond yields, such as quantitative easing (Krishnamurthy and Vissing-Jorgensen 2011), reserve accumulation (Beltran et al. 2012), home bias (Fidora et al. 2006), or pension fund regulation (Greenwood and Vayanos 2009). The database by Andritzky (2012) facilitates estimations of the relationship between investor base and yields in a larger sample of 13 advanced countries independent of specific policy changes or trends. Empirical analysis shows a significant negative correlation between changes in the bond yield and the share of securities held by certain investor groups. For instance, an increase in the share of securities held by non-residents by ten percentage points is associated with a decline in yields of 32 to 43 basis points, and up to 66 basis points in the euro area. For domestic institutional investors, the effect is somewhat smaller at about 26 basis points and less robust. The data thus lend support to the notion that larger non-resident, and also institutional investor holdings, are associated with lower yields. There is also some evidence that the volatility of yields increases with the share of non-resident holdings, which are perceived to be less 'sticky'.
However, the relationship between non-resident holdings and yields does not establish a causal relationship. While the arrival of non-resident buyers, for whom foreign bonds may offer a diversification benefit, is often associated with a drop in yields, it could also be low stable yields based on sound macroeconomic fundamentals that attract foreign buyers. Granger causality tests show a multifaceted lead-lag relationship between changes in holdings and yields. Using a VAR analysis, Andritzky (2012) finds no significant evidence for non-resident investors pushing down yields, while the effect of falling yields attracting foreign buyers dominates the joint sample.
The comparative study of the investor base of government securities in advanced countries provides several insights.
- First, the run-up to the crisis was marked by increasing portions of securities held by non-resident investors. This trend was fuelled by reserve accumulation, financial integration, and a supportive regulatory environment. It has now ended and is unlikely to return to the same degree.
- Second, domestic investors emerged as primary buyers of domestic issuance during the crisis, while non-resident investors tended to withdraw. This pattern is reminiscent of previous crises, after which home bias increased.
- Third, large government securities holdings by financial institutions in Japan create a close link between risks in the bank and government bond market. This development could be indicative for other countries after the crisis where investors continue to deleverage and government debt expands.
- Fourth, econometric analysis of the data confirms that an increasing share of non-resident investors and institutional investors is associated with lower yields. The data also provide evidence that volatility increases in the presence of non-resident investors.
Andritzky, J (2012), “Government Bonds and Their Investors: What Are the Facts and Do They Matter?”, IMF Working Paper No. WP/12/158, Washington D.C.
Beltran, D, M Kretchmer, J Marquez, and C Thomas (2012), ”Foreign Holdings of US Treasuries and US Treasury Yields“, Federal Reserve Board.
Fidora, M, M Fratzscher, and Christian Thimann (2006), “Home Bias in Global Bond and Equity Markets”, ECB Working Paper 685.
Greenwood, R, and D Vayanos (2009), “Price Pressure in the Government Bond Market,” Unpublished.
Krishnamurthy, A., and A. Vissing-Jorgensen, 2011, “The Effects of Quantitative Easing on Interest Rates,” Northwestern University, Unpublished.
Presbitero, Andrea F, Gregory F Udell, Alberto Zazzaro (2012), “Home bias and the credit crunch: Evidence from Italy”, VoxEU.org, 12 February.
Wyplosz, Charles (2012), “The ECB’s trillion euro bet”, VoxEU.org, 13 February.